'Stakeholder' Theory: What it Means for Corporate Governance
by Samuel Gregg
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As an ethical theory of corporate governance,stakeholderism is an incoherent and implausible guide to how corporations act or should act.

As corporations move into the 21st century, their environment will continue to change at a rapid pace.

Directors and executives of corporations will find their ability to deliver shareholder value under scrutiny from an increasing number of sources. Apart from traditional watchdogs such as regulatory agencies and banks, the rise of share ownership within much of the population of developed nations will undoubtedly increase the pressure for corporate performance that delivers shareholder value. The unprecedented competition for shareholder investment among corporations, the increase in sophisticated financial information and analysis, and the growing transparency of investment flows will only add to this pressure. Fund managers and institutional investors, such as superannuation schemes that act as proxies for millions of individuals, will closely monitor corporations and seek to influence their performance.

At the same time, corporations are likely to encounter another set of demands from a variety of quite different sectors. These reflect a desire on the part of many for business corporations to change their modus operandi and make certain objectives as fundamental to the corporationÕs purpose as the objective of delivering value to the owners of corporationsÑthe shareholders.

One such demand is that corporations be more Ôsocially responsibleÕ. The implication is that corporations have been less than socially responsible in the past or have somehow lost sight of their Ôwider obligationsÕ. In particular, companies that deal with products that are finite and potentially hazardous are bound to find themselves under increased pressure from some non-government organisations (NGOs) who seek to bring their influence to bear through the mediums of the press and political action.

From the standpoint of good corporate governance, these ideas reflect a general effort to change decisively the manner in which corporations operate and the ends that they serve. This development may do much damage to the capacity of corporations to deliver shareholder value, and, perhaps more significantly, encourage corporate leaders to involve their organisations in activities that corporations are simply not designed to perform.

Back to basics

At the heart of any clear understanding of what constitutes good corporate governance is the Aristotelian notion that institutions should be primarily understood in terms of their purpose; that is, the telos that constitutes their fundamental aim. This forces us to recognise that business corporations are not athletic associations or even social welfare organisations, and that a horseriding club does not exist primarily to make a profit.

Each organisation has its own special task to perform and should be wary of allowing itself to be excessively diverted from its commitments. A trade union, for example, that becomes focused on political activity to the extent that it gradually becomes an explicitly political movement will cease to serve its membersÕ everyday interests and needs except in an indirect and detached way.

The same observation may be applied to corporations. Some may choose to engage in what are at face value non-commercial activities. But once a business corporation loses sight of its corporate objective, or forgets that its primary responsibility is maximisation of shareholder value, then it has effectively betrayed its telos. This commitment to maximising shareholder value is not of course a mandate for, say, wanton ecological destruction. It does, however, mean that shareholder value must be the priority for directors, managers and other employees. To do otherwise would be to betray the primary responsibility with which they have been entrusted.

The relationship between shareholder-owners, the directors, and the managers is primarily one of collaboration and coordination mediated in part through contractual arrangements. Aristotle classed all such relationships as relationships of utility. Shareholders want to maximise their wealth, and managers want to earn a living. Shareholders will pay managers and directors if and only if managers make money. And managers will only make money if they are paid out of the earnings of the corporation that is, in the final analysis, owned by the shareholders.

Shareholders: the owners

While shareholders in corporations may be individuals, institutional investors, banks, or other corporations, their common denominator is that they are suppliers of risk capital. In most cases, their main concern is Ôthat they receive the highest possible return, either in the form of income or in accretion of their share values, that is possible for the risk class of their investmentÕ.1 Shareholders are therefore correctly understood as partners in contract with a firm of which they acquire some ownership by way of the market. This contract entitles shareholders to a return on their investment if profits are made.

While corporations enjoy a perpetual legal existence, with assets and liabilities distinct from that of their shareholders, they remain the subject of shareholders insofar as they are the property of their shareholders in aggregate. Shareholders can also terminate the corporation, or allow it to be acquired by or merged into another corporation. This makes it clear that the ultimate responsibility of a corporationÕs board of directors and management is to the shareholders. It is to shareholders that they owe what is called a Ôfiduciary dutyÕ.

Directors and executives: the stewards

The role of directors is best described as that of good stewards. Their fundamental responsibility is to represent the shareholders and direct the corporation to achieve the purposes established by the shareholders. Thus, in business corporations, directors are properly accountable to shareholders for maximising shareholder value. Their first loyalty must therefore be to the corporate purposeÑnot the employees, managers, or even customers.

Executives are appointed by and serve to execute the strategy and decisions of the board of directors. In practice, many boards have one or more directors who also have an executive management role in the corporation. This is one area that generates much discussion about the operations of boards of directors. In strict conceptual terms, however, the distinction between the responsibilities of individuals who manage the corporation and their responsibilities as members of the board is clear.

The possibility of a divergence of interest between owners and professional managers is a primary problem of modern corporations. Corporate governance is directed, in part, at preventing such disjunctions from occurring. It is designed to prevent situations emerging whereby boards of directors and managers lose sight of their responsibility to pursue the purposes of corporations as designated by the shareholders. A corporation which has, for instance, a non-profit dimension built into its constitution may be legitimately criticised by shareholders if it appears to be making the pursuit of profit its primary activity.

Many would disagree with this description of the relationship between shareholders, directors, and executives, not to mention the description of the end and nature of corporate governance. Prominent among these are proponents of various versions of what are popularly known as ÔstakeholderÕ theories of corporate governance. Given the extent to which these have permeated corporate and academic thinking about business life, such theories deserve close attention.

An incoherent theory

As a word, ÔstakeholderÕ reflects an unsubtle play on the word ÔstockholderÕÑthe implication being that it confers an entitlement not dissimilar to that of ownership. But what does it mean to take account of the interest of stakeholders?

Corporations should be aware that an ÔinterestÕ, even if legitimate, is not necessarily a stake. Even people affected by a corporationÕs activities do not necessarily have a stake in them. Simply being offended by a practice, for example, is hardly sufficient to make an individual, group, or even society qualify as a stakeholder. Nor does a corporationÕs decision about a possible practice which may or may not advantage or disadvantage a particular individual or group necessarily mandate consultation with that individual or group. If good corporate governance is about maximising shareholder value, then stakeholder theory is bound to distract directors and managers from achieving this end.

Undermining accountability

Whenever one entrusts oneÕs assets or affairs to another, an agent-principal relationship is established. In formal terms, then, the corporation remains accountable only to its shareholders, those to whom the corporation makes itself accountable by way of legitimate contracts, and, like everyone else, the law.

Stakeholder theory confuses, distorts, and ultimately destroys any real lines of accountability insofar as it subordinates the agentÕs particular duty to their principals to the ÔdutiesÕ that directors and managers owe to other groups. Stakeholderism thus disrupts the moral relationship between owners and employees. It also endangers contractual relationships in the sense that no contractual relationship would be secure if they were constantly being revised in light of the need to make political-like stakeholder decisions.

This has not, however, prevented some stakeholder theorists from arguing in favour of legislation to force corporations to become more accountable to their respective alleged stakeholders. Yet enshrining any variant of stakeholderism in law would lead to an inevitable increase in state power over civil society. Given the potentially limitless scope that stakeholder theory gives for people to be calledÑor to identify themselves asÑstakeholders in any one or every corporation, it would seem that giving the state responsibility for reinforcing corporationsÕ responsibilities to a multitude of stakeholders is a recipe for a dramatic expansion of state power. Most countries already have laws and regulations that specify employment practices, health and safety requirements, consumer protection, planning restrictions etc. Many of these are indeed necessary. Stakeholder theory nonetheless gives governments many opportunities to increase regulation, or for political groups to use regulation to advance and institutionalise their particular agendas within the functioning of corporations.

Directors and managers of business corporations have to make a myriad of decisions every day. Each decision, however, is governed by the organisationÕs fundamental purpose: to maximise shareholder value for the owners. But in a stakeholder world, a corporation could easily become accountable to almost anyone or everyone: as is well known, an organisation that is accountable to all easily becomes accountable to no-one.

Corroding ownership

Closely associated with stakeholderismÕs capacity to blur clear lines of accountability is its subtle undermining of private ownership. Property, derived from the Latin proprietas, means (in the juridical-ethical sense of the word) the dominion that a person may exercise over a certain object possessed. It expresses the possibility of controlling the object as one desires, subject to the provisions of the rule of law. Stakeholder theory undermines private property insofar as some stakeholder theorists argue that the assets utilised by corporations should be used for the balanced benefits of all stakeholders. Immediately, one observes that the ÔdominionÕ that shareholders enjoy over the corporation is arbitrarily diluted in this stakeholder scenario. A concept that is, at least ostensibly, concerned with producing a situation of fairness, actually disadvantages those who have chosen to undertake risks that others have not.

To this extent, stakeholder theory may undermine the process of issuing shares as a means of financing the corporationÕs growth and new entrepreneurial ventures. For why would potential shareholders invest, if they knew that their interests would be subordinated again and again to those who had made no financial investment?

Appeasing stakeholders in financial terms also means that lenders would have less expectation of receiving an adequate return on their investment. Stakeholderism is thus likely to produce poorer, static, risk-averse corporations and hence a poorer, static, risk-averse economy. If this is true, then stakeholder theory may actually serve purposes that are contrary to the interests of the very stakeholders that it purports to help.

So does the term ÔstakeholderÕ have any use at all? If being attentive to stakeholders simply means that corporations must take into account a wide variety of interests when pursuing the corporate purpose, then stakeholder interest simply describes something that we have long known. A business cannot afford to ignore those external concerns that might affect its ability to generate long-term owner value. Issues such as environmental impact of economic activity, regional development and employment are legitimate topics to discuss not just in the wider community, but in the board room as well.

It is entirely possible, of course, that appeasing stakeholder groups may contribute to the corporate objective (not least as a way of avoiding government regulation) in the long term. One problem with this strategy is that some corporations may accept the views of stakeholders without engaging them in debate about whether views are mistaken, based on faulty evidence, or downright wrong. In such instances, corporations seeking to appease particular groups by promoting particular causes may actually be engaged in socially irresponsible behaviour.

The good of corporations

The emergence of stakeholder theory illustrates that boards of directors as well as executives must have some consciousness of the direction and character of public policy debates. For whatever the facts, it remains that corporations are likely to find themselves subject to continuing criticism. This is despite the real moral, social and material good that is realised by corporations on a daily basis. Aside from creating wealth, jobs, material goods and services, one such good is their associative dimension.

Corporations are, by nature, voluntary and part-time associations. They involve communal risk-taking and the pooling of resources. Business corporations are thus social enterprises that take people beyond the scope of the family and other smaller groups and help them to mix with people with whom they might not otherwise have associated The very word ÔcorporationÕ suggests ÔcommunalÕ in the sense of many people acting together.

The growth of corporations as autonomous organisations also contributes to the growth of that non-state sphere of social activity commonly known as civil society. Contrary to much contemporary wisdom which persists in limiting civil society to non-government organisations and the voluntary sector, business corporations are part of civil society insofar as they too are part ofÑindeed, essential toÑthe non-state sector of society. This much has been recognised by philosophers ranging from Smith to Marx.2 Similarly, their wealth-creating actions help to expand the sources of private capital, wealth and property that, as Pope John XXIII noted,3 are crucial for the survival of civil and political liberties. It is no coincidence that the destruction of civil society in communist countries was accelerated by the banning of private commercial activity and the collectivisation of private property.

Finally, by engaging in commercial activity, corporations also contribute to what the French philosopher Charles-Louis de Montesquieu described as the civilising power of commerce 4 Ñthat is, it relies upon respect for law; it benefits from peace; it teaches prudence and attention to small losses and small gains; and it diverts attention from grandiose schemes in order to facilitate modest progress. In these and other ways, corporations play a role in the creation of moral, material and social goods that extend beyond the monetary returns to their owners.

ÔCorporate social responsibility?Õ

The capacity of corporations to facilitate these goods is not enough for some. In recent years, the language of business life has become increasingly replete with phrases such as Ôthe triple bottom lineÕ, Ôcorporate social responsibilityÕ and Ôethical investmentÕ.

Precisely what is meant by such assertions is unclear. But as Alexei Marcoux notes, the image of the corporation presented in the corporate social responsibility literature tends to be Ôthat of a free rider, unjustly and uncooperatively enriching itself to the detriment of the communityÕ.5 Such thinking reflects a failure to recognise the moral, material and social goods facilitated by business activity, as discussed. It also ignores the fact that shareholders expect the highest possible return on their investment. This limits a corporationÕs scope for programmes of Ôsocial responsibilityÕ.

ÔEthicalÕ investment

One means by which people can invest their money to further various Ôsocially responsibleÕ causes is through Ôethical investment fundsÕ. The list of concerns promoted by some ethical investment funds, however, is long and not especially coherent. These range from investment in armaments, tobacco, gambling, any product using animal experimentation, mining, and countries with oppressive regimes, to failure to match First World employment opportunities in Third World countries, to the emission of excessive greenhouse gases.6 The implication to be drawn from such lists is that if you invest in corporations that match one or more of such criteria, then you are morally suspect.

This tendency to distinguish between good and bad products ignores the fact that what matters, from an ethical viewpoint, is the use to which people put the product. It is a bizarre ethics that suggests that certain products are in themselves ÔethicalÕ or ÔunethicalÕÑafter all, only human beings are capable of morality. There is, for example, a real ethical question about the use of animals in testing various products. But should we test such products on humans instead? Or should we let people use the products without testing them at all?

Much of what passes for ethical investment criteria seems to have more to do with fashionable causes, inevitably involving a high degree of moral selectivity. In the 1980s, for example, promoters of ethical investment invariably listed South Africa as a country in which it was ethically wrong for corporations to invest.7 But why did they not also list countries with regimes as oppressive as Cuba, Libya, East Germany, Iraq, Zaire, Zimbabwe, Ethiopia, the Soviet Union, Romania, or Vietnam?

There is no doubt that we all have the duty to oppose tyrannical regimes. The real issue, however, is how. Some argue that investments in countries such as Cuba ruled by regimes as oppressive as Fidel CastroÕs will only further entrench his rule. Others maintain that such investment will lighten the burden for the oppressed, and gradually undermine the regimeÕs control of the Cuban economy. Surely much depends on the nature of the investment, the degree of control exerted by any one corporation over that investment, and the conditions of the country at different points in time. To assume that such complex ethical issues will be resolved merely by refusing to invest in firms that test drugs on animals, or which have holdings in Cuba or Iraq, is simply inadequate.

The complexity of obligation

The promotion of notions such as Ôcorporate social responsibilityÕ and Ôethical investmentÕ has spawned an unprecedented debate about ethics and corporate life. Yet if these notions are flawed means by which to promote a genuine appreciation of the moral life within the corporation, what are the alternatives?

When it comes to developing a sound moral ecology within corporations, there is no substitute for abiding by long-established conventions, observance of the rule of law, and an enhanced understanding of the nature of ethics. While this is a somewhat humbler (and far less politicised) path than many propositions advanced by some stakeholder theorists, it is a way that takes the moral life more seriously, precisely because it focuses upon the only moral agent there is: the individual human person. In any event, the plausible and ordinary moral duties that one expects people working in corporations to recognise, such as honesty and fair dealing, flow from ordinary morality rather than from so-called Ôbusiness ethicsÕ.

The nature of ethics

We live in a time when Ôthere is no clearly settled meaning of ÒethicsÓ in modern philosophical discussionÕ.8 Part of the problem is the fragmentation of moral discourse in Western societies highlighted by Alasdair MacIntyre in his seminal book, After Virtue (1981). Yet no matter how fragmented the state of Western culture, no matter how different peopleÕs heritages, allegiances or commitments, it remains possible for every person who possesses unimpaired reason to discern basic moral truths.

Ethics is not about Ôgetting alongÕ with otheres or picking values we ÔpreferÕ, find ÔcongenialÕ or suit our ÔlifestyleÕ. Rather, ethics revolves around the question of what one ought to do, a question faced by those working in corporations on a regular basis. There are several senses in which the phrase ÔoughtÕ may be used. Human beings possess free will and reason. Hence, we do not act purely from instinct. The choice of the good is the subjective part of morality. Nonetheless, by use of our reason we are capable of identifying objective standards that tell us whether or not our subjective choices and actions are good or evil.

One moral philosopher who provides corporations with guidance in this area is Immanuel Kant. This prominent 18th century thinker maintained that when we act, we act with an intention, and our intention may be tested against standards of morality which Kant called categorical imperatives.

He formulated these in a number of ways. The first was ÔAct only according to that maxim by which you can at the same time will that it should become a universal lawÕ.9 This is a thought test which involves generalising an action by asking questions such as Ôwhat would it be like if everyone behaved this way?ÕThe second formulation was ÔAct so that you treat others, whether in your own person or in that of another, always as an end and never as a means onlyÕ.10 This does not mean that corporate executives may not use others as a means to produce profit. They are simply reminded not to treat such people solely as a means to an end.

Free adherence to such obligations contributes to the development of a moral ecology that allows people to attain both their private purposes as well as those objectives conceived and executed as common enterprises (such as corporations) that advantage the community as well as specific persons.

These obligations are crucial, indeed essential, to the functioning of corporations and market economies. Where they do not exist, one either has to resort to the clumsy tool of regulation or helplessly watch as mafia-like/ crony-capitalist arrangements begin to prevail. John Paul II has insisted again and again that if market and corporate relations are to endure, there must be some degree of moral consensus about our obligations.11

Focusing upon the moral choices made by individuals working within corporations avoids the pitfalls associated with the thinking underlying notions such as ÔstakeholderismÕ and Ôcorporate social responsibilityÕ. It also focuses the responsibility where it belongs: on the moral agent that is the individual human person.

There will, of course, be those directors, managers, employees and owners of corporations who shirk the responsibility of trying to live the moral life in their business activities. Here we inevitably rely upon the law, social conventions, and other devices to deter them. Such deterrence does not always work, and some individuals working in corporations will engage in immoral activity that may or may not be discovered and punished. But to an extent, this is one of the prices of living in a free society. The alternative is to introduce stringent controls that unduly hamper the initiative and entrepreneurship required in corporations, not to mention undermine the scope for the free choice that is an essential prerequisite for a personÕs actualisation of moral good.

Conclusion

Corporations need to explain more carefully the seriousness of their obligations to shareholders and why they cannot be taken lightly. This in turn points to a more general need for intellectual engagement on the part of corporations.

The Achilles heel of many modern corporations has been a lack of intellectual self-consciousness. Corporate leaders should not underestimate the size, intelligence and commitment of the many organisations determined to undermine their legitimate autonomy and activities. In an age of instant communication and easy demagoguery, corporate leaders who lack a clear philosophical picture of where they and those critical of corporationsÕ activities stand, leave the shareholder value which they serve to maximise unnecessarily exposed to depreciation.

Endnotes

1 M. Jensen and W. Meckling, ÔTheory of the Firm: Managerial Behaviour, Agency Costs and Ownership StructureÕ, Journal of Financial Economics 11 (1976), 6.

2 A. Black, Guilds and Civil Society in European Political Thought: From the Twelfth Century to the Present (London: Methuen, 1984).

3 John XXIII, Encyclical Letter Mater et Magistra, in C. Carlen, I.M.D. (ed), The Papal Encyclicals, vol. 5 (Ann Arbor: McGrath Publishing), para. 108-110.

4 C.L. de Montesquieu, The Spirit of the Laws, tr. T. Nugent (New York: Macmillan, [1748], 1949).

5 A. Marcoux, ÔBusiness Ethics Gone WrongÕ Cato Policy Report 22: 3 (Washington D.C., The Cato Institute, 2000), 10.

6 D. Anderson, What has ÔEthical InvestmentÕ to do with Ethics? (London: Social Affairs Unit, 1996), 8.

7 R. Sparkes, The Ethical Investor (London: HarperCollins, 1995), 5.

8 J. Finnis, Natural Law and Natural Rights (Oxford: Clarendon Press, 1980), 128.

9 I. Kant, Foundations of Metaphysics of Morals, tr. L. W. Beck (New York: Macmillan, [1785] 1990), 38.

10 Kant, 38.

11 John Paul II, Encyclical Letter Centesimus Annus (Sydney: St Paul Publications, [1961] 1981), para. 36.

Samuel Gregg is Director of the Center for Economic Personalism at the Acton Institute (USA)and Adjunct Scholar with The Centre for Independent Studies (CIS).This is adapted from his forthcoming CIS publication,The Art of Corporate Governance:A Return to First Principles.

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