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Despite Critics, There’s ‘No Going Back’ From Stakeholder Capitalism, Says the Professor Who Pioneered the Theory in the ‘80s

UVA Darden School of Business

That there is even a mainstream debate about stakeholder capitalism is good news to R. Edward Freeman, professor at the University of Virginia’s Darden School of Business. “I’ve been at this since 1977,” he said, laughing, referring to his first paper on the subject. “Eventually, some people start to pay attention. I don’t mean to me, but to the idea.”

Freeman has been quick to point out from the beginning that he did not coin the term “stakeholder” in a business context – he points to the work of the Stanford Research Institute and others in the 1960s – but his work in the ’80s developed an idea of business with responsibilities to more than shareholders into a practical management theory. It’s why we spoke to him ahead of the second anniversary of the Business Roundtable’s stakeholder-centric Statement on the Purpose of a Corporation. It was a statement that surprised him when it was released in 2019, but one that also made him happy.

We discussed some of the accompanying critiques of stakeholder capitalism that have been frequent over the past couple weeks, whether alleging the approach is misguided, impossible to truly achieve, or nothing more than “woke” nonsense. To him, these are variations of the same arguments that have existed for decades, from critics who are unwilling or unable to see shareholder and stakeholder value as linked. He also believes that the stakeholder movement has momentum beyond a tipping point. “There’s no going back,” he said.

By the time Freeman arrived at the Wharton School of the University of Pennsylvania as a postdoctoral researcher in 1976, he had spent years studying mathematics and philosophy, both economic and otherwise. His next challenge was management theory, and his boss at the time wanted him to see what was behind the stakeholder ideas being tossed around. That led to 1984’s “Strategic Management: A Stakeholder Approach.” The text is now regularly referred to in management research as foundational to an increasingly popular approach, but at the time failed to make an impact.

It wasn’t until the ‘90s, when shareholder primacy was the norm, even for the BRT, that he saw a renewed interest in his work. That accelerated with the financial crisis and then with what he calls “a perfect storm” of social movements, rising inequality, and political instability that followed. Freeman joined the board of Whole Foods founder John Mackey’s Conscious Capitalism organization, and has spent years consulting corporate leaders.

Early in our discussion, Freeman alluded to the way many Business Roundtable CEOs said their latest statement was less reactionary to these forces than a proclamation of how they had long been approaching business. Critics have latched onto that point as proof that the statement was a marketing gimmick, but Freeman explained his interpretation before jumping to one of of stakeholder capitalism’s prominent critics, Vivek Ramaswamy, whose book “Woke, Inc.” was released the day Freeman spoke with us.

The following interview has been edited for length and clarity.

Prof. R. Edward Freeman: Now that we realized this, we can get better at it. We can improve it. We can look for how creating value for customers affects communities or suppliers, etc. And there are lots of companies out doing that. So I’m extremely optimistic about that.

And no, I haven’t read “Woke, Inc.,” because a review I read pissed me off so much. “Woke” [used by critics to mean disingenuously or suffocatingly progressive] is one of those phrases like “political correctness” – it stops arguments. “Oh, you’re woke, so therefore I’m going to discount you.” I’m a philosopher by training and phrases that stop arguments like that are formal fallacies.

On the other hand, over the years, I’ve managed to piss off the left and the right. Left, they think I’ve sold out to business, and they don’t think business can do anything good.People on the right, on the other hand, think I’m a socialist. But I actually think what stakeholder capitalism is, it’s about the business model. It’s about how business actually works in the real world.

But there are a lot of people who are in the grip of this old story. They just can’t imagine business as anything but a duality between stakeholders and shareholders. I’ve never thought that was interesting.

JUST Capital: When you see recent pushback, are they the same arguments that you’ve been seeing for decades at this point?

Freeman: Oh, God, yes. I mean, none of this stuff is new. It’s a little bit like Wall Street and the academic world, finance and accounting people, have discovered ESG. Well, wait a minute. That’s been around since Abt Associates [a research institution that began using “social audits” in 1971 as a way of measuring benefits and costs of its research on its stakeholders]. Let’s get out of the grip that it’s only economics that counts. Let’s look at business as a societal institution.

JUST: There is another form of pushback that can start with, “We agree with these theories, but the companies that say they are following them are lying.” Harvard’s Lucian Bebchuk and Roberto Tallarita have argued that there is no evidence BRT companies are following their statement of purpose.

Freeman: Arguments like, “Everybody’s lying, here’s what’s really going on,” are problematic. Even if all you care about is making money for shareholders, how are you going to do it? You’re going to have great products and services for customers, suppliers who want to make you better, employees who want to be engaged in the company, and communities who want you or at least allow you to operate. I’ve only looked very briefly at the Bebchuk paper, but I’ve heard for a lot of years he’s very much caught up in the sort of standard way to think about governance. I read the law, even, differently. I read it as saying directors have a duty of care to the corporation. And what’s the duty of care to the corporation? Well, I’d pay attention to how they create value for their stakeholders.

Again, I think seeing it as a duality between stakeholders on the one hand and shareholders on the other is a mistake. That’s not to say that there aren’t some people acting in bad faith. But for the most part, I don’t believe businesspeople are like that.

JUST: Do you reject the premise of the argument, then, that for stakeholder capitalism to be real, that governance and bylaws within a company would have to be changed?

Freeman: I don’t think that at all. There’s this idea that you have to eschew shareholder value, but that that’s ridiculous. Companies have to make money. It’s a lie to say, well, they’re only stakeholder capitalists if they put making money second. No, what they might do is see them as connected.

JUST: Arguments do exist that a full rethink of how companies make money and function is needed – like Sen. Elizabeth Warren’s “Accountable Capitalism” message bill – but I’ve never seen that as the primary stakeholder capitalism take. Critics often do, however, and I wonder if they’re conflating those positions by mistake or in bad faith, because it’s easier to turn down for a broader audience.

Freeman: I think there’s some of both.

There are at least four ways you can understand stakeholder capitalism. The first way is this is just PR – greenwashing and virtue signaling. The second way is well, people mean it, but this is really just CSR [corporate social responsibility], just dealing with social issues. The third way is around top-down elites and government policy shaping business.

The fourth way is about the business model, and this is about understanding how business actually works. And that’s been my view for 40-plus years.

There’s a great back and forth with Milton Friedman and John Mackey a number of years ago, before Friedman died. [Freeman considers Friedman a “hero” for his research on markets, but believes he misunderstood how corporations operate.]

And it was clear that Mackey understood this the same way I did. We might need some top-down stuff, we might need to change how we think about capital markets, we certainly need better PR, and we need to worry about social issues – but fundamentally we need to change the story about business.

JUST: To me, the rise of stakeholder capitalism is linked to the rise of ESG investing. SEC chair Gary Gensler has said there’s going to be standardized ways of reporting climate impact from companies and then it’s highly likely that there will be some human capital metrics standards after that. Do you think companies should be run in the way where you’re looking at potential value creation and risks in things like climate and the composition of your workforce, or should ESG analysis be relegated to a form of investment? How do you see it?

Freeman: I would look at it slightly differently. The perfect storm here is a function of what happened in the global financial crisis. Add global warming, Black Lives Matter, Me Too, inequality on a global level, and political instability. What you get is a recognition that we need to change the way we think about this.

If you think the right way to think about a business, evaluating it from the outside, looking at the risks to the future cash flows, then you’re going to see risk in all of those things. And there’s nothing wrong with that – that’s right. If you’re on the inside, you’ve got to probably start from a different perspective.

Some people will look at that just in terms of the risks of the future cash flows, but some people will look at it in terms of what they stand for while they’re here. Purpose matters to most human beings. And I think, [BlackRock CEO] Larry Fink would say purpose might drive profitability. Again, we’re realizing how those things are intertwined.

There’ll be some standardized versions of ESG, but I’m a little skeptical of having that too standardized. When you do that you lose opportunities for people to do it differently. And one of the things we know about businesses is they’re not all the same. And so their ability to deal with things like global warming or inequality are different. From the company perspective, we need companies innovating.

ESG is great. I’m all for it. I’m a little amused by it, because it’s a new toy that people think they have just invented. But I’m also like, “Great, welcome to the big tent of stakeholder capitalism.”

JUST: I’ve seen the same arguments around management repeated in articles and research over the past century of American business. And in the ’70s, you can find almost identical arguments to today around CEOs getting too bold in taking political stances. But we’ve also seen in our polling research that the public, across demographics, does want CEOs to take stands. Yes, they tend to want them to take stands that they agree with, but they are looking for them to step up, which I think is fascinating. How do you believe this has evolved?

Freeman: Well, I’ve recently had conversations with a number of CEOs who have said things like, “I know I have to do stuff here. I just don’t know how.” That’s been an issue – I’ve started a new course called “Societal Issues in Business,” trying to help students figure out how to do it. Look, not taking a position is taking a position. So the idea that you can escape from this by saying, “Well, I only deal with economic issues,” that’s a political position – it’s a position that says economics and politics are completely separate, which we know certainly from Adam Smith on is a foolish idea.

Now, Friedman said we elect officials to do this. He was worried for the most part about corporate philanthropy, about executives supposedly giving away owners’ money. But setting that aside for a minute, he was also worried about companies doing stuff that they didn’t know anything about – and I agree that’s worrisome. I much rather see companies trying to figure out, for instance, how they can offer up opportunities with their business model to people who’ve been shut out of the system, or how they can encourage their employees to be community builders in the communities where they live. One of the other vectors that we have going on here is the multi-sector, multi-stakeholder partnerships where you have NGOs, governments, and companies sharing their expertise to deal with societal problems. I think that’s an equally important thing that’s going on.

And around polling – of course, you’re right. The public is firmly behind stakeholder capitalism. There’s not much ambiguity about that.

JUST: Do you see this moment as a turning point, similar to the way that shareholder primacy gradually went from fringe to mainstream ideologically, and then became ingrained through corporate leadership, judgments, and deregulation? Is the pendulum swinging back?

Freeman: Yeah, I think it is. I actually think we’ve gone past the tipping point. Nobody’s arguing that what we really need to fix everything is to double down on shareholder value. And for good reason – it doesn’t work. The best you can say about it is it’s incomplete.

What causes a company to be profitable is how it manages its other stakeholder relationships. We’ve come to understand that. One of the other things that goes on, at least here in the U.S., is of course younger people are demanding this of where they work, and that’s a good thing. The forces are such that I don’t think there’s any going back.

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