Corporate Sustainability

Shareholder Primacy Versus Stakeholder Primacy

Rezaee Zabihollah, Zabihollah Rezaee

• Publisher: Business Expert Press
• Year: 2021
• Print ISBN:
  9781637420867
• eBook ISBN:
  9781637420874
• Topic: Business
• Subtopic: Business Law
• Index: Business

Business organizations have recently been encouraged by investors, regulators, and communities to define their purposes, values, and fiduciary duties of creating shared value for all stakeholders.

Public companies have traditionally operated under the corporate model of "shareholder primacy" with the primary purpose of generating returns for shareholders and thus corporate activities are managed toward creating shareholder value. The stakeholder primacy system encourages directors and executives to focus on managing corporate activities toward creating shared value for all stakeholders. The role of the board of directors under stakeholder primacy/capitalism as opposed to shareholder primacy/capitalism is to oversee the managerial function of focusing on the long-term sustainability performance, effectively communicating sustainability performance information to all stakeholders.

A shift away from the shareholder primacy model and toward the stakeholder primacy model has been gaining momentum worldwide in recent years as investors demand, regulators require, and companies define the "profit-with-purpose" mission in creating shares value for all stakeholders.

This book offers guidance to organizations for considering both shareholder primacy and stakeholder primacy in defining their mission of "profit-with-purpose" and in creating shared value for all stakeholders. It also highlights how people, business and resources collaborate in a business sustainability and the stakeholder primacy model in creating shared value for all stakeholders. Anyone who is involved with business sustainability and corporate governance, the financial reporting process, investment decisions, legal and financial advising, audit functions, and corporate governance education including directors, executives, investors, and auditor will be interested in this book.

CHAPTER 1

Introduction to Shareholder Capitalism and Stakeholder Capitalism

Executive Summary

Corporate sustainability has become an economic and strategic imperative with the potential to create shared value for all stakeholders. Public companies in the United States have traditionally operated under the corporate model of “shareholder primacy/capitalism” that makes the board of directors’ fiduciary responsible primarily to shareholders with protected interests. Under the shareholder primacy system, the primary purpose of a corporation is to generate returns for shareholders, and thus corporate activities are managed toward creating shareholder value. The stakeholder primacy/capitalism, which is better known as the European corporate governance model, makes the board of directors’ fiduciary responsible of protecting interests for all stakeholders including shareholders, creditors, employees, customers, suppliers, society, and the environment. The 2020 COVID-19 pandemic has been an exogenous shock in the global economy and capital market with substantial impacts on individuals, organizations, and society. The pandemic also demands that business organizations focus on safety, health, and well-being of their employees, customers, and suppliers, and thus a global move toward stakeholder primacy. This introductory chapter describes the models of shareholder primacy and stakeholder primacy, and the next three chapters provide more in-depth discussion of these models.

Introduction

Shareholder primacy is a concept that makes the board of directors’ fiduciary responsible only to shareholders in protecting their interests with the main mission of creating value primarily for the shareholders. This shareholder primacy system is also known as U.S. corporate governance model and is being criticized for focusing on generating short-term profits for shareholders while compromising long-term sustainability performance that creates shared value for all stakeholders and promotes innovation, growth, and social and environmental impacts. Corporations can create the right balance between the wealth maximization for shareholders under the shareholder primacy concept, while achieving the welfare maximization for all stakeholders under the stakeholder primacy concept.

Recently, the Business Roundtable (BRT) announced the adoption of a new Statement on the Purpose of a Corporation, signed by 181 high-powered chief executive officers (CEOs), which recommend the move away from the shareholder primacy concept toward the stakeholder primacy concept that promotes sustainability of creating shared value for all stakeholders.¹ Corporate purpose and stakeholder considerations have gained recognition in the business community worldwide. The stakeholder primacy challenges companies to put stakeholders at the heart of a company’s purpose. A shift in corporate purpose from shareholder primacy to stakeholder primacy reinforced by the U.S. BRT’s Statement on the Purpose of a Corporation. This focus, combined with public pressure for CEOs to engage on social and political topics (e.g., human capital, diversity, immigration, gun control, and gender pay equity), enables corporate America to advance toward business sustainability. This chapter provides a synopsis of shareholder primacy and stakeholder primacy models.

Book Objectives and Sustainability Definition

The primary objective of this book is to focus on shareholder primacy and stakeholder primacy models of business sustainability by contrasting and comparing these models and their relevance in advancing business sustainability. Business sustainability is defined as a process of achieving financial economic sustainability performance (ESP) to create shareholder value while generating nonfinancial environmental, ethical, social, and governance (EESG) sustainability performance in protecting the interest of other stakeholders. Stakeholders are those who have stake in the organization and take risk and share returns including shareholders, employees, creditors, customers, suppliers, society, and the environment.

Business sustainability can best be promoted under the stakeholder primacy model. The board’s role under stakeholder primacy/capitalism as opposed to shareholder primacy/capitalism is to oversee the managerial function of focusing on the long-term sustainability performance, effectively communicating sustainability performance information to all stakeholders. The board should be informed and able to comprehend the stakeholder objectives, rationales for focusing on sustainability factors of performance, risk, and disclosure, and managerial strategic planning, sustainable operational performance, and executive compensation in promoting long-term corporate value. The board should also provide oversight, insight, and foresight function on the achievement of both financial ESP and nonfinancial EESG sustainability performance driven from financial, human, social, environmental, and manufacturing capitals as well as innovation, culture, and corporate governance. The concept of impact investing (II) in achieving desired financial returns for investors while generating social and environmental impacts is relevant and important under the stakeholder primacy model.

Recently, a definition of corporate purpose has been proposed and elaborated to include three key guiding principles as follows:²

1. The proposed definition of corporate purpose for publicly traded business (for-profit) corporations is to measure their actions by what is in the best interests of shareholders (the shareholder primacy governance model).

2. In reaching for this new corporate purpose definition, the reality is ignored that the shareholder primacy governance model embraces the ability of directors to consider a broad array of nonfinancial EESG sustainability performance factors.

3. Companies who chose to address EESG/stakeholder-oriented decisions pursuant to the stakeholder interests balancing act contemplated by the proposed new purpose definition run the risk of losing the valuable protection of the business judgment rule.

The COVID-19 pandemic has brought on many challenges, including focusing on the inequality in our society and the fact that many public companies’ primary goal is maximizing shareholder value at the expense of other stakeholders such as employees, creditors, customers, suppliers, and communities. However, under their new corporate purpose definition, directors will have “latitude to make decisions that reasonably balance the interests of all constituencies” and they urge corporations and their shareholders to “recognize that ESG and stakeholder purpose are necessary elements of sustainable business success.”³ Thus, public companies should ensure that they have effective corporate governance structure and measures to creating shared value for all stakeholders and serving the interests of all stakeholders including shareholders. Public companies and their elected board of directors and appointed management should be responsible and accountable to shareholders and ensure that they run the company in the best interests of shareholders in creating sustainable and long-term value.

Impact Investing

The relationship between financial/market performance and nonfinancial EESG performance has been extensively yet inconclusively debated in the literature in the past decade, which suggests that investors pay attention to sustainability factors of risk, performance, and disclosure. A growing number of investors are now considering II with a keen focus on financial return and EESG sustainability factors and integrating nonfinancial EESG sustainability factors into their investment strategies.⁴ The Global Impact Investing Network (GIIN) refers to II as “investments made with the intention to generate a positive, measurable, social, and environmental impact alongside a financial return.”⁵ Regulators have responded to the demand for environmental, social, and governance (ESG) information and have either mandated ESG sustainability performance disclosure (European Union, EU Directive, 2014) as more than 6,000 European public companies are required to disclose their ESG information in the fiscal 2017 year and onward or recommended voluntary disclosure of ESG information.⁶

Corporate purpose and stakeholder considerations have gained recognition in the business community worldwide. In August 2019, 181 out of 188 member CEOs of the U.S. BRT signed an amended Statement on the Purpose of a Corporation, moving away from the traditional shareholder primacy of maximizing shareholder returns.⁷ The stakeholder primacy challenges companies to put stakeholders at the heart of a company’s purpose. A shift in corporate purpose from shareholder primacy to stakeholder primacy reinforced by the U.S. BRT’s Statement on the Purpose of a Corporation. The idea of establishing the purpose for the company beyond profit maximization for shareholders, combined with public pressure from investors and regulators to engage on social and political topics (e.g., human capital, diversity, immigration, gun control, and gender pay equity) has encouraged business organizations to define their purpose and focus on II. The concept of II suggests that corporations achieve a desired rate of returns for their shareholders while generating social and environmental impacts. Although the II concept has often been used interchangeably with socially responsible investing (SRI), the two concepts have important differences. SRI is commonly referred to as the investment strategy that maximizes financial returns while minimizing any negative impact on the society or environment, whereas II is a deliberate investment strategy to achieve both financial returns and social and/or environmental impacts.⁸

The distinction between II and SRI investment strategies is important for several reasons. First, investor sentiment plays a role in firms’ commitment to II when investors place a valuation premium on nonfinancial EESG sustainability performance. Second, in the aftermath of the COVID-19 pandemic considering financial and operational challenges, firms, their shareholders, and directors have increasingly become attuned to EESG considerations in allocating scares resources between II and SRI investments in achieving EESG objectives. Third, investors now pay more attention to EESG initiatives and investments as asset managers of the Big 3 investment families (BlackRock, State Street, and Vanguard) consider EESG risks and opportunities in their investment strategies.⁹ Finally, investors with stronger EESG preferences with a focus on II with portfolios that tilt more toward green assets earn lower expected returns than investors with a focus on SRI investing in brown assets.

Defining corporate purpose has been a key trend in Europe over the last several years and will continue to spread in 2020. In France, expect more companies to adopt a “raison d’être” (corporate purpose), an expectation which may become a legal requirement. The raison d’être gives a sense of meaning to stakeholders and puts EESG at the core of corporate strategy. Climate change and transitioning to a lower-carbon economy are also top priorities for European stakeholders. Boards will need to be able to understand and discuss ESG data—and its impact on key matters such as executive remuneration—with investors. In France, the number of board committees focused on ESG has doubled in the last two years. This is an important development, as EESG is the focus of a quarter of the questions raised at general assemblies and half the resolutions submitted by shareholders. In Spain, investors will begin to exercise their vote on nonfinancial reporting. Spain also is extending its corporate governance principles, which promote key components of EESG, to private companies in 2020. More transparent sustainability disclosures on long-term economic and EESG performance create opportunities to identify and correct operational inefficiencies, reputational and financial risks that would improve economic performance and thus increase the firm value.¹⁰

Investors typically have incomplete financial and nonfinancial information about a firm’s ESG sustainability performance and thus they may not be aware of the firm’s governance effectiveness, ethical culture, and social and environmental commitments. Lack of knowledge on the part of investors reduces the firm’s investor base, which in turn makes risk sharing incomplete and inefficient and thus stocks of these firms are out of line with their market’s fundamentals, which may incentivize firms to obtain certification to influence stock prices. Disclosures of sustainability information however make investors aware of the firm existence and enlarge its investor base, which improves risk sharing and thus make their stocks closer to their market fundamentals. Stakeholders may attempt to pressure and/or motivate firms to disclose sustainability information about their social, governance, and environmental activities and release of such information leads to disclosure of private information. Managers tend to analyze the costs/benefits of obtaining sustainability ranking to improve sustainability disclosures and how these disclosures are integrated and observed by capital markets.

Sustainability information on long-term economic and EESG performance increases the quality and quantity of the firm’s disclosures, and thus more focus on long-term and sustainable performance and fewer incentives for short-term performance that could be detrimental to the long-term sustainability. Gi...

Table of contents

• Cover
• Half-Title Page
• Title Page
• Copyright
• Description
• Contents
• Preface
• Acknowledgments
• Chapter 1 Introduction to Shareholder Capitalism and Stakeholder Capitalism
• Chapter 2 Corporate Capitals
• Chapter 3 Shareholder Primacy and Capitalism Model
• Chapter 4 Stakeholder Primacy and Capitalism Model
• Notes
• References
• About the Author
• Index
• Backcover