CHAPTER 4

Stakeholder Primacy and Capitalism Model

Executive Summary

The emerging concept of profit-with-purpose corporations suggests that public companies should have the dual mission of profit-making function of creating shareholder value, while protecting interests of other stakeholders through their social benefit function. It appears there is a move away from pure shareholder primacy to stakeholder primacy of profit-with-purpose corporations. It appears that European and Asian companies are moving closer to the concept of stakeholder primacy than their counterparts in North America. This chapter presents the stakeholder capitalism primacy model with the main objective function of creating shared value for all stakeholders.

Introduction

In the past several decades, there has been a movement worldwide toward the stakeholder primacy model of corporations and related corporate governance measures intended to fundamentally rebalance power among stakeholders. The stakeholder primacy model holds that public companies should focus on corporate purposes beyond shareholder value, and thus maintains that corporate governance measures and corporate decision-making should also consider every stakeholder who provides capital (including financial, operational, human, societal, and environmental) and contributes to corporate success. The Board’s Role Under Stakeholder Primacy/Capitalism as Opposed to Shareholder Primacy/Capitalism is to oversee managerial function of focusing on the long-term sustainability performance, effectively communicating sustainability performance information to all stakeholders. The board should be informed and understand the stakeholder objectives, rationales for focusing on sustainability factors of performance, risk and disclosure, and managerial strategic planning, sustainable operational performance, and executive compensation in promoting long-term corporate value. This chapter presents the stakeholder capitalism primacy model and its governance mechanisms and measures with the main objective function of creating shared value for all stakeholders.

Stakeholder Capitalism Primacy

The goal of companies has evolved from profit maximization, to shareholder wealth enhancement, to creation of shared value for all stakeholders. The magnitude of ESG (environmental, social, and governance) sustainability-focused investment is now more than $20 trillion. ESG funds require that corporations define their purpose of generating financial returns and achieving social and environmental impacts. For many years, the focus on profit maximization for shareholders worked in U.S. financial markets. Globalization, technological advances, and often disruption have forced corporations to focus on the short-termism of meeting or beating analysts’ forecast expectations. However, corporations are now facing pressures from social activists and stakeholders to pay attention to the interests of customers, suppliers, employees, society, and the environment, among others, to create shared value for all stakeholders. In August 2019, the Business Roundtable issued a statement, signed by the CEOs of 187 major public companies, in which they committed to “lead their companies to the benefit of all stakeholders,” and to “deliver value” not just to shareholders but also to employees, customers, suppliers, and communities.¹ The World Economic Forum (WEF) highly recommends companies to move from the traditional model of “shareholder capitalism” to the model of “stakeholder capitalism.”² The WEF supports the concept of stakeholder governance in the context of stakeholder capitalism and has developed the stakeholder governance principles to protect interests of shareholders, employees, customers, suppliers, governments, and society as part of its COVID Action Platform.³

The Rise of Stakeholders/in Action/Compensation

At these times, there is a rise in stakeholder action, which grows with the increasing pressure for companies to respect all stakeholders versus the shareholder. The digital age has created a new way of work, shifting the service economy to become more automated, which results in the need for more skilled, talented, and experienced workers. Employees, customers, suppliers, and even the local and global communities are now viewed as major stakeholders, as well as central to the long-term success and sustainability of a company. Even during trying times such as the COVID-19 pandemic and other short-term pressures on companies, the key to success will remain with the support of all major stakeholders and the integrated ecosystem the firm is involved in.⁴

Stakeholders are individuals or groups who affect the company’s strategic decisions, operations, and performance, and are also affected by its decisions or activities. Traditionally, shareholders have been the primary users of the company’s financial reports, which reflect the company’s financial condition and the results of operations. While shareholders are still the primary recipient of the company’s reports on economic performance, stakeholders are now becoming more engaged and interested in the company’s multiple bottom lines (MBL) performance on a variety of economic, governance, ethical, social, and environmental issues. Shareholders’ initiatives, proposals, and resolutions on environmental and social issues are being considered by the board of directors and incorporated into the corporate governance structure.

Stakeholder theory of corporate governance is gaining support in the aftermath of the 2007–2009 global financial crisis and the move toward business sustainability. Stakeholder theory requires the following: (1) identification of all stakeholders who affect and are affected by the organization’s business and affairs including investors, creditors, customers, employees, suppliers, society, and the environment; (2) determination of rights, authorities, responsibilities, and accountability of each stakeholder; (3) development of a systematic process to ensure proper accountability for the stewardship of the organization’s resources and capitals; and (4) establishment of a fair system of rewards based on the risk taken by stakeholders. Under the stakeholder theory of corporate governance, the corporate primary objective is to achieve sustainable financial and non-financial performance in creating shared value for all stakeholders.

Several initiatives have been undertaken in moving away from shareholder primacy and toward stakeholder primacy under this new corporate governance model, including the following:⁵

The future of the corporation has been the subject of the extensive debate in the business and academic community. Colin Mayer’s Prosperity: Better Business Makes the Greater Good challenges the fundamentals of business thinking and purpose, and criticizes many businesses for causing inequality, poor innovation, environmental degradation, and low growth.⁶ The book also suggests that the corporation of the future can make capitalism sustainable by establishing and implementing corporate governance measures and reforms that promote an alignment of corporate conduct with social purpose, ensuring that companies’ strategic plans and their governance, measurement, and incentive systems as related to the environment, culture ownership, and other social issues, are appropriate for these purposes.⁷ The future of the corporation will focus on aligning corporate goals with social interests, an approach promoted by the British Academy, the UK’s national body for the social sciences and the humanities.⁸ In moving toward the implementation of this concept of the future of the corporation, business organizations should (1) define their purpose with the goal of aligning the maximizing of shareholder value with social purpose, (2) specify their commitments to all stakeholders, (3) design mechanisms to uphold their commitments, and (4) disclose their accountability with respect to ownership, governance, and performance measurements in achieving their stated purposes.⁹ This view of the corporation, based on stakeholder primacy rather than shareholder primacy, promotes the main goal of creating shared value for all stakeholders rather than that of merely maximizing shareholder wealth.

Stakeholder Governance

Corporate governance effectiveness has been the main focus of business organizations and their stakeholders including shareholders, employees, suppliers, customers, and communities. The stakeholder governance recognizes the importance of business survival and continuity in the short term as well as sustainable value creation for all shareholders in the long term as corporate strategy. The stakeholder model of corporate governance focuses on the broader view of the company with purpose and profit as the nexus of contracts among all corporate governance participants with the common goal of creating shared value for all stakeholders. The stakeholder model concentrates on maximization of wealth for all stakeholders, including the following: (1) contractual participants such as shareholders, creditors, suppliers, customers, and employees; and (2) social constituents including the local community; society and global partners; local, state, and federal governments; and environmental matters. Under this view, public companies must be socially responsible—good citizens granted the use of the nation’s physical and human capital, managed in the public interest and leave a better environment for the next generations. Thus, the performance of public companies is measured in terms of key financial indicators (earnings, market share, and stock price), social indicators (employment, customer satisfaction, and fair trading with suppliers), ethical indicators (proper business culture and business code of conduct), and environmental indicators (antipollution and preservation of natural resources). Public companies’ performance is measured based on financial impacts as well as social and environmental impacts.

Stakeholders have a reciprocal relationship and interaction with a firm in the sense that they contribute to the firm’s value creation, and the firm’s performance affects their well-being. Stakeholder theory applies to all managerial processes in the sense that the synergy and integration among all elements of the business model and its processes are essential in achieving overall sustainable performance objectives. From the stakeholder’s perspective, an organization is viewed as part of a network consisting of groups that work together to achieve the network/system goals. However, management may take actions to improve sustainability performance that benefit stakeholders (shareholders) who have the power to influence its compensation. The application of stakeholder theory to corporate governance, and thus management processes suggests that a company should be viewed as a nexus of all stakeholders. Corporate stakeholders are shareholders, creditors, customers, suppliers, employees, government, competitors, the environment, and society. Under stakeholder theory, management’s role is to improve sustainable performance in creating shared value for all stakeholders. The stakeholder governance paradigm requires a new set of guiding principles driven by shared value concept, new governance functions redefining the fiduciary duties of directors and executives to all stakeholders, and a new set of corporate governance measures to ensure its effectiveness.

The board should also provide oversight, insight, and foresight function on the achievement of both financial economic sustainability performance (ESP) and nonfinancial environmental, ethical, social, and governance (EESG) sustainability performance driven from financial, human, social, manufacturing capitals as well as innovation, culture, corporate governance, and ESG initiatives.¹⁰ The Board’s Role Under Stakeholder Primacy/Capitalism as Opposed to Shareholder Primacy/Capitalism is to oversee managerial function of focusing on the long-term sustainability performance, effectively communicating sustainability performance information to all stakeholders. The board should be informed and understand the stakeholder objectives, rationales for focusing on sustainability factors of performance, risk and disclosure, and managerial strategic planning, sustainable operational performance, and executive compensation in promoting long-term corporate value. The board should also provide oversight, insight, and foresight function on the achievement of both financial ESP and nonfinancial EESG performance driven from financial, human, social, manufacturing capitals, as well as innovation, culture, corporate governance, and ESG initiatives.¹¹ The financial and nonfinancial key performance indicators (KPIs) should be identified, measured, and disclosed through metrics that reflect corporate value, long-term investment, and innovation on EESG initiatives. In general, the five sustainability oversight functions of the board of directors are given as follows:¹²

The stakeholder governance concept with the focus on stakeholders has recently been debated among policy makers, regulators, investors, business community, and the accounting profession with both discussion of positive impacts of benefiting all stakeholders and imposing additional costs on shareholders and society.¹⁴ However, the WEF advocates the stakeholder governance concept and has established the stakeholder governance principles to protect interests of all stakeholders including shareholders, employees, customers, suppliers, governments, and society.¹⁵ the International Business Council (IBC) of the WEF, in collaboration with the big 4 accounting firms, has released its final recommendations for a set of globally accepted, standardized, and industry-oriented ESG sustainability performance metrics and disclosures.¹⁶ These recommendations are intended to provide guiding principles for focusing on the ESG sustainability factors of performance, risk, and disclosures on governance, people, planet, and prosperity.

The IBC/WEF framework defines a set of “Stakeholder Capitalism Metrics” for business organization worldwide to use and publicly report their ESG sustainability factors of performance, risk, and disclosure on a more standardized, comparable, and consistent metrics. These metrics can also be used to examine a company’s compliance and contributions toward achieving the SDGs. These suggested guiding principles, recommendations, and related metrics reflect the insight from, and views of many constituencies including IBC members and nonmembers, workshops, and meetings with investors and across industry sectors, as well as conversations with and inputs from regulators, stock exchanges, and standard-setters. The recommendations encourage companies to report on their core ESG metrics using a “disclose or explain” like corporate governance reporting of “comply or explain non-compliance” approach by focusing on a “materiality test” of reporting ESG information that is material, important, relevant, and/or critical to long-term shared value creation for all stakeholders.

These recommendations emphasize materiality of ESG disclosure that are relevant subject to confidentiality constraints, data availability, legal prohibitions, or other considerations. Companies are encouraged to disclose ESG information where relevant and possible, in their annual reports, proxy statements, or in a separate stand-alone integrated sustainability report. Business organizations that choose to comply with the recommended core metrics would disclose ESG sustainability factors of performance, risk, and related metrics relevant to (1) governance issues including corporate purpose; quality of governing body (e.g., the board of directors and related audit, compensation, and nominating committees); composition, competencies, and diversity of board committees; stakeholder engagement; oversight and disclosure of material risks and opportunities, pertaining to economic, environmental, social, and governance issues; and ethical behavior and practices (anticorruption; fraud prevention’s internal and external mechanisms for ethics advice and reporting); (2) people including dignity and equality (diversity, inclusion, and fair compensation); health, safety, and well-being; skills for the future (training hours and expenses); (3) planet including climate change and climate-related financial disclosures, nature loss, and freshwater availability; and (4) prosperity including employment and wealth generation, innovation and growth through offering the best products and services, (R&D expenses), and community and social vitality. Exhibit 4.1 presents the IBC/WEF’s recommended ESG factors of governance, planet, people, and prosperity, and their related metrics.

Exhibit 4.1 Recommendations of IBC/WEF for ESG sustainability factors and four pillars under stakeholder governance

Stakeholder governance principles provide guidelines for corporate gatekeepers and participants from the board of directors to executives, investors, legal counsel, and financial advisors and auditors to effectively discharge their responsibility and fulfill their accountability. Stakeholder governance guiding principles are advancing and intended to provide a basic framework and foundation for an effective governance in protecting interests of all stakeholders and as such they are applicable to all types and sizes of organizations. The primary oversight function of the board of directors under stakeholder governance is to protect interests of multistakeholders by appointing competent, accountable, ethical, and responsible executives to manage the business for the benefit of all stakeholders. Regulators worldwide should promulgate proactive, cost-efficient, effective, and scalable rules and regulation to protect the interests of all stakeholders. Internal and external governance mechanisms should be established to achieve the organizational purposes, mission, vision, values, and goals. Internal mechanisms consist of a vigilant board of directors in overseeing the organization’s purpose, mission, objectives, and strategies, executives’ commitments to implement proper strategies to minimize the negative impacts and maximize positive impacts of the organization’s activities, operations, and performance. External mechanisms established by policy makers, regulators, and standard-setters can play an important role in stakeholder governance in establishing applicable laws, regulations, rules, and standards, which are intended to benefit all stakeholders and protect their interests.

The new stakeholder governance paradigm recognizes the importance of short-term and long-term sustainable value creation for all shareholders by viewing governance as coordination and collaboration among all corporate governance participants from shareholders to boards of directors, executives, and other stakeholders to achieve financial ESP and non-financial EESG sustainability performance in creating shared value for all stakeholders. The emerging new stakeholder governance enables global business organizations worldwide to better realize their responsibility for the safety, health, and well-being of shareholders employees, customers, and suppliers, as well as redefine their business purpose of achieving financial ESP and nonfinancial EESG sustainability performance. The new stakeholder governance paradigm requires a new coherent set of guiding principles provided by the WEF driven by shared value concept, new governance functions redefining the fiduciary duties of directors and executives to all stakeholders, and a new set of internal and external governance mechanisms.

Conclusion

There has been a move toward the stakeholder capitalism and primacy model to ensure long-term sustainability of business corporations in generating desired financial returns for their shareholders while protecting interests of all stakeholders. Stakeholders such as employees, creditors, customer, suppliers, social responsibility activists, and communities, who are affected by and can affect the success of the company, do not have the right to direct or monitor the company. Nonetheless, the interests of stakeholders are protected under the contract and tort laws and the stakeholder capitalism and primacy model. Stakeholder capitalism and its stakeholder governance concept are intended to benefit all stakeholders. The stakeholder governance paradigm including guiding principles, functions, and measures should assist governance participants from the board of directors to management, accountants, auditors, legal counsel, stakeholders to address, and take actions in protecting interests of all stakeholders. Stakeholder governance is driven from the stakeholder primacy concept with focus on creating and protecting shared value for all stakeholders. Business organizations worldwide should modify their corporate governance to ensure protecting interests of all stakeholders. Business organizations should understand the move toward the stakeholder governance with focus on sustainability factors of performance, risk and disclosure, and integration of these factors into corporate culture and business environment as well as managerial policies, decisions, and processes to protect interests of their stakeholders.

Chapter Takeaways