Stakeholder Capitalism: Why and How
July 29, 2021 was announced as Earth Overshoot Day — the day by which more natural resources have been used than can be replenished by the Earth in one year. Any resources used from that date on are borrowing from our future resource reserves. Notably, this was one of the earliest Overshoot Days since it began being tracked in 1970, and a mere 30 years ago, the overshoot day was October 10. Similarly, income inequality is at an all-time high; it came out in October 2021 that the top 1% in America has more wealth than the entire middle class (defined as the middle 60% of households by income). Wilderness and species are being lost at an alarming rate. Pledges galore are being made at COP26, but global emissions continue to rise. Much of the world’s population still doesn’t have the COVID-19 vaccine. These doomy headlines on the state of the world raises a key question: who is really being served under the economic models we have in place?
The capitalism models in place need major reform. We are stuck in a Milton Friedman-esque focus on shareholder primacy; a focus that leads to short-term profit being valued over long-term outcomes that are inherently better for society. While much thought and discussion have been put into the modern issues we face such as inequity, climate change, biodiversity loss, etc., it seems that we are not viewing them from the perspective needed to bring systemic change. There is a prevalent silo-thinking perspective in which these wicked problems are approached in isolation. We need a more holistic approach that fosters cooperation and creation of shared-value between the players with the power to enact change — governments, businesses, investors, suppliers, employees, and consumers. An approach that encapsulates this interconnected view of business and society is stakeholder capitalism.
“The idea here is to optimize outcomes for multiple stakeholders versus trying to maximize for just one. It’s the obsession with value creation for any single group that knocks things out of balance.” -Paul Polman and Andrew Winston, Net Positive.
The McKinsey Quarterly defines stakeholder capitalism as a business approach that “requires business leaders to define their mission as creating long-term value not only for shareholders but also for customers, suppliers, employees, communities, and others.” An essential ingredient of stakeholder capitalism is a focus on business purpose. For a company to succeed under stakeholder capitalism, it must be able to articulate the societal benefit which it provides . In other words, it challenges businesses to become problem-oriented, rather than profit-oriented. By shifting focus from profits to purpose, businesses become better equipped to take on societal issues. Edward Freeman, widely considered to be the father of “stakeholder theory,” offers the following six principles that distinguish stakeholder capitalism from the several other shades that are talked about:
1. Stakeholder Cooperation- Stakeholders can make mutually beneficial agreements between each other.
2. Stakeholder Engagement- Stakeholders must be kept engaged for a business to create long-term value.
3. Stakeholder Responsibility- Stakeholders must accept responsibility for the consequences of their actions.
4. Complexity- Humans are complex and therefore can act from differing values and points of view in the process of value creation.
5. Continuous Creation- Value-driven action by stakeholders leads to the creation of new value sources- a vital process to the success of stakeholder capitalism.
6. Emergent Competition- Competition exists in this form of capitalism so that stakeholders can have options.
Notably, these principles and the stakeholder capitalism view are not a panacea. Not everyone will buy into this philosophy of business; there will always be a segment who are focused on their own self-interest at the expense of others. But as Freeman and colleagues sagaciously assert, “Our claim is that we should set the bar for capitalism at the best we can achieve not limit it by trying to only avoid the worst.”
While the case for stakeholder capitalism is strong, the next challenge becomes implementation. There are of course several elements that must fall into place, but I wish to focus on three interconnected areas that I believe must be triggered for stakeholder capitalism to make the shift from a wise idea to an actionable practice. These areas are corporate reform, financial market reform, and legislative reform.
Convincing the board of a corporation to revise its business model is no easy task but is another vital step in completing the shift towards stakeholder capitalism. Appealing to financial gains is one strategy to convince the board of stakeholder capitalism’s validity. The Harvard Business Review notes “that companies that operate with a true long-term mindset have consistently outperformed their industry peers since 2001 across almost every financial measure that matters.” This statistic makes sense considering that prioritizing the long-term ensures the viability of the company’s future operations. If financial appeals fall flat in convincing board members, other action may need to be taken. McKinsey offers two solutions: appointing boards that represent a wide range of stakeholders and rewriting corporate guidelines to explicitly state stakeholders as the primary focus of the corporation. While both options will run into their own challenges, they constitute the strong action needed to rework organizational purpose and focus. When calling for corporate reform on sustainability issues, purpose is the key operative. Purpose is the “raison d’etre”, the reason why a company exists. It must be defined by the CEO and their leadership team and then cascaded through the entire organization. Focusing on purpose leads to long-term value creation, with profits coming as a natural side effect of this value creation. For an example of how purpose-driven organizations have an advantage, look at the current labor problems. Employees are resigning en masse and labor strikes have been especially prevalent since the beginning of the COVID-19 pandemic; a phenomenon also known as “The Great Resignation”. Employee problems range from low wages and longer hours, to a lack of meaning and purpose. Companies that implement stakeholder capitalism are better positioned to tackle these issues as they put a greater emphasis on employee concerns and promote a more purpose-driven workplace. In situations where employees are heard and given purpose, many of the problems they face in today’s workplace are alleviated.
Financial market reform is the third trigger for shifting toward stakeholder capitalism. The 2021 United Nations Trade and Development Report identifies two roles that investors play in enabling sustainable change. The first role is asset allocation; where investors choose to invest their capital shapes financial markets. When investors favor sustainable companies, these companies are strengthened as compared to their unsustainable counterparts. The second role investors play comes in active ownership. Active ownership occurs when investors have a voice in companies they invest in, as this voice can be used to promote sustainable policies within a company. Institutional investors have trillions invested across global financial markets, giving them great power over corporate trends. In this aspect, there is some cause for optimism. It was recently announced at COP26 in Glasgow that $130 trillion in financial capital has been devoted to achieving net-zero emissions. Investors are also valuing ESG metrics much more in making investment decisions, with younger investors specifically committed to investing sustainably. The case for stakeholder capitalism as an investment works on two fronts- increased long-term profits as previously mentioned along with the peace of mind from making the morally responsible decision. As evidenced by a rise in ESG-driven investing, investors are starting to drive real financial-market shifts toward sustainable companies. With increasing numbers of investors allocating funds to sustainable investing, companies that operate sustainably will begin to see a market advantage from their actions. With the climate crisis becoming increasingly urgent, it is likely that sustainable investing will move from a trend to a long-term movement.
While businesses have great power to influence sustainability, in theory, government power still trumps business power. Laws need to be put in place that more effectively hold businesses accountable for the costs of their business actions from the view of the consumers, employees, and the environment. This is where environmental protections, stronger labor laws, and consumer protections must be continually strengthened. Massachusetts Senator Elizabeth Warren has proposed a bill that is stakeholder-capitalism focused, the Accountable Capitalism Act. The act has five key provisions that relate to the concept:
1. All U.S. companies worth over $1 billion must register as a “United States corporation,” a title that would require the company to act with all stakeholders in mind.
2. At least 40% of a United States corporation’s board must be employee selected.
3. Sales of U.S. corporation shares by executives and other high-ranking corporate members would be limited.
4. U.S. corporation political expenditures must receive 75% approval from its shareholders and its directors.
5. Business charters of U.S. corporations may be revoked if they do not comply with these restrictions.
While the bill has faced opposition, it is important to note that these issues are being brought to the forefront on a national level. It will not be possible to achieve a sustainable future without government intervention that promotes sustainable business action. Governments have power to hold offenders accountable in a way that no other groups can. This power must be used to prop up sustainable activity and channel business action toward a stakeholder-oriented approach.
Undertaking a great corporate shift from a shareholder approach to a stakeholder approach will not be a comfortable process; there will most certainly be growing pains. We cannot let these speedbumps keep us from making the hard choice to realign our system of capitalism. Stakeholder capitalism offers a chance to rework company purpose to combat our modern issues comprehensively and cooperatively and offers society a future where business lives in harmony with all those it affects.
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Volume 1, Number 10. © CB Bhattacharya. All rights reserved. Research assistance for this blog provided by Nathan Dobb.