Capitalism – you either love it or hate it, right? Boosters argue that it is a major driver of innovation, wealth, and prosperity in the modern era. Competition and capital accumulation incentivize businesses and stimulates innovation and prosperity.
One of the most ardent pro-capitalism stances in recent decades is known as shareholder capitalism. As envisaged by Chicago University economist Milton Friedman, this considers returns to investors as the chief goal of an enterprise. However, although Friedman argues that business executives should focus on profit maximization, he does not condone all behaviors that increase financial returns. He places four restrictions on profit seeking: business people must obey the law, follow ethical customs, commit no deception or fraud, and engage in open and free competition.
While acknowledging that capitalism has allowed a billion people to escape extreme poverty over the last 20 years, many critics charge that capitalism is leading to growing wealth inequalities and constant market instability. We are also in the climate disaster, they point out, because business decisions are motivated by the maximization of profit rather than the goal of saving the future for human society and the biosphere.
Enter Stakeholder Capitalism
A countervailing phrase bubbling to the surface in recent years is stakeholder capitalism, which is where companies seek long-term value creation by considering not just the need of shareholders but also employees, customers, and society at large. Examples can include companies that reduce CEO pay to more equitable levels and pay fair wages to employees. It can also include enterprises that engage in sustainable business practices.
Stakeholder capitalism is not a new idea, despite the impression it may give. It stems from the 1930s but has long been associated with Charles Schwab, the German economist who established the World Economic Forum. At the annual meeting in Davos he hosts, there has been much talk about “doing well by doing good” over the past two decades.
Schwab argues that the roots of stakeholder capitalism came from the 1950s and 1960s, when it was natural for a company to consider not just shareholders but everyone who has a “stake” in the firm’s success. This approach was common in the West in the post-war decades, Schwab says, when it was clear that one person or entity could only do well if the whole community and economy functioned.
This fostered a powerful sense of local companies being embedded in their surroundings, and from that grew a mutual respect between companies and local institutions such as government, schools, and health organizations. Stakeholder capitalism weakened as companies globalized, loosening ties with local communities and national governments.
The focus became more on maximizing short-term profits for shareholders in competitive global markets, an approach enthusiastically encouraged by Milton Friedman and his notion of ‘shareholder primacy.’ He believed, “the social responsibility of a company is to make profits.”
Over the past half-century, shareholder capitalism has boosted corporate profits, juiced the world economy, fostered global trade, moved billions of people out of poverty and raised global living standards, achievements that the WEF readily concedes. So, if ‘shareholderism’ has been such a success, why change?
Critics say capitalism has been far more successful in wealth creation than in distributing it. Furthermore, companies have banked immense profits by failing to pay for the externalities of their activities, such as the damage they have caused to the natural world.
Faced with a global climate disaster, consumers, employees, and investors are gravitating toward firms that want to make a difference. In this environment, business cannot continue as normal, so stakeholder capitalism is making a come-back, albeit in a much more comprehensive manner.
Did you know …
- Edelman Trust Barometer, a global survey conducted across 28 countries to assess trust in societal institutions like government, media, business, and NGOs, found that 52% of the polled people agree that capitalism, as it exists today, does more harm than good in the world.
- In a survey across 615 large and mid-cap US firms, a study showed that the revenue of long-term focused companies grew 47% more than the revenue of other firms and with less volatility between 2001-2014.
- The World Economic Forum is developing a set of 'Stakeholder Capitalism Metrics' that companies can use to mainstream their reporting. The 4P approach is built around the four pillars of people, planet, prosperity, and principles of governance. Over 70 companies include these metrics in their annual reports and sustainability reports.
Failing to Walk the Talk
Stakeholder capitalism has long been practiced on continental Europe. However, its revival in the United States dates from August 2019, when the Business Roundtable, a non-profit lobbyist association whose members are chief executive officers of major United States companies, released a new Statement on the Purpose of a Corporation.
Signed by 181 CEOs of leading firms, it redefined the purpose of a corporation and established a “modern standard for corporate responsibility.” The signatories pledged to lead their companies to benefit all stakeholders – customers, employees, suppliers, communities, and shareholders.
Yet, this rebounding ideal has critics. Some say stakeholder capitalism is a publicity stunt and point out that many of the 183 firms that signed the Business Roundtable statement had failed to “walk the talk” in the preceding four years.
Others believe that balancing the competing interests of stakeholders requires executives to be “legislator, executive, and jurist,” as Friedman called such all-in-one power. The problem is that, goes the argument, corporate leaders are self-serving and will enrich themselves if allowed to determine the purpose and role of companies. In comparison, emphasizing shareholder value means executives are least restricted with a clear goal of increasing profits.
Where Shareholder and Stakeholder Align
The two approaches of shareholder and stakeholder capitalism seem inherently in opposition, but they are not as far apart as they seem. Serving the interests of customers, employees, communities, and the broader public is imperative for purpose-driven organizations but is not necessarily at odds with profit generation.
Happy stakeholders – employees, devoted customers, satisfied regulators, and suppliers – help companies deliver long-term benefits for all parties.
The thing about profits is that successful companies make them consistently and sustainably over the long term. This is where shareholder and stakeholder interests align. Happy stakeholders – employees, devoted customers, satisfied regulators, and suppliers – help companies deliver long-term benefits for all parties.
The problem is not emphasizing shareholder value but using only short-term increases in a company’s share price as a proxy for it. This idolisation of short-term profits and fixation on share price need to be under discussion. Many companies are now responding by designing strategies that positively impact their entire value chains as well as their own bottom lines, and there is increasing evidence that doing so can be good for their reputation and financial performance.
Ironically, giving shareholders more power to influence management and encouraging them to use it could prompt them and the managers they employ to take a longer view and benefit all stakeholders. In Britain, the Financial Reporting Council has proposed a “stewardship code” to invigorate institutional investors. In the United States, Congress is considering several measures.
Policymakers can help by ensuring that rules governing competition, labor environments, and product safety are fit-for-purpose – social responsibility and sustainable profits go hand in hand. If we manage to do all this, then free market economies can evolve to meet today’s challenges head-on – because believing the current form of capitalism is the best we can create, displays a sad lack of imagination.
This article reflects the personal views of the author.