Stakeholder Capitalism’s Sleight of Hand

Commentary, Economy, Paz Gómez

The Trojan horse of social engineers has crossed the gates. At the latest World Economic Forum in Switzerland, the Davos Manifesto 2020 replaced the original from 1973. The new one lays down a company’s duties towards “stakeholders” rather than shareholders.

This virtue signalling, which gives license for meddling in private affairs, stems from a fundamental misunderstanding of capitalism. When firms serve their shareholders and engage in voluntary exchange, they generate profits by serving the wider economy.

The purported stakeholders-versus-shareholders tradeoff is a false dichotomy and rhetorical trick for violations of private property. The combination of policy encroachment and guilt-tripping by the social-justice mob is a partial appropriation by the enforcers of stakeholder or “woke” capitalism.

During the event, McKinsey & Co. Global Managing Partner Kevin Sneader claimed companies had lost their way. He glibly and misleadingly referenced Adam Smith—perhaps the most influential economist ever—and said the purpose of business was “the responsibility to give to the community and enrich everyone.”

Perhaps the most famous reference from Adam Smith’s The Wealth of Nations (1776) is the “invisible hand.” It describes the emergent order from a man’s actions that “promote an end which was no part of his intention.”

By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the publick [sic] good.

With either ignorance or dishonesty, corporate executives such as Sneader are taking direct aim at the prevailing consensus on how to run businesses: the shareholder-value model. According to this ideal, CEOs should focus first and foremost on the interests of the firm’s owners. It is their firm after all.

How Woke Capitalism Is Evolving

University of Virginia Professor Edward Freeman kickstarted the concept of stakeholder capitalism in 1984. This movement claims companies should serve employees, customers, suppliers, and local communities, as they do investors. It goes beyond corporate-social-responsibility platitudes, and calls for executives to incorporate the interests and needs of stakeholders.

This supposedly enlightened way to lead is a façade to enforce conformity to progressives’ pie-in-the-sky ideas: uncompetitive green policies, “diversity hiring” over meritocracy, and quotas for women, unions, and minorities in executive and management boards. While seemingly noble, the devil is in the details of the arm-twisting.

The outcome would be politicized, conflictive, and wasteful work environments. Decision-making by building consensus among several stakeholders is time-consuming and detrimental to productivity. Economic stagnation could rear its ugly head.

Nobel laureate and progressive economist Joseph Stiglitz has become a prominent backer of this approach. Contra the late Milton Friedman, he argues shareholder wealth maximization produces rising inequality, low economic growth, and encourages anti-social behaviour such as stock-market manipulation and other negative externalities. 

In August 2019, stakeholder capitalism got the major endorsement outside academia it needed. The Business Roundtable, formed by the 181 most influential CEOs in the United States, proposed to redefine the purpose of corporations towards a multi-stakeholder approach.

The Business Roundtable committed to: (1) deliver value to customers, (2) invest in employees, (3) deal ethically with suppliers, (4) support their communities and protect the environment, (5) generate long-term value for shareholders. Curiously, the latter seems not to impede firms from achieving the previous goals.

For this reason, critics point out such manifestos amount to a public-relations campaign rather than a real corporate-behavior overhaul. University of Chicago Professor Luigi Zingales, for instance, called this effort “at best misleading marketing, at worst a dangerous power grab.”

Woke capitalists cannot brush aside existing legal and practical barriers, even if they would like to. Corporate laws in Canada, the United States, and the United Kingdom—for instance—do not allow companies to prioritize social and environmental mandates. Shareholders have taken companies to court and won over dereliction of duty to profitability.

Columbia University Law Professor Katharina Pistor, a participant in a Davos panel, admitted systemic legal change is necessary for stakeholder capitalism’s advancement. Further, if corporations were to embrace stakeholder capitalism as their business model, they would require new indicators to mimic or rival those of financial performance. They would also need to reform corporate-governance systems to ensure accountability.

Still the Best Game in Town

Shareholder primacy promotes extreme competition in pursuit of profits for stockholders. However, firms do not exist in a vacuum. They can hardly thrive in today’s economy without compensating employees at market rates, maintaining good relations with suppliers, and providing customers with environmentally friendly products and services they demand. 

As Friedman explained, in a laissez-faire economy firms pursue profit within the rules of the game, such as contracts and property rights. Since legislation changes to address social concerns such as pollution, these firms must adapt to continue maximizing profit.

Let us not lose sight of how we got here. Markets have incorporated dominant social concerns through innovation. If legislation provides clear guidelines and abstains from picking winners and losers, firms necessarily look to the long term. Indeed, many Davos speakers admitted that in 2019 investors placed $20 billion—almost four times more than the 2018 record—in so-called environmental, social, and governance (ESG) funds.

Wealth managers are scrambling to deploy capital to ESG funds not because they underperform relative to traditional ones, but because they are similarly profitable and in demand by their clients. Even hedge funds, which exist to generate maximum returns, are incorporating ESG policies. 

By giving shareholders priority, corporations are indirectly serving the wider economy and society. They are just not necessarily serving the interests of government officials and social engineers.

 

 

Paz Gómez is a research associate with the Frontier Centre for Public Policy.