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From Shareholder Theory

to Stakeholder Theory:

New Mindset and Practical Measures

Simon S.M. Ho

President, Hang Seng Management College

simonho@hsmc.edu.hk

10 December 2016

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Limitations of Concepts Promoting

Social Values

Corporate Social Responsibility (CSR)

Creating Shared Values (CSV)

Social Enterprises (SE)

B Corporations

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Shareholders Vs. Stakeholders

Milton Friedman (1970s) -- Shareholder Theory The sole responsibility of a business is to increase its

profit legally and ethically via fair market competition, return it to the shareholders and let hem spend their money as they wish

Edward Freeman (1990s) -- Stakeholder Theory Corporations cannot be thought of as being

responsible to only one group, but must be seen to bear responsibilities to all of the individuals their activities affect, and upon whom their existence depends

Both do not emphasize on creating social or public value

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Shareholders Right & Director/CEO

Duties

1. Company directors & CEO are the agent of the

shareholders only?

2. Company directors & CEO are legally obliged to

maximize shareholder value (MSV)?

3. Existing law prevent the Board of Directors from

considering the interests of non-shareholder

stakeholders?

4. MSV is in the best interests of the company?

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Assumptions of MSV

• Since the mid-20th century, the belief in shareholder primacy & MSV has been deeply embedded throughout the business sector

• Is widely taught in business schools

• Blind faith in the MSV dogma is believed to be one of the main causes of the financial crises and various corporate scandals

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Fixing the Misconceptions & Myths

of MSV

Shareholders (except private proprietors) do NOT own

the company or its assets

Directors and senior executives are NOT the agent of the

shareholders only (the latter are appointed indirectly via

the BoDs).

Directors are NOT legally obliged to maximize

shareholder value.

MSV is NOT in the best long-term interests of the

company.

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Fixing the Misconception & Myths of

MVS (2)

MSV assumptions are false or not supported by the current legal system and dominant economic theories (only a market norm & habit)

Most shareholders mainly have dividends rights and voting rights on limited issues including appointing directors.

“MSV is not a managerial obligation, it is a managerial choice” (Lynn Stout of Cornell Law School), 2012

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The Intended and Unintended

Consequences of MVS (1)

Management focus on expectation (stock) market than real (product) market

High debt financing and high dividend payment

Encouraging short-termism, reducing investing in R & D and innovations

A doubling of stock buybacks was correlated with an 8% fall in R & D spending (The Economists)

Growing macroeconomic instability

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The Intended and Unintended

Consequences of MVS (2)

Excessive and abusing executive stock option pays excessive risk-taking

Other social & environmental externalities

Average stockholding period: 8 years in 1960s 4 months today

Average life expectancy of corporations:

55 years in 1960s 15 years

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Rationale of Stakeholder Theory

there is growing belief that corporate executives should not be concentrating solely on shareholder interests through profit maximisation,

but should also be balancing the interests of various stakeholders to earn reasonable (rather than maximised) profits and to promote sustainable values.

Stakeholder theory posits that non-shareholder stakeholders should be consulted on the major decisions that companies take.

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Edward Freeman’s Stakeholder Theory

6 stakeholder groups have a right to demand certain actions from the management and not to be treated as a mere means:

Shareholders

Senior management

Employees

Suppliers

Customers

Local community

Those engaged in a reciprocal relationship with the company, and are vital to the survival & success of the corporation

The Management should carefully balance the competing interests of many stakeholder groups

Stakeholder Model (Simon S.M. Ho, 2006)

Controlling Shareholders

Minority Shareholders

Board of

Directors

The

Executive

Management

Customers

Suppliers

Employees Government

Creditors

The Community

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Stakeholder Theory: R. Edward Freeman’s Doctrine of Fair Contract

The Principle of Entry and Exit Clearly defined entry, exit and renegotiations rules/conditions

The Principle of Governance Rules of the game set by unanimous consent

The Principle of Externalities If effected person want can be renegotiated

The Principle of Contracting Costs Shared cost of contracting

The Agency Principle Must act in the interest of all stakeholders

The Principle of Limited Immortality Continued existence of corporation is an all stakeholder interests

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Critique of Stakeholder Theory (1)

Allowing other stakeholders to participate to determine the future directions of the firm change the normal dynamics of the business world and violate some rights of the shareholders

Respect to other layman stakeholders is shown by treating them as contractors. It does not require “having a say”

Student’s grade

‘You cannot please everyone and that the inability to appease all stakeholders’.

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Critique of Stakeholder Theory (2)

How to identify relevant stakeholders and should they be individuals, groups or organizations? On what criteria?

How they can elect stakeholder group representatives?

Should all stakeholders’ votes receive equal weight or do some groups have priority interests?

Using Freeman’s model in solving stakeholders’ conflicting interests can still be problematic

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Limitations of Concepts Promoting

Social Values

Corporate Social Responsibility (CSR)

Creating Shared Values (CSV)

Social Enterprises (SE)

B Corporations

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Levels of CSR

(1) Advantageous to both(2)Advantageous to

corporation but not advantageous to the society

(3) Advantageous to society but not advantageous to corporation

(4) Not advantageous to both

Social Value

Eco

no

mic

Valu

e +

-

+ -

The Value Matrix (VM)

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Limitation of Social and Charitable

CSR

Most ‘CSR’ activities today are social, charitable or environmental which are outside their core businesses

While some CSR steam from compensating the social costs incurred (i.e. compensational CSR) or altruism (i.e. caring CSR), and many expect more CSR activities can lead to better reputation and thus more businesses (i.e. instrumental CSR)

Most firms engaging such CSR still adopt a MVS view, not a stakeholder approach

Corporations engaging in CSR do not imply they already comply with legal and ethical obligations, may undermine the interests of employees & customers.

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Limitation of Social and Charitable

CSR

The term ‘social’ is vague. It may mean all stakeholders including employees & customers, or the community or the whole society.

For charitable or community-based CSR outside core businesses, excessive commitments may be applauded by the public but not sustainable

Usually a BoD pre-approved 5% of annual profit is acceptable

The Management should not be too generous on such at the interests of the company, its shareholders and other stakeholders.

Limitations of Creating Shared

Values ((Porter & Kramer, 2011)

• To enhance economic value or competitiveness while at the same time addressing social problems

• Not a new concept, similar to strategic CSR

• Still assumes MVS, though placing greater emphasis on social values

• Like CSR, assumes corporations already follow the law and behaves ethically (which seems not true)

- Do not really allow other stakeholders to take part in determining the directions of the firm

Limitations of Creating Shared

Values (Porter & Kramer, 2011)

• Ignores conflicts between economic and social goals

• Some social initiatives will benefit some firms, under some conditions, some of the time no magic bullet

• Most large companies focus on stimulating further demand among affluent customers

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Purposes of Social Enterprises

The Skoll Foundation: “social entrepreneurs” as “society’s change agents: creators of innovations that disrupt the status quo and transform our world for the better”.

Roger Martin & Sally Osberg: “ a social entrepreneur identifies an unjust social equilibrium, identifies a means of changing it, and implements the change, forming a new social equilibrium”.

Social entrepreneur vs social enterprises

SEs have clear social missions and to be self-financed using market forces

Focus on and create more social values than mainstream businesses, but not the only institutions to create social changes

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Limitation of Social Enterprises

Definition & certification

Emphasising more ‘entrepreneurship’ than ‘social’

Lack of innovations (novelty, impact, size, adoption rate)

Focus on ‘enterprises’ or ‘entrepreneurship’?

Narrow financing sources (donors do not receive tax deductions)

Restricted profit redistribution to shareholders

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Limitation of Social Enterprises

Economic and social impact are relatively small

Still play an important complementary role as for-profit companies may not be interested in addressing some social issues for business

Social entrepreneurship is not the only, and not always the best way to achieve social changes/values (e.g. indivudals, Govt., NGOs, companies)

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Purposes of B Corporations

• New hybrid type of corporation: falls somewhere between SEs and mainstream enterprises, ‘Business as a force for good’

• The company charter of a B Corp specifies that it resolves some social problems in addition to earning profits.

• Unlike SE shareholders, B Corps shareholders are not prevented from seeking high investment returns.

• Protects B Corp. directors from liability when they consider the interests of non-shareholders, even if those decisions do no necessarily MSV.

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Purposes of B Corporations

• The B-Lab system ensures that all certified B Corps adopt charters that explicitly address social and environmental issues and that they are legally accountable for meeting defined performance standards.

• The statutes were passed in most states in the USA

• Through mutual agreements, certified B Corps can trade with one another with special discounts and beneficial terms.

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Limitation of B Corporations

Similar to SEs in some ways

Its primary rationale rests on the mistaken, though widely-held, assumption that existing law prevents BoD from considering the interests of non-shareholder stakeholders

Still hold the unfortunate misconception that existing law forces corporations to single-mindedly MSV

Most states adopted “constituency statutes” explicitly empowering directors to consider the interests of other stakeholders.

B Corp. advocates provide mainstream corporations with excuses not to consider other stakeholders’ interests by overstating the limitations of existing law placed on director’s’ decisions.

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Merits of B Corporations

The more mainstream corporations convert to B Corp., the better? Or in fact there should not be any B Corp. some day?

B Corp still a good idea and play a complementary role in the movement period to focus on social value

The law’s mandatory company charter, accountability, transparency and legal protection provisions will help attract more responsible investors’ capital

The B Corp banner/logo gives marketing, recruitment and other management advantages

However, the ultimate mission of its advocates should urge all companies to adopt a stakeholder approach (instead of excusing them not to do so)

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Mainstream Corporations vs.

Social-purpose Corporations

To have a clear division of labor: Mainstream enterprises focus on creating private economic

values,

SE/B Corp. focus on creating public social value from addressing a specific social issue

Without initiatives taken by social entrepreneurs, the status quo would stand mostly uncontested and pressing social problems would remain largely unresolved.

Not to make every business to become a social business

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Towards Stakeholder-based CG Model:

Reforming Board Governance

1. By amending existing law, expressly extending legal fiduciary duty of board directors & executives to non-shareholder stakeholders, allowing such stakeholders with a legal right to challenge board decisions in court

2. Allocating board seats to a broader groups of stakeholders including at least one employee

3. Forming a Stakeholder Advisory Council

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Towards Stakeholder-based CG Model:

Changing Executive and Employee Pay

1. Restructuring executive compensation to focus mainly on the real market not the stock market (abolishing stock options?)

2. Tie part of incentive compensation to the interests/performance of other stakeholders (including social & environmental)

3. Paying a minimum reasonable % (say as least ¼) of annual profits to non-executive employees

4. Narrowing the pay gap between lowest-paid and the highest-pad staff (say not more than 15 times)

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Towards Stakeholder-based CG Model:

Cross-sector Social Innovations

1. Taking the lead in social/business innovations in order to making a better world (and more profits).

2. Companies at all times should have at least one bold, pioneering & strategic initiative under way

3. Some innovations can be more feasible and beneficial by joint actions with other companies, NGOs, and/or social enterprises

4. Cross-sector collaborations on social innovations: enhancing free exchanges of ideas, values & resources

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Unique Roles of Family Businesses

Leaders as Pioneers

Reduced agency costs

Family values tie with business value

Have a more long-term vision in creating

values

Would be easier to embrace other

stakeholders

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Changes in the Values/Beliefs of

Business Executives and Students

A management job is a noble calling, towards the ‘stakeholder-based liberal art approach’

Promote new mindsets of personal/corporate success vs value: wisdom, integrity, justice, equality, diversity, people caring, contribution to others, win-win, sustainability, harmony

If directors/CEOs engage in strengthening the civil foundation, they would lead more authentic and fulfilling lives

In doing so, we can restore the core of free capitalism and the bond of trust between business, government and society

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Thanks

謝謝