Corporate Governance and Democracy: The Stakeholder Debate Revisited

Journal of Management and Governance 6: 111–130, 2002.© 2002 Kluwer Academic Publishers. Printed in the Netherlands.

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Views and Debates

Corporate Governance and Democracy: TheStakeholder Debate Revisited

CIARAN DRIVER1 and GRAHAME THOMPSON2∗1Imperial College Management School, University of London, UK; 2Faculty of Social Sciences, TheOpen University, UK (∗Author for correspondence, E-mail: [email protected])

Abstract. ‘Stakeholding’ is a term laden with many meanings. In this paper we attempt to putsome order on the discourse by confining attention to the corporation. We assess the origins andthe intellectual foundations of the ‘shareholder versus stakeholder’ debate. We ask whether and how‘stakeholding’ might be a more logical or rational system, a fairer or more democratic system, andone that provides better performative outcomes. Each of these claims is assessed in respect to themicro firm perspective and the macro economy-wide perspective. One of the most difficult andneglected areas in the stakeholding debate concerns the practicalities of its implementation. Thepaper tackles this issue directly, at both the domestic and the international level. We ask not onlyhow stakeholding might be sensibly introduces within a national context but also what it means todiscuss stakeholding in respect to transnational enterprises.

Key words: company performance, corporate governance, corporate senate, democratization, owner-ship, stakeholding, stewardship, transnational corporations

It has frequently been said that stakeholding is a term laden with too manymeanings. It encompasses a concern with corporate governance and performancebut stretches to include social cohesion and inclusiveness at national level as well asissues of international governance (Kelly et al. (eds.), 1997; Stoney and Winstanley,2001). In this piece we attempt to put some order on the discussion by confiningattention to the corporation – we do not deal with questions such as direct demo-cracy and political theory (other than in respect to their impact on the notion ofthe ‘democratic firm’ – see below), and we are concerned with the diffusion ofpower only in so far as corporate power is concerned. Similarly we exclude fromthe present discussion questions such as wealth distribution at societal level whichhas been seen by some as a stakeholder issue.

Clearly, however, the impact of corporate stakeholding is felt at different levelsand our discussion is structured to reflect this. While the formal logic of stake-holding may be discussed at the level of the corporation, the effects of stakeholdingstretch beyond that to the macro-level. In addition, there are a number of possibledifferent stakeholders in the corporation reflecting the wider societal context inwhich the firm is seen to exist and which it is increasingly being pressed to recog-

112 CIARAN DRIVER AND GRAHAME THOMPSON

nize (informally or formally) in its decision making structures. We discuss therange of stakeholders that might have an interest in the firm, and how that interestmight be registered, later in the paper. Stakeholding as a counterweight to concen-trated corporate power is discussed at a level that includes the international becausecorporate power is increasingly global.1 Here it is the difficulties that might arisein generating sensible and workable mechanisms for organizing stakeholding inan international context that are concentrated upon. This will involve a discussionof the way a possible ‘corporate senate’ could be constituted for internationalizedcompanies that pays attention to the range of pressures and interests involved in awider stakeholding conception.

Before moving to a detailed look at these issues we first offer an overview ofthe nature of the stakeholding debate in so far as it concerns the corporation.

1. Stakeholding and the Corporation

The subject of corporate governance rose to prominence in the 1980s in theU.S.A. Previously the term governance was a little-used term in academic politicalscience meaning the practice of government. But as the U.S. corporate sector wokeup to foreign competitive pressures in the 1970s and 1980s, legal restraint oninstitutional investors were relaxed. The resulting wave of hostile takeovers andLeveraged Buy Outs (LBOs) was unprecedented. All of the 50 largest acquisi-tions of U.S. companies in constant dollar terms between 1955 and the end of the1980s took place after 1982. The accompanying increase in leverage caused thedebt-to-asset ratio of the non-financial corporate sector to rise about 20% over thesame period (Blair and Uppal, 1995). In this climate, a debate on the nature androle of corporate governance found a receptive audience. Discussion centered onthe reform of boardroom practice and company law, with particular emphasis onmaking companies responsive to shareholders’ interests. In turn, this also openeda window for critical discussion; stakeholding ideas emerged as a counterfoil tomore orthodox concerns.

The agenda of the mainstream debate was at first narrowly focused on problemsarising from the split between ownership and control of companies. A specificconcern is the difficulty in writing and enforcing a contract between owner andmanager in a context where the latter knows more than the former about companyoperations – the principal agent problem. A related concern is that shareholdersneed to have sufficient incentives to oversee the management of their wealth givenan ownership system where each individual has a small stake. One resolution tothese problems – in theory – is that ease of buying and selling shares enforcesdiscipline on managers by facilitating the replacement of an existing managementteam. This takeover mechanism (or the market for corporate control) had tradition-ally been seen as sufficiently strong to ensure near profit maximizing behavior (seeMarris, 1964 for a critique).

CORPORATE GOVERNANCE AND DEMOCRACY: THE STAKEHOLDER DEBATE REVISITED 113

Managers, however, are not easily disciplined by dispersed shareholders andthe market for corporate control may become a weapon in their armory rather thana spur in their flanks. Whatever the effect of the threat of takeover in enforcingmanagerial discipline (and perhaps over-enforcing it in the form of pressure forshort-term results), the empirical evidence is overwhelmingly against the view thatactual takeovers are primarily aimed at correcting or eliminating poor manage-ment. Most target firms are not in fact under-performing relative to the average.There is substantial evidence of empire building and over-expansion in maturemarkets. Furthermore theory shows that in a takeover of a company with dispersedshares it is likely that most gains will be captured by the target firm shareholders,thus lessening the incentive for takeovers as a device for ensuring managerialperformance. The cumulative evidence of a large number of studies points to theinadequacy of the traditional market for corporate control as a resolution to theprinciple-agent problem. Alternative methods of corporate governance thus haveobvious attractions.

In the U.S. where the dispersal of share ownership was long a matter of policy,there seemed a suitable set of simple reforms that would give ‘voice’ back to theowners without threatening a concentration of power. Bernard Black, law professorat Columbia, proposed a system in which ‘institutions can easily own 5–10% stakesin particular companies but can’t easily own more than 10% . . . a half-dozen insti-tutions can collectively influence major corporations often indirectly through theboard of directors’ (p. 162). Black’s proposal was to move the U.S. closer to theU.K. But most observers tend to bracket the U.K. and U.S. in the same broadsystem of corporate governance with the same virtues and drawbacks. Voice isonly rarely exerted by U.K. institutional shareholders even with the lack of legalrestrictions observed in the U.S.2

While most commentators on corporate governance paid ritual attention to theproblem of ‘voice’ there were two distinct camps that moved the debate forwardaround this question in quite different directions. First, Michael Jensen and hisfollowers argued that managers needed to be constrained by institutional mecha-nisms stronger than Black and others had suggested. Furthermore the form ofacquisition popular in the 1960s and 1970s (the conglomerate merger) was inef-fective and should give way to a different form – LBOs. In this form of takeover,concentration of ownership is partnered by a substitution of debt for equity. Theidea here is that contractual interest payments rather than discretionary dividendpayments would constrain managers from squandering shareholder cash (Jensen,1993).

By way of contrast, Michael Porter (1997) argued that managers’ autonomyneeded to be protected. While not entirely dismissive of the benefits of greatershareholder voice or higher levels of debt, Porter was concerned about the short-term horizons of equity holders and the effects of this on managerial willingness toshoulder risk. Among the recommendations of Porter is one that encourages stake-holding, albeit of a kind that is contingent on shareholding – ‘ownership should


be expanded to include directors, managers, employees and even customers andsuppliers. Expanded ownership will foster commonality of interest and help makeinvestors more aware of the value of investment spillovers’ (p. 14).

The above quotation from Porter illustrates one important argument for stake-holding: it brings results in the sense of strengthening the company or the economygenerally. We may call this the performance argument for stakeholding. Althoughthis theme runs through a lot of the literature on stakeholding it is not the onlyjustification offered. Other writers argue that stakeholding is more consistent orthat it is good in itself by diffusing corporate power – the democratic argument forstakeholding.

In Section 2 of this paper we set out the argument from economic logic. InSection 3 we return to the more reductionist question of whether stakeholdingbrings results: this question extends the level of analysis to the whole economy inSection 4. The issue of power is tackled at an international level in Section 5. Weoffer a discussion of the role of corporate democracy in Section 6, of the companyin law in Section 7, and the practical issues associated with stakeholding in Section8. Finally we conclude in Section 9.

2. The Intellectual Foundations of the Stakeholder Argument

As we have seen, Porter indicated some support for a more inclusive type offirm and a less rigid attachment than most economists to pure shareholder value.Nevertheless he did not subject the concept of shareholder value to a sustainedintellectual attack. The primacy of shareholder value has classically been defendedby economists on the grounds that the residual after contractual payments is areward for risk. In an important set of contributions Margaret Blair of the BrookingsInstitute has looked at the logical foundations of this idea. She argues that the‘residual claim’ argument that equates the maximization of shareholder value withtotal wealth maximization is flawed.

The residual claim argument defines shareholder value as the residual afterall fixed contractual claims are met. Maximizing this will not eat into any of thecontractual claims and thus will be equivalent to total value maximizing. Howeverat least two conditions upset this conclusion. First modern capitalism operatesunder limited liability so that the shareholder is in effect indemnified against heavydownside risk. Secondly, it is argued that stakeholders other than shareholders doin fact share some risk. This is because stakeholders such as workers develop firm-specific skills which are not transferable to other contexts if the worker becomesunemployed. Evidence advanced for this is that the typical U.S. redundant workerof the 1980s took a cut in wages when re-employed averaging about 14% and risingup to 40% with age and experience. The exact result here depends on the state ofthe economy but with stagnant wage growth, the earnings loss can persist (Blair,1995, p. 265; Schultze, 1996, p. 19; Blair and Kochan (eds.), 2000, p. 4).3


Blair is at pains to emphasize the difference between her consistency argumentfor stakeholding and earlier vintages of stakeholding arguments based on fairness.

‘. . . a number of people have jumped to the conclusion that I am arguing for anold-fashioned stakeholder model of corporate governance in which corporatemanagements and directors are viewed as having broadly defined but vaguesocial responsibilities to operate their firms in the interest of society at large. . . that is not what I am arguing . . . . Instead I am arguing that in any givenfirm there are likely to be a number of parties who have made . . . firm specificinvestments [that] are at risk in the same way equity capital is at risk . . . .[Management] should focus on maximizing total wealth-creating potential ofthe firm, not just on the stake held by shareholders’ (1996, p. 13).

Effectively, Blair’s argument is that by maximizing shareholder value, firms arenot maximizing the profit residual at all but rather a particular portion of it. If thisis so it is argued that stakeholding arrangements would constitute a superior formof governance by making explicit a more correct maximand for the company. Inone sense Blair’s argument could be said to be coincident with those who arguefor stakeholding on utilitarian lines. But that is to miss the important distinctionbetween the two sets of views. The Blair argument is that we need to know entitle-ments before we can discuss the merits of different systems. If this prior step is nottaken we will be judging the merit of governance according to a flawed benchmark– shareholder return.4

By way of example Blair (1995) considers a firm where super-normal profitsor quasi-rents are just insufficient to justify continued production so that the firmwill go out of business with the loss of the specific human capital of the workers.However, were this portion of capital to be taken into account as it ought, thedecision would be to stay in business but with a downward revision to the ‘profit’component of workers remuneration.

There is no doubt that this argument from consistency is interesting andpowerful. But it has several loose strands that need to be considered. It is arguedthat workers receive wages above market-clearing wages in recognition of firm-specific skills. It is also suggested implicitly by Blair (from the examples sheemploys) that this compensation roughly equals the (presumably risk-adjusted)yield from their human capital investment in the company. That being the case if theimplicit deal is freely chosen in the sense of having being bargained over, can therebe any anomaly in taking shareholder value as the maximand? Is not the situationanalogous to a member of a family firm who looses the appetite for risk and asks tobe compensated instead by an equivalent fixed sum, relinquishing residual controlas a matter of preference and being compensated for so doing.5 Presumably theremaining members of the family can not then be supposed to take into accountthe interests of the member who contracted out even though firm-specific capitalis bound up in that persons’ contribution to the firm. Certainly it would seem thatthe process of contracting out of short-term risk is Pareto optimal since it is freelybargained over. It may involve the destruction of human capital that is (ex-post)


unnecessary. However, were the arrangement to be banned, it is not clear that theopted out member would have been willing to continue as a risk-bearer or perhapsthey would have insisted on a more risk-averse stance of the firm.6

What then does the point about specific human capital amount to? It is not thatthe workers are being ‘cheated’ at least not in the form of remuneration. It is that anarrangement that allows workers to gamble with their long-run prospects in returnfor short-term compensation is in some way undesirable. While this interpretationof Blair has not been common I believe it is at the heart of what she is saying.And indeed in one passage in her writing she comes close to saying this explicitly:Commenting on the effect of reducing wage income by 10% and replacing it bya return to workers on their human capital input she remarks (Blair (ed.), 1996,p. 15):

‘. . . the short-term variance in total compensation for employees wouldincrease. At the same time the long-term variance of employee’ returns mightactually decline, since their job stability and security would probably improve’.

Thus, the Blair case amounts in essence to a charge of short-termism. Workersor their representatives place too little emphasis on employment stability and toomuch on stability of current earnings. This now begins to look less like an argumentfrom consistency and more one from a moral or political economy perspective. Itis of course no less cogent for that, but it needs to be discussed in different terms.For example societies do often place limits on the extent to which individuals cangamble and they tax that activity heavily, presumably because it has adverse socialconsequences.

Furthermore, irrespective of any moral concerns, it may be that an economywith a low probability of concentrated unemployment loss poses macroeco-nomic problems for society as a whole, the cost of which is not reflected in theimplicit bargain between workers and firms. Certainly there are several argumentssupporting the benign macreconomic effects of greater demand stability (Driverand Moreton, 1992; HM Treasury, 1998).

Viewed like that, Blair’s arguments can be recouched as performance argu-ments, though somewhat different from the usual efficiency arguments for stake-holding which is developed at the level of production relations inside the firm. Inthe following section we look at the issue of stakeholding and performance at firmlevel and at the level of the macroeconomy.

3. Stakeholding and Performance

In the Introduction we showed how the debate on corporate governance has beenpreoccupied with the narrow issue of amplifying shareholder voice as an altern-ative to exit. In Section 2, we discussed the intellectual objections to shareholderprimacy, focusing on the logical arguments as discussed by Margaret Blair. Others,however, have argued that the case for stakeholding is not merely a logical (or


moral) one and that it can be shown to be superior in terms of various measures ofperformance.

This performance case for stakeholding has a number of separate components.One view is that stakeholding frees managers to be creative managers. A relatedview is that stakeholding avoids the so-called ‘hold-up’ problem that arises whencrucial players can with-hold cooperation in wealth creation as they do not sharein any gains. A slightly different argument is that consultation and involvementbrings about motivational changes that enhance performance. Finally a stake-holding versus shareholding orientation may have implications for the performanceof the macroeconomy. Each of these arguments are often backed up with empiricalresults which explore correlations between stakeholding (or its first cousin –corporate social responsibility) and measures of performance such as productivityor innovation.

Consider first the case for stakeholding that rests on the implications formanagement autonomy from shareholder control. The arguments here could besaid to constitute a reaction against the rise of shareholder activism in the U.S.in the 1980s and 1990s. The dissenting case suggests that this debate on exitversus voice is largely irrelevant since restoring shareholder power is simply animpossibility. In practice, corporations have an organic life ‘independent from itsshareholders or stakeholders . . . and this is as true in Britain and the United Statesas it is in Japan’ (Kay and Silberston, 1995). For these authors, the idea that thepurpose of corporations is to maximize shareholder value is the product of a parti-cular economic theory rather than inferred from law or practice. They criticize theargument for more ‘voice’ as one that says:

‘that reality should be made to conform to the model . . . . All experiencesuggests that this is not very likely to happen and would not improve thefunctioning or corporations if it did. The alternative approach – of adaptingthe reality to the model – deserves equal consideration’ (p. 86).

In essence, Kay and Silberston can be seen to be arguing for a privileged role forthe manager, albeit using the language of stakeholding. Citing the term ‘managerialfreedom with accountability’ from the Cadbury Report (1992) they go on to devisea scheme which they say has:

‘one dominant objective. That is to give executive management the greatestpossible freedom to develop the business over a period of years in whateverway they think fit , while holding them rigorously responsible to all partiesinvolved . . . in the long run’ (p. 95).

This is a performance argument, albeit one that makes a concession to theidea of diffusing power.7 But why, exactly, is it that managerial freedom fromshareholders would offer better firm performance? A case could be made forthis on macroeconomic grounds, by arguing that growth has historically beenstrong in countries that are not heavily reliant on shareholder finance: we willreview this claim later in the article. Kay and Silberston prefer to focus on moremicroeconomic issues, in particular the hold-up argument referred to earlier.


The hold-up argument is that asymmetric information and incomplete contractsmake it impossible to pursue undiluted shareholder interests. This is because ifthe governance of the firm requires incomplete contracts always to be resolved infavor of shareholders there will be a reluctance to enter into such contracts. Firmsthat attempt this will be at a competitive disadvantage ‘in areas where implicitcontracts are important’ (p. 90).8 Thus there is an argument for stakeholding interms of superior corporate performance.

The theoretical ground for this case is developed in Hart (1995, 1996; see alsoMilgrom and Roberts, 1992). Hart (1996) recognizes that there may be advantagesin conferring residual rights to workers or even consumers if they are entitled toresidual income, but asks the question whether the market can do this itself? If itcannot – say because of difficulty in enforcing agreements, there may be a rolefor the law and institutional form to encourage stakeholding arrangements. Ofcourse it may be noted that such arrangements do not entirely dispense with themeasurement and allocation problems caused by the existence of co-specializedassets which are of lower value when their use is not coordinated. For example ifworkers only receive a portion of their compensation as equity but have decisionrights over wages there would continue to be a ‘holdup’ problem. Managementmay become more difficult in such circumstances.9

The third performance argument for stakeholding rests on questions of motiva-tion. Motivation is clearly important for performance since measurement of effortand outcomes are uncertain. Even individual ‘rational’ motivation may not be suffi-cient where incentive systems and performance evaluation are difficult, as theyare in many complex operations. Thus collective motivation may turn out to beessential to avoid the ‘1/n problem’ where it may be rational for a worker in alarge organization to shirk It is sometimes argued that employee share ownershipis an answer to the motivation problem but active participation rather than shareownership is what seems to matter from a motivational perspective (Michie andOughton, 2001).10

The final performance argument for stakeholding concerns effects on themacroeconomy. One idea here is that employment cutbacks are used as a signal innoisy share markets to convince shareholders that managers will not hoard labor.This results in competitive downsizing in order to stave off unwelcome takeoverbids (Roach, 1996). The costs of downsizing may then be shuffled off onto otherparties. Companies may break implicit contracts not only with workers but alsowith suppliers when times are hard (Schleifer and Summers, 1988).Thus, costsfall on the rest of society when a firm engages in lay-offs and cut-backs. This iscompounded by costs that fall on government in the form of unemployment payand write-off of tax debts.


4. Empirical Evidence on the Success of Stakeholding

Empirical evidence on the success of the stakeholding approach gives mixedmessages. We will review below some evidence at the level of the corporationitself and at the level of the macroeconomy.

4.1. COMPANY LEVEL STUDIES

Some U.S. studies suggest that employee participation gives a step increase toproductivity but does not cause continual growth (Blair, 1997). Others have arguedthat the full productivity implications of stakeholding will only be observablewhen it is widespread since there will be a market penalty for firms that retrainduring downturns if all firms are not doing so (Levine, 1995). Surveys of theevidence suggest that there is no compelling proof that stakeholding optimizes afirm’s financial performance (Donaldson and Preston, 1995). A number of manage-ment journals have published work detailing a correlation between measures of‘corporate social responsibility’ and financial performance, but these have beenheavily criticized by McWilliams and Siegal (2000, 2001) for failing to controlfor firm characteristics such as R&D intensity. Of course, the use of financialbenchmarks may be queried, given the critique of Margaret Blair, reviewed inSection 2.

Other work looks at the correlation between firm innovation and innovativeinvestment on the one hand and labor market practices on the other. Michie andSheehan (1999) using data based on U.K. Workplace and Industrial RelationsSurvey examine the relationship between firms’ human resource managementpractices and their level of R&D and innovative investment. Using panel datatechniques and controlling for firm characteristics, they find that:

‘Policies aimed at increasing more marginal forms of employment such asshort-term, seasonal and casual contracts and . . . reducing trade union recog-nition . . . are negatively correlated with the probability of firms engaging inR&D and introducing new technology’ (Michie and Sheehan, 1999, p. 231).

While recognizing bi-causality between the sets of variables, the authors interpretthe findings as a critique of public policy that fails to promote ‘high-road’ labourmarket practices.

4.2. MACRO-LEVEL ARGUMENTS

Surprisingly, there seems to have been little study of the longer term macroeco-nomic effects of the downsizing wave of the 1980s and 1990s. There is someevidence that the ‘downsizing’ programs of corporations in recent years havecaused short-term damage to the economies in which they took place by causingexcessive cut backs in investment and R&D. For opposing perspectives on this forthe U.S. see: Shleifer and Vishny (1997) and Donaldson (1995) who argues that the


‘ultimate purpose’ of the restructuring of the 1980’s was to improve performanceby ‘reducing investment . . .’ (p. 90). For the U.K., literature studies showed thatU.K. MBOs combined cost cutting with increases in efficiency investment (Wrightet al., 1992; Thompson and Wright, 1995). This may be explained by the existinglow level of equipment per worker in the U.K. Nevertheless, the effect may havebeen to reduce capacity.

One way of judging the issue is to examine the behavior of capacity utilizationover a long time period. If there is a trend rise in this that is unexplained by otherfactors, it may be that companies are tending to skimp on fixed investment tomaximize the return on capital employed. While rational for an individual firm thiscould pose problems for the economy as a whole as capacity shortages emergedand caused high and variable input costs. Driver and Shepherd (2001) report onthis for the U.S., U.K. and E.U. Only in the U.K. do they find significant evidenceof an overall tightening of the capacity stance of manufacturing firms after the1980s. The absence of any overall negative effect of the ‘deal decade’ economicson capacity formation in the U.S. is notable. This may be either due to fortuitouscircumstances that drove the U.S. boom of the 1990s, to the beneficial effects ofdownsizing on corporate balance sheets, or to the peculiarities of the U.S. system ofcorporate finance – a dual approach of short-termism for mature industry coupledwith liberal finance for start-ups and new ventures (Porter, 1997).11

5. Stakeholding, Fairness and Diffusion of Corporate Power

Often it is argued that corporate power needs to be balanced by systems ofgovernance that oversee fairness; governance in Anglo-American countries canbe contrasted with those based more on informality or trust such as is the casein Japan and continental Europe. Few authors are unalloyed supporters of eitherapproach and there seems to be some wish for convergence, among the theoristsat least (modernization of the financial system and takeover code in Europe andgreater voice for institutional investors in the Anglo-American system). It is alsoargued that different systems have different strengths and weaknesses, with theGerman system suited to industries which require experience, technical skills andcooperation and the Anglo-American system required where authoritarian high-risk management and coordinated rapid responses performs best (Vitols et al.,1997). The complexity of the issues and the clear difficulty of transposing onenational system to another has created caution in calling for the full scale export ofthe European system to Anglo-American economies (Soskice, 1997; Corry, 1997;Desai, 1997).

But, the contemporary debate in respect of corporate governance is somewhatdifferent. It is now argued that the Anglo-American model is being rapidly interna-tionalized in the name of ‘globalization’, so that the Japanese and German systems(themselves both very different) are being transformed into quasi-shareholderdominated orders as shareholder value, financial engineering, takeovers, perfor-


mance bonuses, stock options, and the like, invade these previously less rampantlyfinancialized systems (Lazonick and O’Sullivan, 2000; Dore, 2000; Turner, 2001).

However, just as in the case of the pervious argument about the need for cautionin respect to the importation of elements of ‘continental’ systems into the Anglo-American economies, the reverse is now also the case. The jury remains out onhow extensive, radical and comprehensive the transformation of the German modeland other continental European and Japanese systems actually is (Blair and Roe,1999; Morin, 2000; Jürgens et al., 2000; Dore, 2000; Vitols, 2001). Again there areenormous institutional obstacles to a complete transformation into a single ‘globalsystem’ based upon shareholder value and Anglo-American practice, though thereare definite tendencies and pressures in this direction. In all systems there seems tohave been a definite strengthening of shareholder power over that of other interestsand stakeholders.

But what has been somewhat lost in this discussion is the fact that the firm is anot just a commercial organization but also a public institution with certain publicresponsibilities. After all it is a creation of public law in all societies. In fact, it isthis aspect of the precise legal position of the modern corporation that we stressin a moment as a way of opening up the corporation to a wider set of stakeholderinterests. This is done in the context of the debate about the ‘democratization ofthe firm’. As well as the stakeholder idea being considered in the context of itsperformative outcome for the profitability of the firm and its potentially widereconomic efficiency effects – the traditional emphasis – the democratization ofthe firm could be considered an objective in its own right. And in this contextthere may be a genuine trade off between efficiency and democracy in respect tothe operation of firms, but one that it is considered worthwhile to accept giventhe ‘public responsibility’ aspects of the corporation and its public institutionalform. Indeed, this is partially, at least, already recognized as soon as the idea ofstakeholding is broached, since it speaks to this wider public responsibility of thefirm.

6. Exploring Corporate Democracy

Any discussion of economic democracy must confront the classic triptych: demo-cracy, liberty, equality (Dahl, 1985). Why is there such political sensitivitysurrounding issues of economic democracy? The classic arguments here involvedwhether economic democracy threatens liberty, or whether it is absolutely essentialfor its effective exercise.

Those that feel liberty would be threatened by economic democracy see thisthreat coming by way of greater equality. One of the key conditions securingliberty, it is argued, is the private ownership of property. If this results in politicaland economic inequality, so be it. It is a price worth paying for the benefitsafforded by liberty and freedom. Liberty and freedom are fundamentally ‘nega-tively’ inscribed in this view. They represent freedom from constraint – at its


strongest as an absence of coercion (Hayek, 1944). The private ownership of capitaland wealth is the foundation stone of the capitalist system, and that capitalistsystem in turn guarantees those freedoms and liberties it so readily invokes in itsown name. An excessive concern with equality challenges the proper outcomes thatemerge from the operation of the market system. Any compromise in respect toindividual liberty, occasioned by an over-zealous consideration for equality, wouldact to undermine that system. In as much that democracy fosters an excessiveconsideration for equality or fairness by placing it above the consideration ofliberty, democracy is suspect and should be circumscribed. It is this conceptionof the centrality of ownership that underpins the idea of shareholder democracyand an emphasis on the sole consideration of shareholder value as the rationale forthe firm’s objectives.

On the other hand we have an approach that sees economic democracy, equalityand fairness as absolutely central in the securing of liberty, rather than as a poten-tial threat to it. Indeed, in this case economic inequality and a lack of economicdemocracy pose serious threats to the effectiveness of capitalism. This is becausethe political legitimacy of capitalism is at risk when inequalities are large anddemocratic decision making absent. Here liberty and freedom are more ‘positively’inscribed; they relate to a capacity to initiate actions or undertake tasks rather thanas a lack or otherwise of constraint (Wooton, 1945). Liberty becomes the effectiveability to initiate actions and implement programs in a range of arenas. Thusthere is no necessary ‘sacrifice’ of liberty when economic equalities or democraticdecision making allow for a more varied outcome in terms of property owner-ship or economic control. Indeed, from this position it is the plurality of arenasand forms of economic organization that is celebrated. A pluralism of freedomsand liberties, of spheres of justice and of fairnesses, of ethical considerations anddeployments, is what counts (e.g. Walzer, 1983). In this case the existence of arange of ‘stakeholders’ would be welcomed rather than considered as a potentiallysinister intrusion or threat. It speaks to a basic fairness of the system that is crucialfor its health and maintenance. In this way ‘positive liberty’ and a commitment tostakeholding both within and beyond the boundaries of the firm can be effectivelylinked together.

However, whilst these semi-philosophical argument are all very well it isimportant to recognize that the modern corporation represents a very specificinstrument of economic organization in advanced capitalism, one configured bya range of concrete and historically particular circumstances and considerations.Not least amongst these is the nature of the firm as a creature of company law,something we consider next.

7. The Company in Law

In this section we seek to clarify the nature of the company as a subject in law. Inparticular, this turns on a distinction between property as an economic category and


property considered as a legal category. These are often collapsed together, but it isimportant to keep them apart since this has significant consequences for the notionof ‘ownership’, which can also be considered in terms of these twin categories:economic and legal.

Companies are incorporated in law as subjects in law independently of thosewho ‘own’ them. This means, for instance, that firms can sue, or be sued, in theirown name, independently of those who either work in them or own them. Strictlyspeaking then, the shareholder does not ‘own’ the assets of a company. These areinvested in the company itself. The shareholder ‘owns’ a right to share in the distri-bution of any surplus generated by the company (itself decided by management). Inthis respect the shareholder is in a similar legal position to any other creditors vis-a-vis the company as legal subject – they are both creditors and have no proprietaryentitlements in the company’s assets as such. The company ‘owns’ itself. Similarly,although the managers may be (formally at least) elected by the shareholders,they are legally constrained to work in the best interests of the company in thefirst instance, not the shareholder (Hadden, 1977). Their role is to supervise thecontinuing financial and legal reproduction of the firm – to maintain it as ‘a goingconcern’, to ‘keep its capital intact’, and so on. Obviously a different set of legalconditions hold if the company is in liquidation, creditors having prior interestover shareholders in this instance. But even under these circumstances creditorsor shareholders cannot seize the companies assets at will, so they do not ‘own’it in this sense. Here both shareholders and creditors are similarly constituted as‘claimants’ with only a contingent title in respect to the company’s assets.

In addition, with regard to these assets and the firm, claimants must act inaccordance with due legal process. What this means is that legal rights in respect tocompany law are always highly specific and what they impart to different agents aredifferential capacities and capabilities to undertake actions and engage in litigation.Legal rights do not exclusively or unconditionally guarantee access to ‘ownership’or anything else but only impart possibilities for taking action or undertakinglitigation.

This point is important in the debate about ‘property rights’ in economics forhere such rights are largely thought to impart an exclusive, unconstrained andunconditional possession to a definite subject or agent. Any attenuation of theserights is thus thought as a circumscription or restraint on the exercise of thoserights, usually imposed by the state or the political process. So any restriction orprohibition on the deployment of those rights is again conceived conventionallyin relation to a primary attribution of them as an exclusive subjective possession.However, if we consider ‘property rights’ as attributing no more than a capacityor capability to initiate something (like a claim on the assets of a firm), then thatguarantees nothing in terms of outcomes but only contingently and conditionallyarranges a series of possibilities for disputation and action. With this kind of aconception there is no general public or private possession of, or exclusion from,‘ownership’. In principle the law could thus establish a set of ‘rights’ that impart


capacities and capabilities to any number of stakeholders without undermining adeeper or more fundamental ‘ownership’ relation (because rights in law are neverrendered with respect to an exclusive possession but only in respect to a claim).Here we see the way a discussion of the nature of the company in law can establishthe principles for the wider notion of stakeholder democracy than that given by justa shareholder version.

An important further example of the way rather specific legal conditions consti-tute the firm and constrain its activity concerns company taxation. The state throughthe tax laws and company law has a prior claim to the ‘surpluses’ of the corporationabove those of the shareholder or creditor. Under normal trading conditions, thefirst ‘claim’ on surpluses goes to ‘maintain the capital intact’, i.e. depreciationprovision. But the next ‘claim’ is that made by the tax authorities, which mustbe met before the ‘claims’ of shareholders or creditors. If a company cannot payits taxes the state can declare a company insolvent and begin proceedings to windit up. But the general point about this discussion of corporate tax matters is thatit demonstrates that the state can, in principle, have a significant impact on theconduct of corporate affairs if it so wishes. For instance, tax incentives to encouragestakeholding in various forms would be a perfectly legitimate activity as well as arelatively easy one.

8. Practical Problems with Stakeholding: Internal and ExternalConsiderations

The stakeholder conception broadens the ambit of firm democracy by wishingto promote the interests of those traditionally excluded from any say in theorganization of the firm. These interests could be incorporated into the firmsdecision making structure. The traditional internal stakeholders considered so farhave been the managers and the shareholders in Anglo-American systems, withthe addition of workers in German and Japanese firms. In the German system‘co-determination’ is written into constitutional law with the requirement for atwo-tier management board structure supplemented by works councils. In the tradi-tional Japanese system a much more informal recognition of employee interestshas operated through the life-time employment systems, hierarchical promotionstructures, ‘consensus’ decision making within the firm, and the like.

But there remain a number of external excluded interests and groups, which, inlight of the analysis above of the firm as a social institution with public responsi-bilities, could claim a legitimate stake in the firm and its future. Amongst these arethe firms customers, its suppliers, the local community, the ‘national interest’, evenenvironmental interests. From an expansive stakeholder perspective there could besome explicit recognition of this in company law. A new form of representativestakeholder democracy would thus be forged for the company by this conception.

An expanded notion of corporate governance along these lines has beenproposed by Shaun Turnbull (1994, Figure 6, p. 347, Figure 7, p. 349). Whilst


we do not propose such a complex structure as he suggests we are sympatheticto its general thrust. We would concentrate upon an enhanced role for a form of‘corporate senate’ in a four tier structure involving the traditional ShareholderMeeting, Social or Works Council, Board of Directors, and supplemented witha Corporate Senate where these established interests could be finally broughttogether into a decision making or advisory arena alongside the other interests asjust outlined above.12 Of course, we are not in a position to provide a detailed blue-print of the powers and responsibilities for each of these mechanisms, nor wouldthat be desirable. Rather, what we do is provide an outline of some of the practicaldifficulties that would befall any serious attempt to implement such a structure inan internationalized setting.

For instance, this conception presents a particular practical problem indepen-dently of the political and other obstacles to its implementation. How could thevarious interests be constituted into a ‘constituency’ that can actually claim andexercise their decision-making rights? With the traditional stakeholders this is lessof a problem since the constituencies remain more or less clear cut and ‘internal’to the firm. But to take an extreme example of a potential external ‘stakeholder’,namely ‘the environment’, this is not even an agency with a capacity to exercisejudgement in its own name. Similar difficulties might characterize customers andsuppliers, where these are dispersed and not very easily identified and aggre-gated into a clear constituency. And then there is the local community or nationalinterest (which might include the ‘unemployed’ who also have an interest in thecontinuation of any firm).

In addition, these problematic issues are compounded with the increasing inter-nationalization of production and finance. Even a traditional ‘internal’ constituencylike shareholders are increasingly internationalized and dispersed as portfoliodiversification gathers pace internationally. For instance it is estimated that in themid-1990s 35% of French company equity was held by overseas shareholders, 32%for Sweden, 11% for Japan, 9% for the U.K. and Germany, and 5% for the U.S.A.(though this may distort the true impact since a number of these countries havevery low stock market capitalization to GDP ratios, the rate of change is low, andany way, the absolute figures for the U.K., Germany, the U.S.A. and Japan remainlow). And these issues are compounded in the case of the environment, suppliersand customers, national and local community interests, and workers, which mayalso have a growing international dimension.

One way round this practical problem would be to recast the nature of ‘demo-cracy’ in the case of the firm; not to think of it in traditional representativeterms where a constituency has to be created and then a representative elected orappointed to represent those interests in the decision making arena. In the case ofthe environment this would be impossible anyway . Clearly, any practical arrange-ment is unlikely to involve the standard democratic procedures of direct votingby constituency. These constituencies would be spread internationally and wouldprobably be impossible to properly constitute in many cases. Instead it is suggested


that the idea of ‘champions’ or ‘stewardship’ should be introduced in its place.There would need to be some mechanism by which appointments to companygoverning institutions were instituted – not ‘democratically’ – but in relation topersons who would champion a particular cause, say ‘consumer interest’ or ‘envir-onmental interests’, and act as a steward for that interest within the company’sgoverning structure. The Company Senate would be the institutional mechanismwithin the firm to conduct this activity. Workers and shareholder interests could behandled more easily in terms of traditional notions of democracy, since they alreadyhave an institutional base within most international companies – the shareholdermeeting and the works council. But any wider conception of stakeholding wouldrely upon goodwill on the part of any TNC involved, and the active participationin the ‘civic duties’ of the firm by reputable and concerned stewards or champions.Whilst difficult then – indeed doubly difficult for TNCs compared even to whollynationally operated companies – the problems associated with extending a moredemocratic notion of stakeholding to international companies is not completelyimpossible. In some sense this proposals could be seen as akin to expanding therole of the non-executive directors in firms, but in our case this would becomeexplicitly transparent. Our new Senate members would be elected or appointedto act as a steward and to champion an explicit stakeholder interest, not somevague company interest with appointments based upon friendships, collegiality orcorporate networking.

There has recently been some interest in the idea that companies themselvesmight adopt stakeholder-influence policies, in response to pressure from interestgroups and NGOs . Some firms have had their fingers burnt by not paying sufficientattention to issues of topical concern to campaigners, such as the environment,child labor and access to life-saving drugs for poor countries.13 Certainly it is partof the corporate agenda to learn about this world of pressure groups and to manageit. While arguing mainly a shareholder value approach, the Chairman of BP indi-cates that dialogue is on the agenda due to social pressure groups . . . . ‘Internationalcompanies . . . need wider engagement with society, including governments andNGOs. . . . Companies need partners to achieve their aspirations. Those partnerswill often be NGOs’. A practical way of delivering on this ‘partnership’ ideawould be to constitute accredited lists of NGOs as the basis for the ‘appoint-ment’ of champions and stewards to company senates. Separate NGO groups forcustomer interests and the environmental considerations would then put forwardcandidates. Pools of other ‘expertise’ could also be called upon, created by asso-ciated professional or interest group bodies. International bodies like UNCTADmight be involved in establishing panels of expertise associated with TNCs forinstance, where these could be tailored to particular geographical areas or types ofstakeholder interest. And similarly with other UN bodies. The ‘local community’could also be covered in a similar way, and it would not be difficult to envisage thewider ‘national interest’ being dealt with in a similar manner.


9. Conclusions

Clearly, in creating systems of countervailing power, it is necessary to move beyondthe level of the corporation. As we have seen, confining stakeholding to the firminvolves a bias against broader interests – including customers, suppliers, the envir-onment and even those not working or small entrepreneurs (Corry, 1997). To someextent this can be remedied at national level. One could for example envisagea national mediating forum which not only represented employers interests andtrade unions but also had more than a token role for consumer groups and thosenot represented by traditional stakeholders (O’Donnell and O’Reardon, 2000). Inaddition, and perhaps more in keeping with the realizable goals we have proposed,the introduction of a ‘company Senate’ might be envisaged. This would involvea range of stewards or champions ‘appointed’ to ‘act in the name of’ legitimatestakeholding interests in the firms. This clearly represent a more radical move,one, it must be said, that whilst difficult to fully and easily operationalize, is notimpossible to envisage even in an internationalized commercial environment.

Notes

1 This taxonomy may be considered complementary to that of Donaldson and Preston (1995) wherethe issue of governance and stakeholding is discussed in terms of descriptive, instrumental andnormative accounts.2 Interestingly, it is only very recently in the U.K. that large institutional shareholders (such asthe umbrella group of the Association of British Insurers and the National Association of PensionFunds) have begun to make themselves heard on such issues as the separation of chief executive fromchairman of the board and the remuneration of top managers.3 The argument here may be overstated. Since redundant workers may be less productive than others,a lower reemployment wage does not prove conclusively that they had firm-specific skills.4 For those of a mathematical bent we can distinguish between three systems as follows:Standard shareholder orientation (1)Maximize: R0 = pY – cF – sX,where p, Y, c, F, s, X represent price and volume of output; unit cost and volume of contracted inputs;unit reward for risk capital and level of risk capital input.Modified shareholder orientation (2)Maximize: R1 = pY – cF – sX,where (PY – cF – sX) = f(c) with f’(c) > 0 due to monitoring difficulties, worker morale and otherquestions associated with the efficiency wages view.Blair view (3)Maximize: R2 = pY – c1F1 – sX,where F1 represents the true measure of contracted (i.e. fixed effort) inputs (= F – H) with unit costc1; H is the capital portion of F, mis-measured in (2) as a fixed-effort input. Writing d as the per unitreturn to H we have:R2 = R0 + dH.5 It might also be noted that the banks are stakeholders even in the Anglo-American system since inthe case of serious insolvency there may not be sufficient funds to repay even fixed claims.6 Blair recognizes the problem of risk-aversion (Blair and Kochan, 2000 (eds.), p. 21) and suggeststhat employee ownership is most likely to occur in low capital-intensity industries (Blair, Kruse


and Blasi, 2000). But the problem seems to apply to all forms of stakeholding not just commonownership.7 The scheme proposed amounts to appointing a CEO for a fixed period of four years renewable forone term only with compensation fixed in full in advance. Truly independent directors would appoint(in consultation with stakeholders) the CEO and would also commission reports on the company’sstrategy and performance. The proposal seems to have some parallel with that in medieval Venicewhere the Doge’s performance was reviewed after his death (Barzun, 2000).8 Kay and Silberston suggest that trust relationships are important where reliable components,quick delivery and flexible response to changing market conditions are important. In these areas, theGerman/Japanese model is said to be more favored whereas British corporate governance lends itselfto areas where reputation, innovation and brands are used to defend success. This contrasts somewhatwith the dichotomy in Vitols et al. (1997) where the comparative advantage of German companies is‘in fields requiring a continual redefinition of the work process and long-term customer interaction’and British comparative advantage is ‘in areas which require risk-taking and rapid change’ (p. 21).9 Kay and Silberston step back from arguing for formal stakeholding, preferring to enhance the roleof executive management as a trustee of the corporation and all its stakeholders.10 Recent evidence from the U.K. employers’ organization suggests that firms are actively embra-cing the E.U. rules on worker consultation with many saying that employee-friendly policies improvecompetitiveness (CBI).11 In the U.S., this process is also observed for firms outside the ‘advanced’ sector but not formanufacturing as a whole.12 Note that some of these interests are ones that have a direct counter-part contractual stake inthe firm – like workers, suppliers and some customers – so in this case we are not promoting theinterests of workers in general, but only those that actually work directly for the firm; similarly withcustomers and suppliers, where those included under these headings would be identified by theircontractual relations to the firm. But there are a number of exceptions to this is, of course, e.g.‘the environment’, the local community, the unemployed, etc., where there is no direct contractualcounterpart. The radicalness of our proposal is to included these as legitimate stakeholders. See laterin the main text.13 For example a case study used by Business Schools depicts the decline of the chemicals companyFisons which went from a position of great strength in the late 1980s to a weak takeover target in themid 1990s having fallen victim to a series of events as managerial failure to respond to environmentalconcerns over peat digging spilt over in adverse reactions in other divisions of the company whenthey faced difficulties.

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Documents

Corporate Governance and Democracy: The Stakeholder Debate Revisited