EF4313 Corporate Finance

Department of Economics & Finance

City University of HK
Wayne Yu

Chapter 20: Stakeholder capitalism and

Responsible Business

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Topics Covered

• Who are the Stakeholders?

• The Case for Shareholder Capitalism.
• The Case for Stakeholder Capitalism.
• Responsible Business.
• Responsible Business in Practice.

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Who Are the Stakeholders?
• Shareholders
• Employees
• Customers
• Suppliers
• Local and Regional Communities
• The Environment
• The Government

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The Case for Shareholder Capitalism 1

• Shareholder capitalism – A system in which

shareholder wealth maximization is the goal
• From Milton Friedman’s 1970 article, known as
the ‘Friedman doctrine’
.....there is one and only one social responsibility of
business—to use its resources and engage in activities
designed to increase its profits so long as it stays within
the rules of the game, which is to say, engages in open
and free competition without deception or fraud
• Never advocated exploiting other stakeholders

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The Case for Shareholder Capitalism 2

Friedman based his argument on three points:

1. Government policy ensures companies will
engage in socially responsible behavior
2. Maximizing shareholder value gives
shareholders maximum freedom to support
the social objectives they care about
3. Maximizing shareholder value requires
companies to invest in stakeholders

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Government Policy for Socially Responsible
Behavior
• Prosperity of a society depends not only on
corporate profits but also externalities
• Externalities are best addressed by government
laws and taxes
• A democratically elected government represents
aggregate preferences, and has the mandate to carry
them out
• Thus, the existence of a polluting firm indicates that
the social benefits (such as employment and taxes)
must outweigh the costs (dirty air or water)
• A company pursuing social causes is usurping
the role of government
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Maximizing Shareholder Value Frees Investors
to Pursue Social Objectives
• Individuals may have social responsibilities
• Businesses maximize profit to maximize
individual shareholders’ choices
• Shareholder A may be concerned with the
environment while shareholder B may be concerned
about finding a cure for cancers
• Thus the pursuit of social causes are best left
in the hands of individual shareholders

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Shareholder Value Maximization Requires
Investing in Stakeholders
• Shareholder value cannot be maximized
without taking care of all other stakeholders
• In particular, can a company survive/thrive
with
• Dissatisfied customers/suppliers
• Unhappy and unproductive employees
• A bad reputation in the local/regional
communities?
• Thus, maximizing shareholder value requires
a company to take stakeholders seriously

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Enlightened Shareholder Value (ESV)
• ESV maximization —Explicitly recognizes
that shareholder value maximization
requires investing in all stakeholders
• Singular objective: shareholder value
• Companies invest in stakeholders only if
doing so is positive‐NPV
• E.g., investing in employee happiness to the
point where marginal benefit = marginal cost,
instead of unlimited investment
• Stakeholders are a means to an end

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Enlightened Shareholder Value (ESV)
ESV offers two practical advantages
• A singular, clear criterion for making
decisions
• For example, a company will open a daycare center
for its employees only if the benefits exceed the
costs
• A singular, clear criterion for judging
managerial performance
• No need to separately consider how managers have
treated other stakeholders because the effect will
show up in shareholder value – profitability and
share price
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Figure 20.2 Enlightened Shareholder
Value—Example

Enlightened Shareholder Value favors (b) over (a) but not

(c) over (a).

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A shift to stakeholder capitalism?
• Stakeholder Capitalism – The goal is a company is to
maximize value for ALL stakeholders (society in
general)
• On 19 August 2019, the Business Roundtable ( an
organization of the CEOs from the largest companies
in the US), changed its statement on the purpose of a
corporation to embrace stakeholder capitalism by
• Delivering value to our customers, investing in our
employees, dealing fairly and ethically with our
suppliers, supporting the communities, and
generating long‐term value for shareholders!

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The Case for Stakeholder Capitalism
It may be justified only when Friedman’s assumptions are
violated
Assumption 1: Well‐Functioning Governments
Violations may include
• The government may be influenced by lobbying from
companies, not always democratic (e.g., the tobacco
industry)
• Elections only happen infrequently
• Regulation is imperfect, especially on qualitative
issues such as employee happiness

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The Case for Stakeholder Capitalism
Assumption 2: A company has no comparative
advantage in serving society
Violations
• Some companies may have comparative
advantages in serving society, for example
• $1 invested in reducing plastic waste may be better
spent by a packaging company than $1 donation by
its shareholders to Greenpeace
• Perfume companies switched some resources to
produce hand‐sanitizers during Covid‐19 since they
have expertise in making alcohol‐related products

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The Case for Stakeholder Capitalism
Assumption 3: Instrumental decision making is
effective (investing in stakeholders is a means
to an end)
Violations include
• NPV calculation is impossible for many decisions
because there is uncertainty – the relevant
parameters are not known
• Investing intrinsically in stakeholders sidesteps
this issue
• Stakeholder capitalism provides a valuable decision
tool under uncertainty

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The Case for Stakeholder Capitalism
• Some evidence that doing what’s good for
stakeholders is also good for shareholders
• Share prices of the following companies
outperform relevant peers
• Companies on the list of “100 Best Companies to
Work For in America”
• Companies in the top 20% of American
Consumer Satisfaction Index
• Companies that adopted shareholder proposals
on improving ESG performance

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The Challenge to Stakeholder Capitalism

• No clear rule to replace NPV

• While shareholder capitalism measures value in $,
value measures for stakeholder capitalism are
diverse and hard to quantify (e.g., clean
environment, working conditions, & happiness!)
• No proper weightings on different stakeholders
• 50% on employees, 25% on customers, 15% on
environment, 10% on suppliers?
• Accountability to everyone means
accountability to no one!!

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Responsible Businesses
• Shareholder capitalism or stakeholder
capitalism?
• The answer is perhaps “Responsible Business!”
• Creates value for shareholders by creating
value for society
• But there remains an explicit duty to
shareholders
• Different from Corporate Social Responsibility,
which focuses on image
• A tobacco company would not viewed as responsible,
even if it donates part of its profit to charity
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Decision Making in Responsible Businesses
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Three Guiding Principles

• Principle of Multiplication: Does an
investment in a stakeholder generate a
benefit greater than the cost?
• Principle of Comparative Advantage: Can the
company deliver more value through an
activity than other organizations?
• Principle of Materiality: Are the stakeholders
the activity benefits material to the
company’s business?

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Responsible Business in Practice
• Shareholder capitalism is still the case in the US/UK
• Directors have fiduciary duties to shareholders
• “Directors must make stockholder welfare their
sole end, … other interests may be taken into
consideration only as a means of promoting
stockholder welfare.” – Chief Justice of the
Delaware Supreme Court
• In other countries such as Germany, Denmark, Japan,
and Sweden, employees and lenders are especially
protected

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Figure 20.3 CFOs and Firm Objectives

Source: J. Graham, Corporate Finance and Reality (Journal of Finance, 2022).

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