Under the traditional capitalist model, financial performance for shareholders has been the primary measure of the success of a business. However, a growing awareness of ESG trends has given rise to the concept of “stakeholder value,” whereby the focus is on long-term value creation for customers, employees, society and the environment rather than just short-term value for shareholders. The pandemic has sharpened this focus by highlighting the importance of metrics such as employee health and well-being, safety protocols, cybersecurity and business continuity, to name a few.
While undoubtedly beneficial in theory, the pursuit of stakeholder capitalism comes with a number of practical challenges. How do businesses measure the value created by stakeholder capitalism? How do they balance stakeholder and shareholder interests? And where does all this leave fiduciary duty?
These questions are difficult to answer, and the solutions may not be immediately evident. But one thing is clear: If businesses want to achieve long-term sustainability, they must work to overcome these obstacles.
Aligning stakeholder interests
The interests of shareholders and other stakeholders often conflict. Although it is no simple task, businesses must find a way to reconcile clashing priorities if a true stakeholder capitalism model is to be reached. Often, the answers lie in understanding the nuances between (and, sometimes, within) each stakeholder group.
The allocation of voting powers between majority and minority shareholders, for instance, is one significant area of debate. Should one share equal one vote or should long-term shareholders be granted additional voting rights? Businesses must decide whose interests should be prioritized, and to what extent.
Once such priorities are established, determining the framework through which the value created should be measured further complicates the issue.
The race among AstraZeneca, Moderna and Pfizer to develop a COVID-19 vaccine perfectly exemplifies the difficulty of satisfying the needs of each stakeholder group simultaneously.
Should one share equal one vote or should long-term shareholders be granted additional voting rights?
AstraZeneca, for instance, prioritized wider societal needs by pricing its vaccine lower than any of the others — thereby providing the greatest long-term “value” to its recipients. The Moderna and Pfizer vaccines, however, delivered greater relative value to shareholders, by reason of the higher price.
This begs the question: Can the interests of shareholders and stakeholders ever be reconciled? Critics of the stakeholder capitalism model argue they cannot — believing that the quest for such a reconciliation is not just a fundamental limitation, but a potentially insurmountable weakness for addressing today’s global challenges.
Indeed, Eugene F. Fama, winner of the Nobel Prize in Economics in 2013, goes as far as arguing stakeholder capitalism is “indefinite and ineffective,” for this very reason.
The “value” created by stakeholder capitalism is difficult to measure, and this could limit its operational effectiveness.
The solution to this is perhaps more transparency and accountability — which can be achieved only through enhanced, standardized, non-financial disclosure metrics, as well as the acknowledgement and management of externalities, such as global warming, increasing social fragmentation and unrest.
The drive to improve disclosure around such metrics is ongoing. In September, for instance, the World Economic Forum (WEF) released guidance in collaboration with the big four global accountancy firms on measuring stakeholder capitalism. In its report, the WEF suggested companies track their shared value contribution by defining metrics organized into four categories — Principles of Governance, Planet, People and Prosperity — in order to increase the comparability of sustainability reporting. While this was a step in the right direction, many believe we are still some way away from standardized reporting.
To make matters more challenging, for many companies, it remains unclear what they are being asked to disclose or how to disclose. Often, this means publicly disclosed data is insufficient to perform detailed, comparable and up-to-date analysis and benchmarking of sustainability performance — a key requirement to determine value creation for stakeholders.
There has been some movement in the right direction, however, and a number of high-profile institutions responsible for global reporting standards have begun addressing this issue.
The IFRS Foundation, for example, recently consulted on the establishment of a Sustainability Standards Board and looks set to pursue its establishment. The new board would operate alongside the International Accounting Standards Board under the same three-tier governance structure, build on existing developments, and collaborate with other bodies and initiatives in sustainability, focusing initially on climate-related matters.
The hope is that the emergence of such initiatives will make the transition to stakeholder capitalism quicker and more straightforward for businesses.
Redefining fiduciary duty
Under corporate law, fiduciary duty requires a corporation to act in the best interest of its shareholders, rather than serving its own interests, recognizing loyalty and prudence as the most important duties.
The traditional interpretation of this has been to pursue optimal profit margins. Stakeholder capitalism, however, challenges this view and suggests directors should expand their definition of fiduciary duty, by considering the impact of board decisions on all stakeholders — both internal and external — despite there currently being no legal requirement to do so.
The ‘value’ created by stakeholder capitalism is difficult to measure, and this could limit its operational effectiveness.
Already, a number of initiatives, such as the United Nations-supported Principles for Responsible Investment (PRI) and the U.N. Environment Program Finance Initiative (UNEP FI), have highlighted the importance of redefining fiduciary duty, in order to stimulate long-term sustainable growth and the economic health of companies.
Indeed, sustainable finance veteran Paul Watchman (an advisor to UNEP FI) argues “the concept of fiduciary duty is organic, not static. It will continue to evolve as society changes, not least in response to the urgent need for us to move towards an environmentally, economically and socially sustainable financial system.” We have certainly seen this to be the case in the last two decades.
Future-proofing: The potential of stakeholder capitalism
Despite the challenges associated with implementing stakeholder capitalism, empirical evidence reveals that companies focusing on sustainability issues achieve lower costs, enhance employee productivity, mitigate risk and generate new growth opportunities. In fact, research from Bank of America Merrill Lynch suggests integrating greater stakeholder engagement and ESG initiatives in corporate strategy could help prevent around 90 percent of bankruptcies.
While this wider shift toward stakeholder capitalism has been ongoing for some time, it has been catalyzed by the COVID-19 crisis, which has reaffirmed the materiality of sustainability-related risks, and the deep links between businesses and their stakeholders across the value chains.
In today’s world of deepening socioeconomic challenges, effective stakeholder management will become critical for companies looking to continue operating successfully.