Optimizing Stakeholder Values

• The practice of maximizing shareholder value has led to high debt, market instability, and corporate scandal.
• More corporate leaders, academics, and investors are starting to favor an inclusive model of capitalism that provides benefits to all stakeholders.
• Business schools can help redefine capitalism by teaching students to consider how all stakeholders are impacted by business decisions.

 
After several hundred years of vibrant development, the free-market economic ideals of capitalism face various challenges. The problems with the existing model have been exacerbated by the coronavirus pandemic, which disrupted all business sectors, created new businesses, destroyed others, and prompted economists to rethink the value of our current system.

For more than 50 years, economists have justified their belief in free markets by repeating Milton Friedman’s adage that “the one and only responsibility of a business is to increase its profits.” Corporate directors and executives have focused on earning short-term profits, increasing share prices, and maximizing shareholder value (MSV) without giving much attention to the interests of nonshareholder stakeholders such as employees, customers, suppliers, the community, and the environment.

However, by emphasizing the expectation (stock) market more than the real (product) market, MSV behaviors have been responsible for many of the problems of today’s shareholder capitalism. These include high debt financing, high dividend payment, reduced investment in research and development, more stock buybacks, higher market instabilities, excessive executive compensations, wider income gaps, and the loss of long-term corporate values. These problems also encompass two financial crises and numerous corporate scandals, including Luckin Coffee, ABB Engineering, Volkswagen, Toshiba, Lehman Brothers, and Enron.

Corporations are important social institutions that have the capacity to benefit society. But it is time to reflect on the specious concept of MSV and to redefine the purpose of corporations. Along with many economists, I believe that if we make hard efforts to reform the system, we can move toward a more equitable, just, inclusive, and sustainable form of stakeholder capitalism.

Abandoning the MSV Model

One reason MSV is so entrenched is that many directors and top executives of public companies believe that corporations are, by law, solely the agents of shareholders and have a fiduciary duty to prioritize shareholders’ well-being. This is a faulty assumption.

The truth is that MSV is not a law or regulation—it is merely a market norm or a habit of top executives. Legal precedents suggest that courts have granted business leaders a great deal of flexibility in how they balance the interests of different stakeholders. New constituency statutes and recent court cases in North America clearly indicate that directors and executives owe fiduciary duties to all relevant stakeholders.

Over the past two decades, business leaders and academics have taken steps to reverse the MSV trend and put “responsible management” in its place. The goal is to use capitalism to help solve social problems such as poverty, inequity, and climate change. Leaders in the responsible management movement advocate for promoting charitable corporate social responsibility (CSR), creating shared value (CSV), and devising environmental, social, and governance (ESG) metrics. However, these efforts are having limited effect, for two main reasons.

If corporate leaders are still predominantly focused on the short-term profits of shareholders, they are unlikely to achieve real change with their ESG initiatives.

First, some companies are spending a lot of money each year on CSR, CSV, and ESG activities while treating their employees and their customers unfairly or even unethically. Some of these companies just pay lip service to serving stakeholders, pursuing what critics called “ESG wash.” Others are concerned that responsible management practices will put a strain on their annual profits and stock prices. If corporate leaders are still predominantly focused on the short-term profits of shareholders and have little regard for the interests of other primary stakeholders, they are unlikely to achieve real change with their CSR, CSV, and ESG initiatives.

Second, the concept of responsible management is complex and multifaceted, comprising three hierarchical dimensions: business ethics, sustainability, and responsibility to stakeholders. While these three dimensions are complementary and mutually reinforcing, each is a distinct area and has its own core concepts. There is no common framework for linking these dimensions with the various elements of “business as a force for good.” This makes it difficult for some business leaders to understand how to achieve all the goals simultaneously or even to determine where to concentrate their efforts.

Shifting to Stakeholder-Based Governance

Nonetheless, the responsible management movement continues to grow stronger as some business and academic leaders propose redefining the purpose of corporations from the perspective of social contracting. In other words, because a company enjoys privileges such as limited liability, unlimited life, and status as an independent legal person, it also should bear responsibilities to its interdependent stakeholders, and it should consult these stakeholders before making major decisions. In this model, a corporation’s leaders attempt to balance the interests of the company’s major stakeholders and optimize value for all. They aim to make a reasonable and sustainable long-term profit rather than attempting to maximize profit in the shorter term.

Several prominent organizations have recognized this stakeholder-based governance approach. In 2019, the Business Roundtable, a U.S.-based nonprofit, released a “Statement on the Purpose of a Corporation.” It was signed by the CEOs of 181 U.S. corporations, including Microsoft, Apple, Amazon, Pepsi, Walmart, and Citigroup. They stated that their corporations would abandon the doctrine of shareholder primacy, and they vowed to create value for all stakeholders.

Similarly, the participating leaders at the World Economic Forum in January 2020 jointly signed “The Davos Manifesto 2020: The Universal Purpose of a Company,” which specifies that companies should engage all stakeholders and pursue sustained value creation.

Well-known business leaders also have spoken out against using MSV as a company’s only goal. Peter Drucker, the late guru of modern management, said, “The bottom line is not, by itself, an adequate measure of the performance of management and enterprises.” Elon Musk, CEO of Tesla, expressed at a recent WSJ Summit that “If you are only focusing on the bottom line, you are barking up the wrong tree.”

In his 2021 Letter to CEOs, Larry Fink, chairman and CEO of investment company BlackRock, wrote that “shareholders in your company will benefit if you can create enduring, sustainable value for all of your stakeholders.” He went on to note that “despite the darkness of the past 12 months, there have been signs of hope, including companies that have worked to serve their stakeholders with courage and conviction.”

The global pandemic has further exposed the shortcomings of shareholder primacy and the benefits of stakeholder capitalism. In fact, empirical evidence suggests that stakeholder-based corporations are more likely to survive and thrive in a crisis because they have more competitive advantages and outperform their peers.

Stakeholder-based corporations are more likely to survive and thrive in a crisis because they have more competitive advantages and outperform their peers.

Stakeholder capitalism also appeals to many investors who prefer social and impact investing opportunities. These individuals assess a business’s health, performance, and investment potential by considering nonfinancial and intangible indicators such as corporate culture, strategy, leadership, innovation, social responsibility, long-term risk management, and the values of key stakeholders.

Restoring Core Values

If capitalism is going to continue its legitimacy and sustainability, it needs urgent reform. It needs to shift from a model that promotes profit maximization to one that creates value for all stakeholders, not just shareholders.

To make the shift to stakeholder capitalism, we need to change the mindsets of business leaders and redefine the purpose and responsibilities of corporations. Transformation of the system will depend on trailblazing executives, policy makers, and academics who create a power base for reform. It also will require each corporation to take a series of concrete, measurable steps:

• Revise company constitutions to specify that the fiduciary duty of corporate leaders is not restricted to shareholders.
• Establish a stakeholder advisory council.
• Institute and report key performance indicators (KPIs) to assess the value created for different stakeholder groups.
• Link the executive compensation scheme to these KPIs, especially the nonfinancial ones, rather than basing it upon profit and stock figures. Gradually eliminate executive stock options.
• Compensate the operational-level employees by committing a minimum percentage of the corporation’s annual net profit as bonus, thus minimizing income gaps.
• Undertake at least one sizable social innovation project related to the core business to help resolve pressing social problems and explore new business opportunities.

When directors and CEOs create value for their key stakeholders and actively engage in strengthening civic foundations, they not only will help create a better world, they also will lead more authentic and fulfilling lives.

Redefining the Role of Business Schools

Massive reform of capitalism cannot be achieved solely through the efforts of the business sector. Many of today’s social innovations cut across the traditional boundaries that separate sectors, and they flourish with a free flow of ideas, values, and resources. Therefore, governments, civic organizations, and academic institutions must collaborate with industry to create greater social innovation and impact.

This means that business schools must consider what part we should play in redefining capitalism. Elon Musk once remarked that the biggest problem with corporate America today might be that there are “too many MBAs running companies.” But maybe the problem is that we are not teaching the right concepts to our MBA students.

I propose that we redesign management education to adopt a holistic social contracting perspective and the multistakeholder model.

While many business schools now offer courses related to business ethics, CSR, responsible management, and sustainability, most of these electives do not adopt the social contract and stakeholder concepts. Sadly, business education still largely relies on the outdated shareholder primacy notion and the short-term MSV assumptions, either implicitly or explicitly. Business students often are guided to evaluate strategic options using financial models that prioritize short-term returns for shareholders over the interests of other stakeholders.

I propose that we redesign management education to adopt a holistic social contracting perspective and the multistakeholder model. One practical and immediate approach is for business faculty to promote these theories to all relevant stakeholders in their teaching, research, and service activities. If professors integrate responsible management concepts and tools into their current courses, and supplement the lessons with the available research evidence, holistic long-term strategic thinking soon will permeate the curriculum. When our students graduate, they will be equipped with appropriate decision-making competencies and mindsets.

At the Hang Seng University of Hong Kong, we have been actively promoting this stakeholder governance model to the business community via different platforms and public events. Our team of 15 business professors wrote the book New Perspectives on Corporate Governance, which currently is only available in Chinese. The book is designed for other business classes and executive seminars to adopt. We have started to develop an index that can be used as a way to measure the values created for each stakeholder group and as a surrogate for overall business performance.

Business schools have been criticized for their preoccupation with rigorous academic research that lacks business relevance and impact. To help our schools regain relevance and impact, business faculty need to rediscover the purpose and responsibility of business. They need to find a way to better balance the triple missions of educating future executives, transferring created knowledge, and serving the greater good.