It is telling that from 1979 to 2018 in the US, according to one study, worker pay rose by only 11.6% while CEO compensation grew by 940% and the stock market by 2,200%. Yet it is the wealthiest in society who disproportionately benefit from the booming stock market, with America’s richest 10% owning more than 80% of US stocks. Shareholder value – the measure of a company’s success according to the extent to which it enriches shareholders – reigns supreme.
In recent years, however, the negative economic and societal impact of this model has become apparent. Calls for a more equal, inclusive and sustainable capitalism have emerged, not just from civil society but also from business leaders.
The concept of stakeholder capitalism – with companies having a responsibility not just to shareholders but also to employees, customers, suppliers, communities and the planet – is now being recognised as not only desirable but essential for global survival.
The pandemic exposes the vulnerabilities that can arise where there has been a laser focus on shareholder primacy
It makes business sense, too. In a recent study, McKinsey demonstrated that considering wider needs and managing for the long term is not only good for stakeholders but also for companies as they outperform their peers.
The movement towards stakeholder capitalism received a boost in 2019, when 181 CEOs of the largest US corporations and members of the influential Business Roundtable discarded a long-time policy statement that defined a corporation’s principal purpose as the maximising of shareholder return.
Instead, they declared that companies should serve not only their shareholders but also their other stakeholders, including employees. This was followed last year with the adoption by the World Economic Forum of the Davos Manifesto, which embraced stakeholder and environment, social and governance (ESG) principles.
But just how committed is business to embracing ESG? In a recent study, Harvard Law School’s Lucian Bebchuk and Roberto Tallarita concluded that corporate leaders are generally still focused on shareholder value above all else.
This could change as the pandemic exposes the vulnerabilities that can arise where there has been a laser focus on shareholder primacy. For example, Covid-19 has served to highlight the fragility of companies where an emphasis on cost minimisation and efficiency maximisation favours single sourcing, which is especially susceptible to disruption.
The pandemic has also exposed the harsh conditions facing front-line essential workers whose critical contribution to the functioning of the economy and society has not been rewarded, as well as underlining the importance of social solidarity in the face of today’s inequalities and polarisation.
Which way for the pendulum?
Whether the pendulum is truly swinging towards a more stakeholder-centric form of capitalism is dependent on many considerations. For example, will activist hedge funds continue to demand with the same intensity that companies maximise shareholder value? Will private equity, equally focused on shareholder value maximisation, expand into an increasing number of sectors? Or will social solidarity create the conditions for a return to the stakeholder capitalism that dominated in the post-war period?
In their recent analysis of the US over the past 125 years, Robert Putman and Shaylyn Romney Garrett suggest that society goes through cycles of equality, cohesion and altruism. If so, the signs now are that the pendulum is swinging back to an era of greater solidarity, favouring stakeholder capitalism with positive outcomes for equality and social cohesion.
The birth of shareholder value
In 1970, US economist Milton Friedman’s New York Times essay ‘The Social Responsibility of Business is to Increase its Profits’ argued that companies’ only purpose was to make money. This message heralded the emergence of the belief that the maximisation of shareholder value should sit at the centre of capitalism – a message uncritically promoted by business schools in the decades to come.
As a result, income inequality increased as the ratio between the remuneration of top-level executives to employees grew ever wider and the interests of other stakeholders were at best ignored in favour of short-termism. The pursuit of shareholder value also led to the hollowing out of the corporation, with the outsourcing of many functions leading to an erosion in conditions and pay. In turn, this contributed to the creation of the ‘precariat’: low-paid workers with little job security.