Stakeholder Claims and Corporate Governance

This paper - tends to be somewhat sceptical about stakeholder arguments/concepts. Please read the notes bearing this in mind. The writer is just not convinced by the woolly polemic of the "stakeholder approach" and its arguments. Lots of collective idealism is evident but the lovely, " lets-be-a-collective-together , sharing and caring " idea - seems never to be presented in a way that defines actual new organisational forms and mechanisms for corporate governance and decision-making - that will work!

The call for a "stakeholder economy" gets publicity and attention (see Hutton 1995). But what does the concept mean? Ideas of stakeholder capitalism reflect political values. Matters of redistribution of ownership and the participation for all agenda are difficult to reconcile in practice. Two propositions are involved

1. a political commitment to every individual citizen and important interest having a stake in society with a voice in the way it is run.
2. firms should be reorganised so that all stakeholders - such as, shareholders, consumers, and employees - can participate in the making of decisions.

However it does not follow that the methods adopted for B will satisfy the requirements of A.

The "stakeholder society" notion is one in which

• through forms of democratic representation - all individuals and interests have a stake in X. What is X?
• a public interest "concept" ensures equality of opportunity and a minimum guarantee for all citizens.

This is rhetorical. Practicable proposals for poverty, dependency and job creation etc are - like the Scarlet Pimpernel - elusive.

Social Welfare

Today century stakeholder capitalism accepts programmes of health, social security, training and education so that all citizens can participate fully in the economy and society.

Common ownership - Nationalisation

Many think that for stakeholder capitalism to have real meaning, this should involve stakeholding not just through national legislation and welfare policy but also at the level at which people work. Nationalisation changed ownership but with little internal re-organisation of nationalised companies. Traditional management hierarchies remained in place.

Corporate Governance

• it will improve economic performance
• it is a step towards economic democracy.

But with a tension between economic efficiency and democracy, the former will dominate. A government would find it as hard put to impose changes on firms in the name of the stakeholder society as they found it hard to impose meaningful industrial democracy.

Market entry/exit and democratic voice

All economic systems are characterised by institutions of

1. free market processes of entry/exit and
2. institutions upholding a claim right for a democratic voice i.e. "having a say".

Economists tend to assume perfect competition and information concluding that institutional regulatory structures undermine market efficient, economic outcomes. "Why devise cumbersome institutional mechanisms for individuals and groups to indulge in a democratic voice over market processes when it can have little effect ?"

• The Right argue that welfare improvements stem naturally from free market forces anyway. Individuals as economic agents have the right to enter into or exit from exchanges they find advantageous or otherwise.
• The Left argue that social welfare is best improved through "democratic voice", via national or local participation. The energy of market entry/exit as a mechanism for ensuring autonomy and choice - is discounted. Competition as a mechanism undermines socialist political objectives.

Stakeholder Claim Rights

• Which should have rights to influence key decisions on how and by whom corporate assets are managed ?
• What form would these rights take ?

The orthodoxy is thatthe firm's purpose of the firm is to maximise profits so only stakeholders who bear direct financial risk - shareholders - should have the claim right of voice to determine policy . Other stakeholders have the right of exit. Consumers can stop buying the product, workers leavefor a better job, banks can call in loans.

Yet stakeholders with investments and costs "sunk" in the firm (e.g. workers who have invested in skills specific to a firm) require insurance against the firm acting exploitatively against their interests. But should the stakeholder group receive this protection through a "legal contract" or some other right of voice in the firm's operations?

A shareholder's relationship with the firm is not "periodically renewed". They do not agree an individual contract with the firm before investing in equity. They make judgements and buy and sell in the equity market. Giving voting rights over company decisions to other stakeholders arguably would

• result in extra costs
• constrain the drive for profit maximisation
• muddle objectives (plurality) and undermine performance.

The Problem of Agency

Do all stakeholders support the firm - or is this a NIMBY issue?

• have an incentive to support the firm's search for success. Always?
• detailed knowledge of the firms operations - do they?
• information and motivation to monitor and shape the firms behaviour? How is this mobilised - is this assertion wholly true?
• dispersal of shareholders means limited control over management. But what are the market mechanisms that so this? Many stakeholders inhabit that market and are capable of intervening in a plurality of ways?

Stakeholder claims on Corporate Governance

Advocates see economic benefits coming from.

1. potential reduction in external costs imposed on stakeholders by the firm. The argument however is aspirational..... Firms treat most costs as externalities and disclaim responsibility for them. Conflict results - strikes, lawsuits, and government imposed controls and regulation. Thus - the argument goes - the ideal stakeholder firm would handle these costs through internal negotiation with its stakeholders. Of course they could and they do! The generality already holds true - its implausibility lies in its all embracing claim.
2. The assertion is that a stakeholder approach encourages better transfer of information between elements of the firm. Competitiveness is affected by whether stakeholders (banks, sub-contractors or workers) can reach agreements with managers. Sharing of information and the mutual trust is required. A governance structure which encourages information disclosure may generate such long-term relationships, or "implicit contracts".

   But these occur already via commercial contract negotiations - it is difficult to see how a universal "social" prescription - will apply in all situations.

Takeovers

Takeovers that apparently create value in the form of higher share prices (and thereby increase overall social welfare) may unequally redistribute existing value between stakeholders. Take-over threats can deter long-term stakeholder relationships or R&D spending - important to competitiveness.

Takeovers - privately beneficial to shareholders - may impose costs on the rest of society (who, how, what?). Stakeholder advocates may argue for redefinition of corporate boundaries to incorporate key stakeholder interests in takeovers ostensively to secure better congruence between company interests and "society". But the rhetoric and the practicality are difficult to reconcile. Many on the centre-left to advocate stringent checks on take-overs and we search for better mechanisms to discipline and maybe remove inadequate management teams.

Dispersed ownership of corporations impedes active shareholder governance. The disciplining role is inextricably linked to the scrutiny of the take-over process or fear of takeover. Simply asserting a social cost to this process is not a case for reform unless other proposals would ensure a better way of controlling management.

No solution?

Problems With Reform

1. who are the stakeholders ?

   If any group which is affected by the operations of a company is considered to have an equal stake in it, then the idea of stakeholding would be unworkable. Relevant stakeholders vary according to the firm's circumstances.
   • Consumers need a strong voice in monopolies such as the utilities - inappropriate for firms in a competitive market. Increased competition reduces the cost of stakeholders using the "exit" mechanism and lessens the need for "voice".
   • What procedure will ascribe weight to different stakeholder interests and who will define specific rights of
     • ownership
     • a vote on the Board
     • veto powers
     • a right to consultation
     • compensation.

   • Not every stakeholder should have the same rights
   • participation can be achieved in different ways
   • we must recognise also that being a stakeholder confers obligations as well as rights. What are the obligations?

2. how many stakeholders ?

   With a profusion of stakeholders - all with some veto powers over how the firm is run - deadlock e.g. over strategic decisions will result. Should only share owners to have the final say over strategic management decisions with other stakeholders having a right to consultation, and possibly compensation? This would preserve executive autonomy - but what about shareholders vs. managers?

   So widening the definition of who has a legitimate stake has problems. What stakeholder governance structure would ensure that potential conflicts never occur? Certain conflicts will be worsened with weak notions of " corporate interest" as potential stakeholders such as consumers or environmental groups disagree with producer stakeholders and possibly paralyse the firm. But does this not happen anyway in the market process?

   Clear demarcation of power and responsibility is required. The inevitability of some stakeholder conflict demands comparison of the relative efficiency of the traditional corporate model with what "stakeholder recognising" governance structures - might actually be.

3. Who has power ?

   How do we fix what the "stakeholder firm" is supposed to be?

   Is it a programme to achieve economic democracy or a new form of corporatism with every stakeholder interest given a right of veto over company decisions? Isn't economic democracy available in the marketplace (what are the weaknesses of this argument?).

   The stakeholder concept has little real substance. It directly challenges existing structures and mechanisms. Of course these represent a balance of economic power over who owns and controls assets. Conceding shares in such control is the issue - redistributing power and ownership across the corporate sectors.

4. Who benefits ?

   Economic nationalism comes into the argument. In a global economy, beneficiaries of stakeholder ism may be political, economic competitors to a sovereign position. Those opposed to closer integration in Europe argue against
   • additional costs of systems of corporate governance characteristic of the German model.
   • The costs of minimum wage legislation and the provisions of the social chapter.

   We may indeed see the distinctiveness of Japanese and German models (dedicated to long-term investment and participation of banks and workers in the firm) disappearing as global competition obliges all companies and national governments to converge on Anglo-American patterns of corporate governance which provide the flexibility needed to compete internationally.

   But will social protection e.g. minimum wages inevitably damage employment levels.

What can we extract from the stakeholder approach ?

There is little prospect that the stakeholder concept will spread spontaneously. But there are movements like

• Investors in People
• the Employee Share Ownership Scheme (ESOS)
• organizations in the non-profit making sector

... embody different aspects of the stakeholder concept. These may assist in a gradual dissemination of new practices.

To move beyond rhetoric, the limits must be recognised. For the concept to work a strong stakeholder ethos must be

• incorporated into formation and delivery of political society at different levels - global, national, regional, and local
• there must be a willingness to learn and experiment with new forms of governance and institutions.

One innovation in formation and delivery of regional policy is that of the Northern Development Corporation which brought together the main regional economic stakeholders (such as business, local authorities and trade unions) to devise and implement development strategies in the North -East of England. Is this any different from sound local government which - through its everyday role - attempts to bring participants together to share information and find opportunities for cooperation?

Reform of corporate governance in the private sector may encourage a more active role for institutional investors - to take a closer interest in the firms in which they invest

• compelling them to vote at shareholders meetings - will this change anything?
• greater transparency and accountability
• providing tax incentives for long-term share-holding.

There is little or no research evidence to suggested that such investors do not do this already representing the stakeholder interests of their policy holders (by investing in the highest return possibilities, securing better management etc). Of course - the complaint is often heard that institutional investors need to have more of commitment to long-term investment. But many already hold shares for considerable periods.

Government may tune the tax system to discourage short term share holding. What might the impact be on investment behaviour?

What scope for initiatives beyond the role of institutional investors?

Government might sponsor experiments to promote and spread different kinds of corporate governance. But the size of each operation is different, the stakeholders are different, and the public interest is different.

• Could reforms be targeted at regulation of the public utilities to ensure a better balance
• between shareholders, consumers and suppliers and to make the regulatory procedure transparent?
• Why should utilities be singled out for giving greater weight to consumer interests?
• Should a regulatory structure guarantees a fixed share of profits for consumers in the form of price cuts?
• to make utilities more consumer oriented is a change in management remuneration required - replacing share options with incentive schemes that
• link executive pay to price cuts and quality of service.

Subsidy or social entrepreneurship?

The venture capitalist agency "3i" perhaps provides a model for regional development banks to pioneer new financial relationships between banks and small firms.

The stakeholder approach must be applied to different governance structures not just commercial profit centred enterprises. Many other "social entrepreneurship" factors other than finance are crucial to the success of community-based firms,. The availability of small sized loans may be catalytic in regenerating run down areas. This would require

• public funding
• community based development banks
• local people with local knowledge
• loans at subsidised interest rates with minimal collateral requirements.

Note the experience of Community Development Banks in the US. Experiments in this area suggest that with sound incentive-structures and local peer group monitoring, benefits can far outweigh the costs.

Such wider policy ideas are dependent for implementation on different government departments coordinative disparate initiatives into a meaningful policy package. Four links between changing corporate governance and other economic policies can be identified.

1. between organisational change at the firm level and macroeconomic policy.
   Organisational change is a form of investment with costs and benefits. A crucial factor for entrepreneurs embracing change and new work patterns is the macroeconomic environment. Stable and predictable macroeconomic policy allows firms to feel more confident in bearing transitional costs - crucial to many supply side measures.

2. state provision for training and labour market mobility
   to help individuals leave poor jobs - important in its own right ? Many employers resist improvements to work place conditions and governance. But training and labour market mobility is not an alternative to reforming corporate governance. Learning opportunities are a complement, not a substitute for participatory work places.

3. initiatives for improving corporate governance via stakeholder-ism need not contradict emphasis on competition policy.
   The potential for stakeholder deadlocks and the fudgey-ness of "public interest" when evaluating take-over processes bids must be better alleviated.

4. State financial intervention in situations of market failure tend not to be efficient.
   There are limitations to the state's knowledge. Even if clear areas of market failure or distributive injustice are identified -the actual impact of so called "corrective policies" may not be understood. But intervention by experiment, recognising failure when it occurs, and learning from it - may be realistic.

Conclusion

New forms of corporate governance need to show that they are better to the old. There are few pointers to suggested that they do or they might. There is substantial difficulty in linking high economic performance with stakeholder participation in decision-making. Furthermore stakeholder concepts are argued with a particular rhetoric - from a given political perspective.

See also Elaine Sternberg's conclusions.