A challenge for stakeholder capitalism: resolving voting paradoxes
If companies want to maximize shareholder welfare, managers need to find out what shareholders value; political theory shows how difficult it can be.
Editor’s Note: To mark the 50th anniversary of Milton Friedman’s influential piece on corporate social responsibility in the NYT, we are launching a series of articles on the debate between shareholders and stakeholders. Read previous installments here.
One of the virtues of maximizing wealth is its simplicity. Managers don’t need to know anything about investor preferences when making decisions, they just embrace all projects with positive net present value.
In contrast, to maximize shareholder welfare, managers should know shareholder preferences. For example, are they willing to give up 10% of their profits to reduce greenhouse gas emissions? And that would require a way to settle differences of opinion. What does Walmart do if some shareholders want to stop selling guns while others want to continue selling guns?
Commentaries in this series often mention the complexity of decision-making if managers were tasked with maximizing shareholder welfare (or stakeholder welfare), but the problem is even more complex than we realize. sometimes recognizes. Here I would like to point out some challenges that have been identified by political economy research and offer some thoughts on how they might be addressed.
To maximize shareholder welfare, managers should somehow aggregate the preferences of individual shareholders into a “social welfare function” that can be maximized. One aggregation procedure, for example, would be to determine preferences by voting, giving each share one vote, and leaving majority rule.
1. The first challenge is Arrow’s impossibility theorem, proved by Nobel economist Kenneth Arrow in 1951, which shows that it is impossible to aggregate preferences in a way that does not violate at least one of the some basic decision principles. These principles include: a person’s preferences do not always determine the outcome (not dictatorship), if each person prefers option A over option B, option A is selected and preferences over irrelevant alternatives n ‘not affect the results.
The theorem is difficult to explain in simple English but is recognized by theorists as the starting point for the analysis of collective decisions. Its scope is wide. It’s not that we haven’t yet found a consistent way to aggregate preferences; it is because there is no coherent solution: any collective decision-making process must violate at least one of the basic principles. Making managers pay to maximize the well-being of shareholders would require them to solve a problem that has no solution.
2. A second important element concerns voting, which would probably be part of any process of maximizing shareholder wealth. The Gibbard-Satterthwaite theorem, proven in the 1970s by a philosopher and economist, shows that almost all voting systems are subject to strategic voting. It’s a vote in which people don’t choose their first choice. A simple example, familiar to most readers, is a three-candidate race in which only two candidates are viable. A voter who prefers the third candidate may not vote for that candidate, but rather strategically choose one of the first two. The importance of the theorem is that companies cannot rely on the vote to accurately reveal their preferences.
3. Another concern is the control power of the agenda in determining the outcome of the elections. The person who decides what to vote on and in what order has enormous power to influence the outcome. One of the key theorems in this regard is that if the problems are two-dimensional or more and voters disagree on the options, arranging the order in which the options are decided (voting on A versus B , followed by the winner vs. C), the person in control of the agenda can induce any possible outcome. To avoid this type of manipulation, legislatures impose significant procedural constraints on their decision-making processes. It would also be necessary to restrict leadership control over the voting agenda.
4. Finally, there is the “capture theory”, the problem of the influence of interest groups, which can be traced in an article by Nobel economist George Stigler in 1971 which emphasized the vulnerability of democratic systems. to the influence of wealthy and / or organized groups. In the public sector, capture occurs when elected officials and their appointees are likely to lobby, revolving doors, and campaign contributions. In a corporate environment where directors and managers were tasked with making political compromises, similar channels of influence might well emerge. This problem is alleviated if voters are fully informed, but many investors are now passive owners, with little incentive to collect information, and few are convinced that proxy advisers can cover the information gap. We already have evidence that organized groups such as unions and public pension plans can use shareholder proposals to advance narrow goals.
Ways to follow
Despite these theoretical challenges, countries are able to function more or less effectively with democratic systems (although many would say they are turning to “less” these days). Political theory indicates some possible avenues for circumventing these challenges.
Even though theory suggests that voting results are not reliable indicators of voter preferences, there is one particular exception. May’s theorem, proved by mathematician Kenneth May, shows that the vote faithfully represents preferences and avoids the Arrow problem when there are only two choices and the winner is decided by majority rule. One way forward may therefore be voting on issues for which there are only two essential options, generally referred to as “referendums” in the political context. The obvious limitation is that many questions are not of a binary nature – one can imagine a multitude of climate reduction strategies or an election with more than two candidates – and forcing them to make a binary choice would allow the agenda controller. to induce a result. However, some problems can be resolved naturally into two main options.
To solve the challenge of manipulation by controlling the agenda, the agenda can be forced in advance. Perhaps the easiest way would be to require specific action in the corporate charter, such as Patagonia’s pledge to contribute 1% of net revenues to organizations promoting environmental conservation and sustainability. . A more flexible approach would be to require yes or no votes from shareholders on certain issues. States and cities are asking voters to approve actions like issuing debt, licensing a casino, and school district budgets. One could imagine a progressive corporate charter requiring a shareholder vote before investing in a country listed as a human rights violator by international organizations, or obtaining shareholder approval before testing products on it. animals.
What does this mean for the bottom line: is shareholder or stakeholder capitalism achievable or not? Steve Kaplan’s argument in this series is compelling: The current system of maximizing shareholder value has served us well and should not be replaced without a strong sense that there is a superior alternative. At the same time, Hart and Zingales are correct that there should be space for investors to create and operate businesses that pursue social goals if that is what they prefer. The lesson I would take is that it may be possible to implement stakeholder capitalism, but we would need to know in more detail how collective decisions would be made and how the known challenges of maximizing good- being collective would be discussed.