Shareholder vs. Stakeholder Theory

Introduction
Milton Friedman’s quote gets to the heart of the conflict between shareholder theory vs. stakeholder theory. Shareholder theory posits that a corporation’s sole responsibility is to maximize the return on investment (ROI) for shareholders. Stakeholder theory posits, on the other hand, that a company owes a duty to all stakeholders (not just shareholders)—members of the community, workers, consumers; in short, anyone who is part of or who is impacted in some way by the company. The question is: Do corporations exist only to serve the interests of shareholders or do they also have a responsibility to serve stakeholders as well? This paper will answer that question by looking at the nature and essence of business social responsibility from the standpoint of the four major sources of ethical values in business: Law, Culture, Philosophy, and Religion. It will show that in today’s business environment, stakeholder theory needs to be pursued instead of shareholder theory, and it will explain why starting with Friedman’s own words.
Without Deception or Fraud
Friedman believed that if a corporation is doing right by shareholders, the rest will take care of itself. The problem is that times have changed since Friedman made that statement. When Friedman argued for shareholder theory, corporate share buybacks were still illegal. It was not until 1982 that the rule regarding public companies buying back their own shares on the public market was changed and the activity was permitted by the Securities and Exchange Commission (SEC) (Reda, 2018). That is significant because Friedman qualified his statement with the words “without deception or fraud.” The reason corporate share buybacks were illegal prior to 1982 was precisely because it was viewed as a form of market manipulation—corporations propping up the share price for shareholders and not allowing true price discovery to be allowed by the market (Reda, 2018).
Now that companies can purchase their own shares on the marketplace, one can see what the effect has been: currently the stock market is in the longest bull run in equities history (Chen, 2019). During that time, P/E ratios have soared far higher than their historic norms. Many zombie corporations in the Fortune 500 are borrowing at extremely low (historically low) interest rates to buy back their own shares and thus inflate shareholder value. Many executives sign off on share buybacks instead of putting the money to good use, as in research and development, because they themselves have boatloads of shares that they want to sell and they know that the smart money has been leaving the market for a while now (Szala, 2019). If the executives, who are often compensated with company shares, want to rake in the millions of dollars that they are potentially sitting on in terms of shares and stock options, they have to authorize corporate share buybacks so that they too can unload their shares and make money. They are shareholders, too, after all, and maximizing shareholder value benefits them as well. So long as the share price stays up, they are happy—as are all investors. But what is the outlook like for the company down the road? Buying at inflated levels means that when the market finally does turn and prices fall, billions will be wiped out in an instant. The money that could have been re-invested in the company, that could have been spent on innovation, or that could have been spent on sustainability—i.e., stakeholders, members of the community, a program that would benefit workers, community members or the environment—was instead spent on propping up the share price at a time when no one else was interested in buying.
It is the essence of market manipulation—only now it is legal. The SEC decided in the 1980s that what had once been banned should now be allowed. While corporate share buybacks had been banned when Friedman made his comments, his comments made more sense. Executives knew back then that in order to maximize shareholder value they had to deliver as leaders of the company and grow the company through investment in the company, through research and development, through innovation, and through focusing on long-term sustainability. Those were the keys to maximizing shareholder value because investors looked for value and they saw value in terms of a company doing the right things to be a successful business—satisfying the public with new ideas.
Sustainability is not a new concept. It is simply a return to an old concept. In the past, business leaders knew that to survive, to profit, to have a meaningful future not just for themselves but also for workers and for communities, they had to engage in sustainable practices. They could not abuse or misuse resources, including workers. They could not take tomorrow for granted. They had to earn the respect and trust of stakeholders just to operate. If they did not, they would be run out of business, and people in government would help to see it happen. People had principles, courage, and strength to do what was right. They had virtue, and they knew what virtue was. They practiced a system of virtue ethics back when having an ethical framework meant something more than simply justifying whatever choices one wanted to make regardless of how it impacted others. Today, businesses are not held accountable, and the 2008 crisis showed as much. Their cronies are all in positions of power in the government, looking out for them rather than for any type of sustainable practice or for stakeholders.
Law
When the SEC changed the law regarding buybacks it changed the nature of the business and its duties. Businesses no longer had to be profitable or successful or even have a long-term plan to succeed—now all they had to do was have access to cheap credit (which they all have now thanks to the Federal Reserve keeping the Fed Funds rate so low) and they could support their share price no matter the valuation. Companies from Apple to American Airlines are spending billions upon billions in share buybacks thanks to the law that now permits them to allocate capital in order to artificially maximize shareholder value (Light, 2019).
Rule 10b-18 was the SEC rule that created a legal process for companies to conduct share repurchases (Reda, 2018). In 2018, companies spent nearly half a trillion dollars on share repurchases (Egan, 2018). The tax cut that allowed companies to repatriate vast sums of money to the U.S. also contributed to the spending (Egan, 2018). However, the law allows companies to do it, and the Federal Reserve makes borrowing easy—so why not? Shareholder value is what companies and their executives care most about. Investing in the future for them means investing in buybacks and keeping the share price high so that they can cash out. And cashing out, they are: as Putka (2019) notes, “more than 50 of the insiders selling were chief executives” of companies engaging buybacks. They would be crazy not to sell: the key to winning in the stock market is to buy low and sell high. The execs sell high; the companies they are supposed to be leading buy high. If that is not a conflict of interest that should be illegal (as it once was) one would be hard-pressed to find a better example of one. The law has adopted a Lockean ethical perspective: freedom is the highest value, and corporations shall not be constrained by standards or honesty in accounting. Legalism permits them to do whatever they can so long as they can wend their way around the rules without breaking them.
Instead of the law allowing corporations to serve the shareholders in this manner, the law should be focused on protecting stakeholders. It should look at making sure jobs are protected, that communities are not abused by corporations, that corporations are not permitted to offshore jobs just to increase their bottom lines. The lawmakers, however, are deeply influenced by the companies and their wealth. The legislators are lobbied to no end: billions of dollars annually are spent by all the industries of the world on lobbying to legislators to make sure the laws are never changed to favor the stakeholders.
Thus, the stakeholders are the ones to fair badly. The example of the 2008 subprime crisis is a perfect illustration of how the companies were bailed out while Middle America was turned on. People lost houses, jobs, savings, pensions—and when the Federal Reserve lowered interest rates to stimulate the economy, workers lost the safety of savings: savings in the bank would no longer produce any yield. Plus, with the Federal Reserve spending trillions on Quantitative Easing, the value of the dollar took a hit. Housing costs have gone up; education prices have gone up; healthcare costs have risen; the price of gold has risen (one of the best indicators of inflation), and now the talk is of deflation because the worry among analysts is that the Federal Reserve is now between a rock and a hard place: there is only so much money it can throw at the problem before the problem swallows it, too.
But does the law address any of these problems? No—the law instead creates them. The lawmakers brought the Federal Reserve into existence in 1913 and since then the value of the dollar has depreciated drastically. Yet, for workers, wages have not budged since the 1990s. The law should be promoting sustainability, which means promoting the worker—who is the lifeblood of all sustainability. The worker is the one who keeps it all going. Replacing him with robots will not solve any problems. Providing tax credits for people who buy Teslas will not either (the energy to charge those Teslas will still come from coal). Real sustainability has to focus on the workers, the community. It has to follow the advice of Goldsmith, who observed the corporations have a duty to protect their communities and not to harm them by neglecting them (Rose, 1994). They depend upon each other.
Culture
But can one blame the companies for looking out for themselves, for their shareholders instead of for stakeholders? The culture of the U.S. actually depends upon the stock market staying at all time high levels because so many institutions are invested in it and require a return that they cannot get anywhere else. Pension funds, insurance funds, sovereign wealth funds, mutual funds—they all invest in the equities market because they all need a high ROI to satisfy their own book. Pension funds are predicated on the notion that they can pay out tomorrow’s pensions by investing the money they have today and growing it at a fast enough return that the funds needed for tomorrow do not deplete the overall principle. Insurance funds work the same way, except they are paying out coverage not pensions.
People want insurance and they want pensions, but in order for those to work, the funds that supply them have to have to a way for it to be viable—and the only way that works is if the is a way to achieve an ROI that allows them to grow. Since interest rates are near zero or below zero around the world, the options are limited. Risk assets are the only things that offer any yield—and that is not because retail investors are buying; it is because corporations are buying their own stocks, keeping the market propped up. The economic data suggests that a recession is likely to come in the following year or two—and yet the market stays at all-time highs. Will it ever fall? Can it ever fall? If it does fall, the culture of the U.S. will fall as well because everyone will suddenly realize that they have been lied to about pensions (if they have not already realized this). They will find the idea of insurance is predicated upon the ability of the insurer to obtain a better ROI.
The culture of the U.S. today also is one in which people want to get rich quick without asking questions. Even the President of the United States tweets about new highs in the stock market and seems obsessed with making sure equities remain at all time-highs—most likely because there is an election next year and a tanking stock market would be bad for business (Henrich, 2019). What does the President never tweet about? Sustainability. In fact, he appears to be determined to pursue just the opposite: the national debt is now north of $20 trillion and shows no sign of stopping. The President does not appear interested in developing a clean energy infrastructure, though automobile companies are pursuing the electric vehicle (EV) concept. Tesla is leading the way on that front, having established itself as the frontrunner in promoting sustainability as a business vision: Tesla’s mission “is to accelerate the world's transition to sustainable energy. ... Tesla believes the faster the world stops relying on fossil fuels and moves towards a zero-emission future, the better” (Tesla, 2019). For stakeholders, Tesla’s ambition is a welcome one.
However, the only sustainable thing the President and Wall Street appears to be interested in is the bull market—and the Federal Reserve has shown it is ready to inject billions in liquidity into the market to sustain the bull run for as long as possible (Henrich, 2019). Sustainability of a bull run, though, is not the same as sustainability of the environment, or sustainability of a community. Indeed, the gap between the rich and the poor grows more and more as the bull run continues: the wealthy are the ones who have capital to invest; the working class, not so much.
What the working class cares about is education, communities on the brink of social disorder; pollution; clean energy; clean food; access to health care; jobs. Middle America wants to support companies that demonstrate awareness of stakeholders—not just shareholders. That is why more and more people are turning towards locally produced foods as opposed to the Monsanto-sprayed, genetically modified organisms called “food” by the agriculture industry or by McDonald’s (Mullen, 2019). They are tired of artificial foods that give them cancer, obesity, diabetes, etc. They want sustainable lives, too.
Philosophy
Companies have a duty to maximize shareholder value, as Friedman said long ago, so long as they can do it without fraud or deception. Today, fraud and deception are the ways they do it—except it does not count as fraud or deception because both have been legalized by the SEC and by the Financial Accounting Standards Board (FASB), which has permitted the creation of special purpose entities (SPEs) for companies to hide losses from the balance sheets (as Enron did) and has permitted companies to use mark to market accounting (fair value accounting), which helped exacerbate the subprime housing bubble collapse of 2008 (Laux & Leuz, 2010).
They are not engaging in corporate social responsibility (CSR), in other words. Or, they are engaging in CSR only by way of lip service—because it is the politically correct thing to do. When it comes to actually sustaining anything other than the bull run, the culture of the economy and the society of business could not care less. CSR is something companies show that they are doing the same way people who virtue signal want to show the world that they are righteous and worthy of one’s praise, adulation and support. CSR is a way to build one’s brand. Even Tesla is no different here: it touts sustainability as its corporate vision, but its EVs still rely on electricity that is produced by fossil fuels—not by solar or wind power. Their cars are still full of petroleum it the plastic parts that facilitate its construction.
Neither are companies doing much to sustain communities. There are fewer and fewer “made in America” products because so many companies offshore labor in order to maximize shareholder value by increasing the bottom line. They have no sense of duty ethics (deontology)—the idea that the moral thing to do is whatever one’s duty is. They do not see their duty as being towards stakeholders, workers, communities, the people without whom they would not be in business in the first place. As Goldsmith used to say, owners and leaders of organizations have a duty that they owe to their communities, for laborers and the owners of the means of production should be one in any society, and when they are not, the community will inevitably break down, as workers and owners cannot do without each other over the long term (Rose, 1994). And yet owners are attempting to do without laborers: they are turning to robotics; more and more jobs are becoming automated. Is this sustainability? The world is changing in a way where it appears that slavery is reemerging. People in the East are the new slaves, and people in American prisons are the same. The modern era has been driven by greed and adherence to a zero sum game in which the winner takes all. The motivating philosophy here is Egoism. It is a not a framework of virtue ethics that is motivating companies’ business decisions today. As Paddy Chayevsky famously put it in Network, “the world is a business”—which is a sentiment that shows just how inhumane the nature of the corporate cosmology has become.
The philosophy, like the law, has to be changed. The philosophy that should be used to guide companies today is the philosophy of the ancients—of Socrates, Plato and Aristotle, who spoke about the Transcendental Ideals, the Ideal Forms; about truth and where truth comes from. They spoke about seeking the truth, and even Christ stated that the truth will set you free (John 8:32). Today, people are like prisoners in the Allegory of the Cave. They do not venture outside the cave to seek the truth, and so they are deceived by the shadows dancing upon the wall, entertaining them with their movements. They are deceived by charlatans in the press and in business. They believe in the miracle that is Enron right up until Enron collapses in a heap under the weight of its lies brought out into the sun. They believe in Elon Musk, who claims to be leading the charge for sustainability while flying around the world in his jet, using diesel to charge his electric generators, and making promises that he fails to keep. The idea of sustainability that Musk promotes to sell cars and get investors to become shareholders is more shadow dancing in the cave. The truth is that people are the source of sustainability—it is not machines. So long as man relies on machines he will always rely on the earth and always run the risk of polluting the earth, of neglecting the environment and treating the world poorly. If companies treat workers so unfairly, after all, why should they bother so much about the environment? It is the philosophy underlying the modern culture that needs to be redirected back to the principles that established Western civilization.
Religion
It can be seen as well that from a religious standpoint, companies should be concerned with the needs of their stakeholders, as the Golden Rule stipulates as much: Do unto others as you would have them do unto you. This rule was given weight by Christ (Matthew 7:12). Christ also gave the two great commandments: 1) love God, and 2) love your neighbor for the love of God. In other words, one’s actions should be pleasing to God (i.e., should follow the Ten Commandments). One’s love for God should also animate one’s love towards others.
The Sermon on the Mount is often viewed as the social doctrine of Jesus Christ, in which Christ taught that people should be humble rather than proud and vain, for the humble man sees himself as he is and can learn from that truth; whereas the proud, vain and boastful man sees himself as he vainly imagines himself to be and thus learns nothing about how to grow and improve. In the same Sermon, Christ taught that people should be sympathetic and empathetic towards others—a lesson for the leaders of today’s corporations, who should see that stakeholders have needs, too, not just shareholders. Company executives fear sacrificing today’s capital gains because they have no trust in the Christian ethic or in the principles that animated the Christian ethic in society for hundreds of years. Christ taught that people should be patient and kind, generous and charitable. He preached the parable of the good Samaritan to emphasize the fact that Christians should show charity to everyone, just as the Samaritan did to the man beaten and robbed and left for dead on the side of the road: the Samaritan took care of him and brought him to an inn to see that he would continue to be looked after and paid for all the costs. Christ also taught that people should not judge others—“let he without sin cast the first stone” was the way He put it, knowing that all people have sins and therefore no one should be judging anyone else (Augustine, n.d.).
The whole of the law that Christ taught, however, can be found in the two simple rules that He gave to the person who asked what the most important laws were to follow. Christ said that that man should love God with his whole heart and mind and all his actions. The second most important law is to love one’s neighbors. Thus, the central teachings of Christ are charity—love towards others and love for God. To show love for God, Christ taught that one should respect God’s laws and not deviate from the doctrines that were handed down.
Today’s corporations, however, act like the Pharisees and Scribes: they are more interested in their own power than they are in doing what is right and decent. From Enron to Worldcom to today’s failing unicorns—WeWork, Uber, even Netflix and Tesla, both of which are burning through billions while attempting to appear that they are growing so that investors do not hit the panic button and—they are all focusing on the wrong things: greed instead of sustainability. Leaders like Musk are Gordon Gecko personified: they truly believe that greed is good and their operations, machinations and fraudulent claims prove it. Muck engaged in blatant market manipulation by tweeting out that he had funding secured to take Tesla private at $420 per share. The stock charged up to $380 in minutes before people started realizing that no one in his right mind would ever pay that amount to take Tesla private and Musk was forced to admit that he did not actually have funding secured. He was lying simply to get revenge on short sellers, just as he lied about the reasons he had for buying Solar City. It was not because he saw an opportunity to vertically integrate but rather because he needed to bail out his cousin and by extension himself—because Solar City, Tesla and SpaceX are little more than Ponzi schemes feeding one another. All of this is even now coming out in the public as a result of shareholder litigation. The fact is that Musk is posing as the Messiah of sustainability in order to dupe shareholders. He needs them to keep the Ponzi going.
As the Christian ethic shows, charity is what sustains communities. It is not greed or profits, or unrealistic growth expectations, or fantasies about saving the environment by way of electric vehicles. Cars do not even pollute the environment very much: what does is agriculture—fertilizer, cows, and pesticides. The bogus notion of cars being the death of the environment and the cause of climate change has been sold to the public in order to promote the EV market and the carbon credits market. Tesla makes money be selling carbon credits to other companies that need them because they pollute so much. That is Tesla’s main money-making operation. Otherwise, it is basically a money-losing company.
Sustainability can happen, and companies can help to make it happen. But they have to do right by others in order to bring about a culture of sustainability. That means ending the rapine, ending the destruction, ending the greed. Charity—looking out for one’s neighbor out of a desire to please God, Who looked out for all of mankind when He hung on a cross—that is what is needed. Sir James Goldsmith knew it (Rose, 1994). Today’s executives, however, see only the fact that the SEC has legalized market manipulation and they see the fortune to be made if only they simply authorize more share buybacks. Would Friedman approve of what goes on today? It is highly doubtful, for he understood precisely the problems of what happens when corporations stop acting ethically. They become destroyers rather than supporters of communities. When they engage in fraud and deception they undermine their own sustainability, which is exactly what one is likely to see in the long run with companies like Tesla—as has been seen in the past with companies like Enron and Worldcom. Sustainability is not just about the environment. It is about culture and having the courage to speak truthfully and to act honestly, to create a community that honors loyalty and commitment. Companies need to show that if they truly want to promote sustainability.
Conclusion
Companies have a duty to their stakeholders. That means they have a duty to look out for communities, to sponsor programs for the promotion of education. It is called strategic philanthropy: offer courses that train members of the community to do the jobs companies need instead of sending them oversees. It means they have a duty to protect the environment and not use toxic chemicals and pesticides that cause cancer; it means not polluting the rivers and streams and air; it means having a care for real sustainability that positively impacts stakeholders—not just sustainability of a bull market that benefits shareholders only. Corporations today have been misdirected by the very law makers who should be policing them and obliging them to do what is right, instead of allowing them to engage in market manipulation for the benefit of their own pockets.
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