The Ultimate Victory for Stakeholder Capitalism:
The 50+
year Debate: Shareholder versus Stakeholder Capitalism is Resolved
The Fundamental Mistake of Treating the
Corporation’s Long Term Value and Wealth Creation as Synonymous with the Long Term Value Created
for Shareholders (The Friedman Model).
During the last 50 years people have been
discussing the purposes of a corporation in a capitalist economic system. Why? Because
in 1970 Professor Milton Friedman declared increasing profit for shareholders
of corporations as the only purpose of business. His doctrine has been dominant
in capitalist economies ever since. However, others have argued that there are
other distinct groups affected by business and that business has a responsibility
to consider those groups as well.
One effect on
corporate existence and well-being since the 1970s has been that the
shareholder focus has relegated these other groups to a lower status in terms
of company decision-making, cultures and priorities. This never should have
happened.
The critical overriding mistake
in the 1970 period was to treat the enterprise (corporation or company,
organization, etc.) as synonymous with the shareholder group from a value
creation standpoint. That is, maximize share price, earnings per share (eps), net present value of free
cash flows (npv), etc. for the shareholders and the enterprise’s long term
value and wealth creation will also be maximized. Wrong!
Before addressing the shareholder-stakeholder debate, a further word
about the dominant Friedman profit model is in order. That is, a bit more about
why there is a debate at all. Why change from the Friedman profit-as-purpose
model for capitalism? After all, it has resulted in significant value creation
in capitalist economies for 50+ years – and continues to this day, even with
the assertion about the “critical overriding mistake.”
Some Examples over the last fifty years of
Value Destruction Directly Caused by the Narrow Friedman Profit-as-Sole-Purpose Model, for Context.
The
2007-’08 great recession is the largest example of value destruction directly
flowing from the narrow profit model. More than $2 trillion of value
destruction was caused in the United States alone. The Enron implosion, the
WorldCom disaster and many other value destructive examples – the Boeing 737
800 Max problem, the Takata airbags problem and the VW emissions scandal are
direct results of business leaders acting in accordance with the profit model.
In fact and importantly, the tying of leadership compensation to share
performance (a proposal from the mid-1970s in an article by Professors Michael
Jensen and William Meckling that caught on in a pervasive way) is an explicit
mechanism that takes business leaders’ eyes off the consequences to the other
five primary stakeholder groups (PSGs, defined below) in order to produce near
term share price increases and leadership compensation increases. Enough.
The Debate.
This created a long running and
important debate about the purpose of companies (business) in a capitalist
economy. Broader views that companies must pay attention to other groups too,
like employees, customers, suppliers, etc. in addition to shareholders have
been regularly offered from academia, some business leaders and others. The
debate has been going on for 50+ years. The advocates of the broader vision of
capitalism argue for models that fall generally under the umbrella of
“stakeholder capitalism.” We use “SC” to represent it in the remainder of this
paper.
So, SC advocates have presented a
number of models for how to create value in addition to profit - value for
other groups, stakeholder groups. Some SC proponents, but not all, have even
identified the six primary stakeholder groups that we present here as most
important. Identifying the primary stakeholder groups of a company is one
critically important step.
A full model that also explains why and
how a specific SC model can and should become dominant for capitalism to be the
ultimate catalyst for long term value and wealth creation has been missing all
these years.
We do exactly that in this brief paper
– and we are confident Professor Adam Smith would agree with our model.
Professor Milton Friedman himself would also join in supporting our model.
First, some criticisms of SC as understood
over this 50 year period.
Just this year, we have two recent
criticisms of SC, criticisms from two
respected and widely known American journalists - George Will and Steve Denning.
Mr. Will and Mr. Denning have each written
articles in 2022 criticizing SC (Stakeholder Capitalism). Their criticisms are
discussed and dismissed below.
We then present our model (the ultimately
correct capitalism paradigm). We demonstrate that our model is just what the
world has been waiting for to make the transformative and even existential
change from the narrow but dominant profit-as-sole purpose of business model to
the primary stakeholder group (PSG) model of capitalism – that Adam Smith
really taught and that Milton Friedman would surely support.
So, the
Two Examples
of Criticism of Stakeholder Capitalism.
As explained above, our two highly
respected journalists have recently tried to kill it in articles, using the most
common criticisms.
George Will, known far and wide, tried to kill it in his
Washington Post opinion piece in its June 22, 2022 issue. Steve Denning, also a leading writer in many publications
and a frequent contributor in Forbes, tried to kill it in his article in the
January 5, 2022 Forbes issue and in virtually the same piece in an Agile Week
event, on about April 29, 2022. Assertions or beliefs in their articles are
presented here, along with our gentle but absolute dismissal of their opinions:
1.
George
Will: Mr. Will is concerned that the economic
dynamism in the existing capitalism model will be lost if stakeholder
capitalism ever becomes the dominant model. Quite the contrary: The stakeholder
model presented here will breathe full life into the dynamism of capitalism –
it will be done right, and be more dynamic for right reasons. He also characterizes
SC as a trick of progressives to take the profits from companies in a
capitalist economy, like in the United States, and distribute those profits to
whatever groups express an interest in them or claim they should receive them
because they are affected by the company in some way (that is, the number of
stakeholder groups is unlimited – nonsense). He is so wrong that he does not
deserve a rebuttal. First, SC correctly defined and made actionable is
absolutely apolitical. And, the stakeholder model presented in this paper will
increase the dynamism, not harm it. Also, the notion of an open-ended number of
stakeholder groups is a scare tactic at best and a deep misunderstanding at
worst – Mr. Will’s use of the Oxford
Reference definition of stakeholder to the contrary notwithstanding. Finally, he
advises all to “recoil” from this idea. With George Will’s wonderful
credibility as a wise leader on public policy matters, his opinion piece can
result in readers and leaders following his advice, which would be a terrible
outcome on this important SC matter.
2.
Steve Denning: Mr. Denning, once an
advocate of a broader definition of the groups a company ought to focus on as
those it significantly affects by its very existence (he was formerly an SC
supporter of sorts), has concluded that the “true North” of a company is, as
Peter Drucker proclaimed in 1954, the customer. Everything the company does is
predicated on creating a customer. Any expansion, he says, to focus on more
than one stakeholder group has almost always resulted in “garbage can
organizations.” In fact and following Drucker’s reasoning, Denning calls the
Friedman shareholder focus “an unacceptable form of institutionalized
selfishness.” Mr. Denning goes on to explain his beliefs about other failings
of both the narrow Friedman shareholder focus and the broad stakeholder focus. He
also believes that “agile” companies, ones that adopt the agile model of
company behavior and culture are the way of the future. As with Mr. Will’s
economic dynamism, the stakeholder model in this paper will put full wind into
the sails of companies that also embrace agile behavior models (in fact, the
PSG capitalism model presented here defines the best and ultimate “North Star”
any organization could have). His assertion about “customer capitalism,” is
quite rational as an alternative to shareholder capitalism, but it is still a
narrow focus on the things valued by just one of the six primary stakeholder
groups of every organization. As explained below, it is the main valued things
of each of the six (6) primary stakeholder groups of every corporation that the
business must know and optimally serve to have the business achieve its own
highest long term value and wealth creation as an outcome of getting capitalism
right – not as its purpose!
Like
George Will and Steve Denning, others have criticized SC over the years, but
virtually all criticisms address the several incomplete – though directionally
correct – attempts to bring SC into a dominant role in capitalist economies.
Primary Stakeholder Group (PSG) Capitalism.
While alternative proposals have been
offered, none has yet become dominant. This paper is intended to change that,
once and for all.
Every company has precisely six (6)
primary stakeholder groups (PSGs) – not five or seven or any other number. They
are customers, employees, financial investors, suppliers, communities where the
company has a presence and the general public interest.
Each of these PSGs values certain
things most – because of its role. It wants to receive that value from its
engagement with the company – knowing of course that it (the PSG) must provide
certain specific value to the company in turn. It is a straight forward relationship.
For the company though, the
obligation is always to optimize the value it provides to each of its six PSGs,
each relative to the others – not a difficult task, but it requires a
transformational, even existential, change to company mindsets and behavior in
order to become the dominant capitalism model going forward. This adds a
natural complexity to the matter. It is still not difficult. This complexity is
exactly the natural phenomenon that has allowed the Friedman model to do pretty
good for shareholders since the 1970s while a. not providing optimal long term
value for each of the other five PSGs and, b. as a direct result, falling short
of the ultimate value creation opportunity for both the company (the
enterprise) and the economy – and as a result for people and society.
A Summary statement on Primary
Stakeholder Group (PSG) Capitalism.
PSG capitalism, unlike virtually all other attempts over the years to have
“stakeholder capitalism” become the dominant paradigm practiced in companies
and taught in business schools, is grounded in those things valued by people in
their roles – as listed above - as customers, employees, investors, suppliers,
communities where they have a presence and the general public interest.
This
paradigm, or model, presents the unassailable truth that the company’s
(enterprise or organization) long term value and wealth maximization outcome is
a direct function of optimizing the value the company provides to each of its
six (6) primary stakeholder groups - not seven (7), not five (5) and certainly
not the unlimited number suggested by George Will.
An Important
Word about Company Mindsets. There are two main mindsets that companies
can have - either the good mindset or the bad mindset.
The
good mindset is long term, outward-focused and value-optimizing for each PSG
relative to each of the others. The bad mindset is short term, inward-focused
and win-lose.
Advocates of stakeholder capitalism over
these last 50 + years have not explained this model well enough (nor perhaps
understood its nuanced reality clearly enough), and advocates for the Friedman shareholder
capitalism profit model have clung to its 1st among equals PSG
position over the years – to the long term detriment of all.
Why focus on what people value
in their “PSG” roles?
The
implicit assumption underlying Professor Milton Friedman’s teaching that the
sole obligation of a business is to increase its profits for shareholders is
that profit is the one and virtually only thing shareholders value.
Just
as profit is certainly valued by investors, there are some other things investors
value. Similarly, customers have a number of things they value and look for
from the business, as do employees, suppliers, the communities where the
business has a presence and, in the largest context, the general public
interest values certain things from a business.
Here
are indicative and important but not necessarily exhaustive lists of the main
value expectations of each PSG of every business:
1.
Customers: 1. High quality, 2. Reasonable prices,
3. Kindness, 4. Companies that treat their employees well and 5. Companies that
are good citizens.
2.
Employees: 1. Opportunity, 2. Fair compensation, 3. Security, 4.
Opportunity and Challenge to achieve as individuals and teams/groups and 5.
Company conducts itself as a good neighbor, a good citizen.
3.
Suppliers: 1. Fair dealing, 2. Long term partnership opportunity mutually
earned, 3. Great treatment of employees, 4. Positive citizenship conduct of
company and 5. Enjoyable to work with.
4.
Investors: 1. Best value creation from their funds, for any period but
especially over the long term, 2. Positive company participation in
communities, 3. Great company treatment of employees, 4. Great company standing
in society (loved), 5. Gold standard leadership in the company and 6. Full
participation in society.
5.
Communities in which it has a presence: 1. Good citizen in local
communities, 2. Long term participative partner in community well-being, 3.
Great company treatment of its employees, 4. Full company involvement in
environmental and societal stewardship for the long term and 5. Openness.
6.
Society (The General Public Interest): 1. Great local and global citizen,
participative and engaged, 2. Great social and environmental steward, long
term, 3. Willing partner and participant with others (including governments) in
serving the public interest and 4. Excellent treatment of its employees,
suppliers and neighbors.
When
a business has a leadership and culture that recognizes and serves these valued
things for each of its PSGs (the “stakeholder” groups whose lives the business
significantly affects in the present and over the long term), the business will
maximize its own long term value creation and wealth as its ongoing and ultimate
outcome.
This
is not rocket science. Rather, this is how we live our lives, and business must
go with this reality. They have not yet – although a few are trying and doing
well.
Nevertheless, this PSG model of capitalism was
not contemplated by the Friedman model (except through the “invisible hand”
sterile notion that Professor Adam Smith himself did not emphasize).
And,
while Professor Peter Drucker did say that “the purpose of a business is to
create and keep a customer,” he said many other things treasured by the
business and economic communities worldwide. Creating and keeping a customer is
best done, the PSG model holds, by knowing and genuinely optimizing the value
it provides to each PSG – now and over time.
Is There More?
There
indeed is more, and it is easily deduced but takes explanation at the same time.
“Easily deduced” means that it is all based on
the globally ubiquitous virtues (and traits leading to these virtues) treasured
by all people, the globally unalienable rights of all people, a robust
understanding of fiduciary obligations of a business and the essential
importance of ethical behavior by the business at all times.
This paper is inviting the reader, and the
business and larger societal community, to consider the better angels of our shared
human nature acted out in the context of the marketplace of buyers and sellers.
PSG
stakeholder capitalism, adopted and implemented in business schools and in
companies, as briefly explained in this paper, will maximize the likelihood
that long term maximization of the wealth creation of the enterprise and of
entire economies – all societies and peoples – is achieved as the outcome of
PSG capitalism in action.
.
Summary.
This
article, in an all too brief explanation, dogmatically asserts it is the PSG
paradigm of stakeholder capitalism, finally correctly defined and ready to be taught,
implemented and practiced that will optimize long term value for the PSGs of
all companies and will maximize the long-term value and wealth creation of the
company (enterprise, organization) itself as the natural outcome.
Business
leaders, business schools and all who participate in providing free market
capitalism to society should understand, teach and implement the PSG paradigm
of capitalism so that societies (all people and peoples) can receive maximum
long-term value and wealth.
