Mises Daily Articles
Why Shareholders Are Better Than Corporate "Stakeholders"
In a world of private property rights, where the contracts that derive from those rights must be honored, there would be no controversy about the rights of corporate “stakeholders.” Owners of capital resources pool them and delegate day-to-day control to corporate management as their agents. The only stakeholders those delegated agents agree to represent are the owners of those resources (i.e., the shareholders).
However, stakeholder theory has made major inroads into firms’ fiduciary obligations to owners in recent decades. In consequence, shareholders have been increasingly demoted from owners with decision rights over their own assets to just one of many groups, all of whose desires must be incorporated into management decisions. That makes it worth revisiting the stakeholder approach to corporate management, as its growing influence increasingly insulates it from serious consideration.
Transaction Costs and Social Cooperation
One of the great benefits of clearly defined property rights is that they specify who parties must reach agreement with — everyone whose legitimate property rights would otherwise be violated. The consent of other parties, who have no authority to say “no” to others’ arrangements, because that extends beyond the reach of their property rights, need not be acquired. The result is far lower transactions costs. That enables far more mutually beneficial specialization and exchange, and the massive increases in production and wealth that results.
One consequence of the clear definition of corporations as acting in the interests of those whose resources formed them — stockholders — is that it vastly increases their ability to raise large sums to benefit from economies of scale and scope. It also increases the liquidity of investments, decreasing the risks to owners involved, by making exchanging ownership claims far less costly. In contrast, if stakeholder theory was generally applied to corporations, it is hard to imagine efficiently conducting almost any large-scale or complex production process, involving vast numbers of contractual arrangements, as massive transactions costs would overwhelm the potential gains.
Shareholders’ Interests Take Other Legitimate Stakeholders into Account
Former GE head Jack Welch once criticized the shareholder interest model of the firm as “the dumbest idea in the world.” He asserted that employees, customers, and product quality deserved priority over shareholders. But it is not a choice between employees, customers, and product quality versus advancing shareholders’ interests.
But attention to employees, customers, and quality in an unhampered market (as opposed to crony capitalism, from which GE benefited immensely), is the means to advancing shareholder interests. Share prices reflect gains from better utilizing and motivating employees’ skills and abilities, from better developing and serving customers, and from product improvements that users value more than they cost. All those stakeholders’ interests, derived from their property rights and the requirement of voluntary, mutually beneficial cooperation, are aligned with those of profit-seeking shareholders.
In other words, other valid stakeholders’ interests are reflected by shareholders’ interests, not trampled by them. Workers have to voluntarily agree to their terms of employment. So firms will consider everything that workers or potential workers care enough about to offer the potential for a beneficial alteration in the terms of employment. But no party is ever allowed to escape the constraint of the need for others’ voluntary cooperation.
Suppliers and venders are considered in a similar way. Any alteration that costs a firm less than it saves suppliers could receive mutual agreement. Consumer interests are also clearly taken into account, as they are the ultimate “enablers” of what is profitable and survivable, versus what is unprofitable and unsurvivable. Explicit, enforceable contracts spell out the terms some agree to. Powerful reputation and reliability mechanisms also put up what amounts to a bond to ensure reliability — the present values of future profits from ongoing “good” behavior, put at risk by poor present performance.
As a further example, consider how professional sports teams consider fans. Those teams are certainly interested in making higher profits. So they care about those who go or might go to games, and all the things that might swing their decisions. They care about those who buy or might buy team hats, jerseys, etc., in a similar way, as well as those who might or might not listen on radio or watch on television (through ad revenues, subscription services, or broadcast right sales, etc.). They even care about those who do none of those things, but talk about the team around their water coolers at work, which can influence others’ revenue-generating behavior. Such fans need no direct power over team decisions in order to have their desires reflected in those decisions.
Divergences Between Stakeholders’ Interests and Shareholder Interests
As we have seen, many stakeholders’ interests are consistent with advancing shareholders’ interests, including workers, suppliers, customers, and even fans, are all incorporated in shareholders’ interests because they must be induced to cooperate on mutually agreed terms. If this was all stakeholder claims represented, stockholders would not object to stakeholder claims. But they often object strongly. What does that tell us? Those claims require imposing someone else’s decisions in place of owners’ decisions in an involuntary manner, which requires coercion against them. The coercion involved is also revealed by falling market capitalizations when campaigns for new “social responsibility” requirements target them. Further, even though “benefit corporations” can now be formed to advance specified stakeholder interests as well as stockholder interests, they have remained relatively uncommon, due to the difficulty of finding investors who agree both on their desires to advance the same stakeholder interests and the trade-offs they are willing to make between those ends and profits. That would not be the case if the stakeholder approach was generally superior in the eyes of those whose rights are involved.
The coercion necessary to impose stakeholder obligations in violation of stockholders’ property rights, in turn, explains why stakeholders turn to government actions or threats to advance their claims. It is also why stakeholder claims play greater roles in more heavily regulated industries. Stakeholders’ ability to exercise political clout over government decisions can then more effectively be used to extort firms (e.g., banking, where permission to open new branches or make other transactions can be subject to “community” support or opposition).
Ex Ante versus Ex Post
Stakeholder claims beyond those enabled by pre-existing property rights can often be best understood as ex post (after the fact) theft or piracy. They wait until something valuable has been created by others’ voluntary relationships, then try to deal themselves into leverage or power over subsequent choices, even when they had no appreciable role in causing its creation or growth. That makes their role as “benefactors,” because it is funded with other people’s resources, all benefit and no cost for them — self-defined social nobility for free. It is reminiscent of where people live in neighborhoods that “grew” in place of earlier citrus groves, but who then blockade others’ rights to do exactly the same thing with their land, in the name of protecting the community.
Stakeholder Claims Are Asymmetrical
It is important to note that stakeholder attempts to leverage new power are also asymmetrical. Those non-shareholders who claim they should be given a say in firm decisions do not propose granting outside stakeholders rights to similar influence over their actions.
If “community groups” are to be enabled to dictate firms’ choices because they are stakeholders, shouldn’t firms have similar powers over community decisions, because they are substantial stakeholders in the community? If a firm’s current workers should have decision-making power over it because of their stake in its policies, shouldn’t a firm have similar decision making power over those workers? After all, just as workers have a stake in not having their pay cut, the firm that employs them (and its customers) has a stake in workers’ pay not being jacked up.
The history of political power also shows that it is most commonly utilized to support the already politically powerful. A good illustration is plant-closing legislation, which represented the politically powerful interests of local workers who are outcompeted by others who are not politically influential, but would offer consumers better terms. Similarly, anti-takeover laws were widely enacted to protect rather than prevent inefficient management teams, by insulating them from the threat of losing their jobs due to takeovers whose profitability lay in increasing efficiency and benefits to customers.
The Stakeholder Approach Reduces the Accountability of Management
Another important problem of stakeholder theory is that it wipes out clear criteria — profitability — to evaluate managers, instead substituting ambiguous and often mutually inconsistent criteria, with no way of determining agreed-upon trade-offs. While this will serve stockholders poorly, it will often serve the interests of managers who would thereby see their constraints eased. That is a major reason why many managers support the stakeholder approach. It not only allows them to survive inefficiency and poor management, diametrically opposed to what stockholders hired them to do, but also gives them the ability to be seen as business statesmen and philanthropists in the process.
Shareholder control of corporations follows from private property rights and the requirement that delegated agents perform their contractual commitments. In other words, it derives from self-ownership and liberty in economic arrangements. Firms, as agents for shareholders, have to live up to their voluntarily agreed contractual obligations to customers, suppliers, employees, and owners. As a result, they all benefit from those arrangements. Beyond that, a firm’s sole obligation to others is, in Walter Block’s words, “the one we all have to each other: to refrain from threatening or engaging in initiatory violence against them and their rightfully owned property.”
That is why Block described stakeholder claims as “the entering wedge of yet another attack on private property rights.” Given the immense wealth enabled by that arrangement, the costs of undermining it on behalf of self-determined stakeholders are similarly immense. And the process of determining who will qualify as a stakeholder and how large each stake shall be will entail the arbitrary and coercive substitution of politics over voluntary exchange.