The current concept of stakeholder capitalism, which calls for companies to serve the interests of all stakeholders, is flawed. Most companies merely pay it lip service. If companies are to create value for society, stakeholder capitalism must be workable and real.
A major first flaw is the absence of a practical criterion for deciding how to allocate resources across conflicting stakeholder interests. Consumers call for lower prices while employees want higher compensation; shareholders demand dividends while society calls for pandemic aid. The confusion caused by competing interests at multilateral organizations, like the United Nations, is a warning of what will happen if companies truly adopt stakeholder capitalism as currently defined.
Boards that want to make stakeholder capitalism work for their companies can learn from those that have reconciled their shareholders with other stakeholders, like the global Dutch biotech leader, DSM, or the US yogurt maker, Chobani, or the world’s second-largest wine and spirits company, Pernod-Ricard. As my colleagues and I have shown in a recent article, three principles stand out:
First, create long-term shareholder value by mobilizing as many stakeholders as possible with win-win strategic initiatives
Before short-term shareholder capitalism invaded boardrooms, companies were run in the interests of their owners, founders, or families. These interests were mainly long-term, except during periods of ownership crisis. The perennial health of the company was the overriding criterion for deciding how to deal with conflicting stakeholder interests. Apart from robber-barons with monopoly positions, this meant rewarding customers, employees and the community to improve the company’s long-term performance.
To increase their long-term revenues companies have to offer their customers a superior value proposition; to retain the commitment of their value-creating employees they have to give them superior rewards; to maintain their social license to operate over the long run they have to ensure that they don’t harm the communities and environment in which they operate.
Companies today that create value for a broad set of stakeholders focus rigorously on creating long-term value for their shareholders. They mobilize mobilize as many stakeholders as possible with a shared strategic purpose and initiatives that are a win both for stakeholders and long-term shareholders. These stakeholder relations are not PR gestures. Developing a supporting culture requires committed and effective change management, as well as additional rewards.
For example, Chobani, in the pursuit of long-term shareholder value has compacts with its consumers, employees, and communities where it operates, to drive environmentally friendly growth, including for some, the distribution of ownership shares.
Second, pre-empt the value-destroying traps set by stakeholders who extract value from the company
A second flaw in the existing view of stakeholder capitalism is the call to serve the interests of all stakeholders. In practice, this is impossible. Those who want short-term pay-outs must be treated differently from those who create value for the company. Stakeholders who benefit from the company’s largess must be treated differently from those who suffer from undesired side-effects. To make stakeholder capitalism real, executives must treat broad sets of stakeholders very differently.
Ties must be cut with predators, like activists seeking self-serving short-term pay-outs, and free riders, like zombie executives who deplete long-term shareholder value. Compromising with the demands of asset-strippers, disruptive partners, self-serving CEOs, executive free riders, or self-centered investment bankers, undermines the company’s long-term survival. Executives must ensure ensure that no one can come up with a better way of deploying the company’s resources, for example, leaving no idle cash or underperforming assets lying around.
To continue its pursuit of long-term value that started in 1835, Pernod Ricard announced a major cost reduction program, as soon as it got wind of the analysis by the activist investor, Elliot Management, that it could reduce costs and make bigger short-term pay-outs.
Third, reduce ESG risks early on by avoiding the exploitation of weak stakeholders
A third flaw in the current view of stakeholder capitalism is the lack of a strong incentive to avoid exploiting weak stakeholders. Penalties, if they occur for taking advantage of weak stakeholders, only kick in later, as BP discovered when – after lowering costs and downplaying environmental safety – it had to pay $65 billion for the damage from the oil rig explosion in the Bay of Mexico. VW also learned this the hard way when – after prioritizing US growth and deceiving customers– it had to pay €30 billion in penalties for rigging its diesel pollution control system.
Companies that are serious about stakeholder capitalism should use the long-term value of the firm as the incentive to avoid exploitation and convert weak stakeholders into value creators early on. DSM has worked with and avoided the exploitation of its workers or local communities for more than a century. Now a €20 billion biotech and ESG champion, it recently converted the environment from a potential victim to a focus of sustainable value creation by remunerating its executives with bonuses and stock options tied to sustainability goals.
Yet, many large companies will continue making stakeholder capitalism an oxymoron. They will exploit weak stakeholders where they can get away with it, the way big tech calmly monetizes consumer data and buys out emerging competitors.
To get companies to reduce the exploitation of weak stakeholders, the related ESG risks for long-term shareholders must be more immediately apparent and increased. The impact on long-term shareholders is key, because they play a critical economic role investing in the most promising value-creating companies. Standardized reporting of ESG risks backed up by legal sanctions for deception would help investors penalize companies that systematically expose them to high risk. Politicians must have the courage to cross the political divide and take action to increase the immediate penalties for extracting value from weak stakeholders, including the environment. Too many companies need the threat of penalties to get them to reduce their ESG risks.
Greed is not dead.