Stakeholder Theory - Business Ethics

Stakeholder Theory

R. Edward Freeman

A stakeholder: any group or individual which can affect or is affected by an organization. This wide sense of the term includes suppliers, customers, stockholders, employees, communities, political groups, governments, media, etc. A narrower definition is that the stakeholders in a firm are designated as suppliers, customers, employees, financiers, and communities. 

Stakeholder theory: a set of propositions that suggest that managers of firms have obligations to some group of stakeholders. Stakeholder theory is usually juxtaposed with stockholder theory: the view that managers have a fiduciary duty to act in the interests of stockholders. ‘‘Stakeholder’’ is an ironic twist of ‘‘stock holder’’ to signal that firms may well have broader obligations than the traditional eco nomic theory has assumed. 

The recent history of stakeholder theory has been well documented by Donaldson and Pres ton (1995). One can find vestiges of the concept in many areas of business, from finance, strategic management (cf. Mason and Mitroff, 1982), organization theory (cf. Thompson, 1967; Dill, 1958), and ethics (cf. Freeman, 1994). The actual word ‘‘stakeholder’’ first appeared in the management literature in an internal memorandum at the Stanford Research Institute (now SRI International, Inc.) in 1963. It was meant to generalize the notion of stockholder as the only group to whom management need be responsive. Thus, the stakeholder concept was originally defined as ‘‘those groups without whose support the organization would cease to exist.’’ Stemming from the work of Igor Ansoff and Robert Stewart in the planning department at Lockheed, and later Marion Doscher and Stew art at SRI, the original approach served an important information function in the SRI corporate planning process. The Swedish management theorist Eric Rhenman, who is perhaps the originator of the term, was instrumental in the development of stakeholder thinking in Scandinavia, where the concept became one of the cornerstones of industrial democracy. (See Nasi, 1995, for the history of the concept in Scandinavia.) 

Donaldson and Preston (1995) suggest the research on stakeholders has proceeded along three often confused lines. First, there is instrumental stakeholder theory, which assumes that if managers want to maximize the objective function of their firms, then they must take stake holder interests into account. Second, there is the descriptive research about how managers, firms, and stakeholders in fact interact. Third, there is a normative sense of stakeholder theory that prescribes what managers ought to do vis a` vis the stakeholder. To this framework we can add a fourth dimension, the metaphorical use of ‘‘stakeholder,’’ which depicts the idea as a figure in a broader narrative about corporate life. We shall combine the first two senses of stakeholders and call that the analytical approach to stake holder theory, while the second two senses can be called the narrative approach to stakeholder theory. 

The Analytical Approach to Stakeholder 

Theory Any business needs to be understood at three levels of analysis. The first concerns how the business as a whole fits into its larger environment, or the rational level. The second concerns how the business relates to its environment as a matter of standard operating procedures and routine management processes, or the process level. The third concerns how the business exe cutes actual transactions, or deals or contracts with those individuals who have a stake. 

An example of the rational level is to think of business strategy as a game played, for example, between IBM and AT&T. IBM does action X and AT&T responds with action Y. An example of what we mean by the process level would be to look internally and see how the performance and reward procedures work at both AT&T and IBM. An example of the transactions level would be to closely examine the behavior of IBM and AT&T salespersons to see how each treats customers, and to examine the terms of various contracts, deals, promises, and individual motivations of each player. Obviously, these three levels of analysis are connected. In fact, we argue that in successful businesses they fit together in a coherent pattern. 

The rational level. The rational level of the stakeholder framework must give an accurate picture of the place of a business in its larger environment. It must identify those groups who have a stake, and it must depict the nature of the relationship between stakeholder and firm. 

Who are those groups and individuals who can affect and are affected by the achievement of an organization’s purpose? How can we con struct a stakeholder map of an organization? What are the problems in constructing such a map? Ideally, the starting point for constructing a map for a particular business is a historical analysis of the environment of that particular firm. In the absence of such a historical document, figure 1 can serve as a checkpoint for an initial generic stakeholder map. 

Figure 1 depicts a stakeholder map around one major strategic issue for one very large organization, the XYZ Company, based primarily in the United States. Unfortunately, most attempts at stakeholder analysis end with the construction of figure 1. The primary use of the stakeholder concept has been as a tool for gathering information about generic stakeholders. Table 1 is a chart of specific stakeholders to accompany figure 1 for the XYZ Company. Even in table 1 some groups are aggregated, in

Figure 1 Stakeholder map of a large organization

order to disguise the identity of the company. Thus, ‘‘Investment Banks’’ would be replaced by the names of those investment banks actually used by XYZ. Table 2 is an analysis of the stakes of some of those specific stakeholder groups listed in table 1. Thus, the stake of Political Parties no. 1 and no. 2 is as a heavy user of XYZ’s operations, and as being able to elevate XYZ to national attention via the political process. Customer Segment no. 1 used a lot of XYZ’s product and was interested in how the producer could be improved over time for a small incremental cost. Customer Segment no. 2 used only a small amount of XYZ’s product, but that small amount was a critical ingredient for Customer Segment no. 2, and there were no readily available substitutes. As shown in figure 1 and tables 1 and 2, the construction of a rational stakeholder map is not an easy task in terms of identifying specific groups and the stakes of each. The figure and tables are enormously oversimplified, for they depict the stake holders of XYZ as static, whereas in reality, they change over time, and their stakes change depending on the strategic issue under consideration. 

The process level. Large, complex organizations have many processes for accomplishing tasks. From routine applications of procedures and policies to the use of more sophisticated analytical tools, managers invent processes to accomplish routine tasks and to make complex tasks routine. To understand organizations and how they manage stakeholder relationships, it is necessary to look at the standard operating procedures – the organizational processes that are used to achieve some kind of fit with the external environment. 

Organizational processes serve multiple purposes. One purpose is as a vehicle for communication and as symbols for what the corporation represents. Standard operating procedures depict what activities are necessary for success in the organization. And the activities necessary for success inside the organization must bear some relationship to the tasks that the external environment requires of the organization if it is to be a successful and ongoing concern. There fore, if the external environment is a rich multi stakeholder, the strategic processes of the

Table 1 Specific stakeholders in a large operation
General	Specific
Owners	Shareowners Bondholders Employees
Financial community	Analysts Investment banks Commercial banks Federal Reserve
Activist groups	Safety and health groups Environmental groups ‘‘Big business’’ groups Single issue groups
Suppliers	Firm no. 1 Firm no. 2 Firm no. 3 etc.
Government	Congress Courts Cabinet departments Agency no. 1 Agency no. 2
Political groups	Political party no. 1 Political party no. 2 National League of Cities National Council of Mayors etc.
Customers	Customer no. 1 Customer no. 2 etc.
Customer advocate groups	Consumer Federation of America Consumers’ Union Council of Consumers etc.
Unions	Union of Workers no. 1 Union of Workers no. 2 etc. Political action committees of unions
Employees	Employee segment no. 1 Employment segment no. 2 etc.
Trade associations	Business Roundtable NAM Customer trade organization no. 1 Customer trade organization no. 2 etc.
Competitors	Domestic competitor no. 1 Domestic competitor no. 2 Foreign competitor no. 1 etc.

 

Table 2 Stakes of some special stakeholders
Stakeholder	Stake
Customer segment no. 1	High users of produce Improvement of product
Political parties nos. 1 and 2	High users of product Able to influence regulatory process Able to get media attention on a national scale
Customer segment no. 2	Low users of product No available substitute
Consumer advocate no. 1	Effects of XYZ on the elderly
Employees	Jobs and job security Pension benefits
Consumer advocate no. 2	Safety of XYZ’s products
Owners	Growth and income Stability of stock price and dividend

organization must reflect this complexity. These processes need not be rigid analytical devices, but rather existing strategic processes that work reasonably well with a concern for multiple stakeholders. 

The transactional level. The bottom line for stakeholder management has to be the set of transactions that managers in an organization have with stakeholders. How do the organization and its managers interact with stakeholders? What resources are allocated to interact with which groups? There has been a lot of research in social psychology about the so called transactional environment of individuals and organizations, and we shall not attempt to recapitulate that research here. Suffice it to say that the nature of the behavior of organizational members and the nature of the goods and ser vices being exchanged are key ingredients in successful organizational transactions with stakeholders. 

Corporations have many daily transactions with stakeholder groups, such as selling things to customers and buying things from suppliers. Other transactions are also fairly ordinary and unexciting, such as paying dividends to stock holders and negotiating a new contract with the union. Yet when we move from this relatively comfortable zone of transactions to dealing with some of the changes that have occurred in traditional marketplace stakeholders and the emergence of new stakeholder groups, there is little wonder that transactions with the corporation’s stakeholder map become a real source of dis content. 

If corporate managers ignore certain stake holder groups at the rational and process level, then there is little to be done at the transactional level. Encounters between corporation and stakeholder will be, on the one hand, brief, epi sodic, and hostile, and on the other hand, non existent if another firm can supply stakeholders’ needs. Successful transactions with stakeholders are built on understanding the legitimacy of the stakeholder and having processes to routinely surface their concerns. However, the transactions themselves must be executed by managers who understand the currencies in which the stakeholders are paid. There is simply no substitute for thinking through how a particular individual can win and how the organization can win at the same time. 

The Narrative Approach to Stakeholder Theory 

‘‘The stakeholder theory’’ can be unpacked into a number of stakeholder theories, each of which has a ‘‘normative core,’’ inextricably linked to the way that corporations should be governed and the way that managers should act. On the narrative approach, ‘‘stakeholder theory’’ is thus a genre of stories about how we could live. A ‘‘normative core’’ of a theory is a set of sentences that includes, among others:

1 Corporations ought to be governed . . .

2 Managers ought to act to . . .

where we need arguments or further narratives which include business and moral terms to fill in the blanks. This normative core is not always reducible to a fundamental ground like the theory of property, but certain normative cores are consistent with modern understandings of property. Certain elaborations of the theory of private property, plus the other institutions of political liberalism, give rise to particular normative cores. But there are other institutions and other political conceptions of how society ought to be structured, so that there are different possible normative cores. Such a ‘‘reasonable pluralism’’ is what is meant by the idea of ‘‘enterprise strategy,’’ but even that concept is too much in the instrumental/ descriptive mode. 

One normative core of a stakeholder theory might be the doctrine of Fair Contracts. Another might be Feminist Standpoint Theory, rethinking how we would restructure ‘‘value creating activity’’ along principles of caring and connection. A third would be an Ecological (or several ecological) Normative Principles. Figure 2 is suggestive of how these theories could be developed. 

Figure 2 Stakeholder theory

Any normative core must address the questions in columns A or B, or explain why these questions may be irrelevant, as in the ecological view. In addition, each narrative must place the normative core within a more full fledged account of how we could understand value creating activity differently (column C). 

Research is proceeding along both the analytical and narrative lines. The rich panoply of concepts that is stakeholder theory threatens to replace, once and for all, the old way of thinking about the publicly held business as the sole property of stockholders, and offers the opportunity to build a wider shared vision of business into the twenty first century.

Bibliography

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Donaldson, T. J. and Preston, L. E. (1995). The stakeholder theory of the corporation: Concepts, evidence, and implications. Academy of Management Review, 20 (1), 65 91.

Freeman, R. E. (1984). Strategic Management: A Stake holder Approach. Boston, MA: Pitman.

Freeman, R. E. (1994). The politics of stakeholder theory: Some future directions. Business Ethics Quarterly, 4 (4), 409 21.

Mason, R. and Mitroff, I. (1982). Challenging Strategic Planning Assumptions. New York: John Wiley and Sons.

Nasi, J. (1995). Understanding Stakeholder Thinking. Helsinki: LSR-Julkaisut Oy.

Thompson, J. (1967). Organizations in Action. New York: McGraw-Hill.