Bank of America, Blackrock, Capital Markets, Consumer Surplus, David Henderson, Don Boudreaux, ESG Scores, Fiduciary Laws, George Will, Mark Joffe, Michael C. Jenner, Producer Surplus, Reservation Wage, Semantic Infiltration, Shareholder Value, Stakeholder Capitalism, Theory of the Firm, Virginia Postrel
When so-called “stakeholders” are in charge of a company, or when non-owner “stakeholders” receive deference to their various goals from management, the actual owners have been displaced and no longer have control. That represents a kind of taking in which managers are complicit, failing to keep proper vigilance in their duty to maximize value for shareholders.
Ceding control to stakeholders represents a severe dislocation in the principle-agent relationship between owners and corporate management. Virginia Postrel is on-point in her discussion of the failures of “stakeholder capitalism”, but she might as well just say that it isn’t capitalism at all! And she’d be right!
Stakeholder capitalism represents a “theory” of the firm that accepts an array of different goals that often stand in conflict. This is the key point raised by Postrel. She cites Michael C. Jenner’s 2010 paper on stakeholder theory in which he notes the impossibility of maximizing any single-valued objective in the presence of a multi-dimensional corporate objective function. Thus, stakeholder objectives nearly always subvert management’s most important responsibility: maximizing value for owners.
And just who are these “stakeholders”? The designation potentially includes just about anyone and everyone: managers, customers and potential customers, suppliers and potential suppliers, employees, the pool of potential job applicants, union organizers, regulators, community members and organizations, local governing bodies, “underserved” populations, anyone with a grievance, environmental activists, and the children of tomorrow. Sure, owners are part of the broad set of stakeholders as well, but as Jenner more or less noted, who’s got time to maximize profits in the face of the myriad “claims” on company resources by the larger, blood-sucking hoard?
George Will aptly refers to stakeholder capitalism as “parasitic progressivism”. In fact, in his opening sentence, he notes that the very term “stakeholder” is a form of semantic infiltration, whereby the innocent (and ignorant) adoption of the term is a gateway to accepting the agenda. Will also notes that management deference to stakeholders violates fiduciary laws intended to protect owners, which include worker pensions and 401(k)s, as well as small investor IRAs, charitable organizations, and insurance companies funding life insurance policies and annuities.
This behavior is not merely parasitic — it is truly vampiric. Once bitten by the woke zombie corpses of stakeholder capitalism, either from within the organization or without, the curse of this deadly economic philosophy spreads. Human resource organizations impose diversity, equity, and inclusion training, rules, and hiring practices on operations. Suppliers might be imposed upon to not only deliver valued inputs, but to do so in a way that pleases multiple stakeholders. Woke fund managers, upon whom the firm might rely for capital, will insist on actions that promote social and environmental “justice”. It can go on and on, and no amount of appeasement is ever sufficient.
Unfortunately, there really are activist investors — actual stockholders — who encourage this misguided philosophy. If the majority of a firm’s owners wish to be accountable to the whims of particular non-owner stakeholders, that’s their right. Other investors would be wise to sell their shares… fast! Wastrels and incompetents have blown many a great and small fortune over the years, but capital markets are well-equipped to punish them, and eventually they will. Get woke, go broke!
The best way for a firm to maximize its contribution to society is to do its job well. That task involves producing a good or service that is valued by customers. By doing it well and efficiently, shareholders, customers, employees and society all win. This is the magic of mutually beneficial trade! Produce something that customers value highly while being mindful of tradeoffs that allow resource costs to be minimized. In general, the customers extract surplus value; shareholders extract surplus value; suppliers extract surplus value; and employees extract a surplus value because they receive wages at least as high as the lowest “reservation” wages they’d find acceptable. Here are some comments from Don Boudreaux on this general point:
“… regardless of how well or poorly managers are at running their companies in ways that maximize share values, there’s every reason to believe that managers will be much less competent at running their companies in ways that adequately satisfy ‘stakeholder’ interests. Not only is the definition of ‘stakeholder’ inherently open-ended and ambiguous, even the most skilled managers have no way to know how to trade-off the well-being of one set of ‘stakeholders’ for that of another set.”
This is very nearly a restatement of Jenner’s conclusion, but Jenner’s applies even when managers know specifics about the tradeoffs. Generally they don’t! Remember too that the firm, its shareholders, suppliers, and its employees are all subject to taxes on their surplus values, so their contribution to society exceeds their own gain. Moreover, many firms are already regulated precisely because lawmakers believe government has an interest in protecting larger classes of “stakeholders”. But beyond meeting regulatory requirements, to further insist that firms devote less than their remaining energies and resources to doing their jobs well, and to ask them to focus instead on the varied interests of external parties, whomever they might be, is ultimately a prescription for social harm.
A monster child of stakeholder theory is so-called ESG scoring. ESG stands for Environmental, Social, and Governance, and the scores are intended as “grades” for how well a firm is addressing these concerns. Proponents claim that high ESG’s are predictive of future returns, but that’s true only if lawmakers and regulators look upon these firms with favor and upon others with disfavor. ESG is basically a political tool. Otherwise, it is an economically illiterate notion foisted upon investors by political activists embedded in “woke” financial institutions like Blackrock and Bank of America. There be some real vampires! As David Henderson and Marc Joffe write, ESG fuels higher prices and obstructs economic growth. That’s because it formalizes the effort to serve “stakeholders”, thus raising the cost of actually producing and delivering the good or service one naturally presumes to be the firm’s primary mission. The shareholders pay the cost, as do customers and employees.
When I hear business people talk reverently about serving their “stakeholders” (and when I hear naive investment advisors wax glowingly about ESG scores), it sends up huge red flags. These individuals have lost sight of their valid objectives. They should be trying to run a business, not serving as a grab-bag for other interests. Serve your customers well and efficiently so as to maximize value for shareholders. Do so within the bounds of the law and ethics, but stick to your business mission and the parties to whom you are ultimately accountable!