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June 2021 – What is Stakeholder Theory

In this article, by Ramon P. DeGennaro1, AIER visiting scholar, we address the notion of stakeholder value. The concept has gained traction, and investors should be alert to its potential implications regarding the longstanding notion of shareholder value as well as future economic growth.

According to R. Edward Freeman, “A stakeholder in an organization is (by definition) any group or individual who can affect or is affected by the achievement of the organization’s objectives.” (See Strategic Planning: a Stakeholder Approach, Boston: Pitman Publishing, 1984, p.46). For corporations, his definition could include competitors, workers, customers, and future generations, to name a few. It is conceivable that even entities such as universities, which could enroll a corporation’s employees if they were laid off, could be considered stakeholders. Corporations pay taxes — so are taxpayers included? Readers may want to draw the line somewhere else. This nebulous definition is a particular weakness of stakeholder theory to which we will return.

Setting aside its broad scope, the term stakeholder, per se, is benign. But if it is used to assert that corporate managers should seek to maximize stakeholder value, rather than shareholder value, investors beware. As we will see, many of the laudable goals of stakeholder theory, such as treating workers, vendors, and customers fairly, are already subsumed by the mandate to maximize shareholder value. But to ask management to maximize these constituents’ varying interests while doing the same for the shareholder is to ask the impossible.

Moreover, I argue that stakeholder theory undermines a free and prosperous society. So, ironically, it is dangerous not just to investors but to all the various parties it claims to champion.

Why? Stakeholder theory shields bad managers from responsibility, undermines property rights, and invites corruption and rent-seeking. Begin with shielding bad managers from responsibility. The world is competitive. People like to compete and like to watch others compete. How can we separate winners from losers? In some cases, it’s easy. We knew that Michael Jordan was a fabulously successful basketball player by looking at the scoreboard. Most of the time, at the end of the game, Jordan’s team had scored more points than the opponent’s team. He was the winner. (Continued)

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