The “Stakeholder Corporate Governance Model” — Fallacies Galore


The corporate governance and business worlds are overwhelmed with concepts that have little to do with actual business, i.e. making and selling products or providing services. One these constructs that has been beat to death but continues to permeate (and expand) the landscape is the so called “stakeholder” model of governance. Included here should be Senator Elizabeth Warren’s “Accountable Capitalism act which would require a Federal Charter for all companies with revenue in excess of $1 Billion and would permit (this is the stakeholder part) employees to elect 40% of the board of directors. And closer to home, I actually had an editor at a major (very major) business publication call an article I had written, pitched to him by my PR firm, “evil” as it focused on shareholders rather than stakeholders. Then there is the Business Roundtable statement which I have addressed in separate articles.

The basic premise of the “stakeholder” model is that the board of directors should treat all “stakeholders” equally when establishing initiatives, making decisions etc. The proponents of this unworkable and anti-capitalist model argue that there has been a shareholder primacy model of governance in place for too long that totally ignores the “needs” of all of the other stakeholders in favor of shareholders.

The first fallacy of this premise is that there is a real “Shareholder Primacy” model in place currently. This model would imply that the primary focus of the board is to maximize shareholder value. That is not correct. The current governance model is obsessed with director independence, compliance, social justice, risk avoidance, oversight and quarterly earnings. This is not a governance model that is conducive to shareholder value maximization. To find that model one has to go to the portfolio companies of the best private equity firms or the few companies that have a large presence of operationally oriented activist investor nominees on the board. So, those who fight against the shareholder primacy model are not dissimilar to Don Quixote tilting at windmills. (I point out clearly in my recent book the pressing need to change this model but not to one that is “stakeholder” focused).

The second fallacy is implicit in that the “need” for a stakeholder model is in reaction to the unfairness (choose your word) and lack of attention to stakeholders. Although dependent upon the advocate for this model, typically the stakeholder list includes employees, customers, suppliers and the communities in which the company operates. Granted there may be many companies that do not deal as well as they could with various stakeholders but it is the rare company in which any are abused or treated abjectly bad.

One of the primary arguments made is that the pursuit of shareholder value maximization is “damaging” to other stakeholders. Again, most public companies do not do a very good job of allocating capital and driving performance in such a way that would genuinely maximize shareholder value. But, it is silly to think that shareholder value could be maximized while treating employees, customers, suppliers poorly.

One other stakeholder that is sometimes considered is the environment. Again, this is being addressed now at many if not most companies and done properly is not only not in conflict with maximizing shareholder value, it can be a part of driving this value. However, this assumes that major environmental/sustainability initiatives are treated in the same manner as any other business initiative: 1) Should be directly relevant and material to the company and 2) Standard return investment hurdle rates are applied to any decision of this nature.

The third, and perhaps, major fallacy with the stakeholder model is that it is unworkable. To any basic student of organizational studies, it is axiomatic that “accountability to all is accountability to none.” In short, when the board is equally accountable to all “stakeholders” there is no context for decision making. Consider the following examples from actual situations:

Employees — A company has multiple manufacturing plants in California. A combination of increased minimum wage in these areas and the decreased cost of a certain kind of robot has resulted in return on investment hurdle rates being cleared on implementing robotic technology into the plants. The installation of these robots will result in the loss of the assembly line workers in all of these plants but will increase efficiency and profitability at the company. With a stakeholder model does the board decide for the shareholders (install the robots) or for the employees (do not install the robots allowing the production workers to retain their jobs)?

Customers — A company is acquired and an in-depth analysis is done regarding the profitability of every single customer. The analysis shows that approximately 3% of the company’s customers are unprofitable. After further analysis it is determined that nothing can be done to move most of the customers to profitability. In a stakeholder model does the board decide for the shareholders (discontinue service to these customers) or for the customers (continue servicing them even though money is being lost)?

Suppliers — A deep dive into the efficacy of a company’s procurement operation determines that it is underperforming. The same suppliers for both inputs and services to the company have been in place for many years with no effort to seek lower cost but similar quality suppliers and to negotiate hard with current suppliers. In a stakeholder model, does the board decide for the shareholders (resulting either in the loss of business for certain suppliers or lower prices) or for the suppliers (maintain the status quo)?

Not only does the stakeholder model create chaos, confusion and ultimately lack of competitiveness, there are other likely consequences as noted by the William D. Warren Distinguished Professor of Law at UCLA School of Law Stephen Bainbridge: “If directors were allowed to deviate from shareholder wealth maximization [as in a stakeholder model], they would inevitably turn to indeterminate balancing standards, which provide no accountability. As a result, directors could be tempted to pursue their own self-interest.”

There is a fourth issue with the stakeholder model. Its proponents do not seem to understand that “doing right” goes two ways between the company and at least two of the so called stakeholders: Employees and suppliers. Those who push for the stakeholder model seem to view the company as the “bad guy” and all of the other stakeholders as “victims.”

Employees have clear responsibility to the company. They should be expected to execute their jobs at the highest level possible and to do so honestly and ethically. Even without a written and signed document, there is a form of contractual relationship between an employee and the company for which he or she works. As an example, this does not give employees, in groups, the right to walk off the job to protest some action on the part of the company with which they disagree even though many in the current workforce seem to think this is acceptable behavior. And, while I cannot confirm it, I would risk a bet that most proponents of the stakeholder model would view this as the employees’ right.

In a similar manner, suppliers also have a responsibility to the company to provide products and/or services to the company on agreed terms and with the quality promised. Again, it is not a one way trip from company to stakeholders alone.

While the current public company governance model leaves much to be desired, its negatives pale in comparison to the stakeholder model. Implementing a stakeholder model would ultimately result in no accountability, lowered performance standards, diminished competitiveness and potentially ramp up self-interest actions on the part of the board.

The push for the stakeholder model seems to be part and parcel of a much broader “anti-capitalist, forced equality” major trend sweeping the country. This is not new — review the legislation enacted during the 1980’s in reaction to the wave of attempted and actual hostile takeovers. This legislation, largely lobbied by representatives of incumbent managements and boards, allowed directors to consider the impact of acquisitions on all constituencies, not just shareholders. (It also allowed further entrenchment on the part these managers and boards which was the real objective). But, there is something more pervasive and powerful about the more recent movement toward stakeholders. As the primary defender of entrenched corporate boards and management in the 1980’s (and beyond), Martin Lipton, stated in a recent Harvard Law School Forum on Corporate Governance blog that 2019 was a, “watershed year in the evolution of corporate governance” due to the “advent of stakeholder governance.”

One has to wonder when high performance, exacting standards, excellence, individual responsibility and self-reliance — all of which are integral to capitalism and to a real shareholder value maximization model — became pariahs in the United States. One also has to wonder who are the various “constituents” advocating for the stakeholder model and what the actual motivation for each is.




Takeover entrepreneur, activist investor and author of Governance Arbitrage

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Henry D. Wolfe

Henry D. Wolfe

Takeover entrepreneur, activist investor and author of Governance Arbitrage

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