For the last 50 years academics, investors, and economists have argued over shareholder and stakeholder theories. Shareholder theory says that companies sole duty is to maximize profits within the law. Stakeholder theory says that companies should balance the returns of all stakeholders even if it reduces profits. So, which is it, make money or do good?
When we think about this we usually default to examining large multi-national public companies, but they are just a piece of this debate. According to the Small Business Administration there are 18,600 large companies in the U.S., about 3,700 of these are publicly traded. They define a large company as having more than 500 employees. There are 28,800,000 small businesses! That is 99.9% of all businesses! Small businesses employ about half of the non-governmental workforce and over the last 20 years have created over 63% of net new jobs. Those of us who work in small businesses have a role in this debate.
Milton Friedman is one of the leading voices of shareholder theory. He said, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it…engages in open and free competition without deceit or fraud.” There is a common misconception about shareholder theory that it precludes charitable giving or any activity that reduces short term profits. The theory simply says that for an activity or charitable contribution to be made it must in the long term be beneficial to the company’s profits. For example, if a company made a charitable contribution to build a new hospital that would reduce the cost of employee healthcare, such that company profits would increase, this would be consistent with shareholder theory. Ultimately, all activities must increase profits.
Stakeholder theory on the other hand says that a company must consider all of its “community” and must act in a way that yes, makes a profit, but does so in a way that benefits its employees, vendors, customers, and neighbors.
Each of these are normative theories, that is, they say would a company should do, in contrast to descriptive theories that show what they actually do. (We intend in the coming months to share with you some stories of what our company is actually doing to promote our communities, along with what some others are doing. We invite you to share your stories with us.)
So, which is it, make money or do good? Companies can’t exist without making a profit, and making a profit is hard. About 50% of small businesses survive for five years and only 33% last ten years. If your business isn’t profitable you eventually run out of money and close. There is no conflict here between shareholder and stakeholder theories, you have to make money period. You can’t do good if you’re not in business.
The problem with shareholder theory is that it leads to a myopic focus on profitability that results in lower profitability. Shareholder theory operates in a vacuum. It assumes that what happens to a business’s stakeholders doesn’t affect the operations of the company. The welfare of stakeholders is critical to the success or failure of a business. Our team members have joy and sorrow in their lives. Times of health and illness. Customers have times of expansion and contraction. Innovation leads to changes in our environments. A rising tide lifts all boats, but a receding tide lowers all boats. Our companies are interconnected with our team members, customers, and communities. We cannot succeed, if they don’t succeed. This is why stakeholder theory matters.
“Doing good” is about making our communities better. Our communities include all of our stakeholders. When we do good, we help create a rising tide, and oh by the way, we are more profitable, not less so.
So, what do you think, is it making money or doing good?