Thursday, January 5, 2012

Stakeholder Theory of Corporate Management

Stockholder and Stakeholder Theory are theoretical perspectives within the Nexus of Contracts framework. The Stockholder Theory of Corporate Management says that CEOs (leaders) “ought” to manage the nexus in the interest of stockholders. Stakeholder Theory argues that CEOS are agents for all of the stakeholders, and therefore, “ought to” manage the nexus in order to advance the interests of all stakeholders: stockholders, employees, consumers, suppliers, financiers, and the local community.

Stakeholder Theory provides a pretty big tent for a variety of different views. Many argue that corporations are not the private property of stockholders, but “public property” and that the goal role of the CEO is to increase cooperation and not competition. One implication of this emphasis on cooperation is the notion that the various stakeholders ought to be treated equally, and/or that it is wrong to deliberately allow the most advantaged stakeholders (especially stockholders) to exploit the least advantaged stakeholders. So the basic argument is that the various stakeholder groups come to the bargaining table with competitive disadvantages, and that Stockholder Theory often leads to the exploitation of employees, consumers, financiers, suppliers, and/or local communities. In other words Stakeholder Management implies a special moral obligation to advance the interests of the “least advantaged” (or the most vulnerable) stakeholders.    

But the most important difference between the two theories is their respective views on the role that government ought to play in economic matters. If Stockholder Theory targets policy at increasing competition and personal liberty, Stakeholder Theory seeks to empower government to protect the least advantaged stakeholders; usually employees and consumers. Hence Stakeholder theorists tend to support policies such as a social safety net and/or a living wage. However, Stockholder Theorists prefer to address the needs of the "least advantaged" via individual philanthropy and/or voluntary associations rather than government programs. 

Stockholder theorists tend to emphasize private property rights and personal liberty (Locke). On global issues, they embrace the mantra:”When in Rome do as the Romans do.” Stakeholder theorists focus more on public property, economic security of all stakeholders, and follow their manta: “When in Rome do what’s right.” As a general rule, European countries tend to embrace Stakeholder Theory, while the United States defends Stockholder Theory. But don’t jump to the conclusion that business ethics can be reduced to Stockholder Theory v. Stakeholder Theory. Both theories are more subtle than that; and of course, not all business ethicists buy into that whole "social contract" approach to doing ethics. I would argue that Nexus of Contracts Theory, Stockholder Theory and Stakeholder Theory all represent ideals. And that Realists observe that in the “Real World,” there are (in fact) neither “perfectly free markets” (perfect information, perfect freedom, and perfect competition) nor “perfectly functional governments." Ultimately, business ethics cannot avoid the basic issues in ethics: knowing v. doing, facts v. values,  individual v. collective responsibility, legality v. morality, public v. private, and contextualism v. universalism. Don't let anyone tell you that ethics is easy. It's not!        

Monday, January 2, 2012

Stockholder Theory of Corporate Management

Recall from my previous blog that “Nexus of Contracts Theory” (NOC) says that a corporation is a nexus of contracts between various stakeholder groups: stockholders, employees, consumers, financiers, sub-contractors, and the local community. Business leadership ethics, therefore, is about how to manage that nexus. Within the contractual constraints of the NOC framework there are two competing theories that offer different strategies for dealing with the inevitable stakeholder conflicts that arise: stockholder theory and stakeholder theory.

Now an agent is a person possessing technical knowledge that is paid by someone else to serve their interests. Stockholder Theory states that the CEO is an agent hired by stockholders (or owners), and therefore he/she is legally and morally obligated to serve their interests. Corporations are money machines owned by the stockholders (not persons) and the CEO is hired to manage that nexus. In order for the CEO to make money for the stockholders, he/she must make decisions that affect all stakeholder groups. Stockholder theorists, therefore, argue that the “free market” is simply a system of distribution based the non-coercive, voluntary choices made by the various stakeholders. One of the criticisms of Stockholder Theory is that it seems to justify the unlimited exploitation of other stakeholders for the benefit of the stockholders. However, CEOs cannot simply ignore the interests of the other stakeholders. Otherwise, they’ll withdraw from the nexus: employees will quit, consumers will buy from a competitor, financiers will not lend them money etc. For example, if the CEO offers most workers $8.00 in hourly wages, and if prospective employees can freely accept or reject that offer, then it’s a moral transaction. However, a “good CEO” (that makes money for the stockholders) will, out of necessity, serve the interests of the other stakeholders, within the constraints of the free market. Hence, if  a "good CEO" cannot hire enough workers at $8.00 an hour, then he/she will try $8.25. If there are many willing workers available, the CEO will offer $7.75. The same market-based bargaining will be applied in dealing with the other stakeholder groups.  

What about business ethics? Or better yet…whose moral values is a "good CEO" morally obligated to uphold? Most stockholder theorists are moral relativists, and therefore, argue that the CEO must decide whose moral values ought to guide his/her decisions. Since the stockholders own the company they can collectively agree to operate based on a set of shared moral values. If the CEO disagrees with those values he/she can refuse to take the job or resign. And of course, any corporate morality must be clearly disclosed to the other stakeholders. If some stockholders disagree with those expressed values they can sell their stocks, employees can quit, financiers can refuse to loan money etc.  But then again, very large corporations have thousands of stockholders whom may not share the same moral values. That’s why the stockholders appoint or elect their own agent(s), the Board of Trustees. However, if the CEO chooses to “manage” based on his/her personal morality, which is in conflict with the stockholders values, the Board can fire the CEO. Unfortunately, sometimes the CEO and/or the Board do not act as reliable agents. In those cases, if the stockholders find out, they can either hire new agents, or sell their stock. Although Stockholder Theorists tend toward moral relativism, they are legal objectivists, in the sense that they require corporate leaders to abide by the laws where they are doing business. So when competing in global markets where the laws vary between nations, Stockholder Theorists uphold the mantra: “When in Rome, do as the Romans do.”

Finally, any theory of the modern corporation must also address the political question: “What role should government play in managing the nexus?” Within the Stockholder Model, there’s a considerable disagreement over what role the government ought to play in managing the nexus. Anarcho-capitalists argue that all government violates the non-aggression axiom, and therefore all government intervention in the market is morally unjustified. Minarchists, however, argue that the primary purpose of government is to protect the personal and property rights of individuals. Thus, at a bare minimum government must monitor and enforce laws against theft, fraud, and breech of contract. However, all stakeholders possess “negative rights” and therefore, as bargainers they are guaranteed the equal right to bargain, but there can be no governmentally enforced guarantee that any one stakeholder group will emerge victorious as a result of the competitive process. According to ST, government ought to be “impartial” or “neutral” in the competitive bargaining process, but should not pick winners and losers. Again, the primary purpose of government is to enforce contracts between rationally self-interested bargainers and promote free market competition. Stockholder Theorists argue that over the long run, the free market approach to corporate management unintentionally leads to a moral nexus.

Libertarians generally defend various versions of the Stockholder Theory of corporate management. My next blog will cover Stakeholder Theory, the other approach to corporate management.   

Sunday, January 1, 2012

What is a Corporation?

What is the most influential social institution in the Western world? Now by “influential” I don’t mean just “positive influence” but also “negative influence.” Well, let’s look at some of the candidates. Given the cultural forces that are currently at work here in the United States, most of you would say either religion or government. Both are pretty good candidates. But let’s look a bit closer. Who produced the food that you ate this morning? Who sold it to you? Who loaned you the money to go to college? Who built your computer? Who sold it to you? Who printed your books? Who sold them to you? Who brewed the beer that you drank last Saturday night, and who sold it to you? Who produced your cigarettes and who sold them to you? Who owns the Reds and the Bengals? Who built your home? Who financed it? Get the point? For better or worse, I would argue that corporations are the most influential social institutions in the Western world, especially in the United States. But what is a corporation? The answer to any question requires a theory. Therefore, we need a “theory of the modern corporation.”

Orthodoxy in business management and ethics often cites “Nexus-of-Contracts Theory.” Rooted in in social contract theory, it argues that the firm, or the modern corporation, is a complex adaptive system comprised of definable subsystems, called stakeholders. A stakeholder is any individual or group of individuals that either benefits of suffers as a result of the actions of that corporation. Therefore, the modern corporation is essentially a set of contracts or agreements between various stakeholder groups. The corporate stakeholder groups, engaged in this bargaining process typically include: stockholders, employees, consumers, suppliers, financiers, and local communities. The interests of these various groups are often represented by “agents.” 

Now in order for the Nexus-of Contracts Theory to be useful it must be both descriptive and prescriptive; that is, it must describe how the classes of stakeholders (stockholders, consumers, managers, employees, consumers etc.) bargain in the real world, AND prescribe how those stakeholders ought to bargain. It must also describe and prescribe the role that leaders ought to play in this process. Hence, any theory of the modern corporation must answer three questions:

1. Whose ends (rights or interests) are in fact served by corporate leaders? (E.g.: stockholders, consumers, employees, financiers, suppliers, local communities, nations, humanity etc.) AND, whose ends (rights or interests) ought to be served by corporate leaders?

2. By what means can leaders in fact employ in order to efficiently realize these stated ends (rights or interests) AND, what means can managers morally realize these stated ends.

3. What role does government in fact play in the realization of these various ends? AND, what role ought government (local, state, federal, international) play in this process?

Despite the idealistic ruminations of various “win-win” strategists, in the real world, what’s “good” for one group of stakeholders (stockholders, employees, consumers, etc) is not necessarily “good” for the other stakeholders. If you raise the pay of employees, generally, either the consumers pay higher prices, and/or the stockholders earn less. And, what’s “good” for any given society may or may not be “good” for individual industries or corporations. And, what’s “good” for United States may or may not be “good” for the rest of the world. And what’s “good” for present stakeholders, may not be good for future stakeholders. Hence, corporations are both cooperative and competitive. 

Within the NOC framework, a “good leader,” is a leader that can reconcile the often conflicting interests of the various stakeholder groups. NOC scholars have identified two alternative sub-theories of corporate leadership.

Stockholder Theory: Leaders are morally and legally obligated to serve as agents of the stockholders, and advance their interests regardless of how those decisions might affect the other stakeholders.

 Stakeholder Theory: Leaders are morally and legally obligated to serve as agents of all stakeholder groups, and try to advance all of these interests collectively and impartially.

The next two blogs will discuss these two theories.