Stakeholder Capitalism: the Myth, the Misunderstanding, and a Lie
Today I will explain how a single sentence describing stakeholder capitalism is riddled with errors. After you see the manipulations laid bare, you won't think about stakeholder capitalism the same way.
Here is how Klaus Schwab describes stakeholder capitalism in his book of the same name:
That is the core of stakeholder capitalism: it is a form of capitalism in which companies do not only optimize short-term profits for shareholders, but seek long term value creation, by taking into account the needs of all their stakeholders, and society at large.
I am reminded of the scene in Star Wars Episode VIII – The Last Jedi. Luke Skywalker is facing off against Kylo Ren, who says "The Resistance is dead, the war is over, and when I kill you, I will have killed the last Jedi!" To which Luke replies
Amazing, every word of what you just said was wrong.
That's how I feel about Klaus Schwab's equally amazing sentence. Let's explore the myth, the misunderstanding, and the lie it contains.
The Myth: Companies Seek Only Short-Term Profits
We often hear this criticism of companies: "Companies' shareholder focus means they prioritize short-term profits over everything else."
Don't be fooled by how often you've heard it said. It's a complete myth.
First, the criticism misstates companies' actual responsibility: to deliver shareholder value. Shareholder value is not the same as profit.
- A company's share price often increases when it shows no profit, for example, because it reinvests all its current earnings for future growth opportunities. Consider Amazon, which for many years sacrificed reporting profits for strategic investment.
Second, where did we get the idea that companies are focused on short-term results? They're not. They focus almost entirely on future earnings because that's what shareholders care about.
- Showing a profit in the current quarter does not guarantee a share price boost. Many companies meet or exceed earnings expectations and see their share price fall dramatically. Why? Because shareholders care about future earnings, not short-term earnings.
Shareholders Say They Care About the Long-Term
I sat in on many meetings between management and actual shareholders in the last 25 years. The discussions always centered around our strategy and growth plans. Shareholders want to know what the company's future prospects are.
Don't take my word for it. Let's hear from two of the richest people in the world who have been intimately involved in corporate affairs for decades.
First, here's Jeff Bezos, the founder of Amazon and CEO through 2021. In his first shareholder letter in 1997 he said this:
We believe that a fundamental measure of our success will be the shareholder value we create over the long term.
We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations
We will share our strategic thought processes with you when we make bold choices (to the extent competitive pressures allow), so that you may evaluate for yourselves whether we are making rational long-term leadership investments.
And in his last shareholder letter as CEO in 2021, he said this:
Remember that stock prices are not about the past. They are a prediction of future cash flows discounted back to the present. The stock market anticipates.
Does any of this sound like a CEO who is prioritizing short-term profits? Shareholders rewarded him by making Amazon the world's most valuable company.
Now consider our second guest speaker, Warren Buffet, one of the most successful investors of all time. He is one of the world's most discerning shareholders, capable of ferreting out companies that are delivering exactly what shareholders want.
Here's what Mr. Buffet said in his 2021 shareholder letter:
we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves. That point is crucial: Charlie and I are not stock-pickers; we are business-pickers.
Does that sound like a shareholder who is prioritizing short-term performance?
Well, How Do You Explain All Those Fraudulent CEOs?
You may be calling to mind now high-profile executives who most certainly did put short-term profits ahead of long-term value creation. CEOs who cashed out millions in stock option gains ahead of leaving their companies, and shareholders, in financial ruin.
If you think these examples prove the shareholder model is flawed, please consider the following two points:
- Those managers were acting against the interests of their shareholders. No shareholder of Enron or Worldcom wanted to see them report fake earnings and subsequently go bankrupt. These executives were typically acting illegally and prosecuted accordingly. That's why we know all about them.
- The number of CEOs who commit fraud and destroy shareholder value is a tiny percentage of all the hard-working and law-abiding executives. They are the aberration, not the norm. To say that because some companies commit fraud all companies are fraudulent is sloppy reasoning.
I hope you will agree, delivering shareholder value is entirely consistent with taking a long-term view. And short-term profits have nothing to do with it.
The Misunderstanding: By Prioritizing Shareholders, Companies Exclude Stakeholders
Now we come to the misunderstanding: Even accepting that delivering shareholder value is an appropriate goal, we assume companies that prioritize shareholders ignore their other stakeholders.
The argument goes something like this: because corporations must deliver profits, they are incentivized to screw over all other stakeholders. For example:
- If companies can pay employees slave wages, they will.
- If companies can squeeze suppliers, they will.
- If companies can pollute the environment, they will.
Companies Focus Intensely on Stakeholders
The above tropes also fail even modest scrutiny. Why? Because companies are focused on long-term value creation. They must be successful over many years to deliver shareholder value.
As a consequence, companies are keen to preserve good relations with employees. They want to attract talented employees and keep them productive. Turnover is expensive because companies need to find, attract, and train new employees.
Employees are only human. It's natural for them to say they want more pay and benefits. But don't mistake employee complaints for evidence that companies are taking advantage of them. Instead, ask yourself how often you hear employees say, "Yeah, I am completely satisfied and I don't want anything."
Companies are also keen to maintain healthy relationships with strong suppliers. Putting a supplier out of business serves no corporate purpose. It is similarly self-defeating to squeeze a supplier's profits to the point where the supplier cannot invest in productivity gains or seeks to exit the relationship.
Vanishingly few companies knowingly violate the laws and regulations that apply to all of us. The consequences are just too severe in the sense that such behavior destroys shareholder value.
You may believe companies are filled with secret villains, just waiting for their chance to subvert the Rule of Law and behave illegally. It just doesn't happen that way.
The Lie: Companies Are Answerable to Society at Large
The idea that companies are answerable to society at large is the most dangerous element of stakeholder capitalism. It actually contains two lies.
- The first lie is that stakeholder capitalism can be called capitalism at all.
- The second lie is that companies have a duty to society at large.
I'll start with the second lie because it also explains the first. Legally, companies are people too, just like you and me. See Corporations are People Too. They have duties and obligations, but also rights. The Rule of Law applies to companies just like it applies to us.
Under the legal systems in place today in the United States and Europe, no person has an obligation to society at large beyond what is in place in the currently applicable laws. To give a few examples:
- We have an obligation to pay our taxes, but no obligation to pay more than the legally required amount. It does not matter how good the cause is or how needy the recipient is. You get to decide what to do with your money.
- We have an obligation to follow the law, but everyone is equal under the law. Authorities cannot apply the law selectively or give some individuals a free pass.
- If you operate in good faith according to the current rules, you will be safe from some bureaucrat changing the rules with retroactive effect.
Stakeholder capitalism turns these foundational principles upside down. Now, not only anyone who is a "stakeholder," but anyone in society has a claim on a corporation's resources. See Why Forcing Companies to Do Good Harms Society.
Ask What if Stakeholder Capitalism Applied to Individuals?
Think how you'd feel if any stakeholder in the world could come to your door and demand some of your money and time to work on an issue they thought was important.
You are an attractive target not because of anything you did but merely because you have resources.
And who is to say which stakeholder gets priority? The one who shows up at your door first? Or the one who complains the loudest and threatens you? See Why Stakeholder Capitalism Creates Chaos and Stakeholder Capitalism Inevitably Turns into Identity Politics.
That's nothing remotely resembling capitalism. It's not even socialism, because socialism operates under the guise of the Rule of Law. No, stakeholder capitalism in the form promoted by Klaus Schwab and the World Economic Forum is the worst type of utopianism.
And utopian societies have a terrible track record. See The Simple Reason Utopian Societies Always Fail.
You might be tempted to secretly celebrate the idea of sticking it to those greedy corporations. Keep in mind that if you're in the US or Europe, you are the wealthy ones the other 90% of the world is hungrily eying, not just our corporations.
It would be short-sighted for us to cheer on the erosion of the Rule of Law for corporations to usher in the era of stakeholder capitalism. The rest of us are but a short step behind.
The Alternative to Stakeholder Capitalism
Now that we have dispelled the myth, the misunderstanding, and the lie, what remains is simple, practical, and effective: Shareholder capitalism works well. Really well, in fact. See What is the Social Responsibility of Business?
It's not just that shareholder capitalism has a long-term focus on delivering value that requires companies to pay attention to stakeholder needs broadly.
It's that shareholder capitalism has generated improvements in the world's wealth and living conditions unprecedented in all of human history. See Unintended Does Not Mean Unforeseeable for details.
Let's be careful before replacing shareholder capitalism with utopian ideas that have only ever failed. And for sure, let's not do so on the basis of an idea formulated in myths, misunderstandings, and lies.
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