Corporate Governance

Goodbye Shareholder Capitalism; Hello Stakeholder Capitalism

Fred Lazar
July 5, 2021

Is there a future for capitalism? Setting aside the obvious; namely, that there is no single model of capitalism, there seems to be a growing demand to replace the old system of shareholder capitalism with something different. Let’s call a possible new model stakeholder capitalism.

At a minimum, what would such a new model entail? There are two possibilities, and they are not necessarily mutually exclusive.

One involves an overhaul in corporate governance, where Boards of Directors are selected to represent numerous interests beyond the shareholders. The other involves new rules restricting the strategic decisions of company executives.

There are serious problems with the current structure of corporate governance. But these problems do not require a complete overhaul to include the interests of all possible stakeholders.

Who would determine what stakeholders should be represented; how many board seats each group should be allotted; how directors would be selected to represent each group; and how inevitable conflicts of interest among the directors would be resolved? Anyone who has observed department meetings in universities fully understands the pitfalls of stakeholder capitalism.

Woody Allen once said: “the most bitter fights are in academia because there is so little at stake.”

I once observed a fight break out among a couple of my colleagues at a department meeting, and I sat back and enjoyed the entertainment. The two were fighting over an issue that our department had absolutely no control. Imagine the fights among directors when there really is something at stake?

Instead of creating a monster, why not address the current problems with corporate governance?

The Problems

The Enron fiasco demonstrated that, despite the existence of a myriad of rules and regulations in place, if a company wants to change or break the rules, it can do so — and apparently, quite easily. If the Board of this company had done its job properly, then despite the incentives that motivated the behavior of the senior officers of Enron, its auditors, its financial advisers and bankers, its shareholders and its cheer leaders in the media, Enron would not have taken flight the way it did, and it might not have collapsed with a roar heard round the world. But the Board failed miserably.

Obviously, the Boards of Directors of a number of global financial institutions — Bears Stern, Lehman, FannieMae, FreddieMac, Citigroup, UBS, Merrill Lynch, CIBC, AIG, Countrywide Financial, all the banks in Iceland, most of the banks in the UK, Italy, Germany, etc. — did not learn any lessons from the Enron flameout.

In 2008, the failure by Boards to supervise senior management and their proclivity to take enormous risks with other people’s money posed a much greater risk to the global financial system and world economies.

As both Enron and the last decade’s financial crisis demonstrate, corporate governance matters only because there is a critical externality between the quality of governance at any particular company, the overall confidence of investors in the integrity and fairness of the equity market as a whole, and in the credibility and survivability of financial institutions.

If the fallout of Enron, for example, had been concentrated to the stakeholders of Enron, the damage would have been substantial. But the economic costs were much larger because of the negative spillover onto the stock markets and the resulting markdown in all equity prices, furthermore was the negative spillover onto the economy. The situation was even worse in 2007-09 with the lack of good governance in the financial sector. We were brought to the brink of a financial meltdown because of gambling and dreadful corporate governance.

Boards have also failed in dealing with corruption, sexual harassment and bullying. Only when misdeeds are made public, do they begin to act.


Since there is generally a separation between management and ownership in public companies, the interests of the owners — the shareholders — must be represented to ensure management acts in their best interest. Directors, as representatives of and elected by the shareholders, exist to serve the owners and only the owners.

The Supreme Court of Canada, in its decision regarding BCE, suggested that directors need to consider more stakeholders than just the shareholders. In the United States, a much earlier Supreme Court decision suggested that directors need to consider only the interests of shareholders. It appears that the Supreme Court justices in the US have a better understanding of business and the role of directors.

The most important role for the Board of any company is to select a CEO. But how does the Board know how good or talented the person they hired is?

The Board must closely monitor the key decisions of the CEO and the performance of the company under this person’s leadership. In other words, the Board must play an integral role in the strategic planning and capital budgeting processes. Even in retrospect, if the person hired to be the CEO proves to be the wrong person, the Board cannot allow the company to be put at risk through poor judgment and bad strategic decisions. Too many good companies are driven into the ground by poor senior management, and the Boards of these companies must bear a significant amount of the responsibility for such failures.

Then there is the matter of the employment contract and compensation. The Board must find the right balance between reward and penalty to motivate the CEO and his/her team. However, Board members often face conflicting incentives.

Do Boards (consisting largely of CEOs of other companies) have a strong incentive to effectively evaluate and impose stringent standards for a CEO to realize her/his bonuses and long-term incentive compensation? Setting tough standards and offering frugal base compensation at one company, on whose Board a CEO might sit, could always come home to affect her/his own compensation.

How then does a Board avoid this problem and create the perception of objectivity and responsibility? Hire a compensation consultant — outsource the responsibility and task. Of course, directors don’t really want the consultants to establish high standards and frugal base salaries. Instead, they prefer that the consultants choose some soft comparators and recommend a compensation package placing the CEO at least in the top 25% of the comparator group.

Compensation consultants, like all good consultants, understand the rules of the game and consequently, they will produce the desired results — incentives and money matter all round.

Despite the obvious problems in establishing good compensation practices, the key roles of a Board are:

  • Hiring a CEO and negotiating the employment contract;
  • Supervising the strategic planning process and approving the plan;
  • Monitoring the performance of the CEO; and,
  • Managing risk.



Now I turn to the second question: Whom do Boards represent?

Shareholders — but which shareholders: the current ones, past ones or future ones? Most public companies experience a high volume of trading activity in their shares each day, with most of their outstanding shares theoretically changing hands every 30 to 120 days.

With the exception of large institutional investors who invest in the companies comprising the most popular stock indexes, most investors, including many institutional investors and traders at the leading investment banks and hedge funds, rarely have a long-term horizon for any particular investment. For these investors, the quality of corporate governance and the level and structure of executive compensation are largely irrelevant until there is a major financial crisis.

Momentum and fads matter much more. During the dot-com frenzy in the 1990s, most investors knew little about the companies in which they invested. When we look at the valuations of companies today, such as Tesla, Snap, Beyond Meat, Dropbox, Lyft, Uber, Amazon, and many others, we see that investors might be repeating the same pattern and mistakes. Who says history doesn’t repeat itself?

Why worry about past shareholders who no longer are shareholders today? Unless of course, directors discover, after the fact, that some historic financial information might have been deliberately misleading, which might have led to some past shareholders making the wrong decisions and incurring financial losses as a consequence.

In such circumstances, directors are forced to make a trade-off between past and present shareholders. Disclosing such information might lead to individual or class action suits against the company, and as a result, current shareholders might be faced with a diminution in the value of their equity in the company. If directors disclose such information, will they be fulfilling their fiduciary duties?

What about future shareholders? In other words, should directors choose courses of action that maximize the value of the company’s equity in the short run, or should they be concerned about maximizing the long-term value of the company?

Theoretically there should be no difference, and thus there should be no trade-off between the interests of present and future shareholders. According to finance and economic theory, if all strategic decisions factor in the values, both positive and negative, of all future options created and/or destroyed by strategies currently being evaluated, then a series of annual decisions that maximize the equity value of the company in the short run also should maximize the value of the company in the long run.

However, how many Boards of Directors understand this principal, let alone practice it? Do directors consider every possible future implication of drastic payroll, marketing or R&D cuts when they are trying to improve the short-run profitability of their companies? Did the Boards of Nortel, and other high-tech companies, map out all future options created or eliminated as they acquired other companies and expanded employment levels during the go-go days in the 1990s? Resource companies repeated the same mistakes during the past 12 years as commodity prices rose sharply. No industry has a monopoly on lemming-type behavior.

Consider all of the initiatives announced by GM during the few years prior to its bankruptcy in 2008 to try and improve its competitive position and financial performance. GM killed the electric car, only to bring it back as a possible savior for the company, and it is being beaten badly by an upstart — Tesla Motors, created by an outsider to the industry.

How should trade-offs among different groups of shareholders be made? Good corporate governance requires an answer to this question.


Let’s return to the question of disclosure that might harm present shareholders. I will argue that directors should always vote in favor of full disclosure. Directors will serve the interests of shareholders, past, present and future, when they recognize that their actions and decisions should aim to make the capital markets more efficient. The more efficient the capital markets, and the more confidence investors have in the capital markets, the better off all shareholders, all companies and the economy as whole will be.


Efficient capital markets require full and timely disclosure. All participants must have confidence that they all are competing on a level playing field. If there is a perception on the part of some of the participants in the capital markets that the rules favor some groups over others, then the cost of capital will be higher than it should be and companies will be valued below their potential.

Selective disclosure might favor some shareholders at some point in time. But these same shareholders also will be adversely affected in their other shareholdings over time. The current shareholders in one company also are likely to be shareholders or even debt holders in other companies at the same time, and over time the portfolio holdings of this group of shareholders will change.

I will go so far as to argue that full disclosure should involve making the minutes of board meetings public. Company websites are an appropriate vehicle for publishing such information. Many lawyers will attack this suggestion by arguing that such a rule would have a chilling effect on board discussions and might lead to the release of sensitive competitive information. I suggest that such a rule would compel directors to be more thorough in their preparation for board meetings, and more diligent in their discussions of important strategic issues including executive compensation and succession. As for giving competitors an information advantage; if competitors are followers, waiting for your company to act, then a well-managed company has little to fear.

As the Enron and financial markets debacles clearly show, poor governance at one company can spill over and have negative consequences well beyond that company. There are important externalities associated with corporate governance. Consequently, I argue that all directors of public companies have a fiduciary responsibility to all shareholders, not just those in their respective companies.

But what about other stakeholders? They only matter if better treatment of them increases the value of a firm and creates more confidence in the markets in general. If people lose confidence because it appears that a small number of people gain disproportionately at the expense of large numbers of other people, this erosion in confidence can have deleterious effects on the economy in general, and lead to demands for more extensive interventions by government, many of which might serve only to harm the efficiency and productivity of markets while changing the composition of winners and losers.


If the current rules are producing inferior macroeconomic outcomes, then new rules are in order, but only if the new rules can lead to superior results. Boards should show concern for other stakeholders if they truly believe that otherwise, new government interventions might produce inferior macro results. But do directors have this ability?  

Firms (i.e., senior management and directors) do not have to consider other stakeholders. There may be some circumstances when they will consider more than the shareholders (or the individual interests of the senior managers). But as a rule, they do not need to consider a broader group of interests. Further, breaking the law also might be in the best interests of shareholders on some occasions.

Governments establish the rules, and some of these rules concern the behavior of firms, their senior managers, their Boards and their employees as representatives of the firm. Governments supposedly represent the interests of society at large. Thus, it is easy to argue that governments should set the rules of the game, including regulations and penalties, to motivate companies (senior management and directors) to behave in a manner that is socially desirable.

Canada and the United States have many examples of rules that are intended to do so:

  • environment regulations
  • employment standards
  • competition law (restrictions on misleading, false advertising)
  • occupational health and safety
  • workers’ compensation
  • product safety
  • criminal law governing fraud
  • tax rules (income redistribution)
  • employment insurance
  • securities law
  • corporate law
  • torts

However, there is a major problem. When a politician says that s/he is doing something because it is in the best interests of the public, I turn and run from this person! How do they know what is in the best interests of the public?

Catering to special interest groups who happen to complain the loudest will not necessarily, in fact will rarely, lead to policies and rules that will benefit the economy and possibly society as a whole. Although economists cannot pass judgment on what is in the best interests of society at large.

There are always trade-offs. A new rule will benefit some people, but perhaps at the expense of others. While a new rule might transfer income to large numbers of individuals, the rule might have a negative spillover effect on the efficiency and productivity of the economy, so that aggregate income could be reduced. Protectionist trade policies supposedly fall into this category, but so too might income support programs, ethanol and tobacco subsidies, and stringent rules to tackle the production and emission of greenhouse gases.  

Should government mandate that all companies consider all stakeholders in their key decisions? Are the costs of monitoring the performance of companies to see whether they abide by the rule, and the costs of enforcing the rules worth whatever benefits, however they might be measured, that might result?

A rule without monitoring and enforcement is of limited value.

Are there better ways to protect the interests of other stakeholders than introducing a rule, which places this onus on Boards and senior managers? Are more rules needed? There already are a number of rules protecting other stakeholders.

Is there anything else the government might do to improve corporate governance practices in order to reduce the likelihood of future major blow-ups such as Enron, and the financial industry?

New Rules?

I suggest the following rules as a starting point for governing Boards of Directors and salvaging the current system of shareholder capitalism.

One: All directors should be independent of and unrelated to the company. The Chair should be selected from among the independent directors.

Two: The CEO of a company should not be a member of its Board. The Board is responsible for hiring and possibly firing the CEO.

Three: No senior officer of a company should serve on the Board of any other public company. For directors to truly fulfill their fiduciary responsibilities, they must devote a considerable amount of time and effort to their jobs. This means that senior officers of one company should not serve on Boards of unrelated companies. They already have full-time jobs. Being a director is a profession and a good director cannot serve on more than a handful of companies, and a good director cannot have another full-time job.

Four: No one should remain on the Board of a company for more than six or seven years. The regular infusion of new people will bring new insights into board discussions, will reduce the tendency for directors to grow close with the senior officers, and should bring a broader perspective to the roles and responsibilities of directors.

Five: No one should serve on more than three or four Boards at any one time since being a director should become more of a full-time job and profession. As a result, directors should be properly compensated — this should be seen as the price to pay for ensuring well-functioning capital markets. The compensation should not be linked to the performance of any individual company. Shares, SARs, PSUs, DSUs and options should be ruled out.

Six: Directors should be required to provide full disclosure to the public.

Seven: Just as Boards can and do retain financial advisors for fairness opinions and other matters, and compensation consultants for advice on employment contracts, Boards should retain independent forensic accountants to review the opinions of their auditors. Of course, the accountants retained should not be associated in any way with the auditing firm. Moreover, I would recommend that auditors be appointed for a maximum of three years and then be replaced by another firm.

Eight: Director liability should be greatly restricted so that directors will have less incentive to abrogate their responsibilities and resort to hiring and relying on the advice of outside experts — financial advisors, management consultants, recruitment specialists, compensation consultants and lawyers. Eliminate the legal liability to lessen the need to cover their rear-ends.



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