From Shareholder Primacy To Stakeholder Primacy: How Family Businesses Lead The Way

Family businesses have long been regarded as underdeveloped businesses that could only succeed by adopting the rational, impersonal behavior of large corporations. But today, as we face emerging global challenges, the more personal values and principles of the family-owned business may offer a more desirable model for all corporations. It’s a model in which the voices and perspectives of shareholders, employees, customers and the community are all considered. And consensus is rising that this model is best situated to facilitate long-term success in an uncertainty-based environment.

Competing Models of Corporate Purpose

SAN FRANCISCO, CA – 1986: Nobel Prize-winning economist Milton Friedman poses on the balcony of his … [+]

For most of the last century, two contrasting views of corporate purpose have coexisted. The dominant view, associated with free-market economist Milton Friedman, posits that the exclusive purpose of the corporation is to provide profit for the owners, the shareholders. Other groups involved with the corporation, such as its employees, benefit by being paid for their work, but their needs are subservient to those of the owners. This view asserts that all decisions must optimize profits; each owner can do as they wish with their earnings; and businesses should not be burdened with any responsibility for achieving social goals. In the 1980s, this shareholder primacy model was celebrated and reinforced by the concept of “reengineering,” which led to companies being redesigned by experts to maximize their efficiency. Costs were cut and workers were laid off to heighten profits. Such reengineering was evident during the heyday of General Electric under the leadership of Jack Welch, whose original nickname was “neutron Jack.” Welch and other leaders like “Chainsaw” Al Dunlop were known for cutting costs, shedding employees and adding performance pressure to those who remained. It was a time when CEOs boasted of how they cut costs by firing employees and that the fear of being fired was the best motivator for employees to perform. Employees were viewed as fungible, replaceable and owed nothing but what they earned. The social contract in the corporation was seen as heartless and implacable.

A cautionary tale of the limits of this model concerns Boeing, which recently shifted its long-standing focus on engineering and pride in excellence to a new emphasis on cutting costs and increasing profits. Unfortunately, the shift appears to have led to neglect of safety and quality, causing a huge downturn for the company. Seeking short-term profits, as Friedman’s shareholder primacy model proposed, led Boeing to an immense loss of corporate value and the loss of many long-time employees, whose knowledge was lost to the company perhaps forever.

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A Contrasting Model

A contrasting corporate model is based on the belief that corporations are complex organizations bearing responsibility to all of its stakeholders: employees, customers, partners, the community and society as a whole. Called Stakeholder Capitalism, this model has gained momentum as business leaders have come to understand that they share in the task of fostering the well-being of the larger community. Recent values statements from the World Economic Forum and the Business Roundtable endorse investing in employees, delivering value to customers, having ethical relationships with suppliers and supporting communities and the environment— all as part of a corporation’s responsibilities. Given the rise of multiple societal crises, their message is that businesses cannot thrive without paying attention to ESG (environment, sustainability and governance) issues. Each business must consider and balance these priorities as they build an effective and profitable enterprise. There isn’t a simple formula or goal.

This inclusive view owes much to Edward Deming, an early proponent of the stakeholder model, who in the 1980s formulated 14 principles of management philosophy that became the basis for total quality and continuous improvement programs. Deming’s principles evolved from earlier work he had done with Japanese manufacturers as he helped Japan in its economic recovery after World War II. He envisioned business as a cooperative—a continually evolving community in which employees and management would find common ground, with small groups of workers and management working actively to improve the company. In return, the company would maintain a “social contract” of responsibility to employees. This approach aligned the energies and harnessed the motivation of all levels of a company, and it encouraged everyone to foresee how to navigate unexpected crises in ways that would be fair and equitable to all.

In a related approach, Jack Stack, a family business owner, turned a failing business around—spectacularly—by adopting a the leadership model known he called “open-book management.” Stack shared relevant financial information and critical data with employees and asked them to join him as partners in making the company more effective and competitive. Because they were invited to help and be involved, and because the information they were privy to helped them understand how the business was doing and what was needed, they received what everyone felt was a fair share of profits. Stack and the many adherents of open-book management have observed that this shared engagement leads to greater profits for everyone—for when employees are valued as contributors, the energy and knowledge they contribute add value to the company. It’s an approach that views employees as an investment rather than a cost to be minimized. Stack’s company, SRC Holdings Corporation, is now a 100% employee-owned company.

Corporate Responsibility for the Environment and the Community

The shareholder and stakeholder primacy models offer contrasting views regarding corporate responsibility for the community and the environment. According to the owner-profits-only perspective, if everyone and every company pursues their own self-interest, an “invisible hand” of the market will somehow benefit the whole community. But this does not appear to happen.

In contrast, the stakeholder approach believes that every entity has to attend to the well-being of the social environment. The tragedy of the commons, a concept popularized in 1968 by ecologist Garrett Hardin, suggests that if everyone pursues their own self-interest, shared environmental resources will be overused and exploited, creating damage and cost to the whole community. Who, Hardin asks, ought to shoulder responsibility for the costs of pollution, health risks, environmental decay, erosion, waste, pain caused by faulty products and the worsening environmental situation? The stakeholder model affirms that every company and individual can and must contribute to protecting and restoring the commons and that companies and communities have to join forces to make this happen. These undertakings may be costly in the short-term, but they support future value. And social responsibility emerges when the company joins the community to repair and repay the costs of collective damage. Recent disasters and the breakdown of the power grid, or the cost of wildfires, focus on responsibility for the shared commons.

The Family Business as a Template for Stakeholder Capitalism

While media attention is often focused on large corporations, the vast majority of businesses are small and medium sized (SMEs), primarily owned and managed by the family. And throughout the world, many of the largest public company businesses are owned or controlled by family owners. The predominant assumption has been that the large non-family corporations, often those that adhere to the Friedman model, are models to emulate. But now and as we look to the future, the stakeholder model as embodied in family businesses has come into its own.

Family businesses adapt the collaborative, stakeholder model of business because of their very nature. In a family business, the owners are not a group of strangers who share only a desire for profit; the owners are related to each other, and because of their relationship they care about more than profit, though that is certainly important. This concern about personal relationships within the family leads them to value their bonds with their employees. They care about employees who have worked with them for many years, often employing several members of a family and even across generations. And family business owners also care about the community they live in, because if the community does not thrive, everyone loses, and the community’s quality of life is reflected in their reputation. For these reasons, many family businesses have been restrained in moving manufacturing offshore or dismissing employees during down-turns.

This inclusive model is not new; it has always been prevalent among family companies. In the 19th century, companies such as Cadbury’s created villages, housing and services for employees because they felt a responsibility for their well-being. Family owners accept personal responsibility because their values are on display in their business. They realize that their success is connected to the support of their employees, suppliers and customers, and they live by values that are greater than just financial success. The owners of a family business also care about their family’s legacy and the world they will bequeath to their children and grandchildren, which leads to a longer-term perspective. The owners are willing to limit what they take out of the business now to reinvest in its future, and this includes the cost of caring about and investing in their employees. In this respect, family businesses answer one of the major dilemmas in the Friedman model: When making decisions, should the rational, profit-optimizing company aim for short-term returns to owners, or should they create conditions for the company to thrive long-term? Family businesses care more for the latter, and to ensure long-term success, they for example, may create two classes of stock, with one class given to a small number of family owners who have voting rights on major decisions. These voting shareholders can preserve a long-term view and resist quick fixes that generate immediate profit but weaken investment on the future. When non-voting owners invest in the company, they know about and support that perspective. An owner primacy company also must balance current benefit with future opportunities, but its inherent demands for immediate profit place a heavy weight on its decision making.

Rising Generations as Champions of the Stakeholder Model

Larger family businesses are connected to broader communities—often global in scope—yet size does not seem to diminish their owners’ values or concerns that go beyond immediate profit. This is often because the owners’ children, who are in training to become the new leadership, have been educated and prepared to sustain these values. They grew up exposed to environmental concerns and are sensitive to the role the company plays in making the environment sustainable. They are also well aware of how their family wealth and influence can help build the community. These rising leaders want to make a difference, and the success of the family enterprise allows them to focus on social concerns and to even challenge their elders. They want to be able to point with pride at what their family has done.

This energy, talent and concern of the rising generation is an advantage that family businesses have over non-family corporations. Young people who grow up in a successful family business recognize that they are likely to inherit ownership and responsibility for the future of the business. And while they grow up with affluence, their parents are generally and rightly concerned that they do not become entitled young people, living with the benefits of their wealth without any sense of responsibility for its future. Fortunately, many young people from such families have grown up with the opportunities of a broad education and global travel, both of which have instilled in them a concern for the environment and a sense of responsibility for the wealth they are due to inherit. They want their family to adopt a socially responsible view of their business and how they use their wealth.

While not every heir develops these views and rejects entitlement, it appears that every family business has at least some young people in this camp. And in the most successful business families, steps are taken to discourage excessive spending and irresponsible behavior, and the family leaders, alongside future leaders from the rising generation, adopt a socially responsible ethic in their corporate priorities.

There are many examples of how, after building a profitable and successful enterprise, a family business began to focus on social impact. A generation ago, Ray Anderson, who founded the carpet tile company Interface, began to consider the impact his company had on the environment. He saw that Interface was profitable in part because it did not have to bear the costs of waste and discarded carpets. Corporate waste was an expense that was left to the community. The profit primacy model would say that Anderson should not have been concerned about this as it was not his or his company’s problem. But Anderson and others asked an essential question: Who was going to pay those costs to reduce the long-term impact of their waste? Subsequently, Anderson made a commitment for his company to pursue a policy of zero waste—in a way that kept the company in business but did its part to solve the collective problem of waste. Realizing that discarded carpet tiles were a shared problem, Anderson redefined his business model from selling tiles to providing the service of floor covering, which included taking responsibility for removing used carpet. Anderson realized that this change would be difficult and costly, but he also believed that the investment could eventually lead to lower costs and other efficiencies and would help instead of hurt the environment. And being the owner as well as the CEO, he was able to make that shift without having other owners revolt against the initial expense of this effort.

When it comes to creating this kind of responsible innovation, family businesses have a great advantage over public companies. If a CEO of a large corporation wants to follow Anderson’s example, they might be facing owners, including short-term investors, who seek immediate profits and do not share this concern. Is the pursuit of profit interpreted to mean immediate returns or reinvestment in capabilities that may not bear fruit for many years? This is where the values of long-term family owners and their concern for future generations can show the way.

The Family Business Network, with chapters in scores of countries, asks its members to make a sustainability pledge that they call Polaris, suggesting that these values become the North Star of the family focus. They ask family owners and their companies to create a plan for social, community and environmental sustainability. To show the various paths this can take, they have collected many stories that tell how rising generation family members have become champions in helping their family business move toward environmental sustainability and social responsibility.

After several generations in which the profit-only orientation was seen as the superior model of corporate values, today, as we face environmental and social crises that cannot be resolved by the “invisible hand” of the market, there is a growing need for companies and individuals to see that their own interests are best pursued when they view them as connected to the of others and the survivability of their community and beyond. Family businesses have become wellbeing the vanguard in defining the stakeholder approach to enterprise and showing how it can simultaneously be profitable and help to create a better world.

For the last 40 years, I have been one of the early architects of the field of “family enterprise consulting.” Family enterprise consulting means primarily assisting

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