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 build back better and create value for society after the pandemic, stakeholder capitalism must become workable and real.
A major 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 to companies if they truly adopt stakeholder capitalism as currently defined.
Focus on long-term shareholder value creation
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.
In our experience working with boards and top teams on governance issues at the IMD Global Board Center, the companies that do create value for a broad set of stakeholders focus rigorously on long-term profitability, creating long-term value for shareholders.
It may seem counterintuitive, but by focusing on long-term value for shareholders, stakeholders share in the benefits. 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.
Distinguish between stakeholders
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 create value for the company must be treated differently from those who want short-term pay-outs. 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.
Executives must mobilize as many stakeholders as possible with a shared strategic purpose and win-win initiatives that increase the long-term value of the company. These stakeholder relations cannot be PR gestures; developing a culture that supports them requires committed and effective change management, as well as additional rewards.
For example, Chobani, the U.S. yogurt maker has compacts with its consumers, employees, and communities where it operates, to drive environmentally friendly growth, including for some, the distribution of ownership shares.
Executives must cut ties with predators seeking short-term pay-outs and free riders who deplete long-term shareholder value. Compromising with the demands of asset-strippers, disruptive partners, self-serving CEOs, or executive free riders at losing divisions, undermines the company’s long-term survival. To continue its pursuit of long-term value that started in 1835, the world’s second-largest wine and spirits company Pernod Ricard announced a major cost reduction program to see off activist investor Elliot Management.
Reduce ESG risks 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.
Executives should take the ESG risks for their shareholders seriously. But 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. The Dutch company, DSM, has done so for more than a century. Now a €20 billion biotech and ESG champion, it 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 reduce the exploitation of weak stakeholders, the related ESG risks for shareholders must be more immediately apparent and increased. 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.