“Capitalism” – the dominant economic system and reigning economic ideology in this country – comes in two very different flavors, commonly known as “shareholder capitalism” and “stakeholder capitalism.” These terms refer to two radically opposed ideas about what kind of economic values and practices a business firm should pursue, and they have played a significant role in shaping the behavior of our large, publicly traded firms, as well as the outcomes for our society.
Stakeholder capitalism is actually the older of the two models. Although it’s now mostly forgotten, during the first two decades after World War II, when there was still a carry-over of wartime patriotism and a strong sense of community in this country, large American corporations commonly practiced a “good neighbor” policy, and their CEO’s were viewed as “corporate statesmen.” There were no formal institutional differences back then, but managers and boards of directors were highly attuned to maintaining good public relations and keeping their workers happy. As the chairman of Standard Oil of New Jersey in 1951, Frank Abrams, put it: “The job of management is to maintain an equitable and working balance among the claims of the various directly interested groups… stockholders, employees, customers, and the public at large.”
It helped that there was also a supportive cultural environment. The public expected socially responsible behavior and punished firms that were tone deaf. But more important, it was also an era of widespread prosperity, when American corporations dominated the global economy and did not have to deal with foreign competition, for the most part. Strong labor unions also played an important role in that era, while a wave of post-war socialist governments in various countries offered a challenging (even threatening) alternative model that put capitalism on the defensive.
Although the post-war capitalist model didn’t have a formal label, it amounted to what we now call stakeholder capitalism. The basic idea is that everyone who has an interest, or stake in a business firm – managers, workers, sub-contractors, suppliers, customers, communities, the government, and, of course, the shareholders – should have a say in its governance and behavior, and receive a fair share of the benefits.
The rise of the alternative “shareholder capitalism” model dates from a landmark article in 1970 by the Nobel prize winning University of Chicago economist Milton Friedman. “There is one and only social responsibility of businesses,” he declared, “to increase profits.” Anything else is “unadulterated socialism.” In other words, shareholder capitalism requires a single-minded focus on profits and the interests of shareholders over any other stakeholders.
Over the next two decades, as a tidal wave of foreign competition, deregulation, and the rise of predatory corporate raiders radically changed the ecosystem for American corporations, shareholder capitalism provided a rationale for outsourcing, undercutting labor unions, squeezing worker wages, reducing benefits, shutting factories, abandoning communities, avoiding taxes, and a variety of other practices designed to protect and enhance profits.
The results were transformative. American workers have seen a dramatic decline in their standard of living and quality of life since the 1980’s. Meanwhile, 95% of the increase in personal incomes in recent years has gone to the top 1% of earners. The top 10% now take home almost half the total, and they own some 89% of all stocks as well. CEO incomes have also exploded. In the 1940s, CEO’s averaged some 20 times more income than their workers. These days it’s about 350 times more.
The excesses of shareholder capitalism and a widespread “greed is good” business philosophy contributed to the financial meltdown and the so-called “Great Recession” in 2008-2009, but corporate America has long since recovered from that disaster and profits are now at all-time highs. The stock market has recently been setting new records, and the new tax “reform” law only adds a thick layer of frosting to the cake.
Shareholder capitalism justifies its economic favoritism by claiming that, in the end, everyone will benefit from economic growth. A rising tide will lift all boats, to use the old cliché. The problem is that most of the boats have holes in their hulls and are bailing furiously just to stay afloat, while the boats in the bottom quintile economically are actually sinking. It’s a nautical disaster.
This shameful situation, as well as our growing, multi-faceted environmental crisis (which is treated with indifference as an “externality” by many of our large industrial enterprises) have reignited the idea of shifting to a more socially responsible “stakeholder capitalism.” Indeed, stakeholder capitalism has recently become a hot topic in academic journals, and in the media – from the Harvard Business Review to Fortune, the Economist, American Prospect, the Wall Street Journal, and the University of Pennsylvania Law Review, among others.
The case for stakeholder capitalism is very strong. For one thing, the claim that the shareholders deserve to take precedence because they are the “owners” of any publicly traded company is flatly contradicted by 200 years of legal theory, laws, and court rulings that define a corporation as an “autonomous individual” that owns itself. Nor are shareholders favored in any (known) corporate charters. In fact, corporate managers and boards of directors have an explicit fiduciary responsibility to pursue the well-being of a company as a separate entity. The shareholders have a legal claim only to the “residual value” of the company after all of its other obligations are paid. Shareholders are not even the primary source of capital for corporate America these days. Most of it comes from debt financing.
It has also been pointed out that the workers are much more at risk (including their livelihoods, their training, and their roots in a given community) than are the shareholders in an age when the duration of the average stock holding is about six months and much of the money that is invested in stocks comes from surplus wealth and passive income (dividends and appreciation).
A bias toward shareholders over other stakeholders is also at odds with every modern theory about how to manage people, going back to the work of management guru Peter Drucker in the 1970s. Efficiency and productivity in any large organization is heavily dependent on “social capital” – trust, fair dealing, and reciprocity.
A comparison with the performance of corporations in other countries that have rejected the shareholder model also refutes the claim that it is superior. Germany for instance, has a long-standing corporate governance system called “co-determination,” where workers are by law required to occupy up to one half the seats on the board of directors (depending on the size of the company) and where there is also a strong government voice in corporate behavior. The result is that it actually increases corporate responsibility and cooperation and has made large German business firms highly efficient and profitable. Likewise, Scandinavian countries like Norway have been able to combine more generous worker salaries, a flattened pay scale, an extensive social welfare system, high social trust and responsive democratic government with very successful, and profitable capitalist economic systems.
A formal theoretical model (and analysis) developed by economist Franklin Allen and his colleagues in 2009 also lends support to the stakeholder model. They showed that an alignment of interests among various stakeholders is both attainable – depending on the circumstances – and can lead to higher overall efficiency and value for a firm. They cited a number of concrete examples, ranging from Germany and the Nordic countries to Japan, Austria, and Luxembourg.
More recently, a new study in our own country showed that American companies with narrower pay gaps between the CEO and the workers tend to perform better. By the same token, there are many thriving non-profit business firms and organized cooperatives these days, as well as a relatively new category of so-called B-Corporations (more than 550, plus 960 others that meet the certification standards) that are committed to pursuing values that are aligned with the stakeholder model.
However, as various theorists noted, the challenge is how to make stakeholder capitalism work in practice. How do you engineer a change in the management values and boardroom behavior of a large company without undermining its efficiency, flexibility, and profits? The ideal, as I and other supporters envision it, is to enhance a business firm’s performance and value by aligning and harmonizing the interests of the various stakeholders, rather than simply creating obstacles and roadblocks that might harm the company and reduce its value. This is far easier said than done, of course, but the principles of compromise and mutual accommodation, where needed, can achieve a great deal.
Beyond the vital lubricant of mutual good will, there are many incremental, practical changes that could also be made. For starters, corporate managers and boards should be re-educated. Many of them are taught the wrong things and don’t really understand their fiduciary responsibilities. As one business writer pointed out, the re-education should start in the MBA programs where future corporate leaders are trained. There must also be a change in performance expectations, both in board rooms and on Wall Street, and a shift away from the single-minded fixation with short-term quarterly profits and stock prices. Other values are far more important for the long term. Consider, for instance, the fact that some 87% of the $3.4 trillion in new corporate debt between 2009 and 2014 was used for increasing dividends and share buy-backs to pump up share prices. This is a clear case of sacrificing long-term interests for short-term gains.
New regulations could also be enacted to discourage predatory corporate takeovers and reduce the pressure to bolster short-term performance measures. The “incentives” in CEO compensation packages could also be decoupled from the widespread current practice of being tied to stock prices, or at least diluted and tied to other corporate performance measures as well.
In a recent international poll of 1470 CEOs in 12 countries that asked which category best characterized their firm’s overall “purpose”, CEOs in the U.S. were ranked at the bottom in naming an obligation to “stakeholders” (only 27% versus 67% in China). Yet our CEO’s also ranked at the bottom in naming the shareholders (16%). On the other hand, they ranked highest (at 41%) in putting value to the customers first.
Perhaps these poll results are merely an indication of what our CEO’s thought they should say – public relations. But at least their lip service has changed, and there are indications that corporate cultures and expectations are changing as well. One significant indicator was the recent announcement by Laurence Fink, the CEO of BlackRock – by far the world’s largest investment house, with some $6.3 trillion under management – that henceforth it would require its clients to be socially responsible. “Society is demanding that companies, both public and private, serve a social purpose,” he wrote. Likewise, Walmart – our nation’s largest employer and notorious for paying sweat shop wages – recently announced that it would use some of its savings from the new tax law to increase its minimum wage to $11 per hour. That’s better, but not good. We still have a long way to go, but, to borrow a punch-line from Winston Churchill, it may at least be the end of the beginning.