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  • Robert Hinkley

Stakeholder Capitalism Needs to Become Law


By Robert C. Hinkley

Berry, New South Wales—29 May 2021

In September 1970 the New York Times printed a soon to be famous op-ed by the University of Chicago economics professor, Milton Friedman. The title of the article was “A Friedman Doctrine—The Social Responsibility of Business is to Increase Its Profits.” He argued that businessmen who promote corporate social responsibility “are preaching pure and unadulterated socialism… and undermining the basis of a free society.” The purpose of corporations was to make money. Achieving that was good for the economy and therefore good for everyone. Or at least that was the theory.

Transition to Stakeholder Capitalism

By September 2000, there was reason to believe that not very many people in America felt the same way. Business Week published a poll it took in both 1999 and 2000. It asked Americans generally which statement they agreed more with more strongly:

  • · Corporations should have only one purpose—to make the most profit for their shareholders—and pursuit of that goal will be best for America in the long run. Or,

  • Corporations should have more than one purpose. They also owe something to their workers and communities in which they operate, and they should sometimes sacrifice profit for the sake of making things better for their workers and communities.

In both cases, 95% of those polled said they agreed more strongly with the second statement than the first. This was a surprise. American business followed the first statement. The corporate law required directors “to act in the best interests of the corporation.” It said nothing about companies owing something to their workers or the communities in which they operated.

The poll showed people’s dissatisfaction with companies who only cared about profits. In the two decades since then, a movement began and grew to make companies more socially responsible. Investments made with a social or ethical purpose have grown from nearly nothing to many trillions of dollars.

Business schools have all begun to teach a new way of doing business that makes environmental, societal and governance (ESG) considerations as much of the curriculum as accounting, marketing, management and finance. Graduates of these programs are filling spots in Sustainability Departments of the largest corporations. Major companies now report on their ESG efforts as well as their financial results.

The movement towards a more socially responsible way of doing business was finally recognized by the Business Roundtable (BR), an association of Chief Executive Officers from 200 of America’s largest companies. On August 19, 2019, the BR issued a statement declaring the purpose of the corporation was more than just serving shareholders (which had been the BR’s position since 1997). One hundred and eighty-two CEOs proclaimed that their companies would begin to take into consideration all stakeholders, including in addition to shareholders, its customers, employees, suppliers, communities and the environment.

The BR’s statement was seen by some as an attempt to cut off the turn in public opinion against corporations and big business. Economic populism was on the rise. Inequality was becoming an issue. The Great Recession caused by financial crisis of 2008 was blamed on the fraudulent mortgage practices of America’s big banks. Global warming was perceived as a largely corporate generated problem. Big business had to do something to improve its image.

There’s been significant shift in the way business is done over the last fifty years. Corporate social responsibility has gone from being the object of Milton Friedman’s scorn to CEOs declaring that their businesses will consider the interests of other stakeholders. So-called “stakeholder capitalism” is the new business model.

The law lags behind

There’s one critically important problem. Stakeholder capitalism appears to be limited in its ability to rid the world of the worst forms of corporate abuse of the environment and other elements of the public interest.

Our planet is still heating to dangerous levels as the result of corporate generated greenhouse emissions. Inequality in America is expanding as wages and benefits fall behind those in the developed world and the benefits of economic growth are mostly gobbled up by the very affluent. Communities are being torn apart by social media business models that set people against each other. Big corporations still manufacture and distribute products that annually kill millions.

Stakeholder capitalism is based on the notion that corporations should be respectful of and protect the public interest. However, the corporate laws of the world are still stuck in the twentieth century. Not only do the laws not support the move to stakeholder capitalism, they actually discourage it. These laws need to be amended to make corporate respect for the public interest the rule rather than the exception.

Corporations only exist because the law allows corporations to be formed and operate. For more than a century the law has provided that the duty of people who run corporations, directors, is solely “to act in the best interests of the corporation.” There’s no balancing obligation to respect the environment or other elements of the public interest.

As a consequence, corporations have all the rights of citizenship, but bear none of its obligations. When a company is discovered destroying the public interest, the law doesn’t require directors to cease. Worse, it expects them to defend their company’s anti-social behaviour. This should change.

Big companies are now our most powerful citizens. They should set an example for everyone else to follow. Nations get into trouble when their most powerful citizens are also their worst. The corporate unrestricted pursuit of self-interest is not an example which everyone should follow.

The extent to which directors are willing to follow ESG principles to protect stakeholders is becoming clear. Not far enough. Big companies are happy to have SRI investors, but they don’t need them and don’t change their behaviour to attract them. Directors are unlikely to pursue ESG when the cost is high, or the necessary technology is not readily available.

Consider the directors of a company that owns five large coal-fired, power generating stations. All five operate in accordance with current regulations that allow them to emit greenhouse gases into the atmosphere. The directors worry about climate change and consider shutting the five stations as soon as possible. Decommissioning the stations early will require their value to be written off resulting in billions of losses.

Now consider the directors of a tobacco company. Their company faces a similar problem. Their business model depends on manufacturing and selling a product the gives their customers cancer. The directors feel bad about it and consider causing the company to get out of the tobacco business. The tobacco company will also have to write off billions and figure out what it might do instead.

Both businesses are operating legally. The law says directors must act in the best interests of the corporation. Even, it they wanted to, how could either board voluntarily shut down profitable operations? How can closing down be “acting in the best interests of the corporation”? Both have competitors which may or may not decide to close. What if their competitors decide to remain open? How could both decisions (the company’s and its competitors’) be in the best interests of their respective corporations?

Existing law is inhibiting SRI, ESG and stakeholder capitalism to the point where they can’t solve the most serious corporate generated problems. The underlying principle behind these ideas, protecting the public interest (i.e., citizenship), is sensible and should be supported in the law. Yet, our system of regulating corporate behaviour remains rooted in an old paradigm that encourages companies and their management to do the opposite.

Changing the law

The corporate social responsibility movement’s efforts have been transformative leading us to reject the idea that sacrificing the public interest is necessary or desirable to the pursuit of profit.

Existing law needs to be changed to reflect the move to ESG and stakeholder capitalism. It needs to be changed to require every company to respect the interests of other stakeholders and make every investment a socially responsible investment.

To be effective, the change will need to be relatively easy for everyone to understand and implement. I believe that adding 28 words to the existing duty of directors will be a good start. These words will balance the duty to act in the best interests of the company with a duty to protect five elements of the public interest. I call these words the Code for Corporate Citizenship (Code). As amended, the new law would read:

Duty of directors: The duty of directors shall be to act in the best interests of the corporation, but not at the expense of the environment, human rights, public health and safety, dignity of employees or the welfare of the communities in which the corporation operates.

The Code has two functions. First, it is designed to foster continuing ESG efforts by eliminating any idea that companies have no obligation to protect the environment and other elements of the public interest. Second, when companies are found to be doing extreme harm to the public interest, it tells directors they have an obligation to stop the destruction—either by closing down or finding a way to convert the company’s operations to eliminate the harm.

The revised duty of directors does not ask directors to consider other stakeholder interests (which is ESG’s method). It requires directors to respect those interests by providing that the pursuit of corporate gain shall not come at the expense of these interests. Rather than affect individual companies one at a time (as ESG does), it will require all companies to lift their game.

Changing the law to require directors to consider other stakeholders would be no more effective than the now operation of ESG under existing law. It would leave directors to weigh the interests of shareholders and other stakeholders. Most probably, they would come to the same decision they do now. After due consideration, the decision will be to allow the abuse to continue.

Note the Code also doesn’t try to require directors to serve the interests of both shareholders and stakeholders equally. This would be cumbersome, confusing and ultimately impossible for directors to follow. Directors can’t be required to serve more than one master.

The Code puts balance in the law between the company’s interests and the public interest. It lifts protection of stakeholder interests to a position that actually takes priority above shareholders. While the goal of directors is still profit, it puts protection of the environment and four other elements of the public interest ahead of making money.

Some laws set ideals or aspirational goals and then rely on self-regulation or other laws for enforcement. The existing duty of directors is a good example. Without being told, directors know their job is to preserve and enhance shareholder value. Including the existing duty in the law more or less reduces the obvious to writing.

The Code will similarly reduce to writing the aspirations of ESG and stakeholder capitalism. This will put companies on notice that the law has higher expectations regarding corporate behaviour than it did previously. It will also facilitate the passage of other laws that move corporate behaviour towards the Code’s goals (e.g., stricter environmental, labour and consumer safety laws to strengthen).

Enacting the Code will complement the existing duty of directors to act in their company’s best interests. Directors will become concerned with more than just return on investment. It will allow directors to be as good citizens when they serve on boards as they are in their private lives.

Under the Code, the precautionary principle should take hold making safeguarding the environment and other elements of the public interest part of everyone’s job. Harming stakeholder interests will pose real risks for the company (see “Enforcement—Extreme Abusers” below). It will become everyone’s job to spot these increased risks and speak up before it’s too late.


When considering any new statute, it is natural to think about how it should be enforced and what penalties should be assessed for violations. At the outset, it should be recognized that the purpose of the Code is not to prohibit every abuse of the public interest and then put government in the role of overseeing that it does.

Business Judgment Rule

Some have said that existing law requires directors to maximize profits. This isn’t true. The courts have never said that the duty of directors is to maximize profits. Milton Friedman was an economist, not a judge.

The law has always allowed directors to use their discretion in making business decisions. It’s flexible enough to realize that considering the interests of other stakeholders can benefit the corporation as well (e.g., marketing, public relations and improving brand awareness).

In fact, judges generally defer to directors and rarely allow boardroom decisions to be re-argued in court. They dismiss out of hand lawsuits regarding whether directors have fulfilled their duty under the corporate law to “act in the best interests of the corporation.” This is known as the business judgment rule (BJR).

This doesn’t make the obligation to act in the best interest of shareholders toothless. Everyone within the company understands their job is to help the company make money and preserve its assets. It’s the driving force behind all company action. It is a powerful force without needing to be the subject of constant legal action.

Practically the only exception to the BJR is where directors engage in self-dealing to enrich themselves. Some legal commentators have said that the duty of directors when combined with the BJR amounts to the corporate equivalent of, “Thou shalt not steal.”

The BJR gives directors plenty of leeway under existing law to adopt ESG principles to protect stakeholder interests. The Code will not reduce this leeway. It will reinforce it, enshrining in the law corporate action to safeguard the environment, human rights, the public health and safety, dignity of employees and welfare of our communities specifically.

The Code should also not reduce courts’ existing reluctance to second guess boardroom decisions. Applying the BJR should ensure the Code’s additional duties do not result in extensive litigation or require constant government oversight. There are however, times where judicial enforcement of the Code may be necessary.

Extreme Abusers

The purpose of the law is to further the public interest. In cases of extreme abuse of the public interest, corporations (creatures of the law) are violating this principle and should be stopped. They are no longer serving the public interest. They are serving themselves at the expense of the public interest.

Not all companies are extreme abusers of the public interest. Indeed, probably only a few fall into this category. They tend to be in a limited number of industries.

I’ll open consideration regarding which companies are extreme abusers, with an observation that I think the following should be considered. They are companies engaging in the:

  • · emission of material quantities of greenhouse gases,

  • · mass manufacture and distribution of tobacco and

  • · provision of platforms that build profit be setting large portions of the populace against others.

Others will differ with regard to the third example, but is there really any debate at this point regarding the first two? I can see a lively discussion regarding the possible addition of other examples to the list. That being said, the penalties for inclusion on this list should be severe and adding a company to it should not be taken lightly.

When a company is externalizing extreme costs on the public, it should be required to stop. At the very least, the law should require directors to cease or quickly phase out the operations which are causing the harm. The financial fall out from this decision is a risk that shareholders and lenders should bear.

A company discovered to be doing excessive damage to the public interest, is in principle, not altogether different from one which finds itself being unable to pay its bills and files for bankruptcy. In that situation, the directors’ duty to act in the best interests of the corporation is transferred from representing the interests of the company’s shareholders, to representing the interests of its creditors. This makes sense. Technically the shareholders’ interests have been wiped out by the company’s losses. The shareholders no longer have an interest to protect.

Similarly, it makes sense for the duty of directors to shift when it is found externalizing extreme damage on the public. In this case, the shift should be from “acting in the best interests of the corporation” to “acting in the public interest.”

The amount of time offending companies are given to close down or eliminate the harm can be debated, but it should be as short as practicable giving due consideration to the harm being caused, how long it has been going on and the difficulties closing down or eliminating the harm will cause to the public interest. The Code will put corporate personnel on watch to make sure no new instances of extreme abuse arise. It is likely that, even in spite of the increased vigilance, some company or industry will once again discover after-the-fact that it is doing extreme harm. In that circumstance, the Code should force shutdown or conversion within a similar time after discovery.


Enactment of the Code is meant to put companies that aren’t already doing extreme harm on notice that they should not commence in the future. They should monitor their operations and continually ensure they aren’t about to violate the Code. Company managers will know that, if their business does, it will be dealt with harshly. The effect of this should alert directors, managers and employees to be cognizant of harm their company might be doing to other stakeholders and take appropriate steps to reduce that harm as quickly as possible.

In addition to eliminating the worst examples of corporate abuse of the public interest, the Code will remove all justification for anti-social behaviour that now occurs in the name of serving shareholders. The result will be legal support for a new normal that fulfills the aspirations of SRI, ESG and stakeholder capitalism.

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