Shareholders or stakeholders?

Posted by Marc Hodak on October 18, 2007 under Economics | Read the First Comment

Franklin Allen, Elena Carletti, Robert Marquez raise the age-old question, “Shareholders or stakeholders?” in this study. When finance and economic professors resurrect this popular dichotomy, they invariably blur a much more useful distinction: short-term vs. long-term. From their study:

A surprising finding is that “some companies may choose to become stakeholder-oriented because it increases their value and benefits shareholders,” according to Allen.

I live in two worlds. In the academic world, we can create artificial distinctions like “stakeholders,” and show how concern for stakeholders actually improves shareholder welfare, as this study seems to show. We can show, as these authors do, that over three-quarters of managers across countries actually claim that “a company exists for all stakeholders,” and think that’s surprising or meaningful.

In my other world, the real world, I have to tell managers what to do day-to-day. (Actually, I create incentives to encourage certain behavior.) And I know that managers, like all of us, have this inherent limitation–we can have many objectives at one time, but we can only maximize according to a single rule when they come into conflict. So, when a conflict arises between the interests of the shareholder’s and those of, say, the workers, how do we decide what to do? One has only four choices:

1) Maximize for the shareholders
2) Maximize for the workers
3) Sometimes maximize on (1) and sometimes on (2)
4) Maximize according to some objective function that accounts for both according to some decision rule or formula

Option 4 is a canard. There is no such objective function that all managers can adopt for that option; and even if there were, they couldn’t do it, besides. Most managers, as a practical matter, choose 3, which means that they don’t maximize anything at all.

This study would suggest that you should focus on (2), the workers…and shareholders will be better off!

Well, in the real world, if you find that taking care of your workers leads to better shareholder results (which is often, but not always the case), and that’s what you’re really after, then wouldn’t it make life easier if you simply choose (1), and make sure that your shareholder value-maximizing business model accounts for other stakeholders along the way?

Duh.

The problem with managers, who are regular people after all, is that if you give them the excuse to diffuse their focus, they will dissipate their energy and attention accordingly, and will do silly things, like option 3, helping the workers when it’s the easy thing to do even though it might hurt the shareholders (who wants to shut down a plant and lay people off?); then all stakeholders are eventually worse off. It’s much better for everyone, as these authors implicitly acknowledge, if you simply focus on taking care of shareholders over the long-term.

Oh, it’s hard to take care of the long-term interests of shareholders. It requires managers to stretch themselves far beyond the minimum requirements of their fiduciary responsibilities. It requires them to develop a truly sophisticated model of the business that takes every factor into account, not just the ones they can easily control. It requires that they sometimes sacrifice their personal interests for the sake of the owners (sorry, you have to miss many of your kids’ ball games). A diffused, stakeholder focus offers much less accountability. Knowing that that’s the real-world difference, is it any wonder that managers prefer to believe that the “company exists for all stakeholders,” as this study shows to the surprise of the authors?