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Q Academy of Management Review

2016, Vol. 41, No. 2, 113.


http://dx.doi.org/10.5465/amr.2016.0012

INTRODUCTION TO SPECIAL TOPIC FORUM

MANAGEMENT THEORY AND SOCIAL WELFARE:


CONTRIBUTIONS AND CHALLENGES
THOMAS M. JONES
University of Washington

THOMAS DONALDSON
University of Pennsylvania

R. EDWARD FREEMAN
University of Virginia

JEFFREY S. HARRISON
University of Richmond

AQ:1 CARRIE LEANA


JOSEPH T. MAHONEY
University of Illinois at Urbana-Champaign

JONE L. PEARCE
University of California, Irvine

In this Introduction to the Special Topic Forum on Management Theory and Social Welfare,
we provide an overview of the motivation behind this special topic forum. We highlight the
contributions of the six articles that make up the special issue and identify some common
themes, and we suggest some reasons why social welfare issues are difficult to address in
the context of management theory. We also discuss means of assessing social welfare and
urge scholars not to make unwarranted wealth creation claims.

Over a decade ago, Walsh, Weber, and Both Walsh et al. (2003) and many of the authors
Margolis (2003) lamented the lack of attention to in the AMJ special forum called for an integration
social welfare issues by management scholars. of social and economic objectives. Neoclassical
Using data ranging from the research topics of economists might have suggested that this call
papers published in major journals to member- was/is unnecessary. A market-oriented economic
ship in various Academy divisions, they made system has been defended from a number of per-
a strong case that organizational scholarship had spectives, including the protection of political
drifted from its rootswhich had emphasized freedom through economic freedom, the pro-
both the social and the economic objectives of tection of property rights, and the honoring of
organizationsto focus overwhelmingly on the contractual obligations. But an important foun-
economic objectives alone. This drift was re- dational justification for the system is based on
grettable, in their view, both because it limited the utilitarianism, the moral philosophers term for
range of intellectual inquiry in organizational social welfaresometimes expressed as the
studies and because it meant that the findings of greatest good for the greatest number. More par-
organizational scholarship were not being ap- ticularly, a version of market capitalism that
plied in ways that might result in better societies. closely approximates neoclassical microeco-
Two years later the Academy of Management nomic models of perfect competitionthat is,
Journal (AMJ, 2005) published a special forum on competition based on price, a laissez-faire ap-
organizational research in the public interest, proach to governmental involvement in the
again calling for more consideration of social economy, and a profit (or shareholder wealth)
welfare in organizational research. maximization objective for firmsis posited to
1
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2 Academy of Management Review April

produce high levels of societal welfare because it layoffs that enhance shareholder welfare simul-
puts societys resources to their most efficient taneously enhance social welfare, even in the
uses. In short, social objectives could be assured if long run. Indeed, Jones and Felps (2013b), using
economic objectives were attained (Jensen, 2002). stakeholder happiness as their measure of social
Unfortunately, there are several reasons to doubt welfare, suggest that society as a whole may be
that this relationship is applicable in todays econ- made much worse off by massive layoffs, at least
omy. First, as we discuss more fully below, the in the short run. A similar calculus could be ap-
characteristics of modern market capitalism bear plied to corporate practices at extreme ends of
little resemblance to the conditions under which the a potential harm spectrum. Hiring contractors of
perfect competition model assures social welfare. questionable repute to dispose of hazardous
This divergence of conditions strongly suggests that wastes might anchor one end of this spectrum.
the models prescriptionsin particular, laissez- Cutting costs by increasing wait times for cus-
faire governmental policy and a shareholder wealth tomer service calls might anchor the other end. In
maximization objective for corporations are un- both cases externality costs (to the environment
likely to lead us to ever-increasing levels of social and customers, respectively) are incurred and
welfare. should be included in social welfare calculations.
A second and related point is that a substantial Finally, the wisdom of relying on a model that
number of scholars, practicing managers, and focuses exclusively on alleviating economic scar-
entrepreneurs are actively engaged in making city no longer makes sense. Throughout much of
the perfect competition model even less applica- history, economic scarcity was a pressing social
ble to the contemporary economy. A great deal of problem, and an approach focused on addressing
research in strategic managementthat is, the scarcity may have been defensible, despite the so-
search for sustained competitive advantage cial welfare problems created in its wake. However,
depends on market conditions that deviate sig- now that material abundance better describes ag-
nificantly from those of perfect competition and, in gregate outcomes in most developed economies,
some cases, involve an intention to carve out social welfare problems, new and ongoing, are less
mini-monopolies in order to obviate competition easily dismissed. Some of these problems have
based on price alone.1 While it may make sense to emerged with a vengeance, particularly in the
explore means of exploiting market frictions to United Statesfor example, scandals involving
enhance firm profitability or start new ventures, enormous sums of money, increasing inequality of
determining whether social welfare improves is wealth and income, underemployment, homeless-
an empirical question; simply assuming that so- ness among former members of the middle class as
cial welfare is enhanced in conjunction with im- well as the chronically poor, soaring health care
proved profits is inappropriate. costs, and a political system closely tied to the
Third, it takes a substantial leap of faith to vested interests of corporations and wealthy in-
conclude that some corporate actions taken to dividuals. Thus, although the market-oriented eco-
increase shareholder wealth actually improve nomic system has an enviable record of making its
social welfare. Consider the case of massive citizens collectively richer, it is increasingly ques-
layoffs. These actions often do result in increases tionable whether it is capable of addressing some
in shareholder wealth (via stock price increases), other urgent social welfare problems that have
but they also result in substantial hardships emerged from the relationships between the econ-
economic, social, and psychologicalfor the dis- omy and the rest of society.
placed workers and for the surviving workers who Nonetheless, despite calls from scholars rep-
must take on the responsibilities of their former resenting a range of disciplines (AMJ, 2005; Walsh
coworkers. Thus, it is not clear that all massive et al., 2003) and the noble vision of the Academy of
ManagementWe inspire and enable a better
world through our scholarship and teaching
1
Some of what follows is based on a utilitarian view of about management and organizationsthe
morality. This view evaluates acts and policies on the basis of management literature has been remarkably
whether they maximize certain kinds of consequences, usually quiet on the role of managers and corporations in
couched in terms of happiness. Utilitarianism has been
criticized on several grounds, the most prominent of which is first creating and now solving the problems that
its apparent failure to account for justicethat is, its apparent threaten social welfare. Indeed, little appears to
willingness to allow the ends to justify the means. have changed since Walsh et al. lamented an
2016 Jones, Donaldson, Freeman, Harrison, Leana, Mahoney, and Pearce 3

eerie silence in the management literature with efficiency, with an occasional nod to economic
respect to issues of human welfare at the societal stability. Building on the work of Habermas (1971),
level and urged management scholars to bring they argue that social welfare has three major
social welfare back in to their research agendas, components: efficiency, stability, and justice.
most importantly by integrating social and eco- While stability has clearly taken a back seat to
nomic objectives (2003: 860; 875). In this special efficiency (witness the financial meltdown of
topic forum our objective is to help fill this void by 2008), in the perspectives of both scholars and
encouraging theoretical work that addresses im- regulators, justice has been given no seat at all.
portant societal welfare issues related to the ac- Marti and Scherer submit that a very important
tivities of large corporations in the economy and question should be added to the list of regulatory
of those who manage them. In a later section we concerns: Does the proposed regulation make the
will address the eerie silence issue. economy more just? For management theorists
this question could be distilled to how the pro-
posed regulation of financial innovationshigh-
NEW APPROACHES TO MANAGEMENT THEORY
frequency trading in their exampleaffects top
AND SOCIAL WELFARE: THEMES
incomes and income inequality. In essence, the
AND CONTRIBUTIONS
authors question whether social welfare is actu-
In examining the various perspectives taken by ally enhanced, irrespective of efficiency im-
our contributing authors, two themes emerge. provements and stability preservation, if the
First, fairness and justice are argued to be im- great bulk of the benefits flow to those already
portant elements of social welfare; in other words, well off. Ultimately, they advocate an inclusive (as
utilitarian measures of aggregate well-being opposed to a technocratic) approach to financial
either economic (e.g., GDP) or human happiness regulation, one that focuses on both the ends and
(e.g., stakeholder happiness)are not adequate the means of promoting social welfare. Distribu-
metrics for social welfare. tive justice, in the form of income inequality, also
In two of the included articlesMarti and plays a prominent role in Cobbs (2016) contribu-
Scherer (2016) and Mitchell, Weaver, Agle, Bailey, tion, discussed below.
and Carlson (2016)the authors argue that social Bosse and Phillips (2016) argue that if in our
welfare should not be understood in terms of eco- dominant theory of corporate governance
nomic welfare alone, at least not in terms of ag- agency theorywe replaced the assumption of
gregate economic wealth (e.g., GDP). Marti and narrow self-interest with one of self-interest
Scherer address the issue of financial regulation, bounded by norms of fairness, then positive re-
beginning with an argument that social welfare is ciprocal behaviors on the part of managers could
best seen in terms of three elements: efficiency be increased and negative reciprocal behaviors
(with a long scholarly history), stability (with could be reduced. This change in assumptions
a much shorter history), and justice (their main could not only enhance our ability to understand
theme). Mitchell and colleagues make a case for some anomalous agency theorybased empirical
a pluralistic view of social welfare. In the process, results but also could inspire corporate boards to
they find flaws in both economic welfare maximi- base executive contracts on a well-documented
zation (through shareholder wealth maximization; human behavioral tendencya quest for reci-
e.g., Jensen, 2002) and stakeholder happiness en- procity and fairnessand achieve social welfare
hancement (Jones & Felps, 2013b). gains through agency benefits, as well as through
the avoidance of destructive agency costs based
on revenge.
Justice, Fairness, and Many Objectives
Finally, Mitchell and colleagues (2016) address
Marti and Scherer (2016) begin by elaborating the metaphysical specter that haunts discussions
on the argument that social science theories not of economic welfarenamely, the question of
only describe social reality but also shape it. With one versus many. Having more than one ob-
this insight in mind, they raise the vital norma- jective aggravates complexity in decision mak-
tive question, How should these theories shape ing, and it is not surprising that a major strength of
our world? In their illustrative example these traditional neoclassical economic theory resides
authors show how financial regulation has, up in its use of a single valued metricthat is,
to the present, focused primarily on economic happiness in nineteenth-century utility theory
4 Academy of Management Review April

and its twin concept, marginal utility (measured the article is that although issue equivocality is
through preference rankings and indifference often perceived as an impediment to action, it can
concepts), later on. also provide an opportunity for social change agents
How about the corporation? Do we need a to favorably shape the meaning of a social issue,
single yardstick or many yardsticks to evaluate thus leading to corporate actions that enhance social
its contribution to social welfare? Jones and welfare.
Felps (2013a,b) have argued that corporate ac- At the firm level, process is also a focus of
tion requires a singled-valued objective that Bridoux and Stoelhorst (2016), particularly with
allows managers to make principled choices regard to a firms relationships with stakeholders.
among policy alternatives and that functions as These authors employ relational models theory to
an analog to the normative maxim that man- create a hierarchy of relational modes based on
agers should optimize value for the firms equity their joint value creation capacity. In the context
owners. In contrast, Mitchell and colleagues main- of knowledge-based firm/stakeholder endeavors,
tain that adopting a multi-objective approach to communal sharing relationships are shown to be
managerial decision making permits the engage- superior to equality matching, authority ranking,
ment of a broader array of market-enhancing pref- and market pricing relationships. The choice
erences and market signals and allows a more among these relational modes is influenced by
inclusive process that enhances multidimen- stakeholder perceptions of the model that are
sional social welfare. The authors envision an made salient by the firms behavior. The authors
intracorporate marketplace in which man- also argue that there is a tendency toward market
agers engage competing objectives. They argue pricing when the behavioral standards of the
that invoking a single-valued corporate objec- other modes are not met.
tive would only hamstring the virtuous process Finally, Cobb (2016) examines employment
of social welfare enhancement made possible processes and how they contribute to, or un-
by the existence of intracorporate markets dermine, social welfare. A central social welfare
among stakeholders. concern has been the growth in income inequality
throughout the world. Heretofore, most commen-
tators seeking to understand income inequality
Organizational Processes
have focused on government policy, technology,
Second, several of the authors focus on the or economic explanations to try to understand the
processes by which the twin objectives of eco- growth in income inequality. Cobb demonstrates
nomic and social welfare are enacted. Sonenshein how scholars of organization and management
(2016) explains how the perceived illegitimacy can contribute to our understanding of this chal-
and equivocality of social issues act as deterrents lenge. He argues that the way managers structure
to increased corporate attention to activities that the employment relationships in their organiza-
enhance social welfare (beyond economic). Issue tions is a key factor in producing relative societal
illegitimacy refers to perceptions that allocating income inequality. His theory contains several
resources to a particular issue falls outside of insights suggesting fruitful further research in
a justifiable basis for firm action, whereas issue management, as well as public policy recom-
equivocality deals with disagreement regarding mendations. For example, he demonstrates how
the meaning of an issue, including its purpose, the spread of nominally market-focused com-
scope, and implications for the firm. In addition, pensation practices such as pay-for-performance,
Sonensheins article offers a meaning-making external hiring, and pay benchmarking lead to
perspective that unpacks how social change greater inequality within occupations, and most
agents can overcome these impediments through starkly within organizations. While management
linking specific tactics (framing, labeling, im- researchers have long documented the damage
porting, and maintaining) to different types of such systems can do to the collaboration on
social issues (convertible, blurry, risky, or safe). which organizational performance depends (e.g.,
The author also explores the multiple levels of Lawler, 1971; Pearce, 1987), Cobb draws our
meanings that shape a social issue, including attention to the larger social welfare costs of such
very macro levels, such as economic philoso- systems. Similarly, he documents how different
phies, and very micro levels, such as individuals ownership forms (e.g., private equity ownership)
beliefs. One of the many novel ideas advanced in drive the management external orientation that
2016 Jones, Donaldson, Freeman, Harrison, Leana, Mahoney, and Pearce 5

exacerbates income inequality. His work opens First, it is entirely possible that many indi-
a promising new avenue of management re- vidual scholars who populate our discipline
search and brings our understanding of organi- believe that shareholder wealth maximization
zations to bear on a central public policy concern on the part of corporations does indeed lead to
in many countries. optimal social welfare. Although not all of these
We were somewhat surprised that none of the scholars are likely to be familiar with the de-
submissions addressed (1) the role that religion tails of the logic(s) behind this theorized re-
could play in the relationship between manage- lationship (e.g., Jensen & Meckling, 1976; Jones &
ment and social welfare, particularly in view of Felps, 2013a), the shareholder wealth maximi-
the recently created Management, Spirituality, zation objective remains appealing for a num-
and Religion Division of the Academy of Man- ber of other reasons. First, as a single-valued
agement, or (2) possible single-valued corporate objective, it is simple to articulate and, in theory,
objectives that include a stronger social welfare possible to implement (because multiple objec-
orientation (under the assumption that share- tives cannot be maximized simultaneously).
holder wealth maximization [e.g., Jensen, 2002] Second, it has a long history of acceptance by
and stakeholder happiness enhancement [ Jones managers and management scholars. Third, it
& Felps, 2013b] do not exhaust the possibilities). conforms to the mandates of financial markets
In the former case, social welfare is inherently that is, Wall Street. Fourth, social welfare is-
values based, and religions are inseparably sues are often thought to be the concern of gov-
connected to values. In addition, some religious ernment, not business. Fifth, in theory, it renders
organizations pursue social welfare through many profit-motivated activity morally legitimate in
types of programs in local communities and utilitarian/social welfare terms.
often worldwide, providing potential models for In addition, the single-valued shareholder
other organizations, including businesses. In wealth maximization objective renders man-
the latter case, Walsh once called the corporate agement theorybased research much more
objective issue arguably the most important tractable and, therefore, more attractive to
theoretical and practical issue confronting us management scholars. Theories based on eco-
today (2004: 349). In addition, whatever their nomics are certainly not value free, as was
shortcomings, single-valued objectives do have once claimed, but the values that underpin them
the benefit of radically simplifying both man- are widely accepted, meaning that scholars
agement practice and management scholar- employing them rarely have to address thorny
ship. Furthermore, multiple corporate objectives questions involving values in their theoretical
could be interpreted to mean that the pursuit of and empirical work. Indeed, studies based on
any one of them is acceptable or, more cynically, economics are highly amenable to the scien-
that there is no objective at all. Given the im- tific method that conveys a great deal of le-
petus of this special topic forum, perhaps future gitimacy and prestige to many disciplines,
management scholarship will address these including management. The assumptions of
neglected themes. economics may not be as realistic as we might
want them to be, but they render the research
process much more manageable, a matter of no
WHY THE EERIE SILENCE?
small concern to those of us whose careers
As noted above, Walsh et al. (2003) claimed that depend on doing management research. Fi-
there was an eerie silence among manage- nally, figuring out how to assure that social
ment scholars with respect to issues involving welfare is improved in the context of manage-
social welfare. If this is still true (and we believe ment theory is very difficult, a topic to which we
it is), an important question emerges: Why have now turn.
management scholars made so little progress in
addressing social welfare problems and, more
Enhancing Social Welfare in the Economy AQ:5
specifically, integrating social and economic
objectives? Here we suggest some reasons why Social welfare is broadly defined in terms of
this silence exists and, by extension, why it may the well-being of a society as a whole, encom-
emerge again, even in the wake of this special passing economic, social, physical, and spiri-
issue. tual health. Although the term social welfare is
6 Academy of Management Review April

often defined more narrowly to refer to govern- maximizing firms play their designated role in
ment programs that provide assistance to needy a rule utilitarian moral system that assures
individuals and families, here our reach is longer maximal social welfare (Jones & Felps, 2013a).
and comports with recent efforts to gauge social Thus, the primary objective of managers is to
welfare more broadly. For example, UN-sponsored maximize firm profits.
rankings of well-being rate countries on a range Unfortunately, many of the assumptions of
of factors, including economic (e.g., GDP per perfect competitionmany buyers, many sel-
capita), health (e.g.,healthy life expectancy), social lers, and so forthare violated in contemporary
(e.g., social support), and moral (e.g., generosity market capitalism and, according to the theory of
and corruption) dimensions (Helliwell, Layard, the second best (Lipsey & Lancaster, 19561957),
& Sachs, 2013). Gallup (available at http://info. all of the assumptions must be met for optimality
healthways.com/hubfs/Well-Being_Index/2014_ to be achieved. Importantly, moving closer to
Data/Gallup-Healthways_State_of_Global_Well- any one assumption (making it more true)for
Being_2014_Country_Rankings.pdf?t51449866 example, breaking a large firm into several
045324) similarly ranks regions by well-being smaller firms through antitrust actiondoes not
based on perceived social, financial, commu- necessarily increase, and may actually decrease,
nity, and physical health. Our task in this spe- aggregate social welfare. This means that man-
cial topic forum is filling out our understanding agement cannot simply maximize shareholder
of social welfare writ large by focusing on the returns and expect social welfare gains to
role of the corporate sector. emerge; improving social welfare has become
In theory, there is an array of net benefits a much more complex and less well-understood
benefits less costs for each individualthat is undertaking.
socially optimal. Indeed, there is no reason that From the perspective of the principal-agent
such an optimum could not include concerns model taught to most business school students,
about stability and justice as well as efficiency complete contracting is assumed and share-
(Marti & Scherer, 2016), or even several other di- holders are (by construction) the only residual
mensions of welfare (Mitchell et al., 2016). Practi- claimants. However, in our world of incomplete
cally, however, such an optimum would be and implicit contracts, there can be multiple re-
enormously difficult to achieve even in a static sidual claimantsthat is, stakeholders (Klein,
world. In a dynamic world the slightest distur- Mahoney, McGahan, & Pitelis, 2012). From this
bance would require a new optimal array of net perspective as well, because managerial de-
benefits, rendering its achievement impossible in cisions can have an impact on multiple stake-
all but a theoretical sense. holders, improving social welfare becomes far
If we narrow our focus to economic variables more complex than simply maximizing share-
alone, microeconomic theory (specifically, the holder wealth.
first fundamental theorem of welfare econom- As compelling as the arguments of Marti and
ics) maintains that such an optimum can be Scherer (2016) and Mitchell and colleagues
achieved when a competitive equilibrium is (2016) may be with respect to multiple di-
reached. Such an equilibrium is possible only mensions of social welfare, they further com-
under conditions of perfect competitionfor ex- plicate the task of identifying improvements
ample, markets consisting of many buyers and (let alone optima) in social welfare. Since the
many sellers, competition based on price alone, components of social welfare writ large
markets undistorted by government policies, for example, efficiency, stability, and justice
perfect information, undifferentiated products, (Marti & Scherer, 2106)are incommensurable
AQ:2 zero externalities. In equilibrium, a state of (i.e., lacking a means of making principled
Pareto optimality obtains; that is, no one can be trade-offs), we cannot deal with multiple di-
made better off without making someone else mensions of social welfare simultaneously,
worse off. The role of the firm in this scenario, making a social optimum a destination beyond
from both practical and moral perspectives, our reach. Combined with the futility of pursu-
is simple: firms should attempt to maximize ing an economic optimumequilibrium under
profits. From a practical perspective, profits are perfect competitionas discussed here, focus-
the measure of firm efficiency and assure firm ing on Pareto improvements in aggregate eco-
survival. From a moral perspective, profit- nomic welfare becomes a reasonable approach,
2016 Jones, Donaldson, Freeman, Harrison, Leana, Mahoney, and Pearce 7

albeit an incomplete one since it ignores ques- FIGURE 1


tions of justice (Marti & Scherer, 2016) and in- The Economics of Profit Making (from Peteraf &
trinsic values (Donaldson & Walsh, in press), Barney, 2003)
among others (Mitchell et al., 2016). We can make
someone economically better off without mak-
ing anyone else worse off. Therefore, in the
analysis that follows, incomplete though it may
be, we focus on improvements in aggregate
economic outcomesPareto improvementsas
our standard for the improvement of social
welfare, as well as on improvements in firm
profitability, the driving force behind many
corporate actions. We will return to the issue of
multiple measures of social welfare at a later
point in the discussion.

Pareto Improvements and Firm Profitability


As noted above, the term Pareto improvements
applies to exchanges/relationships wherein one
or more parties are made better off without mak-
ing any other party (parties) worse off. Because
one partys gain does not involve another par-
tys loss, there is always a net gain, resulting in
unambiguous improvements in economic wel-
fare. There are three generic ways to increase
the most that a buyer is willing to pay for a good or
firm profits (along with various combinations
service or (b) the least that a seller is willing to
of the three types), each with implications for
accept for a good or service. When these prices
social welfare. 2 As derived from Figure 1, firms
overlap, voluntary exchange can occur and, since
can (1) increase economic value and price
few exchanges are made at the reservation price
while holding input costs constant, (2) reduce
of either the buyer or the seller, both parties usu-
input costs while holding economic value and
ally receive surpluses.
price constant, and (3) increase/reduce price
Under category 1, firms meet the Pareto im-
while holding economic value and input costs
provement standard if they (1) develop new
constant. Under certain conditions, each of
products/services or improve or differentiate
these profit-enhancing actions also enhances
existing products/services (thereby assuring
(or at least does not harm) nonshareholder
market disequilibrium) without increasing costs,
stakeholders.
(2) raise prices no more than the incremen-
Figure 2 presents the components of eco-
tal economic value added, and (3) appropriate/
nomic cost in somewhat greater detail and
capture no more than the incremental surplus
makes explicit the participation of corporate
created by price increases and/or increased
stakeholdersfor example, employees, sup-
volume. New wealth is created and no one
pliers, creditors, neighboring communitiesin
is made worse off. However, if the firm, as-
addition to customers (as recipients of consumer
sumed to have some market power under con-
surpluses) and shareholders (as recipients of
ditions of disequilibrium, raises prices more
producer surplus). A reservation price is either (a)
than the incremental economic value created,
then surpluses for continuing customers will
2
Note that under equilibrium conditions, firms are price decline, violating the Pareto improvement
takers; they have no power to raise or lower their prices. Since standard.
we are dealing exclusively with conditions of economic dis-
equilibrium, firms can raise or lower their prices and will In addition, Priem (2007) outlines a number
presumably do so in accordance with the price/quantity re- of ways that go beyond new or improved
lationship of the product/service in question. products/services and that allow firms to grow the
8 Academy of Management Review April

FIGURE 2 Even if profits do increase, the losses incurred by


The Components of Economic Value customers result in a failure to meet the Pareto
improvement standard.
We emphasize the point that we elaborate on
the role of Pareto improvements because, at
the level of discrete economic transactions/
relationships, they represent the only actions
that can be definitively tied to improved social
welfare. Pareto improvements do not represent
a robust and exhaustive representation of social
welfare. They do, however, reveal problems with
the shareholder wealth maximization model and
with the use of the term wealth creation in the
strategic management literature, as discussed
below. Since we are not able to identify an ideal
criterion for improving social welfare, we use
one that yields a particular form of better
outcomes.

Externalities
top line. Noting that value creation involves the
willingness of consumers to pay more for a prod- Profitable actions taken by the firms that ei-
uct/service, he describes means of increasing the ther (1) create positive externalities or (2) create
use value of a product/service so that the ex- no negative externalities also result in Pareto
change value (price) can be increased, calling improvements. In economic analyses of social
this the consumer benefit experienced (CBE) welfare in the context of shareholder wealth
approach. maximization, the caveat no negative exter-
Under category 2, with economic value and nalities is usually invoked. Negative external-
price held constant, reductions in input costs ities result when losses are incurred by parties
that result from production cost and/or trans- not involved in a given (mutually benefi-
action cost efficiencies will result in Pareto cial) transaction/relationship. The production
improvements as long as the firm does not ap- of untreated toxic waste as a by-product of
propriate more than the savings created. How- manufacturing processes is an obvious example
ever, assuming that it has power resulting from of a negative externality. However, if a reason-
disequilibrium conditions, a firm can also in- ably broad definition of stakeholder is used
crease its profits by reducing the prices paid to one that includes those affected by corporate
its input suppliers, resulting in wealth transfers actions (Freeman, 1984)the caveat involving
from the firms input suppliers. No new wealth is negative externalities becomes redundant.
created, suppliers suffer losses, and the Pareto Actions involving Pareto improvements will,
improvement standard is not met. Thus, the by definition, not harm (and may benefit)
nature of input cost reductions is critical to those affected by the firms actionsthat is,
the link between profit seeking and wealth stakeholders.
creation.
Under category 3, Pareto improvements can
Pareto Inferior Actions
also be achieved by firms that can increase
profits by reducing pricesan outcome de- In our analysis thus far, we have focused on
pendent on the price/quantity relationship Pareto improvementscorporate actions that re-
while holding economic value and input costs sult in Pareto superior outcomes. The other side of
constant, thus increasing the consumer sur- the coin is Pareto inferior actionsthose that re-
plus of existing customers and adding new sult in losses for one or more corporate stake-
customers. However, firms with power result- holders. A short list of Pareto inferior actions
ing from disequilibrium conditions may also should facilitate an understanding of what we
attempt to increase profits by increasing prices. regard as actions that, at a minimum, are not
2016 Jones, Donaldson, Freeman, Harrison, Leana, Mahoney, and Pearce 9

unambiguously socially beneficial and, in some Marti and Scherer (2016) deal specifically with
cases, may be socially harmful: the (distributive) justice aspect of social welfare.
In terms of financial regulation, they argue,
employee layoffs or salary/wage cuts;
reductions in employee benefitse.g., health scholars and regulators put far too much empha-
care coverage, pensions, sick leave; sis on efficiency, too little on stability, and almost
allowing normal attrition to overburden none at all on justice. In fact, a criterion based on
remaining employees; Pareto improvement could be applied to economic
price concessions imposed on suppliers; policy writ large; that is, efficiency (or stability or
non-price concessions imposed on suppliers
e.g., delivery schedules, payment terms; justice) should not be improved at the expense of
reduced customer servicee.g., lengthy the other two. For example, regulatory changes
waits for poorly trained customer service intended to improve efficiency in financial mar-
representatives, reduced warranty coverage, kets could not be implemented if they resulted in
product/service price increases unsupported less stability in financial markets or an increase
by cost increases;
tax exemptions, zoning relaxation, or in- in the Gini coefficient,3 a measure of equality
frastructure improvements extracted from for example, income, wealthin the popula-
local communities; tion. However, given the economic collapse of
environmentally risky resource extraction 2008 and ongoing increases in concentrations of
practicese.g., BPs operations in the Gulf of wealth, we suspect that many citizens of Western
Mexico; and
careless disposal of toxic wastese.g., democracies would sacrifice a fair amount of
tannery wastes in Woburn, Massachusetts, efficiency for improved stability. Those in the
disposal in countries without protective United States would probably prefer more egal-
regulations. itarian distributions of wealth and income as
In short, a number of common corporate ac- well.
tions intended to increase profits certainly do
not meet the Pareto improvement standard and Kaldor Improvements
may not improve net social welfare. Simply
equating improvements in shareholder wealth Situations in which profit-generating corpo-
with social welfare improvements (wealth cre- rate actions do not harm any nonshareholder
ation), as is often done in the strategic man- stakeholdersPareto improvementsfar from
agement literature (for explicit exceptions see exhaust the social welfare possibilities, however.
Klein et al., 2012, and Peteraf & Barney, 2003), is Indeed, opportunities for Pareto improvements
not justifiable. Unless the profit-improving ac- are likely to constitute a relatively small pro-
tion can be shown to actually improve social portion of potential corporate actions. Kaldor
welfarethat is, create new net wealthno (1939) offered one means of extending Pareto im-
conclusion to that effect should be drawn or provements to include actions for which trade-offs
implied. between shareholders and other stakeholders are
required.4 If the benefits anticipated by one party
are great enough to allow compensation ade-
quate to make whole those who would be
Pareto Improvement and Other Elements of
harmed, the policy in question would be regarded
Social Welfare as an improvement in welfare and desirable
While Pareto criteria are assumed to be ap-
3
plied in a world in which economic exchanges Higher Gini coefficients connote less equal distributions of
are voluntaryif one party does not benefit, he or wealth or income; lower coefficients connote greater equality.
she does not make the exchangepower differ- Among national economies, most Gini coefficients fall in
a range of 0.20 to 0.50. For example, for OECD countries, over
entials between exchange partners make it the 20082009 time period, after-tax Gini coefficients ranged
likely that, even if no one loses, the gains of the between 0.25 and 0.48, with Denmark the lowest and Mexico the
powerful will be greater, perhaps far greater, highest. For the United States, the country with the largest
than the gains of the less powerful. Thus, re- population in OECD countries, the after-tax Gini coefficient
peated applications of the Pareto criterion could was 0.38 in 20082009.
4
Some economists believe that Kaldors extension of the
result in increased concentrations of wealth, Pareto criterion should be applied only at the macro level
which re-raises the issue of multiple measures of (e.g., governmental regulations). We see no reason that it
social welfare. cannot be applied at the corporate policy level as well.
10 Academy of Management Review April

under Kaldors criterion.5 Although Kaldors for- 1978; Sidak & Spulber, 1996; Williamson, 1996), we
mulation involves only hypothetical compensa- cannot endorse a criterion such as Kaldor im-
tion, it is sufficient to meet the standards of many provements with compensation.7 We do, however,
forms of utilitarianismthat is, those that focus suggest that, given the problems with other
solely on aggregate economic welfare, without optionsequating shareholder wealth creation
regard for the distribution of harms and bene- with wealth creation/social welfare improvement,
fits. As long as the winners gains exceed the Pareto improvements, and Kaldor improvements
losers losses, utilitarian standards are met. such a criterion might represent an intriguing line
Those whose wealth/income is dependent on of inquiry for future exploration,8 but one that is
shareholder returns would become richer owing far too complex to examine with any thorough-
to efficient (but uncompensated) wealth trans- ness here. To sum up, the assessment and mea-
fers from nonshareholder stakeholders, who surement of social welfare and, by extension, the
would become progressively poorer.6 relationship of social welfare to management
Indeed, repeated applications of the Kaldor theory are not problems for which easy solutions
criterion could result in even more rapid in- are apparent.
creases in concentrations of wealth/income than
repeated applications of the Pareto criterion. Un-
CONCLUSIONS AND IMPLICATIONS
der Pareto, there are no losers; under Kaldor, not
only are there losers but they are uncompensated. The most striking conclusion that can be drawn
In addition, the Pareto approach has the advan- from the six excellent articles that make up this
tage of being based on voluntary exchanges, special topic forum and our own examination of
while the Kaldor approach could be highly co- the role of social welfare in management theory is
ercive. Although the Kaldor criterion would seem that assessing and measuring social welfare is
to be an improvement on the apparent current a very complex and difficult undertaking. One
social welfare criterion (i.e., shareholder wealth theme that emerges from the included articles is
creation is wealth creation) because corporate that social welfare cannot be understood in terms
actions resulting in reductions in net social wel- of economic efficiency alone. Two articles (Marti &
fare are not allowed, the distributive justice im- Scherer, 2016; Mitchell et al., 2016) directly address
plications remain very significant. For these this issue, and a third (Cobb, 2016) addresses it
reasons we do not endorse Kaldor improvements implicitly. Marti and Scherer (2016) and Cobb
as an alternative to Pareto improvements.
Perhaps because Kaldor was concerned only 7
On its face, compensating nonshareholder stakeholders
with hypothetical compensation, actual compen- for wealth transferred to producer surplus (Figure 2) makes no
sation of those harmed by corporate policies sense. If producer surplus is used to compensate non-
shareholders for their losses, there is no net gain in producer
that is, wealth transfers, externalitieshas never
surplus. Indeed, this sort of wealth transfer is a zero-sum game;
been seriously considered. Nor is it surprising that is, producer surplus increases (approximately) equal
that such harms do not play a role in attributions (nonshareholder) stakeholder surplus decreases. It appears
of economic efficiency that accrue to profit- that no new wealth is created. However, when producer sur-
maximizing corporate behavior. However, the plus (profit) is translated into shareholder wealth, this is no
fact that we rarely calculate the extent of harms longer true. Because price/earnings (P/E) ratios for corporate
shares are almost universally greater than 1 to 1 (among S&P
caused by specific corporate policies, let alone 500 firms, P/E ratios averaged from 13.01 to 16.66 in the period
compensate those harmed, does not diminish the from September 2011 through December 2012 [ycharts.com,
harms themselves. And because the Kaldor cri- 2013]), shareholder wealth gainsshare price increasesare
terion is itself fraught with thorny problems both likely to be greater than stakeholder losses, leaving resources
theoretical and practical (e.g., Layard & Walters, available to compensate harmed stakeholders. Importantly,
compensation must be paid in company stock. An unpublished
working paper authored by two of the special issue editors of
this special topic forum, entitled Sustainable Wealth Crea-
5
What we have called the Kaldor criterion is often referred tion (Jones & Freeman, 2013), begins an exploration of this
to in the economics literature as Kaldor-Hicks efficiency after possibility.
Kaldor and John Hicks (1939), who added the provision that 8
To paraphrase Williamson, To argue that (an approach) is
those potentially harmed by an action could (in theory) pay the flawed does not establish that there is a superior feasible al-
potential actor not to proceed with the action. ternative (1996: 1014). All feasible options may be flawed,
6
Some commentators (e.g., Hartman, 2006; Smith, 2012) be- and choices must be made from the feasible alternatives
lieve that this process is already well underway. (Williamson, 1996).
2016 Jones, Donaldson, Freeman, Harrison, Leana, Mahoney, and Pearce 11

(2016) focus on issues of distributive justice, while no coercion is involved in the voluntary exchanges
Mitchell et al. (2016) make it clear that there are that underpin Pareto improvements.
multiple values worth preserving. Unfortunately, Employment of the Kaldor improvements crite-
assessing social welfare in terms of multiple in- rion holds the possibility of obtaining actual so-
commensurable measures is well beyond our cial welfare improvements for a full range of
current capabilities. As a result, we focus on corporate decisions. If winners could (hypotheti-
economic welfare first and take distributive jus- cally) compensate losers for their losses and still
tice into account after the fact. register gains, social welfare would be improved.
In terms of economic welfarethat is, wealth The hypothetical nature of this criterion is a key
creationalone, we examined three possible element here. As long as no actual compensation
approaches to improving social welfare and is involved and the gains of the winners exceed
speculated on a fourth. First, we concluded that the losses of the losers, the Kaldor criterion is
the current practice of equating shareholder satisfied. And although greater economic effi-
wealth improvement with social welfare ciency is achieved, distributions of income and
improvementexplicitly or implicitlyshould wealth are likely to become substantially more
be abandoned in both management theory and unequal. In addition to this distributive justice
management practice. The assumptions on concern, Kaldor improvements clearly involve
which the model that supports this conclusion coercion; losers do not accept their losses
is based bear no resemblance to the realities voluntarily.
of twenty-first-century market capitalism. Fur- An approach that we represented as an in-
thermore, many actions taken by corporate triguing line of inquiry for future exploration
managers to improve company profits harm non- might be called Kaldor improvements with com-
shareholder stakeholders of the firm. The pensation. Because this approach is laden with
losses must simply be absorbed by these stake- thorny theoretical and practical problems, a full
holders. Indeed, they are rarely, if ever, mea- exploration of the prospects for this criterion
sured or counted in calculations of economic would involve an analysis well beyond the scope
efficiency. For this reason it is likely that some of of this article. However, other scholars might give
these actions do not result in net improvements in this possibility further consideration, particularly
social welfare, and some may actually result in in view of the fact that shareholder wealth gains
social welfare losses. Furthermore, in many are measured in share price increases, which
cases, because shareholders gain at the expense grow in proportion to the P/E ratio of the firms
of other stakeholders, distributions of incomes stock (usually 10-1 or more) rather than in direct
and wealth become increasingly unequal, a dis- proportion to stakeholder losses. If this relation-
tributive justice concern. Finally, actions taken ship holds, ample resources could be made
under the banner of shareholder wealth im- available to compensate (in company stock) those
provement are fundamentally coercive; that is, harmed by actions taken to increase shareholder
the losses of nonshareholders are not voluntarily wealth.
accepted. We note that two of the articles included in this
The one approach that yields unambiguous im- special topic forum appear to be based on Pareto
provements in social welfare, at least with respect improvements, the one social welfare criterion
to the discrete action under consideration, is the that can be unambiguously linked to social wel-
Pareto improvements criterion. Making someone fare improvement. Bridoux and Stoelhorst (2016)
better off without making anyone else worse off show that communal sharing firm/stakeholder
does improve social welfare. However, corporate relationships are more efficient than other re-
actions for which there are winners but no losers lational modes. Since no other stakeholders ap-
make up a relatively small proportion of all such pear to be harmed, the Pareto criterion is met. The
actions, meaning that the Pareto criterion cannot same conclusion can be reached with respect to
be widely applied. Furthermore, although volun- the Bosse and Phillips (2016) article. Introducing
tary economic exchanges, by definition, improve notions of fairness and reciprocity into the con-
the welfare of both parties, differences in bargain- tracting process involving the firms board and its
ing power may mean that repeated Pareto im- top executives could result in reduced agency
proving exchanges lead to increasingly unequal losses and possible agency benefits in corporate
distributions of income and wealth. Nonetheless, governance. No stakeholder group appears to be
12 Academy of Management Review April

harmed in this revised process, again meeting the Friedman, M. 1970. The social responsibility of business is to
Pareto improvement criterion. increase its profits. New York Times Magazine, September
13: 32-33,122-124.
In terms of the implications of this special topic
forum in general, and of this introduction in par- Habermas, J. 1971. Knowledge and human interests. Boston:
Beacon Press.
ticular, we offer the following. With respect to
management scholarship, Marti and Scherer Hartman, T. 2006. Screwed: The undeclared war against the
middle class. San Francisco: Berrett-Koehler.
(2016) remind us that our theories not only de-
scribe social reality, they also shape it. With this Helliwell, J. F., Layard, R., & Sachs, J. 2013. World happiness
report. New York: Earth Institute, Columbia University.
caveat in mind, we strongly urge management
scholars to take social welfare considerations Hicks, J. 1939. The foundations of welfare economics. Economic
Journal, 49: 696712.
into account in their theorizing and empirical re-
search. This consideration could take the form of Jensen, M. C. 2002. Value maximization, stakeholder theory
and the corporate objective function. Business Ethics
a thoughtful assessment of the social welfare Quarterly, 12: 235-256.
implications of their work; relying on the as-
Jensen, M. C., & Meckling, W. H. 1976. Theory of the firm:
sumption that increasing shareholder wealth in- Managerial behavior, agency costs and ownership struc-
variably leads to social welfare advances can ture. Journal of Financial Economics, 3: 305360.
no longer be justified. The same recommenda-
Jones, T. M., & Felps, W. 2013a. Shareholder wealth maximi-
tion applies to practicing managers as well; zation and social welfare: A utilitarian critique. Business
Friedmans (1970: 124) claim that the social re- Ethics Quarterly, 23: 207238.
sponsibility of business is to increase its profits Jones, T. M., & Felps, W. 2013b. Stakeholder happiness en-
cannot be taken as gospel any longer. In addition, hancement: A neo-utilitarian objective for the modern
we hope that management scholars will be in- corporation. Business Ethics Quarterly, 23: 349379.
spired to directly address social welfare concerns Jones, T. M., & Freeman, R. E. 2013. Sustainable wealth creation.
in their theory building and empirical studies. If Working paper, University of Washington, Seattle.
they do, we need not experience another eerie Kaldor, N. 1939. Welfare propositions in economics and inter-
silence with regard to social welfare issues in personal comparisons of utility. Economic Journal, 49:
management research once the dust settles on 549552.
this special topic forum. And if theories do shape Klein, P. G., Mahoney, J. T., McGahan, A. M., & Pitelis, C. N. 2012.
social reality, as we believe they do, the better Whos in charge? A property rights perspective on stake-
holder governance. Strategic Organization, 10: 304315.
world envisioned by the Academy of Manage-
ment may begin to take shape. Lawler, E. E. 1971. Pay and organizational effectiveness: A
psychological view. New York: McGraw-Hill.

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Thomas M. Jones (rebozo@uw.edu) retired as the Boeing Professor of Business Manage-


ment at the University of Washingtons Foster School of Business. He received his Ph.D. in
the political, social, and legal environment of business from the University of California,
Berkeley. His research interests include stakeholder theory, normative theories of the
firm, and the intersection of business ethics and corporate strategy.
Thomas Donaldson (donaldst@wharton.upenn.edu) is the Mark. O. Winkelman Professor
in the Wharton School at the University of Pennsylvania. He also holds a secondary ap-
pointment in the Department of Philosophy, University of Pennsylvania. He received his
Ph.D. in philosophy from the University of Kansas. He studies corporate governance and
business ethics.
R. Edward Freeman (freemane@darden.virginia.edu) is University Professor and Olsson
Professor at the Darden School, University of Virginia. He received his Ph.D. from. . . His
AQ:3 research interests include. . .
Jeffrey S. Harrison (harrison@richmond.edu) is a University Distinguished Educator and
the W. David Robbins Chair in Strategic Management at the University of Richmond. His
received his Ph.D. in strategic management from the University of Utah. His research
focuses on stakeholder theory, corporate strategy, collaborative strategy, and mergers
and acquisitions.
Carrie Leana
Joseph T. Mahoney (josephm@illinois.edu) is the Caterpillar Chair of Business in the
College of Business at the University of Illinois at Urbana-Champaign. He earned his
Ph.D. in business economics from the Wharton School at the University of Pennsylvania.
His research focuses on the economic foundations of strategy.
Jone L. Pearce (jlpearce@uci.edu) is Deans Professor of Organization and Management
at the Paul Merage School of Business, University of California, Irvine. She received her
AQ:4 Ph.D. from . . . She studies the effects of interpersonal processes, governmental, and or-
ganizational control systems on organizational behavior.
AUTHOR QUERIES

AUTHOR PLEASE ANSWER ALL QUERIES

AQ:1_Still missing institution and bio


AQ:2_Review punctuation
AQ:3_Please provide details
AQ:4_Please provide details
AQ:5_We have removed the 2nd instance of the footnote 1 citation that originally appeared after
the "Enhancing Social Welfare..." header. Please conrm edit or if it needs to be reinstated
and renumbered.