Sustaining a Commitment to a Stakeholder Primacy Business Model

Introduction

Increasingly, corporate America is using extrinsic rewards, like incentive pay, to drive home a focus on the interests of the broader community whose interests are affected by a company beyond the conventional focus on shareholders. But the challenges of getting companies to focus on a broader range of stakeholders requires much more than creating reward programs that reinforce a shift in focus from primarily shareholder value maximization to a wider range of interests, such as greater commitment to environmental, social, and governance (ESG) issues often viewed as critical to sustaining a mutually beneficial business environment (Porter, 2021).

What does it mean to adopt a corporate mission embracing stakeholder primacy while serving the interests of shareholders? Is a stakeholder primacy model realistic and if so, how do we embrace this direction so that our enterprises operate in an environment where they have the greatest likelihood of being superior generators of value not just today but over time? How do we become an effective stakeholder primacy enterprise while also continuing the superior value creation track record of American industry? We need to evaluate the stakeholder primacy hypothesis more formally to find the path to a corporate America that continues as a powerhouse value creator both for shareholders and important and relevant stakeholders.

Transitioning to a more balanced and proactive focus on multiple relevant stakeholder interests (often referred to as stakeholder primacy) doesn’t become a reality because we find it compelling or consistent with our beliefs. Instead, it happens when we can show evidence that relevant stakeholders benefit from a broader view of the relevant parties whose interests are influenced by the business enterprise. At the outset, those providing capital (i.e., the shareholders) need to be convinced that they are not short-changed as the evolution to a stakeholder primacy business takes hold. Without the support of shareholders, the traditional commitment to open capital markets will be severely damaged.

Since the 1980s, the principle of shareholder primacy has held great weight among public companies and had been subject to academic debate for generations, as suggested by writings by Adolf Berle in the 1930s on the stakeholder model for corporate governance (Smith, Tennent, and Russell, 2019). The “theory” of shareholder primacy became the governance foundation adopted by much of Corporate America over the last 30 or 40 years with the help of Milton Friedman (Friedman, 1970) Michael Jensen/William Meckling (Jensen and Meckling, 1976) and many others in the ‘70s and ‘80s. The shareholder primacy business model argued that the sole responsibility of management is to make money for shareholders. From a different perspective, the current foundation of shareholder primacy suggests that rights and power conferred upon management should only be exercisable for the benefit of shareholders. Further, enterprise obligations to a broader constituency only exist to the extent that such actions are in line with maximizing returns to shareholders.

Much of corporate America found the shareholder primacy “philosophy” compelling and further, has embraced shareholder value maximization as its primary mission guiding business strategy, performance expectations, culture formation, and extrinsic incentives. Shareholder primacy has evolved and is now commonly expressed as an evangelist’s commitment to shareholder value maximization. When concerns arose about the blind pursuit of value created, proponents took the position that serving shareholder interests requires leadership to consider the interests of other relevant stakeholders (employees, customers, the community, vendors, the government, etc.) as they navigate the path to shareholder value maximization. Doing otherwise was assumed to sub-optimize value creation opportunities, although many would argue that sufficient evidence does not exist in defense of this point of view (Smith et al., 2019). Some corporate leaders take the position that long-term value creation success depends on treating all important stakeholders rationally and consistently. But even with this view, many believe corporations put too much emphasis on near-term shareholder value maximization at the expense of essential priorities of other stakeholders. The perception is that enterprises continue to pollute, ignore good-governance roadmaps and community interests, discriminate, and ignore diversity and inclusion goals ostensibly to pursue shareholder (and perhaps personal) interests.

Much of corporate America appears to be trending to a more balanced approach to stakeholders’ interests as they execute their business plans and strategies. If this is a substantial commitment to stakeholder primacy, corporations are significantly expanding the company’s obligations to address other relevant stakeholders’ interests beyond a singular focus on shareholder returns rights. Implementing a true stakeholder primacy ideology requires trade-offs between disparate stakeholder priorities. Elevating other stakeholders’ priorities relative to shareholder interests is not an easy direction to pursue, and for that reason, it is not clear that the current version of this transformation is sustainable. While the current tactics in support of ESG may signal to some progress to stakeholder primacy, not understanding the implications of a stakeholder-focused mission will create conflict, a lack of mission clarity and misunderstanding that will do more harm than good.

A careful assessment of the consequences and ongoing implications of these trade-offs will help ensure that any decision an organization makes is a commitment, not simply a response to pressures to comply from whatever side is most vocal. This assessment can help ensure that stakeholder-related decisions are based on a solid understanding of the full range of the consequences of trade-offs among various stakeholder priorities.

Many companies, however, have yet to find a path for sustaining a stakeholder primacy as a core guiding principle over one that is singularly shareholder-focused. Shareholders will view any path that results in a diminishment of their interests with skepticism at best.

Further, organizations whose missions address multiple priorities can introduce a lack of clarity about an enterprise’s overall business direction. That can translate into underperformance relative to enterprise performance expectations, creating dissatisfaction among important and powerful stakeholders. For example, a nonprofit healthcare institution’s mission may include sustained financial health, a community health commitment, and a mandate as a “Good Samaritan” to those in need and with limited resources. Such disparate priorities make managing “to the mission” more complex and can cloud the path forward to sustained success.

That said, companies have always had to address priorities beyond maximizing shareholder value. For example, companies expend time, resources, and effort to optimize tax outcomes, respond to rules and regulations, and respond to union demands. But these non-shareholder interests are different from those derived from a stakeholder primacy framework because rules, regulations, and legacy procedures provide a roadmap for addressing them and real consequences if the corporation does not.

Today’s stakeholder primacy focus is an attempt to highlight non-shareholder stakeholder interests. However, decisions that are driven by a need to comply or a need to respond to current trends without solidly developed reasons, implications, and benefits will likely not be sustainable. So instead, the initiative should focus on how to increase emphasis on principles that support rationally “balanced” decisions among multiple potentially unaligned stakeholder interests. These interests might include broader priorities such as the environment, diversity, fair pay, community well-being, and other social expectations.

As organizations pursue these stakeholder initiatives, they must create a foundation for decision-making that rationally and transparently directs corporate efforts and resources to the appropriate stakeholder priorities. Corporate leadership will be expected to use this foundation to deliver consistent decisions about how best to respond to a broader range of stakeholder interests. Without a track record of consistent decision-making, organizational commitments to stakeholder interests will be difficult to trust and rationalize over time. Further, the credibility of management decision-making will likely be reduced if the reasons for such “balancing” decisions are not clear and transparently justified. In the end, the lack of coherence of a reactive, less thoughtful shift to stakeholder primacy will ultimately be a roadblock to embracing stakeholder primacy over the longer term.

Of course, shareholders have the power to influence decisions if they perceive that their interests are subjugated to others. Reducing shareholder returns to “fund” other priorities can result in losing shareholder support if the reasons for the trade-off are not well understood or poorly aligned with shareholder interests. An important determinant of success will be how effective corporate leadership provides rational and compelling responses to questions about competing interests. Organizations may not achieve complete alignment across disparate interests, but leadership will need to strive for, at a minimum, grudging acceptance among essential stakeholders.

The Situation

The more intense focus on stakeholder primacy is relatively new for most companies. As such, embracing a multi-stakeholder focus may be outside the “comfort zone” of many leaders. It may also be inconsistent with the values and signals that define its culture and accepted behaviors. Further, in these early days of stakeholder primacy, sufficient context and evidence are not readily available to clearly describe the implications and “ripple” effects on other stakeholder interests of decisions about stakeholder priorities.

A genuine commitment to stakeholder primacy will demand a transformed corporate mission and a sea change in the enterprise’s “raison d’etre.” Often companies struggle to embrace a new mission and direction in part because they have created an environment and organization structure supportive of past successes (i.e., the status quo) which is integrated into every aspect of the company’s makeup. Moving away from “how it has always been done” to a more inclusive business model is usually challenging and often fails, particularly among enterprises with a successful and sustained performance track record. There are many analogies of Companies that needed to change to continue their track record of success but were deeply challenged to change because they were so effective at success under their legacy business models (e.g., Eastman Kodak, Polaroid, Xerox, IBM).

Change may be most difficult for those companies where shareholder value maximization is a part of their core identity. And while a robust foundation for stakeholder primacy may be a key influencer of long-term sustainability, stakeholder primacy also requires managing material additional risks. One source of additional risk comes from tailoring the organization’s processes, procedures, and behavioral norms to fit the new mission and to navigate competing priorities where outcomes are difficult to evaluate. Potentially adverse risk will also come from the reduced clarity created by pursuing disparate, often competing objectives. Stakeholder primacy likely requires companies to replace a “tried and true” framework and adopt an unfamiliar approach that all stakeholders may not fully understand or embrace. At a minimum, this change will likely reduce stakeholders grasp of the rationale for decision-making outcomes, resulting in push-back from empowered stakeholders. Push-back from shareholders is of particular concern because they have choices about where to invest.

A true shift to a stakeholder primacy business model is a profound transformation from where we are today. Unfortunately, many companies may not view it that way. Companies are experimenting with integrating stakeholder interests into their organization’s values, culture, and behavioral fabric. A common approach is determining which factors best reflect relevant stakeholder interests and explicitly adding them to their list of critical priorities. What is being pursued today appears to be unrelated stakeholder-sensitive initiatives with limited consideration of the interplay between various stakeholder priorities. At a minimum, the challenge will be to convince shareholders that addressing other stakeholder priorities will not damage their opportunities to achieve a fair return for the risks incurred. For example, many companies have pursued a broader stakeholder primacy approach by adding related priorities as performance objectives to their management reward plans. Concerns have already been raised that such initiatives are simply means to show compliance to the latest fad or, even worse, might merely be a covert means of providing more flexibility to adjust leadership bonuses. Further, recognizing the trade-offs among different priorities in determining rewards introduces complexity that is difficult to address in a simply defined bonus plan.

Even with the formative state of stakeholder primacy, the pressure to adopt a broader stakeholder mandate grows. One goal is to consider the decisions and actions a company needs to execute an sustainable shift to a stakeholder primacy business model. For companies and leadership where stakeholder primacy has not been an essential part of their value proposition, the change is dramatic—from a singular focus on shareholder value maximization to one that needs to balance priorities of multiple “masters.” As mentioned before, a mission that embraces multiple priorities will require more effort to ensure clarity of direction. In addition, where external pressures drive the response rather than a genuine commitment by the organization’s leaders, the broader focus on other stakeholders’ interests will be ineffective. Finally, if an exogenous event rejiggers a company’s priorities, how will other stakeholder priorities prevail? For example, if a company badly misses financial expectations and the market punishes the outcome, what happens to commitments to other stakeholders?

While studies and anecdotes exist suggesting that proper attention to relevant stakeholders can positively impact value creation trends, it is unclear how companies will allocate and justify the appropriate level of attention to the interests of each relevant stakeholder. As noted before, corporate America often views many stakeholder priorities as independent issues without focusing sufficiently on the implications for other enterprise priorities. But stakeholder priorities are not unaffected by decisions in response to pursuing other priorities, and they can be in conflict with each other.

Major Challenges for Companies Evolving to Stakeholder Primacy

The proponents of stakeholder primacy believe that if organizations properly care for employees, customers, the community, vendors, and the environment, the company will achieve, over time, returns consistent with investors’ risk-sensitive expectations. However, without a comprehensive familiarity with the implications and likely consequences of stakeholder primacy, it is hard to believe that the hearts and minds of leadership are committed to this change. And many pressures work against this level of commitment.

While companies are attempting to transition to a broader stakeholder mandate, it will be essential to understand the significance of such a shift. Stakeholder primacy requires meaningful changes to the corporate mission and responsibilities.

• Stakeholder Primacy Is a Major Shift in Corporate Purpose and Direction: If companies are serious about stakeholder primacy, it will require a transformation that could turn conventional management decision-making on its head. This change, where outcomes are uncertain, is likely difficult to reverse because it suggests a fundamental shift in the mission and values of the entity. Expectations will change and corporate decision-making and execution “habits” will have to change, which can be particularly hard when a company is performing well by conventional standards. Implementing this change will be costly in time, effort, and resource allocation. Doing the work to determine the issues created when implementing stakeholder primacy will help identify potential conflicts, increase directional clarity, and reduce reversals of decisions intended to address stakeholder priorities.

So, what do we need to move forward on a framework that yields, over time, consistent decisions on responses to stakeholder priorities? One standard being pursued by interested parties is a standardized and transparent framework to evaluate progress objectively. Not achieving this goal will likely result in a path to adoption which is not well defined and unfamiliar and therefore subject to “we didn’t expect that to happen” reactions.

While the challenges of moving to a stakeholder primacy model are significant, the ESG movement among the investing population continues to grow rapidly. It describes criteria that examine how a company performs as a steward of the planet and its inhabitants. In addition, socially conscious investors now use ESG criteria to screen potential investments. So, although shareholders might wince at the idea of stakeholder primacy, many investors expect this as a foundation for corporate responsibility. And some posit that a broader stakeholder focus could become a more sustainable, less volatile basis for sustainable returns to shareholders.

The current state of stakeholder primacy begs for a framework that supports rational trade-offs among competing stakeholder interests so that decisions can be transparent and more easily explained. Paths exist to achieve more sensitivity to other relevant stakeholders, but given the formative state of stakeholder primacy, virtually all of them require more development. There are also many tactical and execution-related issues to backfill to facilitate an effective and transparent decision-making framework.

Conclusions

A comprehensive and well-thought out transformation to more sensitivity to other stakeholders’ interests is not the direction that many companies are pursuing. The current approach often appears to be a reaction to pressure, as opposed to a thoughtful examination of the issues when a company’s business model is changing. As with many new ideas or initiatives, the approach looks a bit like pilot tests of specific ESG-related initiatives. If the end results are positive, then the pilot becomes a management guideline or policy to be adhered to going forward. The determinant of success is whether the end result is an enterprise that satisfies its stakeholders while also providing a clear roadmap to enterprise sustainability and success over time. That really is an open question and will determine whether stakeholder primacy is a fad or a sustainable and positive shift in how a Company is managed.

Some areas for further consideration and possibly development include the following:

• Redouble efforts to reinforce a longer-term focus where the outcomes of ESG initiatives are more likely to be practically measurable. Emphasizing longer-term performance also reduces the potential that reactionary responses to near term financial results don’t overwhelm actions that are best for the enterprise and society as a whole over the longer-term.

Each of these potential directions are formative ideas that require substantial work to make them effective. Most are ideas not sufficiently developed to implement. We are at the stage where we need to determine how we can use the good ideas stimulated by stakeholder primacy. The goals are to make our enterprises more effective as generators of long-term shareholder value and as entities that lead us to greater value created for society at large. Considering alternative approaches should lead us to better understanding and possibly a hybrid approach that achieve the balance that many are currently pursuing. Unless we undertake this initiative, actions to embrace stakeholder primacy will likely fail because the foundation was not put in place to succeed.

Finally, we expect to highlight potential paths to more stakeholder sensitivity in a future article, as Corporate America continues to pursue ESG and other related initiatives. Ideas and comments from readers about the issues presented in this article will help inform the potential directions that might be pursued to build a foundation that doesn’t confuse but enhances Corporate America’s global leadership.