Capitalism Is Already Accountable To Stakeholders

In August, the Business Roundtable issued a Statement on the Purpose of a Corporation, in which its members declared a list of duties to all their stakeholders, including commitments to deliver value to customers, invest in employees, deal fairly and ethically with suppliers, support their communities and generate long-term value for shareholders.

Two months later, in letters to Roundtable CEOs, Sen. Elizabeth Warren (D-MA) seized on this, saying the new statement “reversed the Business Roundtable’s troubling position, held since 1977, that ‘corporations exist principally to serve shareholders’.” She then directed each of the CEOs to respond in writing by October 25, telling her a) whether they support the Accountable Capitalism Act she plans to reintroduce in coming weeks, and b) what concrete steps their company is taking to meet its commitments to each stakeholder group.

But public companies don’t need to take concrete steps to meet these commitments, because, for the most part, they are already meeting stakeholder commitments. Certainly, there are bad companies, just as there are bad politicians, but as a whole, companies commit to these stakeholders because doing so makes economic sense.

Test of stakeholder commitments

To check if that’s true, let’s conduct a mental exercise involving one of the stakeholder groups (employees) that Senator Warren feels is disadvantaged by a corporate goal of maximizing shareholder value. Consider the following categories of organizations, and assess where each of them ranks with respect to treatment of employees. The specific measure of employee treatment we will use is the expected award from an employment litigation. This is the dollar amount an employee in each category was likely to receive from an employment suit over the period 2000 to 2010.  It takes into account the probability an organization would violate employment law as well as the severity of the violation. Organizations who best serve their employee stakeholders under this measure should have low expected awards (fewer and less egregious violations), while the worst actors should have high expected awards.

Here are the organization categories:

• Public companies
• Private companies
• Private investment firms
• Charitable organizations
• Government agencies
• Educational institutions

The plot below the article (slightly hidden to avoid cheating) shows the average award per employee for each category and organizes the categories from left to right based on increasing award size.   The first thing to notice is that with the exception of charitable organizations (who have shallow pockets and/or for whom there might be stigma from suing), public companies are the best actors!  They are followed by private companies, government agencies and educational institutions, and finally by private investment firms — who tend to have deep pockets and limited oversight.

Why are public companies ranked so highly?

Public companies are ranked highly, because they are disciplined by the labor markets, product/service markets and financial markets. Labor markets will punish bad actors for high expected awards, because employees won’t want to work for them. This is even more likely now than in the past because of sites like Glassdoor.com. Product/service markets will punish bad actors for high expected awards by boycotting them. This too is more likely than in the past because of social media. Finally, financial markets will punish bad actors for having excessive labor costs or because the awards are evidence of poor governance.

Private companies have substantially higher expected awards than public companies — about 1.67 times higher. Because private companies are subject to the same discipline in the labor and product/service markets as public companies, the 67% increase stems almost entirely from the fact they are shielded from the discipline of the financial markets.

In contrast to public companies, government agencies are the worst offenders, along with educational institutions.  Nevertheless, Senator Warren recommends they be the stewards of corporate behavior through federal charter.  On average government employees have expected awards that are 3.5 times those of public companies.  Educational institutions, the torchbearers of inclusion, ironically are only slightly worse than government agencies, suggesting a “do as I say, not as I do” model. 

Why are government agencies and educational institutions such bad actors?

Government agencies and educational institutions are bad actors because their only form of discipline is labor markets. While both technically have customers, in the case of government agencies, they are monopolists, so they are predictably less responsive to those they serve. In the case of educational institutions, employees often outnumber their customers: the students. At my university, for example, there are 16,428 employees to 16,265 students. In those circumstances, securing the requisite number of customers doesn’t impose much discipline.

Principally serving shareholders is better than having no shareholders

Taken together, the results for at least one group of stakeholders (employees) indicate that “principally serving shareholders” yields better results than having no shareholders — even along a dimension not obviously related to shareholder returns. Given that dynamic, it wouldn’t be a complete stretch to suggest that public companies should charter government agencies, rather than the other way around.