• Shareholder capitalism is making way for stakeholder capitalism.
  • Not taking this approach can, for some companies, seriously threaten their licence to operate.
  • Companies need to look at how robust and fit for purpose their stakeholder governance is.

The past year has seen significant developments that indicate a systemic shift towards purposeful business and responsible capitalism, challenging well-established assumptions about shareholder primacy. Facing this new reality, boards need to consider what role their corporation will play in society and what steps they must take to ensure their corporation is prepared for the future.

In corporate governance terms we are now entering the age of stakeholder capitalism, as we anticipated in a White Paper published last year. 2019 may yet turn out to be a watershed year in the evolution of corporate governance, and 2020 should herald a sharper focus by boards on stakeholder governance and on long-term sustainable stewardship by the investor community.

There have been some important steps that support a new age of stakeholder capitalism.

1) August 2019 – The Business Roundtable Statement on Corporate Purpose signed by 181 North American CEOs essentially embraced stakeholder capitalism with a proclamation that their boards, and management, will promote the long-term value of the corporation for the benefit of all its constituents and not solely to maximize shareholder wealth;

2) December 2019 – The British Academy’s publication of their Principles for Purposeful Business which posited that corporate law should place purpose at the heart of the corporation and require directors to state their purpose and demonstrate commitment to it.

3) November 2019 – The Institute of Directors published a Manifesto for Corporate Governance in which they advocate 10 specific policy proposals designed to achieve the following objectives: to increase the accountability of the UK corporate governance system to stakeholders and wider society; to improve the competence and professionalism of UK board members – whose role is central to business decision-making; and to enhance the ability of board members to pursue long-term, sustainable business behaviour, including addressing the challenge of climate change.

4) December 2019 – The World Economic Forum launched a new Davos Manifesto: The Universal Purpose of a Company in the Fourth Industrial Revolution, a set of ethical principles to guide companies in the age of the Fourth Industrial Revolution to coincide with its 50th anniversary.

Contrary to what many boards and commentators understand, shareholder primacy is grounded not in law, but in the teachings of business schools influenced by Milton Friedman, predominantly in the US, for the past half century.

Stakeholder capitalism has, in fact, been grounded in Anglo-Saxon corporate law for some while, especially in the two jurisdictions with the highest concentration of listed public corporations, namely, the UK and Delaware, United States. It also can be found in corporate laws of civil jurisdictions, the most advanced example being in The Netherlands, where it has been imbedded in corporate law for some years now.

In UK law, through the enlightened shareholder approach in the Companies Act 2006, which requires directors to promote the success of the company for the benefit of shareholders as a whole, having regard in so doing to the company's stakeholders (including employees, suppliers, customers, communities and the environment), the likely consequences of any decisions on the long term, the desirability of the company maintaining a reputation for high standards of business conduct and the need to act fairly between members of the company. Recent UK corporate governance reforms now require many UK companies to report on how boards have complied with this duty.

The late Professor Lynn Stout best articulated the position under Delaware law in her 2012 paper: "Shareholder primacy had become dogma, a belief system that was seldom questioned, rarely justified, and so commonplace most of its followers could not even recall where they had first learned of it."

She explains very succinctly: "Put bluntly, the principal-agent model is wrong. The first incorrect factual claim is that shareholders “own” corporations. As a legal matter, shareholders do not own corporations. Corporations are independent legal entities that own themselves, holding property in their own names, entering their own contracts, and committing their own torts.

What do shareholders own? The label “shareholder” gives the answer. Shareholders own shares of stock, and shares in turn are contracts between the shareholder and the corporation that give shareholders limited rights under limited circumstances. (Owning shares in Ford doesn’t entitle you to help yourself to the car in the Ford showroom). In a legal sense, stockholders are no different from bondholders, suppliers, and employees. All have contractual relationships with the corporate entity. None “owns” the company itself."

Directors need to be aware of their legal responsibilities as members of the board. Good corporate governance is all about understanding roles, responsibilities and accountability across the company; it is also about good decision making.

In the words of Lord Cadbury in his report of 1992: "Governance is the system of rules, procedures and processes by which a company is directed and controlled. Specifically, it is a framework by which various stakeholder interests are balanced and efficiently and professionally managed." At the heart of directors’ responsibilities and what should be their guiding star is the fact that directors are trustees of the company, of its enterprise.

As mentioned before, there is one area where the laws or approaches of various countries are beginning to converge and that is in the area of stakeholder engagement. Directors are increasingly required (or expected) to take into account the interests of the company's stakeholders.

Stakeholders can mean any parties interested in or affected by the operations of the company and, in addition to shareholders, are generally divided into employees, customers, suppliers, the community and the environment.

Businesses that win the trust of their stakeholders will prosper over the long term.
Image: Baker McKenzie

Not taking this approach can, for some companies, seriously threaten their licence to operate. Acting in a way that promotes the success of the company is understood to mean securing its long-term financial success or increase in value. This requires boards to consider present and future shareholders, so there is a need to balance short and long-term interests.

It is largely up to directors to determine how success can be achieved, and indeed how to define success (subject, of course, to shareholders’ specific instructions and the company's constitutional documents). In most companies, strategies to achieve financial success for shareholders will include addressing environmental, social and governance (ESG) matters and integrating them into the company's strategy and business model.

Against this backdrop, CEOs and Boards are faced with a myriad of challenges arising from macroeconomic, geopolitical, societal and tech externalities. These challenges include: increasing societal unrest from wealth inequality, which puts pressure on trust in corporations and its leadership; and the dilemma of how best to balance short-term and long-term decision-making, especially in light of the focus by markets on short-term financial performance;

Data is the new currency to chase for the creation of new opportunities, but is also making it difficult for companies to influence the conclusions made about their business, as society is vocal and public in its views of corporations. Profits and shareholder value, at any cost, are no longer accepted business behaviour, especially by newer generations. At the same time, the focus on traditional financial reporting metrics is impeding the ability to assess and compare how companies are performing in the context of stakeholder capitalism.

So what more can boards do? In addition to pursuing generally accepted good governance practices, companies need to look at how robust and fit for purpose their stakeholder governance is; how well they integrate ESG/sustainability factors into their strategy, and pursue these all the way through the company and its subsidiaries, wherever they might be located.

They should ask questions such as:

• have we a clear understanding what our fiduciary duties are and who we owe them to?

• do we really understand who our key stakeholders are, internally and externally?

• have we tested our strategy with regards to the impact it has on our stakeholders? have we integrated them across our strategy?

• how effective is our engagement with them? should we engage directly with key stakeholders, rather than relying on management alone to do so?

• are we bringing our stakeholders' voices into the boardroom? How well do we, as a board, communicate with and listen to our stakeholders?

• are our purpose and our values strong enough for the whole company to embrace the highest standards of business integrity, thereby helping us attract and retain both employees and customers?

• do we have the appropriate skills to understand the risks and opportunities presented to our business by the environment, especially climate change?

• how well do we communicate to our shareholders/investors our progress as regards the above? what reporting standards do we follow?

• do we have the right leaders, in terms of personal qualities and experience, which this generation can trust?

As my colleagues Beatriz Araujo, Julia Hayhoe and I continue our work on the Future Face of the Corporation with the World Economic Forum, we invite wide participation and contributions in this project from across the Forum community.