The clash of shareholder and stakeholder interests has been at the heart of several cross-border battles between European companies in recent months. Consider, for example, ABN Amro’s struggle to take over Italian banking group Antonveneta, Eon’s unsuccessful attempt to take over Endesa and the current Arcelor saga.
Over the last 25 years, the pressure for companies to follow a shareholder value model has spread from the US. Now well established in the UK, acceptance in continental Europe and across the world has gradually been gaining ground. Yet companies are also under counter pressure to acknowledge the claims of other stakeholders which is more than simply treating employees fairly, being law-abiding and donating to charities.
Shareholder value and stakeholder approaches: the key differences
A shareholder-value approach is when a company measures its success in terms of value achieved for its shareholders, usually in terms of total shareholder return (TSR). A company’s TSR is compared with that of sectoral peers. Internally, it is translated into making sure that earnings exceed the cost of capital. Treating shareholder value as a priority influences the way a company: makes strategic decisions and establishes criteria for investment and growth (including acquisitions); decides on internal priorities about customers, costs and asset management; makes financing decisions, including using debt, share buy-backs and whether to retain cash or pay dividends.
Under a stakeholder approach, by contrast, the company acknowledges equal or greater obligation to employees, customers, suppliers and/or society as a whole (including the environment).
Some industries – especially energy, and, within energy, oil – have long had to contend with well-organised pressure groups. But the number of issues and the intensity of the pressure has intensified over the past five years. Many of the world’s major pharmaceutical companies have been pushed to sell low-cost drugs to developing countries.
Gap and Nike have been attacked for exploiting child labour in the Indian sub-continent. Coca-Cola, Kraft and other food and beverage companies have been accused of contributing to child obesity in the developed world.
More fundamental is the call for companies to acknowledge the need for a so-called “triple bottom line”. This requires the production of not only financial but also social and environmental accounts, as a means to trace the contribution of the company to society and to the needs of the environment.
So, how can companies reconcile the apparently conflicting requirements to focus on shareholder value, while meeting the needs and aspirations of other stakeholders? Only by recognising that the pressures from stakeholder groups are constraints to pursuing shareholder value, not alternatives to it. The fact that these pressures are now stronger than before does not alter the requirements of a company to pursue shareholder value.
This agenda does not mean that companies should ignore the claims of other stakeholders. On the contrary, for many organisations listening to, acknowledging and, if required, meeting these claims it is essential for them to carry on their business successfully.
BP’s current advertising focuses heavily on its green agenda. Walk into Marks Spencer and the messages on the walls are about the sustainable sources of its supply. These messages are not incompatible with pursuing shareholder value. Rather, they give the companies a licence to operate in order to pursue it.
Companies that do not acknowledge such claims run risks of reputational damage. Shell famously discovered this over Brent Spar, McDonald’s has been facing it over the content of its burgers and Wal-Mart is currently coping with it over a cascade of accusations, from exploiting its workforce to wrecking the traditional US Main Street.
Reputational risk affects share prices because shareholders understand the dangers of consumer pressure from boycotts and unfavourable publicity. Being seen to acknowledge these claims, on the other hand, is seen as good for business. Starbucks, once accused of driving out small businesses, is now keen to emphasise its fair-trade credentials. And look out for Wal-Mart’s first sustainability report, due in 2007.
The prerequisites of making stakeholder concerns a priority
What conditions need to be in place before companies can change their agenda, putting one or more stakeholder interests – employees, society or the environment, for example – ahead of those of shareholders? Certainly, they need protection of some kind from the demands of the capital markets. This protection usually comes in one of two forms: legal or financial.
■ Legal protection Having a monopoly granted by the state (in the case of most state-owned enterprises), having the state keep down competition (in the case of professions), or having the state intervene directly (as the French government has done to “protect” so-called “national champions” such as yoghurt maker Danone).
Protection by the state is usual in developing countries and in particular industries, such as national airlines. It is possible so long as companies are insulated from the requirements of international capital flows. In some developed countries, such as Japan, there is a long history of selective state protection. But as globalisation brings down barriers, the pressures to remove these barriers will increase.
■ Financial protection Taking a company to the stock market brings in outside shareholders and, therefore, outside pressures. The Bacardi family is famous not only for its drinks, but also for having retained ownership of its company since the famous rum brand was founded in Cuba in the 19th century. Nevertheless, as it operates in a big international league of quoted companies, there is a constant conflict between the desire to retain family control and the need to raise funds for expansion. For years there has been a semi-public family debate about whether to bring in outside capital.
Financial protection offers the ability to pursue alternative, even personal agendas. Consider Ikea, for example. Founder Ingvar Kamprad has kept the company private to give him the flexibility to develop the business as he wants, including achieving a number of specifically social aims. For Mr Kamprad, opening in Russia despite endless bureaucratic obstacles was “a social mission to come with good things to poor Russians”.
So, owning the whole of the shares yourself is the most obvious form of financial protection. This is fine for small businesses but, as they become larger, few can finance expansion without selling some equity.
A stock market quote need not necessarily mean losing protection. There is a long history of founders organising things to retain control by having a blocking majority of the shares or restricting the rights of other shareholders. Google is a recent example of the latter, to the disapproval of the FT’s Lex column, which declared that it “smacks of antiquated Milanese or Swedish capitalism”. Or, if you decide you really don’t want outside shareholders at all, you can buy them out, as Richard Branson did with Virgin and as the Bertelsmann publishing family is currently seeking to do.
There are also isolated examples of specific restrictions. One is the Reuters shareholder structure, where a single founder’s share can be used to safeguard the company’s independence by outvoting all other shares. Another is control by a charitable trust, which has kept US chocolate company Hershey out of the hands of multinational food companies.
■ Others forms of protection High transaction costs can offer protection, if, for example, there are severe legal complications to a takeover for a relatively small reward. “Poison pills”, such as that recently deployed by News Corp to ward off Liberty Media, can provide more direct protection against predators.
Another barrier is shareholder loyalty to the current management. Few companies would be able to keep $40bn in cash without pressure to give it back to the shareholders. But Berkshire Hathaway’s outside shareholders are only too pleased to put their faith in Warren Buffet, without him needing to wield the power of a huge personal shareholding. There is also information failure – if a company does not register on a predator’s radar screen because it is too small to do so.
Protection of a different kind can be offered by a company where returns are just good enough, there is no need for new capital, and where management has no inclination to seek any. If they are quoted, their shares may languish, but they will not be subject to direct pressure as long as there is no lurking predator and shareholders are willing to accept lower returns than they might otherwise receive.
This has certainly been the case with Sweden’s Wallenberg family, who have received lower returns over a long period from their majority shareholding in the Swedish investment company Investor than they might have enjoyed from investments less focused on Sweden’s flagship industries.
For the last few years, there has been a similar position at Heineken, in which the Dutch founding family retains just over half the shares. As for unquoted companies, resistance to outside capital can threaten their viability, as the president of BVMW, the main German Mittelstand organisation, has pointed out.
Obstacles to stakeholder prioritisation
In spite of the possibilities mentioned above, legal or financial protection for the pursuit of stakeholder goals over those of shareholders cannot be guaranteed. For example, a state’s policy may change – in the case of the Italian banking industry, through the ousting of the central bank governor.
Alternatively, key shareholders may sell out, as California winemaker Robert Mondavi did after a history of family disputes. Or their heirs may decide to do so, as with MIM, the company of US sports marketing entrepreneur Mark McCormack.
Protection is even more fragile once the majority of shares are held by outsiders. The UK hotel and catering group Forte fell victim to a hostile takeover, despite the wishes of the founders. Indeed, boards in some countries may be obliged to accept a financially attractive offer to avoid the danger of being sued for failing in their fiduciary duty – reportedly a factor in the takeover of US ice-cream maker Ben and Jerry’s by Unilever.
A company is not protected if pressures alone don’t force a change, since the business may simply not survive. In the case of United Airlines in the US, a majority holding by employees determined to safeguard employee conditions did not save the company from Chapter 11. The UK insurance company Equitable Life was brought to its knees even though it was a mutual.
Or take the example of boo.com, a notorious internet boom start-up. It was, as one former employee put it, “a fun, open-minded company that treated its employees extremely well. There aren’t many companies like that around. Now I think I know why.” Treating the employees on a par with shareholders contributed to cash burn of $135m in 18 months before a spectacular collapse.
The desire of rich people to hold trophy businesses is another example of how a company can be protected from market pressures – many newspapers have been more valued for status and power than dividends. Chelsea Football Club is today’s most prominent UK trophy asset. Loss-making haunts of fellow sybarites, such as London luxury store Asprey, are less well known. But the chances are that even the rich (or, eventually, their children) will get fed up with an investment that is at worst a drain and at best incapable of providing a proper return.
No protection, no alternative
Protected companies may choose to pursue shareholder value anyway – most do. But without protection, a company has no alternative but to pursue shareholder value. The needs of other stakeholders will be constraints on the company, not equal calls to those of shareholders. With very few exceptions, such as the John Lewis Partnership, a UK retailer held in trust on behalf of its employees, almost all companies that have tried to elevate the interests of particular stakeholders above those of the long-term shareholder without protection have had financial problems.
This should not be surprising. Going for alternatives can be expensive, even potentially ruinous – the Body Shop’s focus on environmental and social objectives at the expense of more conventional goals almost brought the company to its knees. Shareholders whose interests are sacrificed to those of other stakeholders will almost certainly move their money to more attractive opportunities elsewhere.
Giving more attention to the environment than to shareholders is not the same as attracting customers by being seen to behave ethically. Many customers of the Body Shop were (and no doubt still are) attracted by the idea that a visit contributes more to the environment than a visit to competitors. But this balance must be carefully struck. Earlier this year, Body Shop was taken over by L’Oréal, an organisation that has pledged to maintain the ethical values of the products, but within a framework that has a much more conventional view of the importance of shareholders than Body Shop’s founders.
A similar balance is being shown by Unilever with Ben and Jerry’s. The company’s cheerfully idiosyncratic values and way of working have been combined with more conventional management disciplines in “an even more dynamic, socially positive ice cream business”. It is only when alternative agendas result in actions that are not in the long-term interests of shareholders that a company’s independent existence will be threatened.
Conclusion
This article makes an unambiguous proposition: the move to shareholder value, expressed as total shareholder return is one way, not a passing fashion. However, the internationalisation of capital markets means that companies can only follow an alternative route if they have protection, and protection can never be guaranteed in the long term.
There are many who would disagree with the implications of this statement. They dislike the fact that shareholder value does not appear to provide sufficient weight to the interests of other stakeholders. But the proposition does not make a judgment about whether shareholder value is desirable, only that without protection, it is inevitable. Such judgments presumably lie behind the unashamed advocacy of national protection by Dominique de Villepin, prime minister
of France, and the description of private equity funds and hedge funds as “locusts” by Franz Müntefering, now deputy chancellor of Germany.
At the same time, the argument does not imply that it is in a company’s interests to behave unethically and ignore (or at least be seen to ignore) the interests of society and wider environmental issues.
A company that is seen to act irresponsibly is increasingly likely to run into reputational risk problems. It will find it difficult to attract the best recruits. It could be subject to consumer boycotts. It might just be the subject of unwelcome scrutiny by government. It is very much in a company’s self interest to act responsibly – more so now than ever before.
Those running companies without protection should be in no doubt: following an alternative strategy without protection may work in the short term but is high risk. Sooner or later it is likely to cost them their jobs.
Sir Andrew Likierman is professor of management practice at London Business School. He is working on ways to improve company performance measurement.
