The Post-enron Era for Stakeholder Theory: a New Look at Corporate Governance and Coase Theorem - Marianne M. Jennings and Stephen Happel

• Citation: Vol. 54 No. 2
• Publication year: 2003

The Post-Enron Era for Stakeholder Theory: A New Look at Corporate Governance and the Coase Theorem

Marianne M. Jennings^* and Stephen Happel^**

I. Introduction

Fallen Enron was the model of corporate social responsibility—a veritable stakeholder theorist's dream.¹ Its code of ethics touted diversity and philanthropic giving.² Enron's former CFO, Andrew Fastow, was active in the Houston Art Museum and had been the cornerstone in fundraising for Houston's Holocaust Museum.³ Clifford

Baxter, an Enron executive vice-president, who would take his own life shortly after leaving the company, was involved in Junior Achievement.⁴ Enron paralleled FINOVA Group, American Continental Corporation (Charles Keating), and WorldCom with regard to philanthropic activity. All of these companies had officers heavily involved in community and philanthropic activity, yet all of their companies imploded from accounting improprieties.⁵ In their minds they were, according to Jeffrey Skilling, Enron's former CEO, "on the side of angels."⁶

Ironically, at the same time Enron, WorldCom, and others were collapsing, so also was Aaron Feuerstein's Malden Mills. Mr. Feuerstein enjoyed the accolades of business ethicists for his decision to continue to pay idle workers when his plant was destroyed by a fire in 1995.⁷ But Malden Mills is in bankruptcy court alongside those companies led by alleged rogues.⁸

Enron followed a model of corporate social responsibility ("CSR") that has long been the ideal in terms of corporate governance, the formula for corporate success. Touted for years in the business ethic literature as theory, it had emerged as a force among government leaders. British Prime Minister Tony Blair appointed the first Minister for Corporate Social Responsibility in 2000. The mandate Blair gave to his appointee was to persuade companies to "give something back" to their communities and convince businesses that "a caring attitude" is good for the bottom line.⁹ Blair's critics were disturbed by the word "encourage" in the mandate, instead expressing preference for legislation to mandate corporate social responsibility.¹⁰

John Howard, Australia's Prime Minister, has encouraged his nation's businesses to follow a similar philosophy: "The spirit of corporate citizenship suggests that a company that derives profit from the community has an obligation to contribute to its development. . . . [I]t is reasonable to expect the principle of mutual obligation to apply to the business sector."¹¹

What was once a scholarly debate on the role of the corporation in society advanced rapidly toward governmental mandate. Our European brethren contemplated conditioning the right to engage in commerce on perceived responsiveness to social issues.¹²

As icons of CSR fall, the debate over CSR must be revisited. Is CSR the best—indeed, is it even a suitable method of corporate governance? Economics is a system of resource allocation, and stakeholder theory is touted as a substitute for that system when it comes to business operations and corporate governance. Stakeholder theory, a formula and theory grounded in the notion of structured appeasement, is at the heart of these government proposals and activist groups' increasing demands for changes in corporate governance. Likewise, stakeholder theory and CSR are at the heart of many of the failures we witness. Companies that followed all the CSR rules ended in shambles—most were a model of shareholder deceit even as stakeholders such as employees and communities enjoyed a fabulous ride as the companies' share prices escalated beyond market realities. A question that CSR proponents and business ethicists now avoid is whether stakeholder theory and CSR are the best models for corporate governance. An exploration of that question does yield some answers as well as proposals for reform.

In addressing the stakeholder/CSR approach to corporate governance, one must begin with the flaws in the theory. Stakeholder theory, as a means of achieving CSR or even as a means of measuring CSR of corporations, has four fundamental flaws that arise when principles of law and economics are integrated with this management and business ethics theory. Those flaws are: (1) the definition of CSR, which remains nebulous and a bit of a moving target with political underpinnings; (2) the relationship between CSR, as defined by stakeholder accountability, and superior financial performance is a theory advanced and worthy of examination, but to date has not been measured in a manner that can withstand empirical scrutiny; (3) governmental imposition of CSR requirements ignores fundamental property rights and protections and may serve to remove the incentives such property rights provide in the intricate balance of the marketplace; and (4) government mandates or normatively-imposed CSR are poor substitutes for market forces. It is within this last flaw that the exploration of the work of Ronald Coase is enlightening. There exists a void in the business ethics and corporate governance literature regarding Coase's work. This void is surprising because under the Coase Theorem, companies may already be led economically to those CSR behaviors that maximize benefits with resulting increased shareholder return while also providing societal satisfaction—thus reducing the alleged conflicts between business achievement and social responsibility, a particularly sensitive area among business ethicists and stakeholder theorists.

This Article provides a discussion of these four flaws in light of the once proposed mandatory application of CSR, whether by government body or private pressure, and the astonishing failures of companies following the CSR ideals.¹³ Included within the discussion of these issues are the results of a study in which the financial performance of companies was compared with their devotion to CSR, particularly stakeholder theory. These results are then examined in light of the Coase Theorem and its application in the CSR debate. These quantitative results seem to demonstrate that there is a voluntary interaction between corporations and those who are generally depicted as combatants in the battle for CSR. Companies that advocate CSR voluntarily reflect financial performances that exceed the performance of those companies identified by CSR advocates as ideal corporate citizens. Coase's Theorem offers both an explanation for the study results as well as a proposed alternative means for achievement of CSR. Mandatory subscription to CSR, whether by government mandate or public relations campaigns waged by special interest groups to ensure corporate submission, is not the best means for achieving CSR goals, and additionally, it presents property and legal issues that may undermine the economic system that generates products, jobs, and earnings. CSR for the sake of CSR is a dangerous fagade. The findings of this study and the application of the Coase Theorem suggest that voluntary interaction with stakeholders is not only a means of allocation, but a somewhat more satisfying one in terms of the happiness of those affected by such allocation as well as a more efficient means of allocation than the stakeholder/CSR models proposed to date. It is the economically focused CSR that contributes to business success, while the theoretical and superficial devotion to it appears to have the opposite effect. Sincerity, then, is at the heart of CSR.

Because there has been so little empirical work regarding the impact of CSR, the study reported herein represents one of the first attempts to examine the relationship between CSR and performance.¹⁴ Using the notion of voluntary management embracement of stakeholder accountability as a proxy for CSR, this study examines the relationship between that unilateral stakeholder commitment and financial performance. However, an unanticipated result of the exercise of analyzing the data and performing the comparison of financial performance of unilaterally committed stakeholder firms ("UCSF") with firms not so committed was the additional insight into the flaws of stakeholder theory and the dangers of the mandatory imposition of CSR.

II. Flaw One in Stakeholder Theory: The Lack of Parameters and Definition: The Moving Target and Imprecision

Stakeholder theory suffers from conflicts and imprecision in its definition and role and lack of interdisciplinary analysis. This overview is offered to establish the need for a framework different from the nebulous and somewhat chameleonesque one offered in the fields of management and business ethics and touted as the basis for both government mandates and changes in corporate governance.

A. What Is Stakeholder Theory, and Who Are Stakeholders?

Proponents of the CSR and stakeholder models of corporate governance, often used interchangeably, argue that employees, creditors, suppliers, customers, and communities, in addition to shareholders, all contribute to the success of the corporation and that the company directors, therefore, have responsibilities to all of these constituencies.¹⁵

This list of stakeholders is not intended to be exhaustive, and both scholars and companies grapple with the definition of "stakeholder."¹⁶

The scholarly roots of stakeholder theory and CSR date back to the 1930s when the idea of the central state was prominent and the thought of autonomous corporations seemed to undermine that utilitarian perspective.¹⁷ However, the theory was not advanced as an alternative to corporate governance until it re-emerged in the work of Edward Freeman on strategic management in the 1980s.¹⁸ The work on stakeholder theory since its re-emergence in strategy has focused on its use as an alternative to existing means of corporate governance.¹⁹ Others take the theory further by proposing it as a utilitarian alternative to individual property ownership.²⁰ Still others urge businesses to employ stakeholder theory as a means of business self-regulation that avoids...