Existing criticisms of the stakeholder concept of corporate governance, centering on the threat to private-property rights that it poses and the distortion of traditional notions of accountability in the firm that it entails, are highly persuasive (Barry 1998; Sternberg 1999). Still insufficiently recognized, however, are the logical flaws in the stakeholder argument. It is a serious defect of stakeholder methods of decision making that were a firm to adopt them, bad decisions would result. However, an equally serious defect is that no decisions at all might result or that the decisions reached might not reflect the values regarded as integral to the stakeholder idea. The whole stakeholder theory is vulnerable to a logical problem that has long been a feature of democratic theory and practice. This paradox was formally demonstrated by Kenneth Arrow (1963) in 1951, although it had originally been identified much earlier by the Marquis de Condorcet, the French Enlightenment thinker who died at the hands of the French revolutionaries. (1) It has perplexed democratic theorists ever since.
Business practice and business ethics are subject to intellectual strictures that belong to political philosophy because the predominant motive of much business ethics is to politicize or democratize the corporation--to take power away from the stockholders and to vest it in more inclusive groups. It is no coincidence that supporters of the stakeholder idea frequently use the term constituencies to refer to the groups that they think ought to have an influence on corporate governance (Kuhn and Shriver 1991, chap. 3), as if the members of such groups were equivalent to the voters in a representative democracy. If this claim is the primary motif of stakeholder theorists, then it is perfectly permissible, indeed obligatory, to attack the doctrine with all the artillery of orthodox social science and democratic theory.
Stakeholder theory is normally confined to academic theories of business ethics, although most publicly held corporations regularly pay some obeisance to it in their annual reports and public pronouncements. Still, as we know from environmentalism and other public-policy matters, abstract academic doctrines have a habit of reaching government and even, perhaps especially, company boardrooms. Ultimately they have an effect on business, usually adverse. The stakeholder theory is especially important because if it were applied in practical business, it would involve a radical departure from traditional methods of corporate governance. Not only would it amount to an additional cost imposed on the stockholders, as other socially oriented business policies do, but it would also completely overturn customary methods of decision making in a company and might well make capitalist enterprise impossible. The stakeholder movement wishes to reorganize companies so that the decisionmaking procedure would not be geared toward the maximization of share value, but instead resources would be shifted to satisfy any group or coalition of groups that could claim influence in and reward from the company irrespective of ownership claims or the lack thereof.
I am dealing here with Anglo-American business, (2) in which the stakeholder doctrine has not had much practical success, though it poses a long-term danger. To some extent, stakeholderism has historically been a feature of business in Germany, where trade union representatives sit on the supervisory boards of companies (although owners have the ultimate decision-making power), and also perhaps in Japan. Both economies have at least one thing in common that makes them appropriate models for stakeholder theory: their indifference to share value, especially in Japan, where the nominal owners of companies are virtually excluded from the decision-making process. Both countries traditionally have been hostile to the takeover mechanism, which in the Anglo-American economies is the primary method for the discipline of managers and the enforcement of the ultimate rights of ownership. Recently, share ownership has widened in Germany, and a spectacular takeover (to be discussed later), with its strong Anglo-American overtones, has occurred, but the German corporate economy still differs from the economies in English-speaking countries.
Governance of the Anglo-American Corporation
Before we can analyze the logic of stakeholderism and its deleterious effect on the traditional corporation, we must briefly consider the main features of the Anglo-American firm, especially its authority structure. This type of corporation is a collective body, or artificial person, recognized by law. At one time, its personhood was limited to civil law, basically in relation to torts and contracts, but in recent years, especially in the United States, corporations have been held criminally liable in certain cases. Now boards of directors may be personally responsible for criminal actions, and stockholders may be liable for the extraordinarily heavy fines that sometimes result. Ironically, it is difficult to imagine stakeholder theorists favoring this legal situation, even though their doctrine implies that responsibility must be shared by groups who may not be owners. Surely they would not want their flavored "constituencies" to be held liable for criminal actions.
People form the collective entities called corporations to acquire wealth, although corporations might have other purposes (as they did historically in both Britain and the United States): the articles of incorporation specify the entity's precise purposes. The modern corporation has an economic rationale first identified by Ronald Coase (1937), although he was actually dealing with "the firm" in general, not necessarily with the corporate firm. He showed that because of transactions costs, it would be inefficient to conduct business entirely through pure market relationships, in which every individual deals with every other individual on a contractual basis; therefore, the firm operates by means of an authoritarian management structure designed to reduce transactions costs. In the modern corporation, persons are not linked to each other by a series of individual contracts (multilateral contracting); instead, they are tied to the firm by a single, bilateral contract--the "master-servant" relationship par excellence. Of course, in widely held corporations, the separation of ownership and managerial control, with the shareholders being largely passive, produces an "agency problem." How do the principals, the owners, ensure that their agents (employees from top managers down to shopfloor workers) work for the company and not for themselves by shirking on the job, cheating, stealing, and so forth? For lower-level personnel, the ultimate threat is dismissal, which is especially effective in a regime of "employment at will" contracts. (3) For top managers suspected of indolence or "rent seeking," (4) the takeover threat may be necessary (takeovers often result in job losses at the higher levels). Short of these sanctions, the firm has the authority and a power structure to enforce day-to-day discipline. Of course, transaction costs may change over time. In recent years, for example, working from home has become more common, and use of the Internet in the "information economy" has fostered greater resort to individually negotiated and often short-term contracts. Hence, the large-scale public corporation and its bilateral contracting may be in decline. In such a new commercial world, what meaning would attach to "the social responsibility of the corporation"?
In the conventional structure of the firm, the nexus of rights comprises residual rights, control rights, and decision rights (Ricketts 1994, chap.4). The residual rights, held by the stockholders, entitle them to the surplus (profit) that remains after all the operating costs have been paid. Control rights pertain especially to the appointment of managers; the shareholders normally delegate these rights to the board of directors. The managers in turn exercise decision rights in their day-to-day oversight of the production process. Thus, because of the separation between ownership and control, shareholders are...