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Even Milton Friedman would agree: Stakeholder capitalism pays off

February 1, 2022, 10:30 AM UTC
Economist Milton Friedman in a 1986 photo
Economist Milton Friedman in a 1986 photo. Though Friedman helped establish the doctrine of shareholder primacy, he would have understood the importance of what we now call stakeholder capitalism, writes Sarah Keohane Williamson.
Photo by George Rose/Getty Images

In a “Letter to CEOs” earlier this month, BlackRock chief executive Larry Fink used his annual message to address a topic that seems to be on the tip of everyone’s tongue—stakeholder capitalism. In the letter, Fink makes his position clear—that stakeholder capitalism is about what’s best for the business in the long term, not about optics, or politics, or appearing to be “woke.”

The objections Fink is pushing back against are popular critiques of any new business approach that broadens objectives beyond immediate returns. Recall when Nasdaq made its push last year to regulate boardroom diversity. Some derided it as baseless, unlawful, and a play to appease the political left—ignoring the fact that there is hard evidence showing that companies with the most gender and ethnically diverse boards earn higher returns on invested capital as compared to their least diverse peers.

The same is the case for stakeholder capitalism. For those of us taught the economics of the last 50 years, which focuses on short-term shareholder-value maximization, a new twist has been a shock to the system. It’s no surprise, then, that there has been pushback. But a careful reading of Milton Friedman’s famous 1970 New York Times essay (“The Social Responsibility of Business Is to Increase Its Profits”) shows that even he understood the importance of what we would call “stakeholder capitalism” today:

“To illustrate, it may well be in the long‐run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects.”

This comes from the paragon of shareholder primacy himself. So, why the pushback on stakeholder capitalism now?

One reason is the ambiguity of the term. Who are the stakeholders? In Friedman’s example, they are employees in a company town. Today’s “company town,” on the other hand, often stretches over borders and across continents. What does putting emphasis on stakeholders mean? Some would define it as managing for long-term shareholder value in a multi-stakeholder context. For others, it means prioritizing multiple stakeholder groups equally. Or, different still, it can be a way for business leaders to use their influence to address societal outcomes. 

To address this ambiguity at a company level, every firm needs to clarify its purpose, strategy, and definitions of success. 

The other reason for the pushback is a lack of evidence. Up to this point, there has been little by way of proof that stakeholder capitalism pays off. Without any data, asking a firm to change its strategy requires a leap of faith. Leaders may feel that an investment in stakeholders will pay off, but that has been hard to show, especially to investors. Now a new study may provide the data that many business leaders are seeking.

A new report from the Wharton School’s ESG Analytics Lab and FCLTGlobal compares the characteristics and performance of companies pursuing various stakeholder-oriented strategies. The study used natural-language processing to analyze the annual reports of over 3,000 global companies to look for stakeholder-oriented language. It then compared the presence of that language and the performance on certain ESG metrics with financial outcomes. 

What the data shows is that firms focused on a wider swath of stakeholders outperformed their peers in the long run. Based on a scoring system that accounts for how often a firm talks about its stakeholder orientation (the “talk”) and its actual stakeholder outcomes (the “walk”), if all firms performed like companies in the study’s top third they would have combined to create $3.2 trillion in additional value between 2010–2020. The firms that were best at “walking the talk” also generated higher and more stable returns over a three-year period, were more likely to meaningfully invest in R&D, and delivered higher sales growth over longer periods of time.

That’s not to say we should ignore shareholders. A false dichotomy has arisen that a firm must choose between shareholder return and stakeholder value. Strong return for shareholders is correlated with—not opposed to—good working conditions for employees or a high-quality product for consumers. In the short run, the study finds that firms focused primarily on shareholders also performed well, but those benefits appear to fade over longer periods of time. The conclusion, it would seem is that pursuing long-term shareholder value in a multi-stakeholder context is a winning strategy.

Of course, stakeholders may have divergent interests, and some may make unreasonable requests of companies. The role of the board and management is to recognize which stakeholders can affect the company’s achievement of its objectives and fully integrate those considerations into their overall strategy.

Armed with the data and a clear long-term strategy, it should be easier for CEOs to go confidently to their shareholders and say that they can earn strong returns and positively impact the other areas of their corporate communities. And the pushback of “political” or “unsubstantiated” or “hollow” will no longer apply. 

“We focus on sustainability not because we’re environmentalists, but because we are capitalists and fiduciaries to our clients,” Fink says in his letter. With this, he affirms what many business leaders have been eager to hear for some time—stakeholder capitalism pays off. If Milton Friedman were here, I think he would agree.

Sarah Keohane Williamson is CEO of FCLTGlobal, a nonprofit organization that develops research and tools to drive long-term value creation.

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