Shareholder Capitalism is dead. Long live Stakeholder Capitalism!

Headlines coming out of the 2020 World Economic Forum would have us believe that there is a fundamental shift in public corporations’ raison d’etre: from creating value for shareholders to benefiting society-at-large. A group of 200 influential CEOs declared that the primary purpose of the corporation was to serve all stakeholders customers, employees, suppliers, communities and shareholders, not just capital providers. Larry Fink, the CEO of BlackRock, declared that it would shift its investments towards firms that support sustainable growth. Goldman Sachs recently announced that it wouldn’t take companies public if they have all-male corporate boards.

 I have, for long, believed that there is no conflict between shareholder and stakeholder capitalism. The notion that one can maximise shareholder wealth to the exclusion of stakeholders is misplaced. For instance, if you paid your employees poorly, they would shift to another company that paid a more reasonable wage. The incumbent firm would be left with low productivity employees that would raise costs, lower profits and reduce shareholder value. Take another case, if a supplier is not paid timely or pressured too much on price, she may start supplying poor quality inputs impacting the overall quality of the final product. One can maximise shareholder value only if we maximise value to all stakeholders. Thus, there should be no conflict between the two. This debate is captured nicely in the movie, Other People’s Money. Yet, we regularly see a focus on shareholder value maximisation.

So, what is the genesis of this contradiction? Two possible reasons.

 Market imperfections: Imperfections in markets make it difficult for people to change jobs quickly, find another producer, or, find another customer.

 Short-termism: CEOs live from quarter to quarter in the belief that weak performance in a quarter would lead to a clamour for their ousting. Boards hire and fire based on metrics like revenues, profits and share prices. The board of directors continue to be selected by shareholders to protect their interests. Thus, the blind focus on quarterly EPS and stock price to the exclusion of everything else.

 Market imperfections are something we cannot do much about. Short-termism, however, it is relatively easier to work on even though it is a wickedly tough question. Merely changing the narrative from shareholder to stakeholder is not enough, but it is a start. Business leaders need to align themselves to the new narrative. This requires a change in the mindset of both the board as well as the CEOs. Behavioural economists talk of nudging to change behaviours. These nudges will come from government, society and stakeholders. With business leaders nudged into appropriate actions, there will be a need for alternative measurement. Share price and EPS are not enough. The financial statements need to be retooled. The balance sheet and profit and loss statements need to capture economic, social and governance (ESG) elements. Take the case of emissions. Although difficult to measure the potential harm due to emissions can be captured on the balance sheet as an expense. Similarly, estimates of lack of diversity will appear on the income statement as an expense. These measurements are similar to those used for valuing externalities. Essentially, there is a need for a framework that generates an “ESG” EPS. The idea of “ESG” EPS may sound radical but will help align the interests of all stakeholders and will help reduce the distance between shareholder capitalism and stakeholder capitalism.

 The role of the CFO will change too. From having the central responsibility for delivering financial results to shareholders, she will have to co-opt the COO, CMO, CIO, and the CEO to help her figure out the ESG issues that impact financial performance.

The COVID-19 events have shown that many of the companies that made the call for stakeholder capitalism have furloughed or fired their staff, cancelled contracts of suppliers, reneged on rent payments and taken many more actions that have hurt the stakeholders. The real character shows up in tough times. Boards and CEOs must make stakeholder capitalism a reality.