Capitalism: Should we be shareholders or stakeholders?

Since my secular job involves project management in an investment group, the Romney/Bain debacle is certainly generating buzz with our internal portfolio managers, especially those in the private equity section. That is why this opinion piece that popped up on CNN.com today also generated buzz during my workday today.

In essence, the editorial asks if capitalism should be guided by shareholders or stakeholders:

The choice is between "stakeholder capitalism" and "shareholder capitalism." According to the theory of stakeholder capitalism, corporations are and should be quasi-public entities with responsibilities to the nation-state and to the communities in which they are embedded. The corporation should make a profit and provide a fair return to investors. At the same time, workers who contribute their labor to the company have a legitimate interest in it as well as investors who provide capital. Managers serve the company and the country, not merely the investors.

In the theory of "shareholder capitalism," the corporation exists solely for the purpose of the investors, whom the managers serve as agents. In shareholder capitalism, short-term profits are the only goal, and if that means laying off workers instead of retraining them or reassigning them, breaking up the company and selling the assets to enrich private equity partners and shareholders, so be it.

The title of the piece is "What kind of capitalist is Romney?"

That's a very good question.

I know that I would definitely like to see America be in the stakeholder camp. Even as someone who is in the Bernie Sanders "democratic socialist" camp, I am not opposed to anyone becoming wealthy. However, I do feel a bit sick in the stomach when I hear that a group like Bain Capital can rake in the dividends for its shareholders while the employees get pink slips.

While we were discussing the editorial during a staff meeting today, I was reminded of an article I read in the Wall Street Journal quite a while ago about how Wall Streeters were squawking at the CEO of Costco because he 1) paid his workers too much, 2) gave his workers too many benefits, 3) treated his customers too well, and 4) didn't always think of the shareholders first.

"From the perspective of investors, Costco's benefits are overly generous," says Bill Dreher, retailing analyst with Deutsche Bank Securities Inc. "Public companies need to care for shareholders first. Costco runs its business like it is a private company."

I wonder how much better our nation would be if we did, in fact, care about the shareholders, but not at the expense of the employees, the customers, the community and the nation.

I think I've posted this commentary in the past, but I still feel it rings true today: http://www.salon.com/2011/03/29/fail...

Stakeholders, absolutely.

Sort of related: I was talking with my dad over Christmas about Apple--because my present to him was a new computer of his choice, and he decided on a new Mac. We had spent a lot of time looking at Apple's products and support and whole model of doing business, and also, you know, the competition over at Best Buy. We were also talking a bit about Steve Jobs, and how Apple might change with him gone, if it can maintain the identity he really created or not.

And the central idea that came to mind is that Apple is doing business in a different way--it's still all about profits, and about creating technology, just like the competition. But the way it has been winning is by [em]not trying to win the nickels and dimes[/em]. Almost every business, particularly every big business, seems to have become increasingly focused on extracting every last penny of profit from every corner of the business. And I think that's part of what's become so corrosive about things. Apple, on the other hand, is making money hand over fist by not trying to squeeze every nickel and dime out. Yeah, they do what makes business sense, and try to minimize costs. But, as an example: instead of switching components used in their products every week based on what's cheapest that week, Apple instead figures out what they want and who they want to produce it and either buys the provider or establishes a long-standing contract with them to get consistent parts.

In my mind, that method is much more of a strategy of investment in their suppliers than the model of "make all the suppliers fight each other to provide the service most cheaply."

On the other end of things, Apple has done some crazy things like purchasing large amounts of air freight well in advance of new releases or the holiday season in order to make sure that they have their product available to shoppers when the shoppers are going to go wild for it. Yeah, there are shortages on the newest hot ticket items--but even with the shortages, they make sure stuff that people really want shows up. Likewise, their retail strategy is kind of crazy. I mean, the way you get service in an Apple store these days (if you haven't been in one lately) is to talk to the store's concierge to let them know you'd like to talk to someone about a product--and they'll send over someone who knows that product or class of products well, once that person is available. And if you just walk past the concierge to browse, nobody will bother you until you start looking like you need help. (All of this is somewhat easier for Apple, of course, because the vast majority of stuff people want help with is Apple's own big ticket items, and there aren't many different kinds of those. But their salespeople know all of the third-party stuff they sell, too, and are ready to recommend it if you express an interest.)

Contrast that with the experience at Best Buy, where you're lucky if they only try to upsell you on one thing. Again: nickling and diming, trying to squeeze every cent out of the customer. Not selling Applecare plans in store, for example, even though they sell Apple products (they want you to buy their service plan instead. You can still get Applecare online after buying something, but they won't tell you that.)

Anyway, this has really worked for Apple. Of course, Apple has also positioned themselves as a premium product, and their stuff is enormously expensive... but people buy it anyway, because the stuff is good, and feels solid... and because when Apple introduces a new thing, it's almost always a *new* thing. Apple doesn't generally introduce a new product that's just like the old one but a little cheaper.

Okay, so how does this connect?

The point I'm trying to make is that Apple treats its customers as stakeholders, and does things to give their customers a really satisfying experience and establish long-term relationships with them. (Applecare isn't just about a warranty, it's about being able to walk in and get help from someone friendly. It's not just about the latest product, it lasts over a few new product cycles. It's expensive, but it feels like you're entering into a partnership with Apple--which is what a support contract should be.) Likewise, they treat their business partners as stakeholders and establish long-term relationships with them. And it works. They spend more money than other people do to do things this way, but in the end they make a lot of money. (And I think that's a big part of what Steve Jobs brought to the company: the idea that if you focus on the big things, you'll reap big returns... and that's a viable alternative to paying attention to every little detail and collecting every possible shaving from the cutting floor.)

Everybody else, whether in technology or finance or anything, really, treats their customers as resources to be harvested by providing just enough of the cheapest stuff to satisfy them. They treat their business partners as partners of convenience who'll only be used as long as they're the cheapest supplier. They treat their employees as cogs that will be used just as long as firing them isn't helpful for fixing up short-term profit numbers.

I know which kind of organization I'd rather see more of: the kind that decreases costs by establishing long-term connections to suppliers. The kind that would rather sell one item with a high mark-up that will last three years or more than sell stuff as cheap as they can make it that will either break or be outdated within a year. The kind that doesn't think "long term" means six months.

I'd rather see more companies start acting on [em]actual[/em] capitalist principles and investing in things, instead of acting on mercantilist principles and extracting profit from things.

Because when you're trying to squeeze every penny out, you're just taking and taking and taking... and you're destroying what you use. And that was the whole insight of capitalism: if you build things up instead of just taking all the time, you can naturally increase your ability to make more and better things over time.

How has "the market" forgotten this?

Hypatian I respect your posts. You're insightful and eloquent and thoughtful and always make good points, even when we disagree. But damn are you long winded sometimes.

Anyway I agree with your Apple analogy. Seems like stakeholder capitalism is usually more profitable on a longer timeline.

In the supercapitalist state in which we currently live, "stakeholder" is language reserved for communists. The only legitimate concern is shareholder value. That is the only thing the market will respect. And it will punish with exceptional severity even the slightest variance from it.

The only remedy is government action.

Seth wrote:

Hypatian I respect your posts. You're insightful and eloquent and thoughtful and always make good points, even when we disagree. But damn are you long winded sometimes. :)

If the equivalent of 2-3 pages of printed text is wrong, I don't want to be right. ;> (I do go on way too long way too often, though. My tag on another forum was "Wall of Text". My motivation to go back and try to edit down to size is inversely proportional to how tired I am, and how much I need to edit. So... apologies for that.)

Seth wrote:

Anyway I agree with your Apple analogy. Seems like stakeholder capitalism is usually more profitable on a longer timeline.

I think one of the tricky parts is that really investing in all of the areas around what a business is doing requires much more commitment to a sphere and a style of business. It requires much stronger understanding of the market, a new niche to fill (either an area with low coverage: a set of stakeholders who are not satisfied with their current situation, or a truly novel product or business model), and a lot more time to demonstrate a pay-off.

The nickle-and-dime strategy, when applied as an offensive strategy against a stakeholder-style newcomer, will very often eat the newcomer for lunch. It takes a long time to get the stakeholders to understand what you're trying to do and to build up trust that you're actually going to carry through on it. It takes a long time for dedicated supply-lines to pay off over supplies of convenience. If the established businesses perceive a threat, they can take a loss and make your products and services look even more expensive for a while in an effort to kill you off. And if what you're providing is truly novel, it just takes a long time for people to understand what it is and what it's for.

Apple was very lucky--it had been around for a while and had both a cult following and a market niche (creative professionals) that it owned. In addition, it had a man at the helm who was willing to go the long haul and who had some failures under his belt from which he'd learned what not to do. Finally, since it had been around a while it wasn't really perceived as a threat, just an oddity.

Anyway, long story short: I can totally understand why stakeholder-style businesses are so rare. They require a lot more time and effort to produce a good profit, and a lot more expertise to keep moving forward. Twenty years of investment can be deep-sixed overnight by new management that comes in with the goal of extracting profit... and it'll take another twenty years of effort to rebuild from that sort of failure.

Still: It seems to me that a big part of the problem is that shareholder ideals are enshrined in law (fiduciary responsibility) over and above all other concerns. An established stakeholder-style business shows that its way of doing things is in fact better for the shareholders, too--that fiduciary responsibility is satisfied. But if you don't look ahead to that outcome, it's easy to use fiduciary responsibility as a bludgeon to force a business into very short-term strategies. "Oh, you can establish relationships once you're established and profitable..." Except, you're never quite established or profitable enough.

If it were possible to enshrine in the law the idea that corporations should care about what the other stakeholders think, and not just the shareholders, I think that might improve things. But I'm not sure how that could be done in a general way. (Rather than via specific regulations to prevent abuses of specific stakeholders in specific ways, which is what we have had at times and have ripped out at other times.)

Great discussion, but one thing it ignores is that shareholder companies are very adept at plundering the commons and bending government rules their way. The government should in theory protect consumers and workers, punishing bad CEOs and investment bankers in the same way they'd punish common bank robbers. Instead, government subsidies and tax policy highly favor those at the top. Look at Bain capital. Even conservatives are criticizing a tax policy that allowed Romney and his lieutenant to pay far less in taxes than regular workers. Also, Bain let the taxpayer pick up the tab when it came to fallout from failed pension plans.

jdzappa wrote:

Great discussion, but one thing it ignores is that shareholder companies are very adept at plundering the commons and bending government rules their way. The government should in theory protect consumers and workers, punishing bad CEOs and investment bankers in the same way they'd punish common bank robbers. Instead, government subsidies and tax policy highly favor those at the top. Look at Bain capital. Even conservatives are criticizing a tax policy that allowed Romney and his lieutenant to pay far less in taxes than regular workers. Also, Bain let the taxpayer pick up the tab when it came to fallout from failed pension plans.

When someone hijacks the city fire engine and takes it on a drunken rampage destroying half the town, you don't solve the problem by dismantling the fire engine. You solve it by taking the keys away from the drunk and putting them back in the hands of the public trust.

Paleocon wrote:
jdzappa wrote:

Great discussion, but one thing it ignores is that shareholder companies are very adept at plundering the commons and bending government rules their way. The government should in theory protect consumers and workers, punishing bad CEOs and investment bankers in the same way they'd punish common bank robbers. Instead, government subsidies and tax policy highly favor those at the top. Look at Bain capital. Even conservatives are criticizing a tax policy that allowed Romney and his lieutenant to pay far less in taxes than regular workers. Also, Bain let the taxpayer pick up the tab when it came to fallout from failed pension plans.

When someone hijacks the city fire engine and takes it on a drunken rampage destroying half the town, you don't solve the problem by dismantling the fire engine. You solve it by taking the keys away from the drunk and putting them back in the hands of the public trust.

Oh, agreed - but that requires the middle class to rise up and demand important structural changes. I like to listen to independent podcaster Dan Carlin, and he always talk about that the number one issue people should be talking about is corruption. It's honestly one of the reasons I'm leaning towards Ron Paul. I hate a lot of his policies, but he's the only presidential candidate willing to talk about protecting the Constitution and rooting out corruption.

The problem remains that the American public isn't really engaged in politics, and when they are engaged it's over social issues like God, gays and guns.

Or at least, that is what the corporate interests would like you to believe.

It wouldn't solve the problem, but it strikes me that I might like to see "stakeholder interests" to be an affirmative defense in shareholder lawsuits.

wordsmythe wrote:

It wouldn't solve the problem, but it strikes me that I might like to see "stakeholder interests" to be an affirmative defense in shareholder lawsuits.

LOL. Precisely.

*nod* At the very least, our current legal regime of "the only thing that matters is shareholder profits" is utterly broken. It's really hard to tell if corporations just naturally turn into giant amoral constructs when they're practically required to do so by law.

Even if they were just made to balance shareholder interests against employee interests that would add some amount of nuance to the problem. (Possibly quite a bit, given employees generally have longer-term interests in terms of longevity of employment and maintenance of pensions, in addition to interest in the well-being of the community where they live.)

Related note from my annual re-reading of MLK speeches and writings:

The Reverend Doctor wrote:

We don't have to argue with anybody. We don't have to curse and go around acting bad with our words. We don't need any bricks and bottles. We don't need any Molotov cocktails. We just need to go around to these stores, and to these massive industries in our country, and say, "God sent us by here, to say to you that you're not treating his children right. And we've come by here to ask you to make the first item on your agenda fair treatment, where God's children are concerned. Now, if you are not prepared to do that, we do have an agenda that we must follow. And our agenda calls for withdrawing economic support from you.

wordsmythe wrote:

Related note from my annual re-reading of MLK speeches and writings:

The Reverend Doctor wrote:

We don't have to argue with anybody. We don't have to curse and go around acting bad with our words. We don't need any bricks and bottles. We don't need any Molotov cocktails. We just need to go around to these stores, and to these massive industries in our country, and say, "God sent us by here, to say to you that you're not treating his children right. And we've come by here to ask you to make the first item on your agenda fair treatment, where God's children are concerned. Now, if you are not prepared to do that, we do have an agenda that we must follow. And our agenda calls for withdrawing economic support from you.

I know this came up in the Xe/Blackwater/Monsanto thread, but it is almost impossible to boycott some companies. How does one boycott Monsanto? Or the Koch brothers? They own so much of so many companies or are so far behind in the supply chain you simply cannot avoid them. In some places there is simply nothing BUT a Walmart to go to.

NathanialG wrote:

In some places there is simply nothing BUT a Walmart to go to.

I get that not everyone can be that picky about their purchases, but I think there's call for those who can to do so.

As for financial companies and back-ends, things are trickier. I guess you just try and pay attention, and help inform others as you can.

an app that tells you which products you should boycott. Basically, a database of boycottable stuff. Anyone can connect, enter the product, institution, etc and understand - "yay" or "nay".

Don't thank me. I'm from the future.

The Dumbest Idea in the World: Shareholder Value. From those Communists at Forbes.

The primary advantage of shareholder value is that it's simple to discern what a shareholder is objectively, whereas a stakeholder is a much mushier concept. But "it's easier to adjudicate" is insufficient reason to make it law given all the drawbacks, IMO.

I will quibble a little with Hypatian: I don't think Apple's maximizing stakeholder value, per se -- at least, I don't think that's their root intent. Apple's theory of maximizing shareholder value is to take a holistic approach to its products that, among other things, recognizes valuable advantages in taking care of Apple's stakeholders. So they're maximizing shareholder value in a stakeholder-friendly way.

A true stakeholder-friendly company might easily run afoul of its shareholders. If they can negotiate tax breaks from a local government as a condition of doing business somewhere but choose not to because the community could use the money, that's grounds for a lawsuit. In fact, Apple, among others, continues to defer recognizing overseas revenue unless they can get it into the country tax-free. I imagine that tax money would benefit lots of Apple stakeholders one way or another.

Yeah. Apple is not a paragon of all that is good, nor do they do everything I would like. But they're far closer to engaging in stakeholder-like relationships than pretty much anybody else.

I'm definitely disappointed about the tax thing.

If you don't like corporate behavior, the answer is regulation.

Agreed! But if it is possible to curb some of the excesses with something more general, that would be nice, too. There are specific problems that can be addressed, but there's also the general malaise (in my opinion) of fiduciary responsibility uber alles pushing corporations to do absolutely anything to show increased profits every quarter. If there were some general countervailing force it might at least slow that trend so that there's more time to spot new problems and establish appropriate regulations before something explodes.

Hypatian wrote:

If there were some general countervailing force it might at least slow that trend so that there's more time to spot new problems and establish appropriate regulations before something explodes.

CEO gallows.

As I was reading the beginning of that Forbes article, I started thinking of the scandals surrounding fixed sumo matches in Japan.

Hypatian wrote:

And the central idea that came to mind is that Apple is doing business in a different way--it's still all about profits, and about creating technology, just like the competition. But the way it has been winning is by [em]not trying to win the nickels and dimes[/em]. Almost every business, particularly every big business, seems to have become increasingly focused on extracting every last penny of profit from every corner of the business. And I think that's part of what's become so corrosive about things. Apple, on the other hand, is making money hand over fist by not trying to squeeze every nickel and dime out. Yeah, they do what makes business sense, and try to minimize costs. But, as an example: instead of switching components used in their products every week based on what's cheapest that week, Apple instead figures out what they want and who they want to produce it and either buys the provider or establishes a long-standing contract with them to get consistent parts.

The great trouble with this reading of the situation is that it overlooks both itunes and the app store. Which are just persistent, always-on, nickle and dime upselling operations.

DanB wrote:

The great trouble with this reading of the situation is that it overlooks both itunes and the app store. Which are just persistent, always-on, nickle and dime upselling operations.

Not to mention the sneaky way Apple tries to install Safari with iTunes, and how QuickTime is not only compulsory but nests itself in the OS. Oh, and how about the iPod registration process in iTunes? I've had many MP3 players, but none of the other manufacturers were so keen on getting my personal data. And the only ones gaining from the closed Apple environment is Apple itself.

Apple is Apple-centric, not customer or shareholder-centric.

Apple also does a pretty good job squeezing every last nickel and dime out of its supply chain. They just don't crap where they eat.

dejanzie wrote:
DanB wrote:

The great trouble with this reading of the situation is that it overlooks both itunes and the app store. Which are just persistent, always-on, nickle and dime upselling operations.

Not to mention the sneaky way Apple tries to install Safari with iTunes, and how QuickTime is not only compulsory but nests itself in the OS. Oh, and how about the iPod registration process in iTunes? I've had many MP3 players, but none of the other manufacturers were so keen on getting my personal data. And the only ones gaining from the closed Apple environment is Apple itself.

Apple is Apple-centric, not customer or shareholder-centric.

Apple thinking Apple's way is the best way isn't necessarily anti-stakeholder in Apple's eyes. But then that's the same defense for Microsoft packaging IE within Windows.

As for the iPad registration via iTunes, I think that disappeared with iOS5.

Maq wrote:

Apple also does a pretty good job squeezing every last nickel and dime out of its supply chain. They just don't crap where they eat.

This.

I guess it's ok to disagree a bit, even on the Internet

The Apple digression made me think on the breadth of the social contract though. It seems we all agree that stakeholder-centric > shareholder-centric, even if we might disagree on how to make the switch.

But how far should the social contract go? What about environmental issues, or child labor? What about companies who are based in one country, but manufacter in another (like, again, Apple)?

dejanzie wrote:

I guess it's ok to disagree a bit, even on the Internet

The Apple digression made me think on the breadth of the social contract though. It seems we all agree that stakeholder-centric > shareholder-centric, even if we might disagree on how to make the switch.

But how far should the social contract go? What about environmental issues, or child labor? What about companies who are based in one country, but manufacter in another (like, again, Apple)?

The answer is regulation. Both national and international.

We sign treaties to stop whaling, CFC emissions, and sex trafficking. They don't stop 100% of any of those, but they work well enough to make a gigantic difference. If we left it up to the market, there is no doubt in my mind we'd have massive competing fleets of floating whale abattoirs ready to service the lucrative Japanese luxury food market.

Because nobody else has said it: But won't a shift to stakeholder mindsets drive away investment?

(Perhaps we need to break apart "investment" into two different terms--one for financial speculation and one for actual investment.)