56 The Purpose of the Corporation Managing for Stakeholders R. Edward Freeman

56 The Purpose of the Corporation Managing for Stakeholders R. Edward Freeman

INTRODUCTION T h e p u r p o s e of this essay is to o u t l i n e an e m e r g i n g view of business t h a t we shall call ” m a n a g i n g for stakeholders”.” This view has e m e r g e d over the past 30 years from a g r o u p of scholars in a diverse set of disciplines, from finance to philosophy.’ T h e basic idea is that businesses, a n d the executives w h o m a n a g e them, actually do a n d should create value for customers, suppliers, employees, c o m m u n i ties, a n d financiers (or s h a r e h o l d e r s ) . And, that we n e e d to pay careful attention to how these r e l a t i o n s h i p s are m a n a g e d a n d how value gets created for these stakeholders. We contrast this idea with the d o m i n a n t m o d e l of business activity, namely, that businesses are to be m a n a g e d solely for the benefit of shareholders. Any o t h e r benefits (or harms) that. are created are incidental. Simple ideas create complex questions, a n d we p r o c e e d as follows. In the next section we examine why the d o m i n a n t story or m o d e l of business that is deeply e m b e d d e d in o u r cult u r e is n o l o n g e r workable. It is resistant to c h a n g e , n o t consistent with the law, a n d for the most part, simply ignores matters of ethics. Each of these flaws is fatal in the business world of the twenty-first century. Wc t h e n p r o c e e d to define the basic ideas of ” m a n a g i n g for s t a k e h o l d e r s ” a n d why it solves some of the problems of the d o m i n a n t model. In particular we pay attention to how using “stakeholder” as a basic u n i t of analysis makes it m o r e difficult to ignore matters of ethics. We argue that the primary responsibility of the executive is to create as m u c h value for stakeholders as possible, a n d that n o stakeh o l d e r i n t e r e s t is viable in isolation of t h e o t h e r stakeholders. We sketch t h r e e primary a r g u m e n t s from ethical theory for a d o p t i n g “managing for stakeholders.” We conclude by outlining a fourth “pragmatist a r g u m e n t ” that suggests we see m a n a g i n g for stakeholders as a new narrative a b o u t business that lets us improve t h e way we currently create value for each other. Capitalism is o n this view a system of social cooperation a n d collaboration, rather than primarily a system of competition. THE DOMINANT STORY: MANAGERIAL CAPITALISM WITH SHAREHOLDERS AT THE CENTER T h e m o d e r n business c o r p o r a t i o n has e m e r g e d d u r i n g the twentieth century as o n e of the most i m p o r t a n t innovations in h u m a n history. Yet the changes that we are now experiencing call for its reinvention. Before we suggest what this revision, “managing for stakeholders” or “stakeholder capitalism,” is, first we n e e d to u n d e r s t a n d how t h e d o m i n a n t story came to b e told. Somewhere in the past, organizations were quite simple and “doing business” consisted of buying raw materials from suppliers, converting it to products, a n d selling it to customers. For the most part owner-entrepreneurs f o u n d e d such simple businesses a n d worked at the business along with members of their families. T h e d e v e l o p m e n t of new p r o d u c t i o n processes, such as t h e assembly line, m e a n t t h a t jobs could be specialized and more work could be accomplished. New technologies a n d sources of power became readily available. These and other social a n d political forces c o m b i n e d to require larger amounts of capital, well beyond the scope of most individual owner-manageremployees. Additionally, “workers” or n o n family m e m b e r s began to d o m i n a t e the firm a n d were the rule rather than the exception. The Purpose of the Corporation Ownership of the business became more dispersed as capital was raised from banks, stockholders, and other institutions. Indeed, the management of the firm became separated from the ownership of the firm. And, in order to be successful, the top managers of the business had to simultaneously satisfy the owners, the employees and their unions, suppliers, and customers. This system of organization of businesses along the lines set forth here was known as managerial capitalism or laissez faire capitalism, or more recently, shareholder capitalism. As businesses grew, managers developed a means of control via the divisionalized firm. Led by Alfred Sloan at General Motors, the divisionalized firm with a central headquarters staff was widely adapted. 6 The dominant model for managerial authority was the military and civil service bureaucracy. By creating rational structures and processes, the orderly progress of business growth could be wellmanaged. Thus, managerialism, hierarchy, stability, and predictability all evolved together, in the United States and Europe, to form the most powerful economic system in the history of humanity. The rise of bureaucracy and managerialism was so strong that the economist Joseph Schumpeter predicted that it would wipe out the creative force of capitalism, stifling innovation in its drive for predictability and stability. During the last 50 years this “Managerial Model” has put “shareholders” at the center of the firm as the most important group for managers to worry about. This mindset has dealt with the increasing complexity of the business world by focusing more intensely on “shareholders” and “creating value for shareholders.” It has become common wisdom to “increase shareholder value,” and many companies have instituted complex incentive compensation plans aimed at aligning the interests of executives with the interests of shareholders. 57 These incentive plans are often tied to the price of a company’s stock, which is affected by many factors not the least of which is the expectations of Wall Street analysts about earnings per share each quarter. Meeting Wall Street targets and forming a stable and predictable base of quarter over quarter increases in earnings per share has become the standard for measuring company performance. Indeed, all of the recent scandals at Enron, WorldCom, Tyco, and others are in part due to executives trying to increase shareholder value, sometimes in opposition to accounting rules and law. Unfortunately, the world has changed so that the stability and predictability required by the shareholder approach can no longer be assured. The Dominant Model Is Resistant to Change The Managerial View of business with shareholders at the center is inherently resistant to change. It puts shareholders’ interests over and above the interests of customers, suppliers, employees, and others, as if these interests must conflict with each other. It understands a business as an essentially hierarchical organization fastened together with authority to act in the shareholders’ interests. Executives often speak in the language of hierarchy as “working for shareholders,” “shareholders are the boss,” and “you have to do what the shareholders want.” On this interpretation, change should occur only when the shareholders are unhappy, and as long as executives can produce a series of incrementally better financial results there is no problem. According to this view the only change that counts is change oriented toward shareholder value. If customers are unhappy, if accounting rules have been compromised, if product quality is bad, if environmental disaster looms, even if competitive forces threaten, the only interesting questions are whether and how these forces 58 The Purpose of the Corporation for change affect shareholder value, measured by the price of the stock every day. Unfortunately in today’s world there is just too much uncertainty and complexity to rely on such a single criterion. Business in the twenty-first century is global and multifaceted, and shareholder value may not capture that dynamism. Or, if it does, as the theory suggests it must eventually, it will be too late for executives to do anything about it. The dominant story may work for how things turn out in the long run on Wall Street, but managers have to act with an eye to Main Street as well, to anticipate change to try and take advantage of the dynamism of business.’ THE DOMINANT MODEL IS NOT CONSISTENT WITH THE LAW In actual fact the clarity of putting shareholders’ interests first, above that of customers, suppliers, employees, and communities, flies in the face of the reality the law. The law has evolved to put constraints on the kinds of trade-offs that can be made. In fact the law of corporations gives a less clear answer to the question of in whose interest and for whose benefit the corporation should be governed. The law has evolved over the years to give de facto standing to the claims of groups other than stockholders. It has, in effect, required that the claims of customers, suppliers, local communities, and employees be taken into consideration. For instance, the doctrine of “privity of contract,” as articulated in Winlerbottom v. Wright in 1842, has been eroded by recent developments in product liability law. Greenman v. Yuba Power gives the manufacturer strict liability for damage caused by its products, even though the seller has exercised all possible care in the preparation and sale of the product and the consumer has not bought the product from nor entered into any contrac- tual arrangement with the manufacturer. Caveat emptor\\2& been replaced, in large part, with caveat venditor. The Consumer Product Safety Commission has the power to enact product recalls, essentially leading to an increase in the number of voluntary product recalls by companies seeking to mitigate legal damage awards. Some industries are required to provide information to customers about a product’s ingredients, whether or not the customers want and are willing to pay for this information. Thus, companies must take the interests of customers into account, by law. A similar story can be told about the evolution of the law forcing management to take the interests of employees into account.

The National Labor Relations Act gave employees the right to unionize and to bargain in good faith. It set up the National Labor Relations Board to enforce these rights with management. The Equal Pay Act of 1963 and Tide VII of the Civil Rights Act of 1964 constrain management from discrimination in hiring practices; the56 The Purpose of the Corporation Managing for Stakeholders R. Edward Freemanse have been followed with the Age Discrimination in Employment Act of 1967, and recent extensions affecting people with disabilities. The emergence of a body of administrative case law arising from labor-management disputes and the historic settling of discrimination claims with large employers have caused the emergence of a body of management practice that is consistent with the legal guarantee of the rights of employees. The law has also evolved to try and protect the interests of local communities.

The Clean Water Act of 1977 and the Clean Air Act of 1990, and various amendments to these classic pieces of legislation, have constrained management from “spoiling the commons.” In a historic case, Marsh v. Alabama, the Supreme Court ruled that a company-owned town was subject to the provisions of the U.S. Constitution, thereby guaranteeing the rights of local citizens and negating the “property The Purpose of the Corporation r i g h t s ” of t h e firm. C u r r e n t issues c e n t e r a r o u n d p r o t e c t i n g local businesses, forcing c o m p a n i e s to pay t h e h e a l t h c a r e costs of t h e i r e m p l o y e e s , i n c r e a s e s in m i n i m u m wages, e n v i r o n m e n t a l standards, a n d the effects of business d e v e l o p m e n t o n t h e lives of local c o m m u n i t y m e m b e r s . T h e s e issues fill the local political landscapes, a n d executives a n d t h e i r c o m p a n i e s m u s t take a c c o u n t of them. Some may argue that the constraints of the law, at least in the U.S., have b e c o m e increasingly irrelevant in a world w h e r e business is global in n a t u r e . However, globalization simply m a k e s this a r g u m e n t stronger. T h e laws that are relevant to business have evolved differently a r o u n d t h e world, b u t they have evolved nonetheless to take into account the interests of groups o t h e r t h a n just shareholders. Each state in India has a different set of regulations that affect how a c o m p a n y can d o business. In China the law has evolved to give business some property rights b u t it is far from exclusive. A n d , in m o s t of t h e E u r o p e a n Union, laws a r o u n d “civil society” a n d the role of “employees” are m u c h m o r e complex than even U.S. law. “Laissez-faire capitalism” is simply a myth. T h e idea that business is a b o u t “maximizing value for stockholders regardless of t h e consequences to others” is o n e that has outlived its usefulness. T h e d o m i n a n t m o d e l simply does n o t describe h o w business operates. Ano t h e r way to see this is that if executives always have to qualify “maximize s h a r e h o l d e r value” with exceptions of law, or even g o o d practice, t h e n the d o m i n a n t story isn’t very useful a n y m o r e . T h e r e are j u s t too m a n y exceptions. T h e d o m i n a n t story could b e saved by arguing that it describes a normative view a b o u t h o w business s h o u l d o p e r a t e , despite h o w actual businesses have evolved. So, we n e e d to look m o r e closely at some of the conceptual and normative problems that the d o m i n a n t m o d e l raises. 59 T h e Dominant M o d e l Is N o t Consistent with Basic Ethics Previously we have a r g u e d that most theories of business rely o n separating “business” decisions from “ethical” decisions. This is seen most clearly in the p o p u l a r j o k e a b o u t “business ethics as an oxymoron.” More formally we m i g h t suggest that we define: T h e Separation Fallacy It is useful to believe that sentences like “x is a business decision” have no ethical content or any implicit ethical point of view. And, it is useful to believe that sentences like “x is an ethical decision, the best thing to do all things considered” have no content or implicit view about value creation and trade (business). This fallacy u n d e r l i e s m u c h of t h e d o m i n a n t story a b o u t business, as well as in o t h e r areas in society. T h e r e are two implications of rejecting the Separation Fallacy. T h e first is t h a t almost any business decision has s o m e ethical content. To see that this is true one need only ask whether the following questions make sense for virtually any business decision: T h e O p e n Question A r g u m e n t 1. If this decision is made for whom is value created and destroyed? 2. Who is harmed a n d / o r benefited by this decision? 3. Whose rights are enabled and whose values are realized by this decision (and whose are not)? 4. What kind of person will I (we) become if we make this decision? Since these questions are always o p e n for most business decisions, it is reasonable to give u p the Separation Fallacy, which would have us believe that these questions aren’t relevant for m a k i n g business decisions, o r that they could never b e answered. We n e e d a theory a b o u t business that builds in answers to the ” O p e n Question Argument” above. O n e such answer 60 The Purpose of the Corporation would b e “Only value to shareholders counts,” b u t such a n answer w o u l d have to b e enm e s h e d in the l a n g u a g e of ethics as well as business. Milton F r i e d m a n , unlike most of his expositors, may actually give such a morally rich answer. H e claims t h a t t h e responsibility of the executive is to make profits subject to law a n d ethical custom. D e p e n d i n g o n how “law a n d ethical custom” is i n t e r p r e t e d , t h e key difference with the stakeholder a p p r o a c h may well b e that we disagree a b o u t how the world works. In o r d e r to create value we believe t h a t it is b e t t e r to focus o n integrating business a n d ethics within a c o m p l e x set of stakeholder relationships rather t h a n treating ethics as a side constraint o n making profits. In short we n e e d a theory that has as its basis what we m i g h t call: T h e Integration Thesis Most business decisions, or sentences about business have some ethical content, or implicit ethical view. Most ethical decisions, or sentences about ethics have some business content or im10 plicit view about business O n e of the most pressing challenges facing business scholars is to tell compelling narratives t h a t have t h e I n t e g r a t i o n Thesis at its heart. This is essentially the task that a g r o u p of scholars, “business ethicists” a n d “stakeh o l d e r theorists,” have b e g u n over the last 30 years. We n e e d to go back to the very basics of ethics. Ethics is a b o u t t h e rules, principles, consequences, matters of character, etc., that we use to live together. These ideas give us a set of o p e n q u e s t i o n s t h a t we are constantly searching for better ways to answer in reasonable complete ways.11 O n e might define “ethics” as a conversation a b o u t how we can reason tog e t h e r a n d solve o u r differences, recognize where o u r interests are j o i n e d a n d n e e d development, so t h a t we can all flourish without resorting to coercion a n d violence. Some may disagree with such a definition, a n d we d o n o t intend to privilege definitions, b u t such a pragmatist a p p r o a c h to ethics entails that we reason a n d talk together to try a n d create a better world for all of us. If o u r critiques of the d o m i n a n t m o d e l are correct t h e n we n e e d to start over by reconceptualizing the very language that we use to u n d e r s t a n d how business operates. We want to suggest that s o m e t h i n g like the following principle is implicit in most reasonably comprehensive views a b o u t ethics. T h e Responsibility Principle 2 Most people, most of the time, want to, actually do, and should accept responsibility for the effects of their actions on others. Clearly the Responsibility Principle is incompatible with the Separation Fallacy. If business is s e p a r a t e d f r o m ethics, t h e r e is n o question of m o r a l responsibility for business decisions. More clearly still, without something like the Responsibility Principle it is difficult to see how ethics gets off the g r o u n d . “Responsibility” may well b e a difficult a n d multifaceted idea. There are surely many different ways to u n d e r s t a n d it. But, if we are n o t willing to accept the responsibility for o u r own actions (as limited as t h a t may b e d u e to complicated issues of causality a n d the like), t h e n ethics, u n d e r s t o o d as how we reason together so we can all flourish, is likely a n exercise in b a d faith. If we want to give u p the separation fallacy a n d a d o p t the integration thesis, if the o p e n question a r g u m e n t makes sense, a n d if something like the responsibility thesis is necessary, then we n e e d a new m o d e l for business. And, this new story must be able to explain how value creation at o n c e deals with e c o n o m i c s a n d ethics, a n d how it takes account of all of the effects of business action on others. Such a model exists, a n d has b e e n developing over the last 30 years by m a n a g e m e n t researchers a n d ethics scholars, a n d t h e r e are many businesses who The Purpose of the Corporation have adopted this “stakeholder framework” for their businesses.


The basic idea of “managing for stakeholders” is quite simple. Business can be understood as a set of relationships among groups which have a stake in the activities that make up the business. Business is about how customers, suppliers, employees, financiers (stockholders, 61 bondholders, banks, etc.), communities, and managers interact and create value. To understand a business is to know how these relationships work. And, the executive’s or entrepreneur’s j o b is to manage and shape these relationships, hence the title, “managing for stakeholders.” Figure 1 depicts the idea of “managing for stakeholders” in a variation of the classic “wheel and spoke” diagram. 13 However, it is important to note that the stakeholder idea is perfectly general. Corporations are not the FIGURE 1 PRIMARY SECONDARY STAKEHOLDERS STAKEHOLDERS Source: R. Edward Freeman, Jeffrey Harrison, and Andrew Wicks, Managing for Stakeholders (New Haven: Yale University Press, 2007). 62 The Purpose of the Corporation center of the universe, and there are many possible pictures. One might put customers in the center to signal that a company puts customers as the key priority. Another might put employees in the center and link them to customers and shareholders. We prefer the generic diagram because it suggests, pictorially, that “managing for stakeholders” is a theory about management and business; hence, managers and companies are in the center. But, there is no larger metaphysical claim here. Stakeholders and Stakes Owners or financiers (a better term) clearly have a financial stake in the business in the form of stocks, bonds, and so on, and they expect some kind of financial return from them. Of course, the stakes of financiers will differ by type of owner, preferences for money, moral preferences, and so on, as well as by type of firm. The shareholders of Google may well want returns as well as be supportive of Google’s articulated purpose of “Do No Evil.” To the extent that it makes sense to talk about the financiers “owning the firm,” they have a concomitant responsibility for the uses of their property. Employees have their jobs and usually their livelihood at stake; they often have specialized skills for which there is usually no perfectly elastic market. In return for their labor, they expect security, wages, benefits, and meaningful work. Often, employees are expected to participate in the decision making of the organization, and if the employees are management or senior executives, we see them as shouldering a great deal of responsibility for the conduct of the organization as a whole. And, employees are sometimes financiers as well, since many companies have stock ownership plans, and loyal employees who believe in the future of their companies often voluntarily invest. One way to think about the employee relationship is in terms of contracts. Customers and suppliers exchange resources for the products and services of the firm and in return receive the benefits of the products and services. As with financiers and employees, the customer and supplier relationships are enmeshed in ethics. Companies make promises to customers via their advertising, and when products or services don’t deliver on these promises, then management has a responsibility to rectify the situation. It is also important to have suppliers who are committed to making a company better. If suppliers find a better, faster, and cheaper way of making critical parts or services, then both supplier and company can win. Of course, some suppliers simply compete on price, but even so, there is a moral element of fairness and transparency to the supplier relationship. Finally, the local community grants the firm the right to build facilities, and in turn, it benefits from the tax base and economic and social contributions of the firm. Companies have a real impact on communities, and being located in a welcoming community helps a company create value for its other stakeholders. In return for the provision of local services, companies are expected to be good citizens, as is any individual person. It should not expose the community to unreasonable hazards in the form of pollution, toxic waste, etc. It should keep whatever commitments it makes to the community, and operate in a transparent manner as far as possible. Of course, companies don’t have perfect knowledge, but when management discovers some danger or runs afoul of new competition, it is expected to inform and work with local communities to mitigate any negative effects, as far as possible. While any business must consist of financiers, customers, suppliers, employees, and communities, it is possible to think about The Purpose of the Corporation other stakeholders as well. We can define “stakeholder” in a number of ways. First of all, we could define the term fairly narrowly to capture the idea that any business, large or small, is about creating value for “those groups without whose support, the business would cease to be viable.” The inner circle of Figure 1 depicts this view. Almost every business is concerned at some level with relationships among financiers, customers, suppliers, employees, and communities. We might call these groups “primary” or “definitional.” However, it should be noted that as a business starts up, sometimes one particular stakeholder is more important than another. In a new business start-up, sometimes there are no suppliers, and paying lots of attention to one or two key customers, as well as to the venture capitalist (financier), is the right approach. There is also a somewhat broader definition that captures the idea that if a group or individual can affect a business, then the executives must take that group into consideration in thinking about how to create value. Or, a stakeholder is any group or individual that can affect or be affected by the realization of an organization’s purpose. At a minimum some groups affect primary stakeholders and we might see these as stakeholders in the outer ring of Figure 1 and call them “secondary” or “instrumental.” There are other definitions that have emerged during the last 30 years, some based on risks and rewards, some based on mutuality of interests. And, the debate over finding the one “true definition” of “stakeholder” is not likely to end. We prefer a more pragmatic approach of being clear of the purpose of using any of the proposed definitions. Business is a fascinating field of study. There are very few principles and definitions that apply to all businesses all over the world. Furthermore, there are many different ways to run a successful business, or if you like, many different flavors of 63 “managing for stakeholders.” We see limited usefulness in trying to define one model of business, either based on the shareholder or stakeholder view, that works for all businesses everywhere. We see much value to be gained in examining how the stakes work in the value creation process, and the role of the executive. THE RESPONSIBILITY OF THE EXECUTIVE IN MANAGING FOR STAKEHOLDERS Executives play a special role in the activity of the business enterprise. On the one hand, they have a stake like every other employee in terms of an actual or implied employment contract. And, that stake is linked to the stakes of financiers, customers, suppliers, communities, and other employees. In addition, executives are expected to look after the health of the overall enterprise, to keep the varied stakes moving in roughly the same direction, and to keep them in balance. 14 No stakeholder stands alone in the process of value creation. The stakes of each stakeholder group are multifaceted, and inherendy connected to each other. How could a bondholder recognize any returns without management’s paying attention to the stakes of customers or employees? How could customers get the products and services they need without employees and suppliers? How could employees have a decent place to live without communities? Many thinkers see the dominant problem of “managing for stakeholders” as how to solve the priority problem, or “which stakeholders are more important,” or “how do we make trade-offs among stakeholders.” We see this as a secondary issue. First and foremost, we need to see stakeholder interests as joint, as inherently tied together. Seeing stakeholder interests as “joint” 64 The Purpose of the Corporation rather t h a n “opposed” is difficult. It is n o t always easy to find a way to a c c o m m o d a t e all stakeholder interests. It is easier to trade off o n e versus another. Why n o t delay s p e n d i n g o n new p r o d u c t s for c u s t o m e r s in o r d e r to keep earnings a bit higher? Why n o t cut employee medical benefits in o r d e r to invest in a new inventory control system? Managing for stakeholders suggests that executives try to reframe the questions. How can we invest in new p r o d u c t s a n d create h i g h e r earnings? How can we b e sure o u r employees are healthy a n d h a p p y a n d are able to work creatively so that we can capture the benefits of new information technology such as inventory control systems? In a r e c e n t b o o k reflecting o n his experience as C E O of Medtronic, Bill G e o r g e s u m m a r i z e d t h e m a n a g i n g for stakeholders mindset: 1 5 Serving all your stakeholders is the best way to produce long term results and create a growing, prosperous company . . . Let me be very clear about this: there is no conflict between serving all your stakeholders and providing excellent returns for shareholders. In the long term it is impossible to have one without the other. However, serving all these stakeholder groups requires discipline, vision, and committed leadership. T h e primary responsibility of the executive is to create as m u c h value as possible for stakeholders. 1 6 Where stakeholder interests conflict, the executive must find a way to r e t h i n k the p r o b l e m s so t h a t t h e s e interests c a n go together, so that even m o r e value can be created for each. If trade-offs have to b e made, as often h a p p e n s in the real world, t h e n the executive m u s t figure o u t h o w to m a k e t h e trade-offs, a n d immediately begin improving the tradeoffs for all sides. Managing for stakeholders is about creating as much value as possible for stakeholders, without resorting to trade-offs. We believe that this task is m o r e easily accomplished when a business has a sense of purpose. F u r t h e r m o r e , there are few limits o n the kinds of purpose that can drive a business. WalMart may stand for “everyday low price.” Merck can stand for “alleviating h u m a n suffering.” T h e p o i n t is t h a t if a n e n t r e p r e n e u r or a n executive can find a purpose that speaks to the hearts a n d minds of key stakeholders, it is more likely that there will b e sustained success. Purpose is complex a n d inspirational. T h e G r a m e e n B a n k wants to e l i m i n a t e poverty. F a n n i e Mae wants to m a k e h o u s i n g affordable to every i n c o m e level in society. Tastings (a local restaurant) wants to b r i n g the taste of really g o o d food a n d wine to lots of people in the community. And, all of these organizations have to generate profits, or else they c a n n o t p u r s u e t h e i r p u r p o s e s . Capitalism works b e c a u s e we can p u r s u e o u r p u r p o s e with others. W h e n we coalesce a r o u n d a big idea, or a j o i n t p u r p o s e evolves from o u r dayto-day activities with e a c h other, t h e n g r e a t things can h a p p e n . To create value for stakeholders, executives must understand that business is fully situated in the realm of humanity. Businesses are h u m a n institutions p o p u l a t e d by real live c o m p l e x h u m a n beings. Stakeholders have names a n d faces a n d children. They are n o t m e r e placeh o l d e r s for social roles. As such, matters of ethics are routine when o n e takes a managing for stakeholders a p p r o a c h . Of course this should go without saying, but a part of the dominant story about business is that business people are only in it for their own narrowly defined self-interest. O n e main assumption of the managerial view with shareholders at the center is that shareholders only care about returns, a n d therefore their agents, managers, should only care a b o u t returns. However, this does n o t fit either o u r experiences or our aspirations. In the words of o n e CEO, “The only assets I manage go u p a n d down the elevators everyday.” Most h u m a n beings are complicated. Most of us d o w h a t we d o b e c a u s e we a r e selfinterested a n d interested in others. Business works in p a r t because of o u r u r g e to create The Purpose of the Corporation things with others a n d for others. Working o n a team, or creating a new p r o d u c t or delivery mechanism that makes customer’s lives better o r h a p p i e r o r m o r e p l e a s u r a b l e , all can b e contributing factors to why we go to work each day. And, this is n o t to deny t h e e c o n o m i c incentive of getting a pay check. T h e assumption of n a r r o w self-interest is e x t r e m e l y limiting, a n d can be self-reinforcing—people can begin to act in a n a r r o w self-interested way if they believe that is what is e x p e c t e d of t h e m , as some of the scandals such as E n r o n , have shown. We n e e d to b e o p e n to a m o r e c o m p l e x psychology—one any p a r e n t finds familiar as they have s h e p h e r d e d the growth a n d d e v e l o p m e n t of their children. SOME ARGUMENTS FOR MANAGING FOR STAKEHOLDERS O n c e you say stakeholders are persons t h e n the ideas of ethics are automatically applicable. However you i n t e r p r e t t h e i d e a of “stakeholders,” you must pay attention to the effects of your actions o n others. And, something like the Responsibility Principle suggests that this is a cornerstone of any adequate ethical theory. T h e r e are at least t h r e e m a i n a r g u m e n t s for a d o p t i n g a m a n a g i n g for s t a k e h o l d e r s app r o a c h . P h i l o s o p h e r s will see these as connected to the three main approaches to ethical t h e o r y t h a t have d e v e l o p e d historically. We shall briefly set forth sketches of these arguments, a n d t h e n suggest that t h e r e is a m o r e powerful fourth argument. 17 T h e Argument f r o m C o n s e q u e n c e s A n u m b e r of theorists have a r g u e d that the main reason that the d o m i n a n t m o d e l of managing for shareholders is a good idea is that it leads to the best consequences for all. Typically these arguments invoke Adam Smith’s idea of 65 the invisible hand, whereby each business actor pursues h e r own self-interest a n d the greatest good of all actually emerges. T h e problem with this argument is that we now know with m o d e r n general equilibrium economics that the argum e n t only works u n d e r very specialized conditions that seldom describe the real world. And further, we know that if the economic conditions get very close to those n e e d e d to produce the greatest good, there is n o guarantee that the greatest good will actually result. Managing for stakeholders may actually produce better consequences for all stakeholders because it recognizes that stakeholder interests are joint. If o n e stakeholder pursues its interests at the expense of all the others, t h e n the others will either withdraw their support, or look to create another network of stakeholder value creation. This is n o t to say that there are n o t times when one stakeholder will benefit at the expense of others, but if this happens continuously over time, then in a relatively free society, stakeholders will either (1) exit to form a new stakeholder network that satisfies their needs; (2) use the political process to constrain the offending stakeholder; or (3) invent some other form of activity to satisfy their particular needs. 1 8 Alternatively, if we think a b o u t stakeholders e n g a g e d in a series of b a r g a i n s a m o n g themselves, t h e n we would expect that as individual stakeholders recognized their j o i n t interests, a n d m a d e good decisions based o n these interests, better consequences would result t h a n if they each narrowly p u r s u e d their individual self-interests. 19 Now it may b e objected t h a t such a n approach ignores “social consequences” or “consequences to society” and, hence, that we need a c o n c e p t of “corporate social responsibility” to mitigate these effects. This objection is a vestigial limb of the d o m i n a n t m o d e l . Since t h e only effects, o n that view, were e c o n o m i c effects, t h e n we n e e d to think a b o u t “social consequences” or “corporate social responsibility.” However, if stakeholder relationships 66 The Purpose of the Corporation a r e u n d e r s t o o d to b e fully e m b e d d e d i n morality, t h e n t h e r e is n o n e e d for a n idea like corporate social responsibility. We can replace it with “corporate stakeholder responsibility,” which is a d o m i n a n t f e a t u r e of m a n a g i n g for stakeholders. T h e Argument from Rights T h e dominant story gives property rights in the corporation exclusively to shareholders, a n d the natural question arises about the rights of other stakeholders who are affected. O n e way to understand managing for stakeholders is that it takes this question of rights seriously. If you believe that rights make sense, and further that if o n e person has a right to X t h e n all persons have a right to X, it is j u s t m u c h easier to think a b o u t these issues using a s t a k e h o l d e r approach. For instance, while shareholders may well have property rights, these rights are not absolute, a n d should n o t be seen as such. Shareholders may n o t use their property to abridge the rights of others. For instance, shareholders a n d their agents, managers, may n o t use corp o r a t e property to violate the right to life of others. O n e way to u n d e r s t a n d managing for stakeholders is that it assumes that stakeholders have some rights. Now, it is notoriously difficult to parse the idea of “rights.” But, if executives take managing for stakeholders seriously, they will automatically think about what is owed to customers, suppliers, employees, financiers, and communities, in virtue of their stake, a n d in virtue of their basic humanity. T h e Argument f r o m Character O n e of the strongest arguments for managing for stakeholders is that it asks executives a n d entrepreneurs to consider the question of what kind of company they want to create and build. T h e answer to this question will b e in large p a r t a n issue of character. Aspiration matters. T h e business virtues of efficiency, fairness, respect, integrity, keeping c o m m i t m e n t s , a n d others are all critical in b e i n g successful at creating value for stakeholders. These virtues are simply absent when we think only a b o u t the d o m i n a n t model a n d its sole reliance o n a narrow e c o n o m i c logic. If we frame t h e central q u e s t i o n of m a n a g e m e n t as “how d o we create value for shareholders,” t h e n the only virtue t h a t emerges is o n e of loyalty to the interests of shareholders. However if we frame the central question more broadly as “how d o we create a n d sustain the creation of value for stakeholders” or “how do we get stakeholder interests all g o i n g in t h e same direction,” then it is easy to see how many of the other virtues are relevant. Taking a stakeholder approach helps people decide how companies can contribute to their well-being a n d t h e kinds of lives they w a n t to lead. By making ethics explicit a n d building it into the basic way we think about business, we avoid a situation of b a d faith a n d self-deception. T h e Pragmatist’s Argument T h e previous t h r e e a r g u m e n t s p o i n t o u t imp o r t a n t r e a s o n s for a d o p t i n g a n e w story about business. Pragmatists want to know how we can live better, h o w we can create b o t h ourselves a n d o u r communities in ways where values such as freedom a n d solidarity are prese n t in o u r everyday lives to the maximal ext e n t . W h i l e it is s o m e t i m e s useful to t h i n k a b o u t consequences, rights, a n d character in isolation, in reality o u r lives are r i c h e r if we can have a conversation a b o u t how to live tog e t h e r b e t t e r . T h e r e is a l o n g t r a d i t i o n of pragmatist ethics dating to philosophers such as William J a m e s a n d J o h n Dewey. M o r e recently p h i l o s o p h e r R i c h a r d Rorty has expressed t h e pragmatist ideal: 2 0 pragmatists . . . hope instead that human beings will come to enjoy more money, more free time, The Purpose of the Corporation and greater social equality, and also that they will develop more empathy, more ability to put themselves in the shoes of others. We hope that human beings will behave more decently toward one another as their standard of living improves. By building into the very conceptual framework we use to think about business a concern with freedom, equality, consequences, decency, shared purpose, and paying attention to all of the effects of howwe create value for each other, we can make business a h u m a n institution, a n d perhaps remake it in a way that sustains us. For the pragmatist, business ( a n d capitalism) has evolved as a social practice, an imp o r t a n t o n e that we use to create value a n d t r a d e with each other. O n this view, first a n d foremost, business is a b o u t collaboration. Of course, in a free society, stakeholders are free to form c o m p e t i n g networks. But the fuel for capitalism is o u r desire to create s o m e t h i n g of value, a n d to create it for ourselves a n d others. T h e spirit of capitalism is the spirit of i n d i v i d u a l a c h i e v e m e n t t o g e t h e r with t h e spirit of accomplishing great tasks in collabo r a t i o n with o t h e r s . M a n a g i n g for stakeh o l d e r s makes this plain so t h a t we can get a b o u t the business of c r e a t i n g b e t t e r selves and better communities. NOTES 1. The ideas in this paper have had a long development time. The ideas here have been reworked from: R. Edward Freeman, Strategic Management: A Stakeholder Approach (Boston: Pitman, 1984); R. Edward Freeman, “A Stakeholder Theory of the Modern Corporation,” in T. Beauchamp and N. Bowie (eds.) Ethical Theory and Business (Englewood Cliffs: Prentice Hall, 7th edition, 2005), also in earlier editions coauthored with William Evan; Andrew Wicks, R. Edward Freeman, Patricia Werhane, Kirsten Martin, Business Ethics: A Managerial Approach (Englewood Cliffs: Prentice Hall, forthcoming in 2008); and R. Edward Freeman, Jeffrey Harrison, and Andrew Wicks, Managing for Stakeholders (New Haven: Yale University Press, 2007). 2. 3. 4. 5. 67 I am grateful to editors and coauthors for permission to rework these ideas here. It has been called a variety of things: “stakeholder management,” “stakeholder capitalism,” “a stakeholder theory of the modern corporation,” and so on. Our reasons for choosing “managing for stakeholders” will become clearer as we proceed. Many others have worked on these ideas, and should not be held accountable for the rather idiosyncratic view oudined here. For a stylized history of the idea see R. Edward Freeman, “The Development of Stakeholder Theory: An Idiosyncratic Approach” in K. Smith and M. Hitt (eds.), Great Minds in Management (Oxford: Oxford University Press, 2005). One doesn’t manage “for” these benefits (and harms). The difference between managerial and shareholder capitalism is large. However, the existence of agency theory lets us treat the two identically for our purposes here. Both agree on the view that the modern firm is characterized by the separation of decision making and residual risk bearing. The resulting agency problem is the subject of a vast literature. 6. Alfred Chandler’s brilliant book Strategy and Structure (Boston: MIT Press, 1970) chronicles the rise of the divisionalized corporation. For a not-so-flattering account of General Motors during the same time period see Peter Drucker’s classic work The Concept of the Corporation (New York: Transaction Publishers, reprint ed., 1993). 7. Executives can take little comfort in the nostrum that in the long run things work out and the most efficient companies survive. Some market dieorists suggest that finance theory acts like “universal acid” cutting through every possible management decision, whether or not, actual managers are aware of it. Perhaps the real difference between the dominant model and the “managing for stakeholders” model proposed here is that they are simply “about” different things. The dominant model is about the strict and narrow economic logic of markets, and the “managing for stakeholders” model is about how human beings create value for each other. 8. Often the flavor of the response of finance theorists sounds like this. The world would be better off if, despite all of the imperfections, executives tried to maximize shareholder value. It is difficult to see how any rational being could accept such a view in the face of the 68 T h e Purpose of the C o r p o r a t i o n r e c e n t scandals, w h e r e it could be a r g u e d dtat the worst offenders were the most ideologically p u r e , a n d t h e result was the actual destruction of shareholder value (see Breaking the Short Term Cycle, Charlottesville, VA: Business Roundtable Institute for C o r p o r a t e Ethics/CFA C e n t e r for Financial Market Integrity, 2006). Perhaps we have a version of Aristotle’s i d e a t h a t h a p p i ness is n o t a result of trying to be happy, o r Mill’s idea t h a t it does n o t maximize utility to try a n d m a x i m i z e utility. Collins a n d Porras have suggested that even if executives want to maximize shareholder value, they should focus o n p u r p o s e instead, t h a t trying to maximize s h a r e h o l d e r value does n o t lead to m a x i m u m value, see J. Collins a n d J. Porras, Built To Last (NewYork: H a r p e r Collins, 2002). 9. See R. Edward Freeman, “The Politics of Stakeholder Theory: Some Future Directions,” Business Ethics Quarterly 4:409-22. 1 0. T h e second part of the integration thesis is left for a n o t h e r occasion. Philosophers who r e a d this essay may n o t e the radical d e p a r t u r e from s t a n d a r d a c c o u n t s of p o l i t i c a l p h i l o s o p h y . S u p p o s e we b e g a n t h e inquiry into political philosophy with the question, How is value creation a n d trade sustainable over time? a n d suppose that the traditional b e g i n n i n g question, How is the state justified? was a subsidiary o n e . We m i g h t discover or create s o m e very differe n t answers from t h e s t a n d a r d a c c o u n t s of most political theory. See R. Edward F r e e m a n a n d R o b e r t Phillips, “Stakeholder Theory: A Libertarian Defense,” Business Ethics Quarterly 12, n o . 3 (2002): 33Iff. 11. Here we roughly follow the logic ofJ o h n Rawls in Political Liberalism (New York: Columbia University Press, 1995). 12. T h e r e a r e m a n y statements of this principle. O u r a r g u m e n t is that whatever t h e particular c o n c e p t i o n of responsibility t h e r e is s o m e underlying c o n c e p t that is c a p t u r e d like o u r willingness or o u r n e e d to justify o u r lives to others. Note the answer that the d o m i n a n t view of business m u s t give to q u e s t i o n s a b o u t responsibility. “Executives are responsible only for t h e effects of their actions o n shareholders, o r only insofar as their actions create o r destroy s h a r e h o l d e r value.” 13. T h e spirit of this d i a g r a m is from R. Phillips, Stakeholder Theory and Organizational Ethics (San Francisco: Berret-Koehler Publishers, 2003). 14. In earlier versions of this essay in this volume we suggested that the notion of a fiduciary duty to stockholders be e x t e n d e d to “fiduciary duty to stakeholders.” We believe that such a move c a n n o t be d e f e n d e d without d o i n g d a m a g e to t h e n o t i o n of “fiduciary.” T h e idea of having a special duty to either o n e o r a few stakeholders is n o t helpful. 15. Bill G e o r g e , Authentic leadership cisco: Jossey Bass, 2004). (San Fran- 16. This is at least as clear as t h e directive given by the d o m i n a n t m o d e l : create as m u c h value as possible for shareholders. 17. S o m e p h i l o s o p h e r s have a r g u e d t h a t t h e s t a k e h o l d e r a p p r o a c h is in n e e d of a “normative justification.” To t h e e x t e n t t h a t this p h r a s e has any m e a n i n g , we lake it as a call to c o n n e c t t h e logic of m a n a g i n g for stakeh o l d e r s with m o r e traditional ethical theory. As pragmatists we eschew t h e “descriptive vs. n o r m a t i v e vs. i n s t r u m e n t a l ” distinction t h a t so m a n y business t h i n k e r s ( a n d s t a k e h o l d e r theorists) have a d o p t e d . M a n a g i n g for stakeh o l d e r s is i n h e r e n t l y a narrative o r story t h a t is at o n c e descriptive of how s o m e businesses d o act; aspirational a n d normative a b o u t how t h e y c o u l d a n d s h o u l d act; instrumental in t e r m s of w h a t m e a n s lead to what e n d s ; a n d managerial in t h a t it m u s t b e c o h e r e n t o n all of t h e s e d i m e n s i o n s a n d actually g u i d e executive action. 18. See S. Venkataraman, “Stakeholder Value Equilibration and the Entrepreneurial Process,” Ethics andEntrepreneursiiip, T h e Ruffin Series, 3 (2002): 45-57; S. R. Velamuri, “Entrepreneurship, Altruism, and the Good Society,” Ethics and Entrepreneurship, T h e Ruffin Series 3 (2002): 125-43; and, T. Harting, S. Harmeling, and S. Venkataraman, “Innovative Stakeholder Relations: W h e n “Ethics Pays” (and W h e n it Doesn’t)” Business Ethics Quarterly 16 (2006): 43-68. 19. Sometimes t h e r e are trade-offs a n d situations t h a t e c o n o m i s t s w o u l d call ” p r i s o n e r ‘ s dil e m m a ” b u t these a r e n o t t h e p a r a d i g m a t i c cases, o r if they are, we s e e m to solve t h e m routinely, as Russell H a r d i n has suggested in Morality Within the Limits of Reason (Chicago: University of Chicago Press, 1998). 20. E. M e n d i e t a ( e d . ) , Take Care of Freedom and Truth Will Take Care of Itself: Intervieios with Richard Rorly (Stanford: Stanford University Press, 2006), 68. Argument Evaluation (AE) Note Instructions Each AE note involves three parts: Part 1: Syllogism: Present the primary argument of one of the assigned readings as a numbered syllogism. Some articles might have more than one argument; if so, present what you take to be the strongest argument in the paper. Be sure to present the argument in its most charitable form (hint: Would the author agree that the view you have presented is his or her view?). 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