Monday, November 26, 2007

Stakeholder Theory

One of the most influential ideas on modern business has been the stakeholder theory of the corporation, first proposed by William E. Evan and R. Edward Freeman in 1988.

Their idea was to replace the view that a firm has a primary obligation to its shareholders with the view that a corporation has a responsibility to every group affected by its actions. Evan and Freeman called these groups "stakeholders," and they included suppliers, customers, employees, stockholders, and the local community.

Far more than simply saying that a firm must be legally responsible for its actions, stakeholder theory gives these various groups legal claims on the resources of the firm, and powerful roles to play in its governance. Stakeholder terminology has been rapidly adopted by individuals and organizations that want to appear socially responsible, democratic, or progressive.

But before we make stakeholder theory the new norm for corporate governance, we should ask the questions: Is stakeholder theory logical? Is it possible to successfully run a firm using these ideas?

In a word, the answer to both questions is "No."

Stakeholder theory does not work because every decision quickly becomes political. First, it gives one group of people the privilege to control something owned by another group. Then, in a world where everyone has an equal claim on the resources of a third party, someone unequal must decide the outcome of competing and irreconcilable claims. That someone is almost always the state.

For example, if one group wants a plant to stay open because it fears rising unemployment, and another group wants the plant closed because it fears environmental degradation, who or what shall decide? Someone must, in the chilling words of Freeman, decide what is "in the interest of the collective." In a world ruled by the rights of owners, owners would decide. In a world ruled by the equal claims of all, only the government can decide.

If you want to see what a world looks like when it is run according to stakeholder theory, look at the defunct USSR. The picture that accompanies this post was taken during the collectivization campaign in the USSR during the 1930s. The slogan reads: "We kolkhoz farmers, on the basis of complete collectivization, will liquidate the kulaks as a class."

The kulaks were farmers who owned their own property. The kolkhoz were the stakeholders who claimed it, in the interest of the collective.

At its heart, stakeholder theory is a naive intuition about the way people should live, not a realistic version of the way they actually do. It is a diluted version of the old collectivist dream, dressed up for Western business schools, but as dangerous as ever.

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