Business Horizons (2005) 48, 255 — 264

www.elsevier.com/locate/bushor

The lessons from stakeholder theory for U.S.

business leadersB
Ronald W. Clement

Kelce College of Business, Pittsburg State University, Pittsburg, KS 66762, USA

KEYWORDS Abstract It has been 20 years since Freeman [Freeman, R. E. (1984). Strategic
Stakeholder; management: A stakeholder approach. Marshfield, MA: Pittman Publishing.] first
Stakeholder theory; proposed his stakeholder approach to strategic management, which stated that
Stakeholder corporations must consider the needs and demands not only of their shareholders but
management; also those of a wide range of other external constituencies, or bstakeholders.Q
Stakeholder approach; Examples of stakeholders include customers, employees, suppliers, and commun-
Strategic ities. Freeman’s theory has generated an extensive body of research, including not
management only the efforts of the management researchers who have tested, revised, and
refined the theory, but also the views of corporate executives who have used the
stakeholder approach in their strategic planning. This article, based upon a review of
that literature, identifies five important lessons from the stakeholder model for
today’s business leaders. These lessons are particularly timely, given the inappro-
priate behavior that has occurred in the business world during recent years.
D 2004 Kelley School of Business, Indiana University. All rights reserved.

1. The stakeholder approach
The stakeholder approach to strategic manage-
ment was first proposed by R. Edward Freeman in
1984. In contrast to the traditional view of
corporate strategy, which largely equates the term
bstakeholderQ with the owners, or stockholders, of
the corporation, Freeman defined a stakeholder
more broadly as bAny group or individual who can
affect or is affected by the achievement of the
firm’s objectivesQ (p. 25). This view was revealing
B
This manuscript was accepted under the editorship of Dennis
W. Organ.
E-mail address: rclement@pittstate.edu.
0007-6813/$ - see front matter D 2004 Kelley School of Business, Indiana University. All rights reserved.
doi:10.1016/j.bushor.2004.11.003
in that Freeman was the first management writer
to so clearly identify the strategic importance of
groups and individuals beyond not only the firm’s
stockholders, but also its employees, customers,
and suppliers. Indeed, he saw such widely dispa-
rate groups as local community organizations,
environmentalists, consumer advocates, govern-
ments, special interest groups, and even compet-
itors and the media as legitimate stakeholders.
During the 20 years since Freeman first proposed
his stakeholder approach to strategic management,
an extensive body of research has been performed
on his theory. That research has included not only
the efforts of the management researchers who
have tested, revised, and refined his theory, but
also the views of the corporate executives who
256
have used the stakeholder approach in their
strategic planning. The present article, based upon
a review of that literature, identifies five impor-
tant lessons from the stakeholder model for today’s
business leaders. These lessons are particularly
important today, given the inappropriate behavior
that has occurred in the business world in recent
years. The five lessons, which are explained in the
succeeding sections of the article, may be sum-
marized as follows:
(1) Corporations are facing increasing pressures
to respond to their stakeholders.
(2) Corporations have a legal basis for responding
to a wide range of stakeholders.
(3) Corporations are being led by executives no
longer guided by the principles of their
professions.
(4) Corporations respond to powerful stakehold-
ers with legitimate, urgent claims.
(5) Corporations can improve the bottom line by
responding to stakeholder concerns.
2. Corporations are facing increased
pressures to respond to their
stakeholders
To be blunt, the stakeholders of today’s corpora-
tions have raised their expectations concerning the
decision making of the executives leading those
corporations. Not only customers and employees,
but also investors, communities, governments, and
even competitors are becoming more vocal and
active in seeking improved behavior on the part of
U.S. corporations. The pressures from these many
stakeholders focus on a host of issues important to
both the success of U.S. business and the well-being
of the larger society.
2.1. Pressures from many sources
Waddock, Bodwell, and Graves (2002) indicated
that the pressures to reform stakeholder-related
practices have been coming not only from primary
and secondary stakeholders, but also from general
social trends and institutional expectations. In
dividing stakeholders into primary and secondary
groups, Waddock et al. (2002) used the catego-
rizations suggested by Clarkson (1995). A primary
stakeholder, according to Clarkson, is one whose
continuing participation is critical to the survival of
the corporation. Included in this group are share-
holders, employees, customers, and suppliers, all
of whom clearly can have a substantial, and often
times immediate, impact on the corporation. For
example, the loss of major customers can, obvi-
R.W. Clement
ously, damage a company. Secondary stakeholders,
although able to influence and be influenced by the
corporation, b. . . are not engaged in transactions
with the corporation and are not essential for its
survivalQ (p., 107). Waddock et al. listed four
secondary stakeholders, including non-governmen-
tal organizations (NGOs), activists, communities,
and governments.
Waddock et al. (2002) also identified three
examples of the added pressures corporations have
been facing from primary stakeholders:
(1) The social investment movement—the invest-
ments of which now total more than US$2.3
trillion, or one out of eight professionally
managed investment dollars.
(2) Employee attitudes about where to work—a
critical issue today, given the corporate
demand for high-skilled employees who
can play a major role in a firm’s competitive
advantage.
(3) The increased desire of customers to purchase
from responsible companies—a particularly
important issue, given the rising purchasing
power of those customers.
The pressures from secondary stakeholders have
included two broad developments. The first is the
increasing capacity of NGOs and global activists to
mobilize their resources for improved corporate
responsibility. Due to the global ease and trans-
parency of electronic communication, they are now
better able b. . . to mobilize their resources, dis-
seminate negative information about companies,
and take concerted action against [offensive]
practicesQ (Waddock et al., 2002, p. 136). Their
efforts have led to improved corporate decisions
concerning human rights standards, labor stand-
ards, and environmental management.
The second broad development within the sec-
ondary stakeholder category is the increased aware-
ness by communities and governments of the
potential for harmful business behavior within a
community or region. In the US, communities and
state governments have become more aware that
corporations may lack a long-term commitment to
their investment in a locale (e.g., a new manufac-
turing plant or an expanded distribution facility).
Too often, the result has been that the firm—
perhaps for beconomicQ reasons—abandons the
locale, leaving such problems as increased unem-
ployment and an eroding tax base in the wake of
their departure. At the international level, pres-
sures for corporate reform have come from such
organizations as the United Nations and the Organ-
ization for Economic Cooperation and Develop-
ment, which have developed global standards and
The lessons from stakeholder theory for U.S. business leaders
principles to promote values-based practices among
global firms. For example, the UN’s Global Compact
promotes values-based practices concerning human
rights, labor, and the environment.
2.2. The special case of environmental
management
Concerning environmental management specifi-
cally, Berry and Rondinelli (1998) noted that
governments, customers, employees, and even
competitors are pressuring corporations to make
socially responsible decisions. Part of the reason is
that governments everywhere, particularly those in
the industrialized world, are facing public pres-
sures to assure a cleaner environment. The result
has been a rapidly growing array of stringent
government regulations with burdensome legal
liabilities. As these authors indicate, bNot comply-
ing with government regulations is no longer an
option for corporations that seek to be competitive
in international marketsQ (p. 39). Industrialized
countries, including the United States, have devel-
oped a complex array of environmental regulations
in recent years. For example, in the US alone, there
are more than 100,000 federal, state, and local
rules and regulations on environmental issues.
Corporations entering global competition simply
must be prepared to address the environmental
concerns of worldwide markets.
The cost of environmental performance includes
both a reactive and a proactive side. The reactive
side is the expense of complying with existing
regulations and the cost of heavy fines (and even
prison sentences) for violations. The proactive side
refers to the investments many corporations are
now making in preventive approaches to improve
their environmental performance. In particular,
several companies, including 3M, Sony, and Procter
& Gamble, have recently been recognized for
effective environmental performance. Among
other things, these companies are minimizing or
preventing waste, designing recyclable products,
and using full cost accounting to identify the
environmental costs of ongoing operations.
2.3. Pressures on the corporate governance
process
Finally, corporations are facing pressures to
include non-shareholder stakeholders in the cor-
porate governance process. For example, Luoma
and Goodstein (1999) found that, compared to 20
years ago, corporations are much more likely to
include such stakeholders as suppliers, customers,
employees, and members of the public on their
257
boards of directors. The researchers concluded
that the reasons for including these stakeholders
are (1) the adoption of statutes in many states
that give boards of directors the right to consider
the interests of non-shareholder stakeholders, (2)
the need for corporations, particularly those in
highly regulated industries, to respond more
effectively to public and governmental scrutiny,
and (3) the increasing size and complexity of
today’s modern corporation. Concerning the third
point specifically, Luoma and Goodstein said that,
bBy virtue of their size, large organizations are
more visible and hence subject to greater atten-
tion from such external constituencies as the
state, the media, professional groups, and the
general publicQ (p. 4).
3. Corporations have a legal basis for
responding to a wide range of
stakeholders
Despite a lingering belief in U.S. society that
corporations have a duty mainly to their share-
holders, there is considerable evidence that laws,
regulations, and court decisions favor a responsibility
also to non-shareholder stakeholders. This evidence
includes not only the laws and regulations affecting
business activity, but also the pattern of court
decisions in recent years. It is important to note that
the blegalQ argument here is not the same as that
made in 1962 by Milton Friedman (Friedman, 1962),
who said that corporate executives should maximize
profits for stockholders within society’s established
legal framework. Rather, the point here is that those
executives now have a legal basis for going beyond
simple profit maximization to respond to the
demands of stakeholders other than stockholders.
3.1. The legal support for a stakeholder view
Concerning laws and regulations, this article has
already cited Freeman’s (2001) description of legis-
lation that affects business behavior concerning
customers, employees, and the broader community.
Included are laws on product safety, discriminatory
human resource practices, and pollution preven-
tion. Donaldson and Preston (1995) also emphasized
the role of laws and government regulations in
saying that both court decisions and legislation have
weakened the traditional bbusiness judgment rule,Q
which says that management may conduct the
company’s affairs b. . . only on the condition that
the financial welfare of stockholders is single-mind-
edly pursuedQ (p. 75). As they note, most states have
adopted statutes that allow boards of directors to
give consideration to a wide range of non-share-
258
holder stakeholders, including employees, custom-
ers, suppliers, creditors, and local communities.
Regarding recent court decisions, Marens and
Wicks (1999) concluded that, although courts
historically have encumbered corporate managers
with a fiduciary duty toward stockholders, they
have done so merely to prevent managerial self-
dealing. They have not equated that fiduciary duty
to either a managerial responsibility to favor
stockholders over other stakeholders or a right of
stockholders to oversee managerial decision mak-
ing. These researchers concluded that bNo court
equates this duty with dmaximizing shareholder
valueT. . . What the duty does require is honesty and
candor in the relationship with the stockholder and
a general avoidance of using one’s office for
illegitimate personal gainQ (p. 276).
3.2. The legal view of fiduciary duties
Continuing with the issue of fiduciary duties,
Marens and Wicks (1999) explained that courts are
beginning to impose those duties on managerial
behavior directed toward non-shareholder groups.
As an example, they cite the Supreme Court
decision in Varity v. Howe (1996) concerning a
company that had shifted its money-losing ventures
into a subsidiary that later went bankrupt. The
court ruled that the company had breached its
fiduciary duty with its employees in that subsidiary.
These researchers further noted that stockholder
attempts to challenge managerial behavior toward
other stakeholders have almost always failed in the
courts. As evidence, they cited cases in which the
courts have allowed corporations, in spite of
shareholder opposition, to invest in economic
development to improve community relations, to
build a company town to improve employee
relations, and to make charitable contributions in
the spirit of enlightened self-interest.
Boatright (1994) also made a strong case for the
responsibilities of corporations to stakeholders
other than shareholders. As he indicated, corporate
officers and directors are not, legally, in a con-
tractual or an agency relationship with sharehold-
ers. Specifically, he said that bMany of the fiduciary
duties of officers and directors are owed not to
shareholders but to the corporation as an entity
with interests of its own, which can . . . conflict with
those of shareholdersQ (p. 403). He also explained
that public policy, as determined by the courts and
legislatures, recognizes the fiduciary duties of
corporations to non-shareholder stakeholders and
allows firms to take the interests of those stake-
holders into account.
R.W. Clement
4. Corporations are being led by
executives no longer guided
by the principles of their professions
According to popular belief, top executives are
heavily influenced in their decision making by what
they learn and experience in their areas of func-
tional expertise. For example, accounting execu-
tives should be guided by the principles established
by such professional organizations as the National
Accounting Standards Board, and legal executives
should follow the standards of the American Bar
Association and their state and local bar associa-
tions. On the contrary, however, recent research
indicates that the decision making of top execu-
tives is affected much more by the social influences
they encounter in their interactions with their peer
top executives. In other words, regardless of the
functional areas in which these individuals began
their careers, by the time they reach executive
ranks, they are swayed much more by the values,
beliefs, and attitudes of their new peer group.
4.1. The influence of the top executive team
In a comprehensive study of this issue, Chattopad-
hyay, Glick, Miller, and Huber (1999) examined the
executive beliefs and demographic characteristics
of 371 executives in 58 strategic business units
across 26 industries. Their results indicated b. . .
much stronger support for the effects of social [i.e.,
peer group] influence than for the effects of func-
tional background and current functional posi-
tion. . .Q (p. 780). They noted several reasons for
the much weaker influence of functional condition-
ing. For example, managers increasingly are gaining
experience in several functional areas in their rise to
the top levels of their companies. In fact, executives
often are promoted on the basis of their ability to
see beyond functional boundaries. The reason is that
they need to take a broad view of corporate
opportunities and challenges, rather than the more
narrow view that a one-function career would yield.
Chattopadhyay et al. (1999) also cited earlier
research that further confirms the weak role
functional experience can play in influencing
executive decision making. For example, they
noted that Walsh (1988) had found that three-
quarters of the managers in his study saw success-
ful decision making as crossing functional lines;
that is, they believed the best decisions included
ideas from several functional areas. Beyer et al.
(1997) also found that areas of experience unre-
lated to an executive’s function can play a major
role in his or her decision making. They suggested
The lessons from stakeholder theory for U.S. business leaders
that functional experience may unduly restrict an
executive’s focus of attention, thereby obscuring
his or her view of important non-functional
information.
4.2. The important role played by personal
relationships
Brass, Butterfield, and Skaggs (1998) also consid-
ered the role of social influences on decision
making in organizations. While they acknowledged
the importance of personal factors, such as one’s
moral development, and situational factors (e.g.,
the organization’s reward system) in affecting
decision making, the authors also emphasized the
role played by relationships that develop among
the decision makers. Specifically, they suggested
how both the types of relationships in organizations
and the structure of those relationships can lead to
unethical decisions. Concerning the types of rela-
tionships that form, they said that the ethicality of
an executive team’s decisions can be influenced by
how strong their relationships are and the extent to
which those relationships extend to multiple set-
tings. For example, strong relationships in an
organization culture that values ethical treatment
of stakeholders would minimize the chances for
unethical treatment of those stakeholders. Further,
executives who interact with each other in multiple
settings (e.g., at work, at the club, in personal
friendships) would have greater influence over
each other than those who interact only at work.
The bremindersQ to act ethically would be more
frequent and more obvious. However, for such
personal relationships to foster ethical behavior
(as opposed to the problematic behavior observed
in many companies in recent years), an organiza-
tion culture supportive of ethical behavior must
prevail. The company’s leadership, particularly the
board of directors and the CEO, can help to foster
that type of culture by communicating the impor-
tance of ethical practices, rewarding those who
engage in ethical decision making, and modeling
ethical behavior themselves.
Regarding the structure of relationships that
form within the executive team, Brass et al.
(1998) suggested, among other things, that the
centrality of a key individual and the density of the
relationship can affect the decision making proc-
ess. An executive is bcentralQ when he or she can
easily and directly contact the other members of
the network. This ease of access would give that
individual substantial influence over the other
executives and, therefore, control over the deci-
sion making process. Dense networks are those in
which the members are highly interconnected: they
259
are in contact with each other on a continuing
basis. This btightnessQ can often yield ethical
decisions because it allows for high surveillance
and an increased chance for lost reputation (i.e.,
one is more likely to be caught and exposed).
5. Corporations respond to powerful
stakeholders with legitimate, urgent
claims
As mentioned earlier in this article, Freeman’s
(1984) seminal work on stakeholder theory defined
a stakeholder as bAny group or individual who can
affect or is affected by the achievement of the
firm’s objectivesQ (p. 25). Although this definition is
still widely used throughout the management
literature, it is perhaps too broad to identify the
relative importance of the different stakeholder
groups faced by a corporation. Fortunately, recent
research has made considerable strides in identify-
ing important stakeholder features.
5.1. Power, legitimacy, and urgency: Three
important stakeholder characteristics
Mitchell, Agle, and Wood (1997) proposed a model
of stakeholder identification that suggests how to
identify not only the stakeholders on which exec-
utives should focus, but also the relative impor-
tance of each. Specifically, they said that a
consideration of three stakeholder features—
power, legitimacy, and urgency—can provide exec-
utives with the ability to decide how and when to
respond to their corporation’s many constituencies.
In the model, a stakeholder has power to the extent
that it can impose its will in its relationship with
the firm. That same stakeholder has legitimacy
when its actions toward the firm are widely seen as
desirable, proper, or appropriate within the norms,
values, and beliefs of the larger society. For
example, employee attempts to form a union
generally would be seen as legitimate in today’s
U.S. society, but employee efforts to force a firm to
provide stock options generally would not. Finally,
urgency exists b. . . when a relationship or claim is of
a time-sensitive nature and when that relationship
or claim is important or critical to the stakeholderQ
(Mitchell et al., 1997 p. 867). In other words,
urgency is the extent to which stakeholder efforts
call for immediate attention by a firm.
The Mitchell et al. (1997) model further suggests
that executives should attend to the demands of a
stakeholder organization to the extent that it
manifests each of the three stakeholder variables.
If only one of the three variables (legitimacy, for
instance) is present, the demands of the stake-
260
holder may not be seen as particularly important,
and the stakeholder would be seen as blatentQ or
low in salience. At the opposite extreme, if all
three variables are present, executives should
recognize that an immediate and full response is
needed, and the stakeholder should be seen as
bdefinitiveQ or high in salience. For example,
pension funds with major investments in Disney
Inc., recently pressured the Disney board to reduce
the authority of Disney CEO Michael Eisner. Because
the demands of these powerful, legitimate stake-
holders were seen as urgent, the Disney board
removed Eisner as chairman and assigned that post
to board member and former U.S. Senator George
Mitchell (Gunther, 2004).
5.2. First power, then urgency, then
legitimacy
Agle, Mitchell, and Sonnenfeld (1999) found sup-
port for the Mitchell et al. (1997) model in a survey
of the CEOs of 80 companies. However, they also
found that, of the three stakeholder variables
(legitimacy, power, and urgency), urgency was the
best predictor of executive response. Finally, they
found that the traditional bproduction functionQ
stakeholders (shareholders, employees, and cus-
tomers) were seen as the most important ones by
the executives who responded to their survey. They
concluded that a stakeholder class exists in today’s
business world, in which shareholders, employees,
and customers are privileged, while government
agencies and communities are not.
Despite the emphasis of Agle et al. (1999) on the
prominent role of urgency, it seems likely that
power also plays a major role in determining
whether and how executives will respond to stake-
holder demands. First, urgency is unlikely to be
seen as a critical factor unless a stakeholder also
has the power to successfully take action against
the firm. Second, other research has made a strong
case for the critical role for power in stakeholder
relationships. For example, Frooman (1999) con-
trasted power with legitimacy and suggested that
the appropriateness of a stakeholder’s claim may
not be as important as the stakeholder’s ability
(i.e., power) to influence a firm’s decision making.
He concluded further that the power of stake-
holders would rest on a firm’s dependence on the
resources controlled by those stakeholders. For
instance, investors wishing to purchase high-inter-
est junk bonds might have power over the firms
offering such bonds because those firms carry
reduced investment ratings (and therefore may
not have access to other sources of capital).
Frooman also said that stakeholders with such
R.W. Clement
power can exercise it in either of two ways: (1)
They can simply withhold the needed resources, or
(2) they can dictate the way in which the firm may
use the resources. The first approach might be used
when the stakeholder wishes to prevent a certain
action by the firm, and the second might be likely
when the stakeholder wishes to encourage certain
behavior by the firm.
Rowley (1997) took the power issue a step
further by noting that the relationship between a
firm and a stakeholder may be more than a simple
framework of dyadic (i.e., firm-to-stakeholder)
ties. He suggested instead that the relationship
involves a network of influences in which stake-
holders have multiple and direct relationships not
only with the firm but also with each another. He
said the resulting network of stakeholders will be
powerful to the extent that the network is dense
and the focal firm holds a position that is central to
the network. According to Rowley’s notion of a
bdenseQ network, the stakeholders have many ties
among themselves, thereby yielding shared expect-
ations, efficient communication, and easy coalition
formation— all of which make action against the
firm more effective. The bcentralityQ of the firm
refers to its position within the firm-to-stake-
holders network. For example, a firm that can
easily contact all the stakeholders and which
further can act as a gatekeeper for information
within the network is highly central and, therefore,
in control of the network. In Rowley’s words, the
firm b. . . is able to influence behavioral expect-
ations and manage information flows so that its
actions either go unnoticed or are presented in a
self-serving fashion. . .Q (p.900).
5.3. Even bfringeQ stakeholders can now gain
access to power
Finally, Hart and Sharma (2004) emphasized the
importance of responding to the demands of stake-
holders that historically have been considered non-
powerful, or bfringe.Q Included here are the illiter-
ate, the poor, and the isolated that have, tradi-
tionally, had little impact on corporate decisions;
examples are the urban homeless in the U.S. and
the rural poor in developing countries. Hart and
Sharma said that many of these types of stake-
holders have more power in today’s business world
due to the influence of globalization and the
expanding role of the Internet. Particularly when
they can gain the support of non-governmental
organizations and civil society groups, they can
communicate quickly and effectively in marshalling
their forces against corporate action. An example is
the backlash in the developing world to Monsanto’s
The lessons from stakeholder theory for U.S. business leaders 261

attempt to commercialize seed sterilization tech- to reach a million families in Mexico within 5
nology and become a leading global life science years.
company. Although Monsanto had responded to the
concerns of all salient and seemingly important
stakeholders and had even received government
6. Corporations can improve the bottom
approval of its products and technology, it had line by responding to stakeholder
failed to grasp the importance of certain fringe concerns
stakeholders. In particular, the company had not
Until recently, there was much controversy in the
considered the reaction of the millions of small
management literature about the likelihood of a
farmers in India who protested in the streets
connection between a company’s response to its
against its new technology, fearing that Monsanto’s
stakeholders and its resulting financial perform-
discovery, called bthe terminatorQ by one NGO,
ance; that is, there was little consensus that a
would prevent them from propagating the seed
relationship existed between corporate social per-
from their own crops. The efforts of these types of
formance (CSP) and corporate financial perform-
fringe stakeholders, along with related protests
ance (CFP). However, many of the earliest studies
from around the world, eventually forced Monsanto
on this topic had used questionable measures not
to abandon its efforts in genetically modified
only of corporate response to stakeholders (i.e.,
seeds.
CSP), but also of corporate financial performance.
Hart and Sharma (2004) suggested that firms
A review by Waddock and Graves (1997) found that
need to respond to the demands of their fringe
many of them had relied on surveys of stakeholders
stakeholders with an approach they called bradical
that had yielded very low and unreliable response
transactivenessQ, which includes going beyond the
rates. Others had used the Fortune magazine
firm’s traditional approaches for dealing with
rankings of corporate reputation, which actually
stakeholders to gain an understanding of this fringe
measure overall management performance and not
category. The authors called this process bfanning
just CSP. Still others had relied on case analyses of a
outQ, and said that it includes identifying these
few companies, at best, thereby yielding an
fringe stakeholders, preempting their concerns,
insufficient look at behavior in the broader corpo-
and generating innovative responses to them. An
rate world. Waddock and Graves concluded that the
example is Dupont’s Biotechnology Advisory Panel,
best studies have recognized that CSP is a multi-
which has considered the divergent views of stake-
dimensional variable, calling for the measurement
holders from India, Africa, and Latin America in its
of multiple behaviors across a wide range of
formulation of a strategy for biotechnology devel-
companies and industries.
opment. This effort has exposed Dupont’s senior
Concerning the measurement of financial per-
managers to radically new perspectives, thereby
formance, Roman, Hayibor, and Agle (1999) found
yielding not only new ideas for the company’s
that many studies have used such indicators as
strategy of biotechnology commercialization, but
advertising expenditures, asset age, and executive
also an improved ability to respond to the needs of
compensation, none of which are true measures of
these fringe stakeholders.
a firm’s financial performance. These researchers
Radical transactiveness also calls for bfanning
suggested that established accounting measures
in,Q which means developing the managerial
such as return on assets and return on equity would
capacity to empathize with fringe stakeholders,
be more valid and useful measures. They recog-
understand their language and culture, and build
nized, however, that market-determined indicators
relevant business models. When Cemex, Mexico’s
such as stock returns and changes in shareholder
largest cement company, decided to enter the
wealth could also be effective measures of finan-
huge market of low-income potential homebuild-
cial performance.
ers in developing countries, it first studied how to
do business with the poor in Mexico. The company
created a new business model through a program 7. The conclusion of recent, valid
called bPatrimonio Hoy,Q which provided savings studies: CSP and CFP are related
clubs to allow prospective homebuilders to accu-
mulate the funds to build their own houses. In Studies that have used valid measures of both CSP
exchange, Cemex provided not only storage facili- and CFP have tended to find a positive relationship
ties for the required building materials, but also between the two variables, indicating that appro-
architectural support to ensure that the homes priate corporate responses to stakeholders can
would be designed well and built in sensible improve the bottom line. In perhaps the most
stages. With its success so far, the company plans thorough study of this issue, Waddock and Graves
262
(1997) examined the evidence from 467 firms from
the Standard and Poor’s 500, using a measure of
CSP that was based on eight social performance
variables rated by Kinder, Lydenberg, Domini (KLD).
KLD is an independent rating service that assesses
corporate social performance across many varia-
bles related to stakeholder concerns. Its rating
scheme is a major improvement over earlier rating
methods because it ranks all companies in the S&P
500, it uses a single group of raters who are
independent of the companies rated, and it applies
its CSP criteria consistently across the S&P compa-
nies with data gathered from sources both internal
and external to those companies.
Of the eight KLD variables that Waddock and
Graves (1997) used to develop their measure of CSP,
five emphasized corporate relationships with pri-
mary stakeholders: community relations, employee
relations, environmental performance, treatment
of women and minorities, and product character-
istics (e.g., product safety). The other three
variables, while less directly related to primary
stakeholder groups, did concern areas in which
companies have received external pressures. Those
three included military contracting, participation
in nuclear power, and involvement in South Africa.
To measure financial performance, Waddock and
Graves used three accounting variables: return on
assets, return on equity, and return on sales.
Finally, they established controls in their study for
three non-stakeholder variables that can affect
both financial and social performance, and there-
fore interfere with the measurement of their
relationship. Those three variables were company
size, managerial attitude toward risk, and industry
type. To control for company size, they measured
total assets and total sales. As a measure of
managerial attitude toward risk, they used the
ratio of long-term debt to total assets. Finally, they
used the four-digit SIC industry code as the control
for industry type.
Results indicated not only that CSP leads to
CFP, but also the reverse: that improved financial
performance can yield improved social perform-
ance. Specifically, the authors found through
regression analysis not only that financial perform-
ance led to improved CSP one year later, but also
that the improved CSP led to even better financial
performance after a further one-year lag. As they
explained, the relationship in which CSP leads to
improved financial performance has been called
the bgood managementQ theory, because it indi-
cates that appropriate managerial responses to
stakeholders can improve financial performance.
The reverse relationship, in which CFP leads to
CSP, has been referred to as the bslack resourcesQ
R.W. Clement
theory. It says that firms with abundant resources
can use their bslackQ resources to respond to
stakeholder demands (e.g., by purchasing equip-
ment to protect the environment). Waddock and
Graves (1997) concluded that b. . . it may pay to
give attention to dimensions of management that
are normally outside of strict financial, produc-
tivity, and efficiency considerations. . . That is,
good management and its reflection in financial
outcomes may also encompass the nature of
products produced, a company’s posture with
respect to the natural environment, [and] its
relations to employees, including women and
minorities. . .Q (p. 315).
Other reviews of the more recent and valid
studies of CSP and CFP have also found a positive
relationship between the two variables. For exam-
ple, Roman et al. (1999) reviewed 52 such studies
and found 33 reporting a positive relationship
between CSP and CFP, only 14 reporting a negative
relationship, and five reporting no relationship.
Also, Frooman (1997) found a relationship between
CSP and CFP in his review of 27 beventQ studies,
which focus on the response of the stock market to
a single important event (e.g., a product recall).
Specifically, he found that, for firms engaging in
socially irresponsible and illicit behavior, the effect
on shareholder wealth is negative and substantial in
size.
Most recently, Verschoor and Murphy (2002) used
the Business Week financial rankings of U.S.
corporations and the Business Ethics rankings of
corporate social performance to test for a relation-
ship between CSP and CFP. The Business Week
financial rankings are based on a three-year
average of total return to shareholders. The Busi-
ness Ethics rankings of CSP are based on six
dimensions of the KLD database described above:
community relations, minorities and women,
employees, environment, non-U.S. stakeholders,
and customer relations. Verschoor and Murphy
found b. . . unbiased and rather conclusive empirical
evidence that [firms] committed to social and
environmental issues that are important to their
stakeholders also have superior financial perform-
ance. . .Q (p. 378).
8. The firm must address btrueQ
stakeholder issues, not just bsocialQ
issues
Hillman and Keim (2001) found that some types of
corporate responses to stakeholders are more
important than others; specifically, their analysis
of S&P 500 firms revealed that, while stakeholder
The lessons from stakeholder theory for U.S. business leaders
management leads to improved shareholder value,
mere participation in social issues (e.g., making
charitable contributions) can detract from that
value. They used nine CSP variables tracked by the
KLD database, viewing five of these variables as true
stakeholder issues and the remaining four as merely
bsocial issues.Q The five stakeholder variables were
employee relations, diversity issues, product issues,
community relations, and environmental issues. The
four social issue variables included military con-
tracting, involvement in alcohol, tobacco, or gam-
bling activities, involvement in nuclear energy, and
investment in countries involved with human rights
controversies. As a measure of corporate financial
performance, they used market value-added (MVA),
which is the difference between the value the
market places on a company and the total debt
and equity invested in the company. Finally, like
Waddock and Graves (1997), they controlled for the
effects of industry size, managerial attitude toward
risk, and industry type.
Hillman and Keim found that effective manage-
ment of btrueQ stakeholder issues, such as
employee relations and environmental protection,
can lead to improved financial performance, as
measured by market-value added. In contrast, they
found that merely participating in social issues
leads to diminished financial outcomes. They con-
cluded that, when the corporation’s societal efforts
are b . . .directly tied to primary stakeholders, then
investments may benefit not only stakeholders but
also result in increased shareholder wealthQ
(p.135). However, when those efforts are directed
at social issues beyond the direct stakeholders, the
result is likely to be a reduction in shareholder
wealth. In short, simply being bsocially responsibleQ
will not improve the bottom line.
9. Conclusion
The literature on stakeholder theory, which has
accumulated for 20 years now, holds several clear-
cut lessons for today’s business leaders. This article
has presented what appear to be the most impor-
tant ideas from that literature for the business
world. It seems clear that corporations are facing
increasing pressures to respond to their stake-
holders, with the pressure becoming even greater
since the recent discovery of unethical and illegal
behavior in the business world. Corporate leaders
might be somewhat comforted to find that they
have a legal basis for adopting a stakeholder view in
their strategic planning. Both the existing laws and
regulations and the recent pattern of court deci-
sions support this view.
263
An unexpected finding from the research on
stakeholder theory is that corporate executives are
now guided in their decision making by the
influence of their peer executives more than by
the principles of their functional areas. Although
this finding may concern some observers of the
business world, others may see it as an avenue to
improve corporate behavior concerning stakehold-
ers. Specifically, if boards of directors and CEOs will
communicate the importance of ethical practices
and reward ethical decision making, the top
executive team will be more likely to demonstrate
appropriate behavior toward stakeholders.
The stakeholder literature further indicates that
corporations are responding primarily to powerful
stakeholders with legitimate, urgent claims on the
activities of those corporations. Although this
approach to stakeholders might seem effective to
most business leaders, it still behooves them to
ensure that they are not ignoring the demands of
bfringeQ stakeholders who, although lacking in
power, may have urgent, legitimate claims that
they can pursue by banding together.
Finally, the evidence from the literature on
stakeholder theory indicates quite clearly that
corporations rely on responses to stakeholders that
will yield improved profits. Although this stance
certainly seems legitimate, given that firms should
be allowed to make a profit, business leaders need
to be sure that they are not making decisions solely
on the basis of the almighty dollar. As the literature
on stakeholder theory indicates, society expects
much more than that from its business leaders.
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