by: Michael Hsiung

Stakeholder capitalism is currently trending towards higher importance and one should not get left behind. 

Too Many Stakeholders to Manage

In a recent article, I talked about how capitalism is just a tool. For this article, I would discuss “stakeholder capitalism,” which is a term that has gained popularity lately. I would like to discuss its merits and its challenges. 

Even for those who don’t agree with the concept’s tenants, I highly encourage everyone to acknowledge and understand the concept’s current influence. Many institutional investors (e.g., Blackrock and JP Morgan) create indexes from a stakeholder capitalism’s perspective. Stakeholder capitalism is currently trending towards higher importance and one should not get left behind. 

Shareholder capitalism largely drives the current American economic thinking. In shareholder capitalism, shareholder supremacy means all firm employees and executives’ greatest social responsibility is to maximize shareholder wealth. The logic as follows, “Shareholders own the company, so the company’s moral imperative is to ensure steady growth on its stocks.” 

But, there’s a serious problem with shareholder supremacy. To what extent is one morally allowed in order to maximize shareholder wealth? Is there no moral limit to what a firm can and cannot do to the market?

If the market is 100% efficient with no spillovers the answer is a plausible “yes.” Unfortunately, spillover is omnipresent and individual actions have impacts on others. Thus there are a growing number of individuals embracing stakeholder capitalism. Under a stakeholder capitalist philosophy, those who are impacted (stakeholders) need to be in a company’s ethical calculus. If a polluting company feels responsible towards the villagers at the bottom of the river, a polluting company will pollute less. 

Some of the biggest critics of stakeholder capitalism argue that the label of a stakeholder is too loose. A butterfly can flutter its wing in Africa and cause a chain reaction that results in a hurricane in Florida. When does the social responsibility of an organization start and end? Other critics argue that incentives are just aligned for stakeholder capitalism to work. 

I agree with these critics. 

Working with Not Too Many Stakeholders

Without a narrower definition of a “stakeholder,” anything and anyone would be considered a stakeholder. The definition is inherently unactionable. We certainly should not hold one organization accountable to ALL of the world’s ill. That would be unconscionable. Thankfully, someone has already come up with a great model in narrowing the definition of a stakeholder into manageable, concrete targets: the model of stakeholder salience. 

Stakeholder salience refers to how much ethical and moral claim an individual or group of individuals have over one organization. The more salient a stakeholder is, the more an organization should weigh its impact on those individuals. Salience can come in three different forms: (1) power, (2) legitimacy, and (3) urgency. 

Power refers to the power of a stakeholder over the organization. Legitimacy refers to the stakeholder’s legitimacy of the relationship to the firm. Urgency refers to the urgency of the stakeholder’s claim to the company. A stakeholder with all three of these qualities should be prioritized first, and those with less should follow.

Those who argue that stakeholders capitalism suffers from a giant problem of incentives ask, “Why would a company care about polluting the environment?” The answer is structure. We need to structure a world in which the incentives are aligned with addressing the most salient stakeholder needs ie. stakeholders who are powerful, legitimate, urgent. 

Is capitalism problematic? Yes; Should we toss it out? Not exactly. Instead, we should take a more nuanced approach. In a lot of cases, shareholders do have the quality of power, legitimacy, and urgency. However, in many other cases, there are stakeholders that also fall into that category. Ignoring others that have influence and ethical claim on a company would also be morally unconscionable.