Stakeholder Theory and "The Corporate Objective Revisited" Author(s): R. Edward Freeman, Andrew C.

Wicks, Bidhan Parmar Source: Organization Science, Vol. 15, No. 3 (May - Jun., 2004), pp. 364-369 Published by: INFORMS Stable URL: http://www.jstor.org/stable/30034739 . Accessed: 02/03/2011 10:31
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Science Organization
Vol. 15, No. 3, May-June 2004,pp. 364-369
ISSN 1047-70391EISSN 1526-545510411503 0364

inFORMS
DOI 10.1287/orsc.1040.0066 c 2004 INFORMS

Stakeholder
"The

Corporate

Theory Objective

and

Revisited"

R. EdwardFreeman,Andrew C. Wicks, Bidhan Parmar

TheDarden of 100 22906 School,University Virginia, Darden Boulevard, Charlottesville, Virginia wicksa@darden.virginia.edu, {freemane@darden.virginia.edu, parmarb@darden.virginia.edu} Stakeholder theory begins with the assumptionthat values are necessarily and explicitly a part of doing business. It asks managersto articulatethe shared sense of the value they create, and what brings its core stakeholderstogether.It also pushes managersto be clear about how they want to do business, specifically what kinds of relationshipsthey want and need to create with their stakeholdersto deliver on their purpose. This paper offers a response to Sundaramand Inkpen's article "The CorporateObjective Revisited" by clarifying misconceptions about stakeholdertheory and concluding that truth and freedom are best served by seeing business and ethics as connected. stakeholderrelationships Key words: stakeholdertheory; corporateobjectives; separationthesis; value creatitheory

Stakeholderd is managerialin that it reflects and directshow managersoperateratherthanprimarily addressingmanagementtheoristsand economists.The in focus of stakeholdertheory is articulated two core questions(Freeman1994). First,it asks, whatis the purto pose of the firm?This encourages managers articulate the sharedsense of the valuetheycreate,andwhatbrings its core stakeholders together.This propelsthe firmforwardand allows it to generateoutstanding performance, determined bothin termsof its purposeandmarketplace financialmetrics.Second, stakeholder theoryasks, what does managementhave to stakeholders? responsibility This pushesmanagers articulate to how they wantto do what kinds of relationships they business-specifically, wantandneed to createwith theirstakeholders deliver to on theirpurpose.Today'seconomicrealitiesunderscore the fundamental reality we suggest is at the core of stakeholder theory:Economicvalueis createdby people to who voluntarily come togetherandcooperate improve circumstance. must develop relaeveryone's Managers and tionships,inspiretheir stakeholders, createcommunities whereeveryonestrivesto give theirbest to deliver are the value the firm promises.Certainlyshareholders an important constituent profitsare a criticalfeature and of this activity,butconcernfor profitsis the resultrather thanthe driverin the processof value creation. Many firms have developedand run their businesses in termshighlyconsistentwith stakeholder theory.Firms such as J&J,eBay, Google, LincolnElectric,AES, and the companiesfeaturedin Built to Last and Good to Great (Collins 2001, Collins and Porras1994) provide the compellingexamples of how managersunderstand and use themto crecore insightsof stakeholder theory ate outstanding businesses.Whereasall these firmsvalue their shareholders profitability, and none of them make
364

profitabilitythe fundamentaldriver of what they do. These firms also see the importof values and relationas ships with stakeholders a criticalpart of their ongoing success.They have foundcompellinganswersto the two core questionsposed by stakeholder theory,which underscorethe moral presuppositionsof managingthey are aboutpurposeand humanrelationships. Stakeholdertheory begins with the assumptionthat values arenecessarily explicitlya partof doingbusiand thesis (Freeman1994). ness, and rejectsthe separation The separationthesis begins by assuming that ethics In and economics can be neatly and sharplyseparated. this context, the challenge of doing business ethics or of the improving moralperformance businessbecomesa task becausebusinessethics is, by definition, Sisyphean an oxymoron.Manyproponents a shareholder, of singleview of the firmdistinguish economicfrom the objective the ethical consequencesand values. The resultingtheory is a narrowview that cannotpossibly do justice to the panoplyof humanactivitythatis value creationand trade,i.e., business. In ourview, Sundaram Inkpen(2004) exhibittheir and to of commitment such a narrow interpretation the shareholder ideology in their paper "The CorporateObjecthe tive Revisited." They begin, "Governing corporation requirespurposefulactivity.All purposefulactivity,in turn, requiresgoals." They conclude that the goal of value"is the only appropriate shareholder "maximizing in for managers the moderncorporation. goal More subtly, according to McCloskey (1998), the "maximizingshareholdervalue" view is put forward as a "scientific"theory that is modeled and verified Unforby appropriately ideologistscalled "economists." in an attempt be acceptedby their"scientific to tunately, several managementtheorists have adopted brethren,"

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365

the fashionof acceptingthe economicview of business activityas the most useful one availableand have fallen shareinto the trapof the separation thesis. "Maximizing holder value" is not a value-neutral theory and contains vast ideological content.At its worst, it involves using the prima facie rights claims of one groupshareholders-to excuse violating the rights of others. Shareholder rights are far from absolute,regardlessof how much economists talk about the corporationas of The property the shareholders. rights being the private of shareholders primafacie at best, and cannotbe are used to justify limiting the freedom of others without theirconsent. We wish to offer threemain critiquesof "TheCorporate ObjectiveRevisited"(Sundaram Inkpen2004). and and First, Sundaram Inkpenhave grossly mischaracterized stakeholder theory.Second,there are good reasons for rejectingtheir arguments the primacyof sharefor holdervaluemaximization. Indeed,if stakeholder theory is understood a fairly commonsenseway, then many in of the oppositeconclusionscould be drawn.Finally,we suggest that if the underlyingideological issue is one of eithereconomicor politicalfreedom,then Sundaram and Inkpenwould do betterto become pragmatists and the big tent of stakeholder theorists.We take each join point in turn. The Mischaracterizationof Stakeholder Theory One of the most glaring errorsof their paper is that Sundaramand Inkpen decide to lump all views that are not the shareholder maximizationthesis as stakeholder views. They claim that stakeholder views have dominated significant periods of time over the past 150 years (Sundaram Inkpen2004). They lump all and the following diverse activities together as part of a stakeholderapproachto corporategovernance:corporate chartering, unions, acting in the interestsof conattention the natural environment to and, sumers,paying we would suppose, Nader's proposalfor federal charstatutes(some of which are obvious tering, stakeholder excuses for managerial self-dealing),proposalsfor indedirectorswith a sense of public good, and critpendent icisms of globalization. Although stakeholder theory can be many things to manypeople,it does not follow thatwe shouldcast it as nonshareholder oriented." First,it is impor"everything tant to remember(as Sundaram and Inkpenhave forare gotten) that shareholders stakeholders. Dividing the worldinto "shareholder conconcerns" "stakeholder and cerns"is roughly the logical equivalentof contrasting are and Shareholders stakeholders, with "fruit." "apples" it does not get us anywhereto try to contrastthe two, unless we have an ideological agendathat is servedby doing so. and Second,Sundaram Inkpenwritea greatdeal about the difficultyof resolvingconflicts among stakeholders

andfiguring how to treatdifferent out groups(Sundaram it andInkpen2004). Not only is this concernoverblown, view. Advocatesof the is not uniqueto the stakeholder view also have to deal with this criticism, shareholder even if they have a differentand more simplistictheory to use. On what termsare we going to get stakeholders to sign on and give their best for the firm?Ironically, we would arguethat stakeholder theorygives managers more resources and a greatercapability to deal with this challenge,becausethey can offer not only financial but reward, languageand actionto show thatthey value relationshipswith other groups and work to advance their interestsover time. In an era when firmsare rely(e.g., employees ing on committedvalue-chainpartners and a whole range of suppliersin the supply chain) to create outstandingperformanceand customerservice, with more stakeholder theoryseems to providemanagers resourcesto find success. and Third,Sundaram Inkpen(2004) blow the problem and "whosevalues count"out of proportion make it of seem an impossibletask. Again, there are many companies that have addressedthis challenge,and that use their answers to the values questionsposed by stakeholder theoryto run successful businessesover a long If time (e.g., Merck,J&J,3M, andMotorola). we see this exercise of firmswith their stakeholders as a pragmatic witheach otherthe taskis a lot to findways to cooperate easier and admitsa varietyof answers-something that fits a pluralisticculturethat values freedomand volunIf problem tarycooperation. we see it as a philosophical that has only one answer,an answerwhich has to conthen form to the rigorsof Kant'scategorical imperative, life gets much harder.Stakeholder theorypushes manand approach agersto embracethe pragmatic pluralistic and we andrecommends avoidthe philosophical singletheoryapproach. Fourth,and finally, stakeholder theory does a better behaviorin of explainingand directingmanagerial job markets. Stakeholdertheory claims that whateverthe or ultimateaim of the corporation other form of busiand musttake into ness activity,managers entrepreneurs accountthe legitimateinterestsof those groupsandindividualswho can affect(or be affectedby) theiractivities
(Donaldson and Preston 1995, Freeman 1994). It is quite natural to suggest that the very idea of value creation and trade is intimately connected to the idea of creating value for stakeholders. Business is about putting together a deal so that suppliers, customers, employees, communities, managers, and shareholders all win continuously over time. In short, at some level, stakeholder interests have to be joint-they must be traveling in the same direction-or else there will be exit, and a new collaboration formed (Venkataraman 2002). The best deal for all is if managers try to create as much value for stakeholders as possible. There are, of course, conflicts among stakeholder interests but these conflicts must be resolved

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Freeman, Wicks, and Parmar: StakeholderTheoryand "The CorporateObjectiveRevisited" Science15(3),pp. 364-369,c 2004 INFORMS Organization

so thatstakeholders not exit the deal-or worse-use do the politicalprocessto appropriate value for themselves or regulatethe value createdfor others. All of this seems to us to be managerialcommon sense, dressed up in its Sunday finery for publication. Stakeholdertheory is inherentlymanagerial,as Donaldsonand Preston(1995) argue and as countless executives have testified (for a recent example, see George 2003). As we argue elsewherein this journal, stakeholder theoryfinds its justificationin a pragmatist approachto managementtheory (Wicks and Freeman 1998).

value for shareholders. How else could managerscreate value other than by creatingproductsand shareholder servicesthatcustomersare willing to buy, offeringjobs that employeesare willing to fill, buildingrelationships with suppliersthat companies are eager to have, and being good citizens in the community?Creatingvalue if is for stakeholders important, for no otherreasonthan to avoid the folly of regulationand government exproand this priation.Of course,understood way, Sundaram theoryis pro-stakeholder Inkpen'sclaimthatshareholder is also correct.Hereis the mainpoint:Thereis no need Joneset al. (2002) to posit these theoriesas oppositional. and many othershave made this point for years. The Primacy of Creating Value for Stakeholders (2) StakeholderTheory Gives Us the Correct Way The main rhetoricalthrust of Sundaramand Inkpen to Think About Entrepreneurial Risks. Venkataraman comes in a five-pointargument the primacyof share- (2002) suggests that taking a stakeholderapproach for holdervalue maximization. enablesus to developa more robusttheoryof entrepreThey suggest: risk neurship,one in which the role of entrepreneurial shareholder valueis pro(1) The goal of maximizing is better understood.Sundaramand Inkpen's view is valuecreates stakeholder. Maximizing shareholder (2) would lead to risk avoidthat taking such an approach to the appropriate incentivesfor managers assume ance behaviorby managers, because,accordingto them, more than objective one risks. entrepreneurial (3) Having "constituencies if will function make except the residualcash flow claimants difficult, notimpossible. governing fromtakingexcesIt is easierto makeshareholders of stakeholders haveincentivesto dissuademanagers out (4) risks."Leaving aside the question sive entrepreneurial of thanvice versa.(5) In the eventof a breach contract have or trust, with of excessive risks and whetheravoidingexcessive risks stakeholders, compared shareholders, and contracts is a good or bad thing, this argument protection can seekremedies) (or through again shows that thelegalsystem. Sundaramand Inkpen'sview of stakeholdertheory is Giventhat Sundaram Inkpenhave lumpedso many one of allocatingbenefits to other stakeholdersat the and Of of shareholders. course, it is in each stakedifferent views into stakeholder theory,it does not make expense interestfor to holder's management take risks that can sense to take the time and space to addressevery argulead to increasing the size of the pie for everyone. ment they put forthagainstit. Thereis, in fact, a large Indeed,in the realworld,as opposedto the worldof ecoliterature stakeholder on theorythatclarifieswhat stake- nomics journals,managersoften work with stakeholder holdertheoryis and why it does not fall victim to the groups,such as customersand suppliers,to jointly test and that arguments Sundaram Inkpenuse (Phillipset al. new productsand services.Often,customersand suppli2003). Instead,we wish to suggestthe followingas alter- ers will accept some of the risk inherentin developing for nativearguments the view thatwe shouldunderstand The recentwave of new ideas, products,and programs. capitalismas creatingvalue for stakeholders: alliancesand the emergenceof issues such as corporate (1) The goal of creating value for stakeholdersis are management evidencethatstakeholders supply-chain decidedlypro-shareholder. can see their interestsas joint, not just opposed. (For createsthe appro- a nice review of this value for stakeholders (2) Creating literature,see Inkpen 2001.) By to incentivesfor managers assumeentrepreneurial priate on the allocation aspect of stakeholderthefocusing risks. ory, Sundaramand Inkpen miss the idea of seeing (3) Having one objectivefunctionwill make gover- entrepreneurial risk in its richer context of joint stakenance and management difficult,if not impossible. holder relationships. out (4) It is easierto makestakeholders of sharehold(3) Having One Objective Function Makes Goverers thanvice versa. nance and Management Difficult. It is hard to imagine or (5) In the eventof a breachof contract trust,sharewith stakeholders,have protection how anyone can look at the recent wave of business holders, compared scandals, all of which are oriented toward ever(or can seek remedies)throughmechanismssuch as the increasing shareholder value at the expense of other marketfor shares. stakeholders, and argue that this philosophy is a good in We shall brieflytake each argument turn. Is Theory DecidedlyPro-Shareholder. (1) Stakeholder to are at Shareholders stakeholders, least according every with which we are familiar,or that piece of literature creates value for stakeholders we have written.Creating
idea. The problem with focusing on a single objective is that the world is complex, and managers and directors are boundedly rational (at least we can meet economists on their own assumptions). By employing pseudoscientific measurements and quantifying away

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in uncertainty a naively Bayesian fashion, proponents of techniquessuch as economic value added and other consultingploys have convincedmany companiesand managersthat the effects of a particular projectcan be seen in the short-term movementof a company'scommon stock. There is too much complexity and uncertainty.Managersneed to use judgmentmore than ever. It is not always clear how the new plant in Indonesia is going to affect our operationsin Paris, and how hirin ing a new humanresourcesdirector Omahacan affect stock price. If we see stakeholder interestsas Friday's it will be the managers' to guide fundamentally joint, job these relationships the right direction.If these relain will reap the tionshipsare managedwell, shareholders It has long been known in philosophy,at least profits. since JohnStuartMill andprobablysince Aristotle,that if you wantto maximizea particular thing, such as utilshouldperhapsnot try to do it consciously.As ity, you Hayek and othershave suggested,in a complex world orderemerges. In reducing this complexity, the shareholderview is more susceptible to moral myopia. According to Sundaram Inkpen(2004), having a single function and for the firm makes life easier for managersprecisely becauseit cuts through morassof claims andpotenthe tial responsibilities They placedat the feet of managers. claim managementhas only one responsibility: Make money for the shareholders.Although this is convenient for managersit distortsreality (i.e., both legally and morally)and fosters a worldviewwhere managers do not see themselvesas moral agents responsibleto a wide arrayof groupsfor theiractions.If makingmoney for shareholders my primaryduty and I do not have is to other groups, it might be considerresponsibilities ably easier for me to rationalizequestionable practices thatplace harmat the feet of nonshareholder stakeholders (such as workersor suppliers,to whom I allegedly have no moralresponsibilities) the nameof increased in profitability. This view also downplaysthe languageof morality and moralcomplexity.Businessis aboutmakingmoney for shareholders. Thereis no clear moralgrounding for such a claim, nor is there a discussionabouthow managers deal with the other moral and legal challenges they face in the day-to-dayactivitiesof the firm.There is alreadyconsiderableevidence that managershave a difficulttime seeing the moraldimensionsof businessinsteadthe financialand amoralview of busipreferring ness (Bird and Waters 1984, Freeman1994, Werhane 1998). Offeringmanagersmore proof that business is only aboutprofitsfor shareholders (and that moralityis either irrelevant places only a few broadconstraints or on managerialaction) will more likely foster the kind of tunnelvision, rationalizations else is (e.g., "everyone doing it"), and self-dealing we see in ethics disasters such as those that took place at Enron,WorldCom, and HealthSouth.

We recognizethatthe shareholder view does not condone the activities of managersat these firms. Indeed, the shareholderview finds these actions deplorable. However,the issue is which worldviewenables managers to rationalize risky, unethical, and ultimately illegal behavior.Our claim is that a view that places and moralitylargelyout of the conversation, thatreduces managerialresponsibilityto making money, is more likely to foster unethical behavior.At the very least, Sundaram Inkpen'sview does not seem to offer us and much help in seeing ethics as connectedto the day-today activitiesof managers,and as providingthem with resourcesto bettermanagethe challengesof the day. Out (4) It Is Easier to Make Stakeholders of Shareholders. This one is easy. Shareholdersare already stakeholders. Q.E.D. (5) StakeholdersHave Remedies that Shareholders Do Not Have. This issue is tricky. Oliver Williamson stakehas tried to make the point that nonshareholder do holdershave contractual remediesthat shareholders not have, so that shareholders bear greaterasset specihas ficity (thecost of redeploying assets).This argument been rebutted the idea thatthe marketfor sharesacts by as an instantlycostless redeployment process (Freeman and Evan 1990). Shareholders who sell enough stock to move the price of the stock cannot instantlyredeploy costlessly, of course, but this is a functionof the size of the holdings.It is possible that large suppliers, have more in large customers,and large shareholders and commonthanwould appearat firstglance.Freeman Evan distinguishbetween safeguards-where the parties to the contract the costs of the safeguards-and pay can contracts-where the costs of safeguards be imposed on others.They suggest that the claim that stakeholders can morecostlessly redeployis really the claim that there are mechanismsin society so that partiesexternal to the contractpay the costs. Witnessthe so called protectionsof labor:the Fair LaborPracticesAct, the NationalLaborRelationsBoard,andso on. If this is correct, shareholders appearto be in the sameboat as other stakeholders. The whole point of the recent SarbanesOxley Act, the furorover the Securitiesand Exchange and Commission,and the issue of transparency validof financialreportingwas to protect shareholders. ity Sundaram Inkpenmiss the pointby focusingon the and derivativesuits by shareholders the only means of as shareholder protection.Surely,we want value creation and trade to be self-sustainingwherebyparties to the contractspay the costs of safeguarding those contracts ratherthan imposing those costs externallyon others. The only way this can be conceptualized by takinga is stakeholder approach. In strugglingto make sense of all this, we want to make sure that the readerdoes not searchfor ways to frameor resolve this debatethat miss the core question at the heart of our differences with Sundaramand

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Inkpen.There are severalways one might try to make sense of the differencebetween these two approaches. For instance,one mightbe inclinedto see the disagreement as being aboutlevels of analysis-that stakeholder metrics that work for mantheory gives performance at the operating level, whereasshareholder theory agers metricsthat work for financialmargives performance kets (Meyers and Gupta 1994). Both have their place and use, but they only work well within their domain. Second, one could arguethatit is a conflictbetweenan theideal (shareholder) and a real-world(stakeholder) The formermight do a greatjob of capturingthe ory. ideal workingsof the marketfrom the macroview, well above the rumblingsof the trading-room floor, whereas the latter speaks to managersfrom the vantage point of their day-to-dayactivities.Finally, there might also be groundsfor seeing an issue of scale involved-that stakeholder theorymakesmore sense in entrepreneurial firmsand that shareholder theoryis a betterfit in larger and more establishedcompanies.All of these readings providea way to give each side its due. In our view, althougheach of these issues is interesting and mightprovideuseful insights,each also deflects attentionfrom the fundamental issue-how we understandbusinessand value creationwrit large.If we want thesis and see a moraldimension to rejectthe separation to businessactivity,then stakeholder theoryprovidesthe framework. shareholder The theory,particularly requisite the as propagated economists,continuesto perpetuate by idea of businessas an amoraleconomicactivitythatradically constrictswhat is possible for humanbeings. The thecore questionis whetherwe embracethe separation sis and whetherwe want to be a part of organizations thattakeit as a given. It is criticalthatwe see firmsand marketsas integralvehicles for workingwith othersto improveeveryone'sstake. To do this, we must see the thesis as optional. separation the Of course,we could articulate shareholder theory in a way that does not commitit to the separation thesis. Briefly,it would go somethinglike this: Corporate Moral propertyis the privatepropertyof shareholders. rules that apply to privatepropertyapply to corporate property.No one, or their agent, may use his or her propertyto harmothers (at least withouttheir permisabouthow we and sion). Freedomto make agreements our agents use our propertyis an important principle. So it follows that businessworks because shareholders or their agents use their propertyto create value for if which others freely trade.It is important, this is to be done effectively,thatmanagers (agentsof shareholdthe ers) understand needs of other affectedpartiesand with the how thosepartiesareindeedaffectedby trading In agentsof shareholders. practice,these partiesareusually customers,suppliers,employees,and communities. view would emerge Ergo, somethinglike a stakeholder

from a more-carefully workedout, fully moral version of shareholder theory. Once we have rejectedthe separation thesis, the issue is not whethera theory has moral content, but rather what kind of moral contentit has (Freeman1994). As we have arguedin this paper,stakeholder theorybetter and equips managersto articulate foster the sharedpurpose of their firm. Unlike the narrowview of shareholdertheorythat ascribesone objectivefunctionto all stakeholder theoryadmitsa wide rangeof corporations, answers.In this view, there is not just one stakeholder cores (i.e., particutheory,but manypossible normative lar answersto the two questions)thatmakeup the genre of stakeholder theory (Freeman1994, Jones and Wicks 1999). A carefullook at firms such as 3M, Merck,and Johnson & Johnsonshows that there is a wide range of answersthat firmshave given to the questionsposed theory.On this account,even shareholder by stakeholder is, in fact, a version of stakeholdertheorytheory include a respect for one whose moral presuppositions propertyrights, voluntarycooperation,and individual initiative to improve everyone's circumstances.These providea good startingpoint, but not a presuppositions completevision of value creation. The Real Issue: Economic and Political Freedom There is much at stake in this debate.The shareholder ideologists want us to believe that economic freedom, and therefore by politicalfreedom,are threatened stakeholdertheory.Nothing could be furtherfrom the truth. The whole idea of seeing business as the creation of and value for stakeholders the tradingof thatvalue with free consentingadultsis to think abouta society where each has freedom compatible with a like liberty for all (Rawls 1971). Value creationand trade have to go together.One is no good withoutthe other.Hence, the very idea of economicand politicalfreedombeing sepand arableis questionable (Freeman Phillips 2002). needs to get back to Management theory of management-to the understanding how value gets created and traded-in all of its gory particularistic detail. Talkingabouthow all value must get created,or the one and only best way to organizevalue creation,or the one and only stakeholder group whose primafacie rights must always win, are all intellectualmoves that serve neithertruthnor freedom. References
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