Stakeholder Theory

I was in the Library this week working on something else when I ran across several articles about Stakeholder Theory. It’s another one of those ideas that is so simple that you could probably design an entire Master’s class around it; there are certainly a large number of articles in management journals that deal with the concept. It takes a special sort of person to attempt to explain something that big in 600 words or less; I’ll let the reader decide if I’m arrogant or just crazy for trying.

The first thing to keep in mind is the definition of a stakeholder. Although there is some debate over how broad to make the definition, in general, a stakeholder is anyone affected by a specific company’s operations, including their employees, shareholders, suppliers, and customers, but also including political groups, trade unions, the communities in which the company’s products are made, sold or used, prospective customers, and so on. Stakeholder theory basically states that in order to be strategically sound, a company’s plans should take all of the stakeholders into account, not just the ones who own shares in the company.

This is, of course, a complete departure from the older theory of management, which holds that a company’s primary duty (some would say its only duty) is to generate revenue, and that the management team’s job is to maximize shareholder value. Since the shareholders are literally the people who own the company, and since they can (at least in theory) fire the CEO and the board and replace them, it would seem to behoove the top management personnel to look after the interests of the shareholders; it can also be argued that they have a fiduciary duty to do just that. On the other hand, the stakeholders include many people with no ownership position in the company and no way to punish or reward the management team; in some cases, even the company’s competitors are considered to be stakeholders. So why should the management team attempt to do right by them?

Let me give you two concrete examples. In 1971, Ford Motor Company decided to bury the reports about the Pinto, thus maximizing their share value and the stockholder’s investment at the expense of anyone who owned a Pinto or happened to run into the back of one. They were eventually exposed, vigorously sued, and lost even more money than they would have spent to fix the faulty gas tanks. However, even worse was the loss of the company’s reputation; the public was less confident in the safety of their cars, and investors were less confident in the management of the company. The fallout from that blunder is STILL being felt within the company, none of it good.

By contrast, in 1982 someone managed to put poison into bottles of Tylenol, killing seven people and starting a nationwide panic. The Johnson and Johnson company responded by doing everything it could to help the families of the victims and starting a drive to create tamper-proof packaging that eventually became the industry standard. Now all over-the-counter drugs (and many other products) come with the same tamper-resistant packaging Johnson and Johnson came up with to protect its stakeholders. As a result, their company is widely regarded as being responsible, taking care of its customers, and most importantly of all, being intelligently run. The money spent on the tamper-resistant packaging and in the cleanup after the poisoning scare have been made back many times over by the improved public perception, and the shareholders’ overall value is far higher than it would have been if the company had attempted to stonewall, blame the victims, or deny responsibility.

In other words, the ultimate outcome of stakeholder theory is that if you run your company in a responsible manner, taking into consideration all of the people affected by your operations (and not just the ones who own your common stock), you can expect to do better in the long run than if you cling to the concept of maximizing shareholder value at the expense of everything else. Or, if you like, the argument in favor of stakeholder theory is simple, enlightened self-interest…