Why Stakeholder Theorists Should Support Stakeholder Democracy Jeffrey Moriarty Bentley University February, 2011

Introduction Major points: Stakeholder theorists once supported stakeholder democracy. They no longer do, but they should (again), for instrumental reasons.

Introduction My subject is normative stakeholder theory, as found in Evan and Freeman (1988, 1990) and Freeman et al. (2010). This is a thesis about how firms should be managed. I do not assume that stakeholder theory is justified. The question is what form of corporate governance its proponents should support. Stakeholders = shareholders, employees, customers, suppliers, and community members.

Stakeholder theory Two components to stakeholder theory: 1.Distributive: – Stakeholders’ interests should be “balanced” (Evan & Freeman, 1988). – Possible interpretation: stakeholders should be benefited in proportion to their contribution to the firm (Phillips, 1997). Compare “shareholder theory,” on which shareholder wealth should be maximized (Friedman, 1970; Bainbridge, 1993), within the bounds of law and “ethical custom” (Friedman, 1970).

Stakeholder theory 2.Procedural: – All stakeholders should have (the opportunity to have) input into firm decision-making (Phillips, Freeman, and Wicks, 2003). – Questions left open: What kinds of decisions? What kind of input? One way to participate in decision-making is to exercise binding control through formal voting. Call this stakeholder democracy.

Stakeholder democracy Stakeholder theorists once supported stakeholder democracy. “Stakeholders [should] be accorded voting rights with respect to deciding how to manage the affairs of the corporation” (Evan & Freeman, 1990, p. 338). “[E]very corporation of a certain size... [must] form a Board of Directors comprised of representatives of five stakeholder groups, including employees, customers, suppliers, stockholders, and members of the local community” (Evan & Freeman, 1988, p. 104).

Stakeholder democracy More recently, they have backed away. “[S]takeholder theory... does not require changing the structure of corporate governance... The theory can reasonably remain agnostic, for example, concerning stakeholder representation on corporate boards” (Phillips, Freeman, and Wicks, 2003, p. 491; see also Freeman, Harrison, Wicks, Parmar, & DeColle, 2010).

Stakeholder democracy This shift is a mistake. Stakeholder theorists should go back to supporting stakeholder democracy. For instrumental reasons: it is the best means of achieving their ends. In particular, it is better than the status quo, which is (weak) control exclusively by shareholders.

The instrumental argument The argument is simple. Human beings have a bias toward their self-interest. This is seen in (1) behavior and (2) cognition. Let’s begin with (1). When morality and self-interest conflict, we are tempted by self-interest. Incentives must be put in place to promote the desired outcome (e.g., prisons deter crime).

The instrumental argument One incentive is accountability. Compare democracy in the state: – We incentivize politicians to promote the public good by making them accountable to the public. Compare U.S. corporate governance: – We incentivize managers to promote shareholders’ interests by making them accountable to shareholders. If we want managers to promote all stakeholders’ interests, and listen to their input, we should make them accountable to all stakeholders. If they are not, stakeholder theory’s goals are unlikely to be met.

The instrumental argument Despite their professed agnosticism about the value of stakeholder control, stakeholder theorists themselves cannot seem to resist this logic. In response to the “two masters” problem, they say: “Those stakeholders against whose interests the manager has acted will certainly have reasons for doubting her justifications and she will be answerable to these groups as well” (Phillips, Freeman, and Wicks, 2003, p. 484). But in what sense will the manager be answerable to these groups, unless she is accountable to them?

The instrumental argument Now consider the self-interested bias in (2) cognition. Managers will tend to think the right result, by stakeholder theory’s lights, is the one that favors their interests. Making managers accountable to all stakeholders may help to mitigate this problem. Mitigating it probably also requires giving stakeholders some direct control over firm decisions.

Objections and replies Why have stakeholder theorists backed away from stakeholder democracy? A possible answer is found in Marens and Wicks (1999), who argue that it is possible for managers to achieve stakeholder theory’s goals under current U.S. corporate law. This isn’t the point. The question is: which governance structure is most likely to result in the achievement of these goals, not which structure is it possible to achieve them under?

Objections and replies Stakeholder theorists might next object that I am overestimating the value of accountability in corporate governance. Currently, shareholders have little effective control over firms (Bainbridge, 2006; Bebchuk, 2007). Still, managers seem to manage them in shareholders’ interests. This is achieved by (i) laws requiring managers to manage firms in shareholders’ interests, and perhaps more importantly, (ii) the market for corporate control. So perhaps stakeholder theorists don’t need to support stakeholder control?

Objections and replies Not so. First, some control by shareholders is thought to be useful for promoting their interests. This tells in favor of at least some control by all stakeholders for promoting their interests, assuming the two are parallel cases. Second, they may not be parallel cases. It is unclear how to write (i) laws requiring managers to balance stakeholders’ interests and listen to their input (Bainbridge, 1993). And it unclear what the stakeholder analog of (ii) the market for corporate control would be. In these circumstances, control by stakeholders takes on increased importance.

Evaluating stakeholder theory Does adding stakeholder democracy to stakeholder theory make the latter harder to justify? Not too much, if at all. Stakeholder theories already have to defeat (what are likely to be) the major objections to stakeholder democracy.

Evaluating stakeholder theory Objection 1: democracy is too costly. Reply: stakeholder theorists are already committed to bearing the costs of stakeholder participation in corporate governance. Giving stakeholders formal voting rights may require no extra expense, or one that stakeholder theorists would agree to pay.

Evaluating stakeholder theory Objection 2: some particular group of stakeholders (e.g., shareholders, workers) should have exclusive control. Reply. Stakeholder theorist must deny this, at least if we understand “control” as implying being able to determine the firm’s goals (within broad limits). They believe their goals should be aimed at.

Conclusion I have argued that stakeholder theorists should once again support, for instrumental reasons, stakeholder democracy. I have further argued that stakeholder theorists should not be dissuaded from doing so by the standard objections to stakeholder democracy, since they must defeat (versions of) these anyway.