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How does stakeholder capitalism work?

How does stakeholder capitalism work?

Claims that stakeholder capitalism is flawed and even dangerous reflect a lack of understanding of how the system works. Correctly implemented as a route to value creation for all stakeholders, it is a sustainable model for building both long-term business resilience and financial success.

What is stakeholder capitalism?

After 40 years in the shadow of Milton Friedman’s monetarism, stakeholder capitalism has returned with renewed purpose. The social and economic climate is ripe for a shift away from the investor-centric model, with shareholder primacy replaced by a broader perspective on how shared value can be generated for all.

Stakeholder capitalism is doing business with a conscience, whereby everyone with a vested interest in an organisation benefits from long-term returns. Shareholder capitalism, with its short-term sights fixed squarely on the next quarter’s results, is giving way to the interests of a wider set of stakeholder groups where the investor perspective does not automatically hold sway.

Stakeholders vary between industries and organisations, but generally encompass customers, employees, supply chains, the environment, wider society, the corporation itself and – yes – shareholders.

The aim is not to put purpose before profit, but for all these groups to profit on purpose.

In order to achieve this, the needs of all stakeholders must be understood, and optimised. Businesses have to be aware of stakeholder expectations, how they feel about the company, and what they require from it. Some stakeholder groups may need to be prioritised and their demands offset against those of others.

In response to moves by business leaders towards stakeholder capitalism, there has been some inevitable backlash against the system, including claims that it cannot work. In the wake of the Business Roundtable’s redefinition of the purpose of a corporation, cynical observers presented the commitment of the CEOs of the world’s largest businesses to delivering value to all stakeholders as largely for show.

The Wall Street Journal recently laid the “debacle” of the AstraZeneca vaccine rollout at the door of Oxford University scientists’ misplaced faith in the stakeholder ideal. The fashion to “reject the pursuit by corporations of profit in favour of serving ‘stakeholders’ and pursuing altruistic goals”, it said, leads to terrible consequences.

Such statements reveal a tendency to confuse the tenets of stakeholder capitalism with those of altruism and philanthropy. The latter is voluntary donation towards the welfare of others, at the expense of the giver. Stakeholder capitalism, by contrast, is rooted in shared value creation for all, including profit for the business and financial returns for its shareholders.

How and why stakeholder capitalism works

The incorrect positioning of a pitched opposition between shareholders and other stakeholders makes it ostensibly counterintuitive for the former to support stakeholder capitalism. But the underlying logic of stakeholder capitalism is good business sense. Having a wider view of value than shareholder dividends leads to better business outcomes. These include financial performance, to the satisfaction of investors.

Stakeholder capitalism functions by recognising the perspectives of different stakeholder groups. If stakeholders feel their needs are being met, their investment – both literal and figurative – in the company increases, and with it, the success of the company and the value of its operations.

In most businesses, employees form an important stakeholder group. Identifying, securing and retaining talent is key to business success. Post-Covid, the globalisation of a remote workforce has increased competition among employers for the best and brightest. Companies that can offer purpose aligned to employees’ values, along with flexible working conditions, a sense of psychological safety, and appropriate rewards will win the war for talent.

The stakeholder capitalism model recognises that investors are also looking for shared purpose in the businesses they invest in. The rise of ESG investing reflects the fact that shareholders want to know what is being done with their money, not just how much it’s making for them. They want greater transparency, influence, involvement, and good returns without negative impacts.

Meanwhile, in a digitised, hyperconnected world, competition for the attention of consumers is at an all-time high, and the stakeholder capitalism model enables businesses to catch that attention, by accounting for the customer perspective. Consumers want to know that they matter, to be offered targeted customer service, to have their needs anticipated, to identify with the products and services they buy and the companies they buy them from.

A recent study by Chief Executives for Corporate Purpose (CECP) and Fortuna Advisors found that companies associated by consumers with being purpose-driven outperformed on financial performance, valuation, and value creation.

Practical approaches to stakeholder capitalism

Committing to the theory of stakeholder capitalism is the beginning. Putting it successfully into practice against a backdrop of years of shareholder primacy requires another long stride, and a long-term view. That stride is stakeholder engagement, the understanding of how all stakeholder groups perceive and interact with the organisation, what they need and expect from it, and how that changes over time and in response to outside influences.

The next step is management, using stakeholder analysis to align the purpose of company and stakeholders. This ensures stakeholder support, dissipates potential conflicts of interest, marries expectation and reality, and brings external stakeholders into the fold.

All of which requires ongoing measurement of the impact of stakeholders on the business and the business’s performance in relation to each of its stakeholders.

At Davos in 2020, the World Economic Forum set out its manifesto for a common set of stakeholder capitalism metrics for sustainable value creation. These will allow companies to measure the ways they are contributing to prosperity for all – the root of stakeholder capitalism.

Measurement is still in the development stages. In assessing sustained long-term value creation, the case for stakeholder capitalism among investors is clearly supported by its impact on financial performance, but the measures and tangible returns for other stakeholders are less apparent at this stage. However, with the development of stakeholder intelligence solutions, that gap is being bridged, and the full value of stakeholder capitalism counted.