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The Wasteful Cruelty of “Stakeholder Capital”

A sign for Wall Street, traditional heart of the financial district in New York City.

Capitalism has raised millions, if not billions, of people out of poverty. It is the greatest engine of human flourishing that has ever existed. It is worth defending, but those willing to do so are few and far between, even in the societies that have most benefitted from the wealth that capitalism has generated. In the late twentieth century, economist Milton Friedman stood against the tide of anti-capitalist propaganda that flourished in the halls of academia.

Friedman is gone but anti-capitalism remains, and it is no longer constrained to academia. It is common in the halls of Congress (Senators Bernie Sanders and Elizabeth Warren come readily to mind) and even in corporate boardrooms, with the modern push for corporations to engage in ESG — Environmental, Social, and Governance — efforts. Champions of capitalism have never been more needed, and Professor R. David McLean’s 2023 book, The Case for Shareholder Capitalism: How the Pursuit of Profit Benefits All makes a strong case for inclusion in that category.

McLean begins, as a defender of capitalism should, with an explanation of profit. Not the profit that anti-capitalists caricature, some dark motive of dastardly villains, twirling their mustaches or adjusting their monocles as they plan to exploit yet another widow or orphan. McLean counters the false melodrama of the anti-capitalist with the mundane “profit” of Adam Smith. It is the (sometimes surprising) pile of money left after the small business owner has paid all of the bills for the month. It is the signal that the value a business owner creates in the lives of his fellow citizens is high enough to pay for all the inputs and have something left over.

The allure of profit drives businesses to increase the value of their products to consumers and to limit the costs imposed on society by the productive process. The first task is achieved by finding out what consumers want and giving them more of it. Some add new or improved features to existing products. Others reimagine what will want and invent. If entrepreneurs succeed, the public is much happier, and businesses much wealthier. Wealthier businesses hire more employees and salaries, and generate taxes that boost to local communities. The “invisible hand” of Adam Smith motivates us to look beyond ourselves and serve others, in order to improve our own lot.

The Case for Stakeholder Capitalism lays out the benefits of profit with clarity and simplicity, complete with a variety of Finance 101 principles. That clarity is likely to be lost on those whom it would most benefit, but few of them will read a book that offers a defense of profit and capitalism.

Profit does not worry about the disdain of Marxists, but goes about its business of increasing material abundance. That claim — that profitable enterprise increases availability of resources—often confuses people, but the logic is straightforward. All inputs into the production process have to be paid for, and waste in the process cuts into profits. Maximizing profits means reducing waste. Entrepreneurs are consistently motivated either to make more with the same resources, or to make the same amount with fewer resources.

A couple of important side-notes. First, basic economics is clear that, holding everything else constant, a lower cost of production or fewer inputs means greater availability of those inputs across the market (because less is wasted) and lower cost of production in other industries. Profits drive behavior that keeps prices lower, even for those who didn’t act to increase profit.

Second, pollution is usually the result of waste in the production process. Everything that comes out of a smokestack or drain pipe, or ends up in a landfill, represents inputs that were not effectively used during production or reclaimed for re-use. Profit is an incentive to use those materials more productively or to reclaim them. The available increase in profits isn’t always enough to motivate pollution mitigation, but the incentive is in the right direction. Furthermore, there are some functional examples of this phenomenon.

Consider the Bingham Copper Mine, in Utah. The mining process, since 1904, involves extracting massive amounts of ditto access copper. The process yields large amounts of dirt that risked contaminating groundwater. Over time, however, the owners of the mine recognized that much of the “pollution” was valuable minerals and metals. Now, the Bingham mine extracts 15 valuable compounds from its “waste,” including tellurium for photovoltaic solar panels. The process is now much more environmentally friendly, but that improvement was driven by a desire for profit.

Unrealized profit motivates innovative outsiders to envision entirely new ways of doing business. If their vision is correct, they will make lots of money. If their vision is faulty, they will lose money. If they lose money, other innovators will see their failure and, if possible, improve the new idea until it is profitable. If they do prosper, it’s because they found a way to make consumers happier than they were before.

Successful innovation improves conditions for consumers specifically by attacking established methods and companies. While many critics blame job loss in a particular industry on capitalism or the pursuit of profit, jobs are lost at businesses that were not making customers happy, and gained at those businesses that can. Demanding that capitalism not cost anyone their job is equivalent to Fredrich Bastiat’s farcical petition to ban sunlight, as it interfered with the candlemakers’ business.

McLean next addresses the all-important question in the modern corporate context: to whom do corporate profits belong? Profits are what is left over after all other pre-existing obligations are met. When workers have their paychecks, suppliers their contractual payments, banks and bondholders their interest, and governments their taxes and compliance costs, who owns the pool of assets that remain — the profits?

McLean makes an intuitively appealing analogy of shareholders to owners of the corporation, and the rightful recipients of corporate profits. Even a sympathetic corporate law scholar is likely to draw up short, though, as the legal relationship between corporation and shareholder is more complicated than simple ownership. Shareholders clearly have a better claim on corporate profits than outsiders demand a share for “social benefit,” but the legal contours of the relationship matter, and oversimplification weakens the book’s arguments.

Another shortcoming of The Case for Shareholder Capital is relevant at this juncture — confusion over what to call these outside groups. The term “stakeholder capitalism” has been around for decades, and McLean references the movement later in the book, but by its other names — corporate social responsibility, ESG, “sustainable” capitalism. The early chapters routinely reference corporate “stakeholders” to mean workers, bondholders, banks, suppliers, governments, with the claim that shareholders are entitled to whatever is left over after “stakeholders” have all been paid.

The problem with this phrasing — and it is a big problem — is that “stakeholders” typically include all of the social groups who wish to divert corporate profits to social ends, rather than letting shareholders have what is rightfully theirs. Any proponent of stakeholder capitalism can rattle off a list of “stakeholder” groups with nothing but vague moral claims on the corporate coffers. Even McLean’s title, The Case for Shareholder Capitalism, implies intentional juxtaposition between McLean’s shareholder-based view of corporate governance and the popular stakeholder version. By Chapter 15, McLean circles back around and makes clear that he does not believe that extraneous groups are entitled to largesse from corporate profits, but a reader could be excused for being confused after reading the earlier chapters.

So, what are we to do with those groups, who claim that corporations have responsibilities to society, and often particular groups, beyond paying their obligations and generating wealth for shareholders. Unpacking those claims is more than this essay, or even a book like The Case for Shareholder Capitalism can manage, but McLean does an admirable job in presenting some of the more important ones.

The foundation of any such discussion is the reality that shareholder capitalism — which is to say, capitalism — generates social value by its very nature. The profit motive drives innovation, and that innovation spreads throughout society, lowering costs, increasing product quality, introducing new products that people want, generating wealth, rewarding production, and reducing waste. Of course, these benefits of capitalism are disdained by those activists who insist that corporations must do more.

McLean provides a poignant example of this demand for “more” in the context of the fossil fuel industry. He relates a 2021 shareholder proposal by a Dutch nonprofit, called Follow This, to the Board of Chevron. The proposal required Chevron to reduce its Scope 3 CO2 emissions, or emissions resulting from the corporation’s activities but not by the corporation itself. In effect, Chevron could achieve this goal only by convincing its customers to stop buying fossil fuels from Chevron. In McLean’s words, “[t]he purpose of this resolution, therefore, was to get Chevron to destroy itself.” The “do more” activists inevitably want corporations to stop doing the things that made them successful in the first place.

Some activists are minor shareholders, like the Dutch nonprofit in the 2021 example. Others are large, institutional investors, like BlackRock, State Street, and Vanguard. If the activists are willing to purchase shares, then they have a right to participate in corporate governance, including the right to propose changes in corporate policy. They do not, however, have the right to insist on their changes if the majority of shareholders disagree.

When the 2021 shareholder proposal was put to vote, a majority of Chevron shareholders approved. That outcome seems entirely counterintuitive — why would shareholders vote to reduce their wealth by reducing the value of the corporation? The answer is that sizable percentages of Chevron stock are owned by the large institutional investors, and those institutional investors have taken an activist turn in recent years. Results like this often lead activists to claim that “the market” is demanding more from corporations, but a closer analysis reveals the lie in that claim.

BlackRock, State Street, and Vanguard are not investing their own funds, but the funds of millions of small investors across the country. When institutional investors vote to destroy the wealth of Chevron, they vote to destroy the dreams of single mothers in Wisconsin, pensioners in California, and small business owners in Nebraska. They betray the trust of investors and violate their fiduciary duties. The investors who entrusted these manager with their wealth are not asked whether they are willing to sacrifice their wealth to satisfy the ideological preferences of the managers. Investors do not choose this.

Nor can activists point to democratic outcomes to support their claims that corporations have an obligation to do more. McLean notes that most of the current activist preferences are decades old, and repeatedly rejected by the political process. McLean points this out but makes a fundamental mistake when he argues that corporations would be obligated to do more if regulatory bodies choose to impose the activists’ preferred mandates.

The mistake is not that corporations should obey the law — they should — but that all regulations impose legal or moral obligations on US citizens, including as aggregated into a corporate form. McLean’s mistake arises from an all-too-common source: failure to consider institutional structure. The US government’s power is constrained by the Constitution, so any regulation that violates the Constitution would be unenforceable. Regulatory agencies have limited discretion, and cannot impose a moral or legal obligation on corporations. McLean knows that, and may have even intended to imply it, but institutions matter, and their inadvertent omission could easily confuse. McLean effectively attacks the flaws of Corporate Social Responsibility and its ESG incarnation, calling out activists for pursuing ideological preferences at the expense of shareholders. He traces the flawed, Malthusian lineage of Corporate Social Responsibility to such historical abominations as forced abortions and sterilizations. For all these excellent and needed efforts, McLean misses the institutional questions often enough to fall just short of a complete analysis.

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