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How to Bureaucratize the Corporate World

Mises Daily: Wednesday, January 23, 2008 by

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While already deeply entrenched in government decision-making,[1] consultation and submission to the interests of various "stakeholders" is also becoming more and more common in the business world under the influence of the doctrine of corporate social responsibility (CSR). Weary of the relentless pursuit of profit and the daunting task of satisfying both shareholders and customers, corporate managers are falling all over themselves to emulate the methods of their bureaucratic cousins.

The doctrine of corporate social responsibility is an amorphous one. The name clearly implies some responsibility that the corporation owes to society at large. But what is this responsibility? According to the World Business Council for Sustainable Development, corporate social responsibility is "the commitment of business to contribute to sustainable economic development, working with employees, their families, the local community and society at large to improve their quality of life."[2] Other influential agencies such as the International Finance Corporation define corporate social responsibility in almost identical terms.[3]

This commitment to improving the quality of life of society at large is not merely confined to providing useful goods and services at a price that is agreeable to all those who choose to buy them, nor to providing employment on terms that are agreeable to all those who accept. After all, businesses already do this, and it benefits society greatly. Rather, the common element in most current expositions of the doctrine of corporate social responsibility is that it requires corporate managers to sacrifice profits to the interests of a wide array of "stakeholders" who are affected by the conduct of the corporation. According to the World Business Council for Sustainable Development, "CSR means more than promulgating a company's own values and principles. It also depends on understanding the values and principles of those who have a stake in its operations."[4]

The Sacrifice of Shareholders to Stakeholders

This stakeholder theory of corporate social responsibility is in direct opposition to the primacy of the interests of shareholders as owners of the corporation. Instead of working for the profit of shareholders, corporate managers are instead directed by this doctrine to act in the interests of a diverse group of "stakeholders," with the shareholder considered to be merely one of these stakeholders. The groups to whom shareholder profits are to be sacrificed include employees, customers, business partners, suppliers, competitors, government regulators, the general community and even "pressure groups" and "influencers."[5]

Some may object to the assertion that the primacy of shareholders is compromised by the stakeholder theory of corporate social responsibility or that profits are sacrificed. They may protest that the interests of stakeholders are considered in addition to the interests of shareholders — that corporate social responsibility mandates the pursuit of social objectives in addition to profit. But this is mere wordplay, designed to obscure a single fundamental question: in situations where the interests of stakeholders conflicts with the pursuit of profit for shareholders, should profit be sacrificed? See if you can find this question stated clearly and candidly in any of the glossy brochures on the wonders of corporate social responsibility — you will not. Instead you will find equivocation, ambiguity, and groundless claims that any proposed sacrifices are really in the long-term interests of shareholders, even if the benighted are too stupid to see it.

The capacity of advocates of the stakeholder theory to engage in semantic contortions in order to avoid having to confront this question is quite a spectacle. To wit, we have the following from the World Business Council for Sustainable Development:

Sustainable business cannot be achieved by following the traditional thinking that the only thing business has to do is to make a profit…. [I]t now means not only making a profit but also managing issues that concern many stakeholders. Managing these concerns will enable the company to continue to make a profit.[6]

This passage illustrates a common straw-man argument for the stakeholder paradigm. It tries to smuggle in the absurd idea — which is never openly stated — that the primacy of the profit motive is incompatible with any consideration of the interests of employees, business partners, suppliers, competitors, regulators, or the community at large. Sustainable business "now means not only making a profit but also managing issues that concern many stakeholders." This is in stark contradiction to the actual practice of private businesses, which have always involved consideration of these issues within the framework of the profit motive and shareholder primacy. Notice also that the Council would allow companies to "continue to make a profit," but how much of this profit would be sacrificed to stakeholder interests is not stated.

Package Dealing Shareholders and Special Interests — the "Stakeholder"

As with government decisions, the use of the stakeholder theory in corporate decision making serves to obscure the nature of the claims of the parties — i.e., the issue of property rights. By referring to all parties who are affected by the actions of the corporation as "stakeholders," shareholders are lumped together with groups seeking special favors by using a conceptual package deal.[7] This term obscures the issue of who owns what, and elevates the "interests" of outside groups to a moral claim on the property of shareholders.

But merely being affected by the outcome of another person's decisions does not entitle a person to have a say in those decisions. We are all affected by countless decisions made by others every day. We all have an interest in what they do. We are all "stakeholders" in the decisions of others in the sense described by the stakeholder theory. This is precisely why we have property rights — to delimit the prerogatives of people to use scarce resources — to determine who may do what with what.

If a corporation decides to open a store in my neighborhood then this affects my life. I may find it convenient to have a source of useful goods and services nearby. I may find it annoying to have more people visit my neighborhood to purchase these goods and services. I may even find the products or services offered by this store to be repugnant. My views are certainly relevant to corporate managers insofar as they affect the profitability of such a store — they will be rightly interested in whether or not I would choose to shop there. However, my "interest" in their decision does not give me any legitimate moral claim to a say in whether or not they should purchase property and open such a store. And it certainly should not allow me to impose my will over the preferences of the shareholders of this company.

Bureaucratizing the Corporate World — Voluntary Compliance with CSR

One of the effects of the abrogation of the profit motive in favor of attempts to satisfy a diverse range of stakeholders is that it deprives corporate managers of any objective measure of success or failure. Under this management methodology, the profit-and-loss statement is replaced, or at least tempered, by a diverse array of arbitrary performance indicators. More importantly, the people to whom the manager is beholden expand and transform according to the vagaries of the stakeholding methodology and the corporate manager is himself granted power over determining who he will choose to work for and whose desires he will choose to satisfy.

As the qualitative social goals selected by corporate managers come to replace the clear and quantifiable pursuit of profit, and the various stakeholders jostle for a more influential position with corporate managers, the corporation loses any objective method of economic calculation of its success or failure — it is transformed into a bureaucracy. Indeed, this is the very essence of a bureaucracy. For, as Mises has observed, "[b]ureaucratic management is management of affairs which cannot be checked by economic calculation."[8] He further observes that

Bureaucratic conduct of affairs is conduct bound to comply with detailed rules and regulations fixed by the authority of a superior body. It is the only alternative to profit management. Profit management is inapplicable in the pursuit of affairs which have no cash value on the market and in the non-profit conduct of affairs which could also be operated on a profit basis. … Whenever the operation of a system is not directed by the profit motive, it must be directed by bureaucratic rules.[9]

In a profit-seeking business, the corporate manager is clearly bound by an objective means of determining his success or failure. In order to succeed in his pursuit of profit, he is at the mercy of his consumers, who together have absolute power to determine the level of his success. Moreover, he is at the service of his shareholders who will hold him to account for his success or failure. As Mises observes,

The real bosses, in the capitalist system of market economy, are the consumers. They, by their buying and by their abstention from buying, decide who should own the capital and run the plants. They determine what should be produced and in what quantity and quality.[10]

However, in the absence of any objective method of economic calculation, the corporate manager is no longer required to make optimal use of the corporation's scarce resources in the satisfaction of its customers. His customers are no longer his real bosses. Rather, under the stakeholder theory of corporate social responsibility, the corporate manager is given wide scope to determine the identity and importance of the stakeholders who he will work for. He will determine who are his bosses and his bosses will be at his mercy, lest he decide that their satisfaction is no longer a worthy public-service objective.

Clearly, this is a complete inversion of the structure of ownership and management that exists in a profit-seeking enterprise. Under the stakeholder theory of corporate social responsibility, the dependence of the corporate manager on the satisfaction of his customers and the efficient allocation of the company's resources is severed. Instead, his performance is evaluated on the basis of his ability to comply with the prevailing rules of corporate social responsibility and curry favor with a host of influential stakeholder groups through quid pro quo arrangements — he is transformed from a businessman into a bureaucrat.

This problem of bureaucratic management is a characteristic of any enterprise that eschews the profit motive in favor of other qualitative goals. However, the problem is particularly pronounced when corporate managers are given wide discretion to determine the goals that they will work for and whom they are to be responsible to. In fact, this gives wide scope for outright corruption. Coelho, McClure, and Spry set out this danger in lucid terms:

If shareholder interests lose their primacy, then Pandora's Box opens. How are corporate duties to shareholders evaluated against duties to other stakeholders? How are conflicts between and among stakeholders resolved? These questions are both unanswerable and give management unbridled discretion that will too frequently result in either absolute chaos or criminality.[11]

In assessing the dangers of bureaucratic inefficiency and corporate corruption that are inherent in the stakeholder theory of corporate social responsibility we need not rely purely on theoretical argument. For we are already intimately familiar with a kind of organization that operates in this manner — one which eschews the callous profit motive in the pursuit of "higher" social objectives for the public good. And observe the results: the rampant bureaucracy and waste, the cozy iron triangles, the galling fraud and corruption, and the saccharine political spin used to cover up the whole mess.

Nationalizing the Corporate World — Compulsory Compliance with CSR

Despite the popularity of the stakeholder theory among corporate managers, the prerogatives of shareholder ownership present a fundamental barrier to the full implementation of this methodology. In particular, the prerogative to hire and fire corporate managers, supplanting those who are not performing to the satisfaction of shareholders, ensures that the stakeholder paradigm can only go so far. While corporate managers may attempt to achieve social objectives in derogation of the profits of the company, they are ultimately answerable to the shareholders and must perform to the satisfaction of these shareholders or be removed from office.

So long as this and other prerogatives of ownership exist, the primacy of shareholder interests must remain and any derogation from profits made at the discretion of the corporate managers must be satisfactory to shareholders. Thus, the logical objective of the stakeholder paradigm is to abolish or at least diminish the prerogatives of ownership — especially the ability of shareholders to hire and fire the managers of the company. In order to ensure that stakeholders are properly taken care of, they must have some legal power in the selection of corporate managers and the operations of the company.

But who is to choose which stakeholders are to have a stake in the company and how much of a stake? Who is to choose which stakeholders will have a say in choosing an appropriate corporate manager and how much of a say? Surely it cannot be the managers themselves, since they would then be able to entrench themselves in power and plunder the corporation for their own benefit. And of course, it cannot be the shareholders, for it is allegedly the selfish instincts of these greedy devils, pursuing their own profits at the expense of the public interest, that necessitates the stakeholder paradigm in the first place. Instead, it must be some organization that is committed to the public good, some organization that is trusted with the power to determine what is best for all of us — it must be … the state!

Many corporations already include stakeholder representatives on their board of directors.[12] Some scholars have argued that this practice puts "a formal mechanism in place that acknowledges the importance of their relationship to the firm."[13] So far these arrangements have been imposed with the consent, or at least the acquiescence, of shareholders — there is no legal requirement for such a practice. However, there has already been substantial consideration given to calls for the imposition of legislative requirements to abide by the stakeholder paradigm in corporate management.[14]

There are a number of rationalizations for this course of action. The most common is the view that the government, private corporations, and stakeholder groups must "cooperate" for the smooth running of the economic system. This is not a new claim:

The idea that government, corporations, and organized labor can, and should, cooperate for the betterment of society has a long pedigree. It can be seen in the early Christian church's distrust for individualism, and in its more recent (and discredited) manifestation in the political doctrines of fascism.[15]

In fact, calls for legal recognition of stakeholder interests in private companies are not merely a manifestation of fascism — they are an ambitious attempt to entirely socialize the means of production by arrogating the prerogatives of ownership to the government. Private ownership is the prerogative to control, and as the prerogatives of control of one's property are removed by the government, ownership — in any real sense — is diminished and ultimately eradicated. Thus, the abrogation of the prerogatives of shareholder ownership in favor of stakeholder interests as determined by the government, is a means of nationalizing property by stealth. While the shareholder remains the owner of the company de jure, the government slowly takes on more and more of the prerogatives of ownership on behalf of stakeholder groups. The government becomes the de facto owner of the company and puts it into the service of "the public" through the various stakeholders favored by government regulation.

How Do Companies Operate under the Stakeholder Paradigm?

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"The logical objective of the stakeholder paradigm is to abolish or at least diminish the prerogatives of ownership."

When the prerogatives of ownership in a company are determined by government proclamation rather than by the application of property rights, the company will operate in the same way as a government bureaucracy — by cozy symbiotic relationships between corporate managers who dole out special privileges, and stakeholder groups who lend their support to the continued position of these corporate managers in return for these privileges. Since the ability of stakeholders to control the company will be based on special privileges under the prevailing policy of government, rather than on any genuine claim to ownership, they have little stake in the capital value of the company and will attempt to plunder the company at the expense of shareholders.

Left-wing social activist and Body Shop founder Anita Roddick has lamented the cooption of the stakeholder paradigm by corporate managers and powerful interest groups: "I don't think Corporate Social Responsibility is working. I think it's been taken over by the big management houses, marketing houses, been taken over by the big groups. It's a huge money building operation now."[16] This result is not surprising when we recognize that the stakeholder paradigm is simply a rehashed call for the political economy of fascism — a call for private enterprises to emulate the goals and methods of the bureaucracy.

Rather than allowing the goals of private enterprise to be mandated by government, the goal of any private enterprise must be determined by the owners of that enterprise. For businesses that are established in order to provide profit to shareholders, the social responsibility of corporate managers is adequately captured by Milton Friedman's well-known dictum:

There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.[17]

In order to avoid the bureaucratization and nationalization of private enterprise and all of the calamitous consequences that must follow, shareholders and advocates for liberty must fight to preserve the prerogatives of share ownership. They must fight to uphold the legitimacy of the profit motive and reject the view that merely having an "interest" in the operations of a company implies a right to control.


Ben O'Neill is a researcher at the Australian National University and an advisor in the ACT Legislative Assembly. This article represents his personal views and not the views of his employers. Send him mail. Comment on the blog.

Notes

[1] See O'Neill, B. "The Language of Government Decisions." Ludwig von Mises Institute, 10 October 2007.

[2] Holme, R. and P. Watts."Corporate social responsibility: making good business sense." World Business Council for Sustainable Development, 2000: 10.

[3] See IFC.org: "Corporate Social Responsibility: Introduction."

[4] Holme and Watts, op. cit., p. 15.

[5] Ibid, p. 16.

[6] Cited from stakeholder dialogues conducted by the World Business Council for Sustainable Development. See Holme and Watts, p. 12.

[7] O'Neill, op. cit.

[8] Mises, L. Bureaucracy (Liberty Fund: Indianapolis, 2007), 39.

[9] Mises, L. Human Action, The Scholar's Edition (Ludwig von Mises Institute: Alabama, 1998), 307.

[10] Mises, L. Bureaucracy (Liberty Fund: Indianapolis, 2007), 17.

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[11] Coelho, P.R.P., J.E. McClure, and J.A. Spry. "The social responsibility of corporate management: a classical critique." Mid-American Journal of Business 18, no.1 (2003): 19. This paper sets out some examples of situations where the stakeholder paradigm could lead to corruption. It also sets out an explanation for the popularity of the theory among corporate managers.

[12] See Luoma, P. and J. Goodstein."Stakeholders and corporate boards: institutional influences on board composition and structure." Academy of Management Journal 42, no. 5 (1999): 553-563. The authors studied 224 companies listed on the New York stock exchange between 1984 and 1994 and found that 14 percent of these firms appointed stakeholder directors.

[13] Mitchell, R.K., B.R. Agle, and D.J. Wood."Toward a theory of stakeholder identification and salience: defining the principle of who and what really counts." Academy of Management Review 22, no.4 (1997): 853-886.

[14] In Australia the Parliamentary Joint Committee on Corporations and Financial Services recently considered legislation of this kind in its June 2006 report, "Corporate Responsibility: Managing Risk and Creating Value." While the Committee rejected the view that a legal requirement for stakeholder consideration was justified, they were clearly in favor of the stakeholder paradigm itself. Moreover, the Committee's willingness to make recommendations to investors, stakeholders and relevant business associations, rather than to the Parliament, was ominous.

[15] Coelho, McClure and Spry, op. cit., (2003) 19.

[16] See Sourcewire.com: "Dame Anita Roddick questions effectiveness of Corporate Social Responsibility in online video."

[17] Friedman, Milton. Capitalism and Freedom (University of Chicago Press: Chicago, 1962): 133.