Stakeholders and Cooperation

From the Business Roundtable to the World Economic Forum to leading business schools, many voices promote replacing corporations governed by stockholders with “stakeholder” capitalism. Laws empowering stakeholders might disrupt the social cooperation of corporations.

The cutthroat world of business seems decidedly uncooperative. But businesses enable voluntary cooperation between people trying to improve their lives.

Never forget the voluntary part. Throughout history, force has been the preferred way to secure assistance from others, producing slavery and oppressive taxation. The lure of commanding others endures today. Both the Trump and Biden Administrations commanded businesses using the Defense Production Act during the COVID-19 pandemic.

A business involves many persons as employees, suppliers, and customers. Financial capital is also needed because production must occur before goods can be sold. Terms and conditions for all parties involved must be worked out, and a business must a way to decide what to produce and how. Numerous options for terms exist. Persons providing labor can work as independent contractors or as employees, and if employees, paid every two weeks or receive profit sharing. Financial capital can be provided through a loan with fixed repayment dates and specified interest, or in exchange for a share of ownership (equity).

Sales are never guaranteed in a market economy because potential customers are free to not buy any product. And because costs must be incurred before sales, revenue may fall short of costs, resulting in losses. Guaranteed profit exists only in rare circumstances called arbitrage; otherwise, profits are always uncertain.

Every business must have someone who will bear a loss and someone who gets any profit. Profit and loss are residuals, and the person(s) who receive the profit or loss is the residual claimant. Having different persons bear losses and keep profits generally results in bad decisions, either a reckless pursuit of profit or an obsessive avoidance of loss.

Many forms of business organization exist, from sole proprietorships to employee-owned enterprises to corporations. Each form has different residual claimants and different decision-making structures. The various forms of business cooperation have enabled the prosperity of modern America.

The corporation has played an outsized role though, assembling previously unimaginable amounts of financing to build global enterprises. This proves that the structure of the corporation, with decision-making and residual claims vested in the stockholders, works. This is a delicate balance. Large investors generally do not manage the companies they own in part. Poor management decisions imperil investors’ capital. The efficiency with which stockholders control the corporations they own is hotly debated, but the persistence of corporations means that stockholders are sufficiently satisfied to continue investing their money.

Stakeholderism prioritizes other groups - including customers, employees, and suppliers - over stockholders. Such proposals should face a high bar, given that corporations work. And stakeholders already receive enormous consideration. All market transactions are voluntary, so companies MUST provide value for customers, employees, and suppliers to continue doing business. Of course, the freedom of free enterprise allows companies to fancy that treating stakeholders shabbily will prove profitable.

Many commentators characterize CEO embrace of stakeholderism as pure opportunism. Currently activist stockholders can challenge CEOs over their decisions. Business Roundtable CEOs seek legal authority to ignore stockholders by claiming to serve communities, employees, or the environment.

Yet truly empowering stakeholders through legal mandates for employee, customer, or environmental group representation on boards of directors also creates problems. Customers and employees, for instance, have opposing interests: customers want lower prices, while higher prices can fund higher wages. And neither might mind wasting investors’ money. Legally transferring stockholders’ decision rights is a type of theft and may make investors no longer willing to contribute their capital.

The freedom of a market economy is also a challenge to its critics. The proponents of stakeholderism can start businesses organized in this manner. If their criticisms are valid, their stakeholder driven firms should crush traditional corporations.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.