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A sign is pictured at the Congress Center ahead of the World Economic Forum (WEF) annual meeting in Davos, Switzerland January 20, 2020. REUTERS/Denis Balibouse
Future Development

Stakeholder capitalism arrives at Davos

The 2020 annual meeting of the World Economic Forum opens this week with the theme of “Stakeholders for a Cohesive and Sustainable World.” More than 3,000 global leaders, including 53 heads of state, will convene in the resort town of Davos on the Swiss Alpine to deliberate on pathways to “stakeholder capitalism.”

The Forum’s theme beacons an emerging shift away from the paradigm of “shareholder capitalism” that has guided the world economy since the 1970s. Shareholder capitalism regards the purpose of the firm to be generating profit to its shareholders. Its core principle was aptly surmised by Nobel Laureate economist Milton Friedman as “the business of business is business.” This narrow focus on short-term profit-making is now blamed for everything that bedevils our societies, from the financial crisis to rising inequalities, and from the collapse of societal trust to populist politics and climate change.

The theme reflects the political mood of the day, and the dawning realization among business and political leaders that there should be another way.

The theme reflects the political mood of the day, and the dawning realization among business and political leaders that there should be another way. In August 2019, the Business Roundtable—an influential lobby group whose members are CEOs of leading U.S. companies—adopted a new Statement on the Purpose of a Corporation to guide corporate governance. It affirmed that the purpose of a corporation is not just to create financial return to its shareholders, but to create benefits to all of its stakeholders—customers, employees, suppliers, communities, and shareholders.

According to Professor Klaus Schwab, Founder and Executive Chairman of the World Economic Forum, these responses seek to revive the crumbling legitimacy of business and political institutions. “People are revolting against the economic ‘elites’ they believed have betrayed them,” he says. In the U.S., the median income level has stagnated in the past three decades while the incomes of the top 20 percent nearly doubled, showing that the status quo has failed to ensure prosperity for everyone. Scholars like Nobel Laureate economist Joseph Stiglitz have long pointed out the limits of winner-take-all, shareholder capitalism and called for a renewed social contract that tames the power of markets. The Davos Agenda suggests a growing consensus that stakeholder capitalism is the answer.

The shift is not confined to Davos but reverberates through important social circles including academia. Even academics of business and management disciplines—most of whom spent the best years of their lives using public resources to research and teach how private businesses can enrich themselves—are finally turning to social issues. The 2020 annual meeting of the Academy of Management has the theme of “Broadening Our Sight,” that is, beyond the corporate matters to include social issues. Michael Porter, the guru of modern strategy thinking that guided generations of shareholder capitalists, was one of the first to convert. He now preaches the virtues of “creating shared value,” a concept very close to the idea of stakeholder capitalism. Colin Mayer, a professor of management at the University of Oxford, asserts that: “The purpose of business is not to produce profits. The purpose of business is to produce profitable solutions to the problems of people and planet.”

Yet, as much as the notion of stakeholder capitalism seems to be gaining momentum, it is also riddled with challenges and contradictions that encumber its application.

The first challenge is measurement. Unlike financial performance, social and environmental outcomes cannot be readily monetized or aggregated into simple indicators. The absence of standard metrics for reporting performance creates a scope for companies to cherry-pick what they report to greenwash their images. There is also a risk that managers would focus their energies on multiple, ill-defined or conflicting goals and targets, creating “garbage can organizations.”

This, however, is likely to change with the refinement of current impact measurement tools through improved reporting standards and new certification schemes. A new Davos partnership that involves Bank of America and the Big Four accounting firms aims to develop a harmonized framework for measuring social and environmental performance. Such metrics will make it easier to attract and assess private investments that target the Sustainable Development Goals and the Paris Climate Accord. Greater harmonization of disclosure standards will also encourage major investors and hedge funds to make significant green investments that will help bring impact investing closer to mainstream finance.

The second is managerial complexity. The focus on stakeholders goes against the grain of current management practice in multinational corporations, which sees the world as a disembodied marketplace. On this point, stakeholder capitalism comes to a head on collision with the forces of globalization, which encourage footloose corporations to move around in search of the most efficient production site. The mobility of capital makes local communities and other stakeholders replaceable, leading to arms-length relationships. Given their sheer size, large corporations will struggle to advance community inclusion in the many diverse places where they operate. On the other hand, a significant revision of corporate purpose towards meeting the interests of home-country stakeholders could discourage outward foreign investment, potentially slowing down the wheels of globalization.

The third challenge is the difficulty of ensuring accountability through feasible enforcement mechanisms. Davos 2020 is likely to enshrine more ethical business standards as mangers endorse the new stakeholder-centric “Davos Manifesto.” Perhaps setting an antecedent, Airbnb has just decided to reformulate its mission and institute a stakeholder committee in its board. Even if the ethos of the Davos Manifesto were to be adopted universally, however, progress will be halting without enforceable governance mechanisms to hold managers to account. Multiple incidents of ethical violations by signatories of the U.N. Global Compact have shown that voluntary governance principles lack the teeth to curb corporate misadventure.

Stakeholder capitalism thus requires a fundamental rethinking of corporate governance systems and legal frameworks. In the U.S., Senator Elizabeth Warren, a presidential contender for the Democratic Party, introduced the Accountable Capitalism Act that will obligate company directors to consider the interests of all corporate stakeholders. The act took its inspiration from an emerging legal vehicle for benefit corporations, which regulates the incorporation of for-profit enterprises that address social issues. As business titans at Davos debate the best ways of infusing business with purpose, regulators and lawmakers will have to work out the legal mechanisms that hold managers accountable to this renewed corporate mission.

Stakeholder capitalism will require comprehensive reforms on multiple fronts to deliver on its promises. It is an open question if the global elite will build on the momentum of Davos 2020, and make decisive changes that can usher in a new era of shared prosperity.

This blog was first launched in September 2013 by the World Bank and the Brookings Institution in an effort to hold governments more accountable to poor people and offer solutions to the most prominent development challenges. Continuing this goal, Future Development was re-launched in January 2015 at brookings.edu.

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