It is perhaps the core question in the ongoing debate over corporate governance: Does the corporation exist for the benefit of shareholders, or does it have other, equally important stakeholders, such as employees, customers and suppliers?

A new study titled, “Stakeholder Capitalism, Corporate Governance and Firm Value,” by Wharton finance professor Franklin Allen, Elena Carletti of the Center for Financial Studies at the University of Frankfurt and Robert Marquez of Arizona State University does not provide a definitive answer. But in showing the various benefits of the stakeholder approach, it demonstratesthat the issue is not as settled as some researchers and business people in the United States, United Kingdom and other shareholder-oriented nations might think.

Several conclusions emerge from the study, which uses a mathematical model to explore the advantages and disadvantages of stakeholder-oriented firms. First, stakeholder-oriented companies have lower output and higher prices, and can have greater firm value than shareholder-oriented firms. Second, firms may voluntarily choose to be stakeholder-oriented because it will increase their value, according to the study.

Third, the researchers find that consumers who prefer to buy goods and services from stakeholder firms can increase the number of stakeholder-oriented companies in a society. Finally, the study shows that, with the rise of globalization, domestic companies (both the stakeholder and shareholder types) earn more profits when stakeholder-oriented firms from foreign countries, rather than foreign shareholder-oriented firms, enter those domestic companies’ markets.

Although the study finds much to like about stakeholder-oriented companies, it does unearth one downside: Consumers can be harmed by the higher prices charged by stakeholder firms. Higher prices enable these firms to put into practice the often-costly governance structures that benefit people other than stockholders.

The study comes at a time when some countries with a stakeholder-oriented business climate, such as Germany and France, have felt pressure to revive their (until recently) moribund economies by adopting policies that are closer to the shareholder-oriented view. Both Angela Merkel, Germany’s chancellor, and French president Nicolas Sarkozy rode into office promising at least some change in this regard.

“We were somewhat surprised at the results of the study,” Allen says. People tend to think about the governance issue “in terms of workers versus owners, although there is more to it than that. It’s usually believed that if a company is earning ever-higher profits and is generally doing better, its workers are somehow worse off. But that is not the case. Often, when it comes to stakeholder-oriented firms, both the company and workers can do better simultaneously. But consumers are worse off, so not everyone benefits.”

Another surprising finding is that “some companies may choose to become stakeholder-oriented because it increases their value and benefits shareholders,” according to Allen.

The study adds to the discussion of corporate governance and the role of corporations vis-a-vis their stakeholders. In the United States and other Anglo-Saxon economies, the law makes it clear that shareholders are the owners of firms and that managers have a fiduciary responsibility to act in the interests of shareholders. Most academic literature on governance begins with this perspective and, indeed, this is the dominant orientation of the business and investment communities of such countries.

But in many societies, the maximization of shareholder value is far from the accepted corporate paradigm. In their study, Allen and his co-authors discuss other countries where the interests of parties other than stockholders have bearing on the corporate policies.

Worker Participation in Decision Making

Germany’s legal system, for example, makes it clear that firms do not have a sole duty to pursue the interests of shareholders. Under Germany’s system of “co-determination,” employees and shareholders in large companies hold an equal number of seats on the companies’ supervisory boards, and the interests of both parties must be taken into account in decision making. In Denmark, employees in firms with more than 35 workers elect one-third of the firm’s board members, with a minimum of two. In Sweden, companies with more than 25 employees must have two labor representatives appointed to the board. These employee board members have all the rights and duties of other board members.

The situation differs somewhat in France. French firms with more than 50 workers have employee representatives at board meetings, but they do not have the right to vote. More conventional co-determination systems exist for former public-sector French firms that have been privatized; these systemscan be introduced voluntarily by companies. In Finland, companies can also voluntarily adopt employee representatives on the board. Across the European Union as a whole, another type of worker participation in decision making is the works council, a group that has a say in such issues as layoffs and plant closures. A corporation with at least 1,000 employees, of which there are 150 or more in at least two EU countries, must have a “European Works Council.”

The situation in Japanese firms also differs from that of the United States and United Kingdom. Japanese executives do not have a fiduciary responsibility to stockholders, but they can be liable for gross negligence in performing their duties. It is a widely accepted practice in Japan that firms pursue the interests of a variety of stakeholders.

Indeed, one survey of managers in various countries has shown just how divergent opinion can be on the question of “whose company is it?” In Japan, 97% of those surveyed said a company exists for all stakeholders, compared with 83% in Germany, 78% in France, 76% in the United States and 71% in the United Kingdom.

The survey showed other differences in managerial priorities in these countries. For example, Japanese firms feel that if they are going through a tough period financially, keeping their employees on the job is much more important than maintaining dividends to shareholders. Specifically, only 3% of Japanese managers said companies should maintain dividend payments to stockholders even if it means the company has to lay off workers, compared with 41% in Germany, 40% in France, and 89% in both the United States and the United Kingdom.

In the study, Allen and his colleagues developed a mathematical model of stakeholder governance. The model involves two hypothetical firms (a duopoly) that are selling products in competition with one another and wish to avoid bankruptcy so that they can survive from one period to the next.

The model takes into account the following scenarios. In the first period, the firms are subjected to a random “shock” to their costs. If the shock is great enough, the firms could be forced into bankruptcy. If both firms survive, they repeat the competition in the second period. If only one firm survives, that firm becomes a monopolist in the second period. In choosing their first-period prices, the firms take into account the effects of the prices on first-period profits, as well as on the probability that the firm will survive into the second period.

The model defines stakeholder governance as firms putting weight on the effects of bankruptcy on stakeholders other than shareowners. The model demonstrates that when companies put weight on stakeholders other than shareholders, this concern leads to a “softening” of the competition — that is, firms charge higher prices and their probability of going bankrupt is reduced. As a result, profits in the first period, as well as firm value, can be increased.

“Thus a concern for other stakeholders can actually benefit shareholders through its effect on firm value,” Allen and his fellow researchers write. “Of course, workers, and other suppliers are also better off from the softening of the competition. However, since prices are higher, not everybody is better off and, in particular, consumers are worse off.”

The fact that companies can boost their value by showing concern for employees and other stakeholders raises the possibility that shareholders may actually want to put in place governance structures that commit them to taking steps to address the concerns of others.

The researchers’ model also shows that even in circumstances where firms may not voluntarily adopt a stakeholder orientation, such governance structures as those that exist in Europe may arise nonetheless if consumers are more willing to buy from firms that care about stakeholders other than shareholders. “Interestingly, this leads to a situation of self-enforcing societies where consumers induce firms to adopt stakeholder concerns, and consequently increase the value to shareholders,” the study notes.

Globalization And Governance

Given that globalization makes it more common than ever for domestic firms to compete with companies around the world, the researchers wanted to see how globalization affects governance. Significantly, they found that regardless of the governance structure in any given country, “incumbent firms” — those that already exist — actually fare better, in the form of achieving higher profits, with the entry of a stakeholder-oriented firm into their market than they do with the entry of a shareholder-oriented firm.

“This suggests that firms in countries that are stakeholder friendly [such as Japan] have greater incentives to oppose the entry of firms with shareholder-oriented governance structures [such as U.S. companies] than vice-versa,” they write. “Similarly, the desire for governments to protect domestic firms from foreign competition is likely to be greatest for stakeholder economies facing potential entry by shareholder-oriented firms.”

Globalization and governance are two issues that are not about to disappear. In future research, Allen says he would like to explore in greater depth whether stakeholder- or shareholder-oriented firms will have the upper hand in any given country as globalization marches forward. “It’s a significant long-run issue,” he notes. “The stakeholder orientation of firms is discussed a lot in Germany, for example, because it’s been under attack in that country by some economists and business leaders who argue that such an orientation is harming German competitiveness. The politicians there say they will stick with it, but we don’t know what will happen. This paper is the start of a bigger project that we will do to understand how important this issue is.”

Stakeholder Capitalism, Corporate Governance and Firm Value