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

0007-6813/$ - see front matter D 200doi:10.1016/j.bushor.2004.11.003

B This manuscript was accepted undeW. Organ.

E-mail address: rclement@pittstat

KEYWORDSStakeholder;Stakeholder theory;Stakeholder

management;Stakeholder approach;Strategicmanagement

Abstract It has been 20 years since Freeman [Freeman, R. E. (1984). Strategicmanagement: A stakeholder approach. Marshfield, MA: Pittman Publishing.] firstproposed his stakeholder approach to strategic management, which stated thatcorporations must consider the needs and demands not only of their shareholders butalso those of a wide range of other external constituencies, or bstakeholders.QExamples of stakeholders include customers, employees, suppliers, and commun-ities. Freeman’s theory has generated an extensive body of research, including notonly the efforts of the management researchers who have tested, revised, andrefined the theory, but also the views of corporate executives who have used thestakeholder approach in their strategic planning. This article, based upon a review ofthat literature, identifies five important lessons from the stakeholder model fortoday’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 in1984. In contrast to the traditional view ofcorporate strategy, which largely equates the termbstakeholderQ with the owners, or stockholders, ofthe corporation, Freeman defined a stakeholdermore broadly as bAny group or individual who canaffect or is affected by the achievement of thefirm’s objectivesQ (p. 25). This view was revealing

4 Kelley School of Business, In

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in that Freeman was the first management writerto so clearly identify the strategic importance ofgroups and individuals beyond not only the firm’sstockholders, 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 proposedhis stakeholder approach to strategic management,an extensive body of research has been performedon his theory. That research has included not onlythe efforts of the management researchers whohave tested, revised, and refined his theory, butalso the views of the corporate executives who

Business Horizons (2005) 48, 255—264

diana University. All rights reserved.

R.W. Clement256

have used the stakeholder approach in theirstrategic planning. The present article, based upona review of that literature, identifies five impor-tant lessons from the stakeholder model for today’sbusiness leaders. These lessons are particularlyimportant today, given the inappropriate behaviorthat has occurred in the business world in recentyears. The five lessons, which are explained in thesucceeding sections of the article, may be sum-marized as follows:

(1) Corporations are facing increasing pressuresto respond to their stakeholders.

(2) Corporations have a legal basis for respondingto a wide range of stakeholders.

(3) Corporations are being led by executives nolonger guided by the principles of theirprofessions.

(4) Corporations respond to powerful stakehold-ers with legitimate, urgent claims.

(5) Corporations can improve the bottom line byresponding to stakeholder concerns.

2. Corporations are facing increasedpressures to respond to theirstakeholders

To be blunt, the stakeholders of today’s corpora-tions have raised their expectations concerning thedecision making of the executives leading thosecorporations. Not only customers and employees,but also investors, communities, governments, andeven competitors are becoming more vocal andactive in seeking improved behavior on the part ofU.S. corporations. The pressures from these manystakeholders focus on a host of issues important toboth the success of U.S. business and the well-beingof the larger society.

2.1. Pressures from many sources

Waddock, Bodwell, and Graves (2002) indicatedthat the pressures to reform stakeholder-relatedpractices have been coming not only from primaryand secondary stakeholders, but also from generalsocial trends and institutional expectations. Individing stakeholders into primary and secondarygroups, Waddock et al. (2002) used the catego-rizations suggested by Clarkson (1995). A primarystakeholder, according to Clarkson, is one whosecontinuing participation is critical to the survival ofthe corporation. Included in this group are share-holders, employees, customers, and suppliers, allof whom clearly can have a substantial, and oftentimes immediate, impact on the corporation. Forexample, the loss of major customers can, obvi-

ously, damage a company. Secondary stakeholders,although able to influence and be influenced by thecorporation, b. . . are not engaged in transactionswith the corporation and are not essential for itssurvivalQ (p., 107). Waddock et al. listed foursecondary stakeholders, including non-governmen-tal organizations (NGOs), activists, communities,and governments.

Waddock et al. (2002) also identified threeexamples of the added pressures corporations havebeen facing from primary stakeholders:

(1) The social investment movement—the invest-ments of which now total more than US$2.3trillion, or one out of eight professionallymanaged investment dollars.

(2) Employee attitudes about where to work—acritical issue today, given the corporatedemand for high-skilled employees whocan play a major role in a firm’s competitiveadvantage.

(3) The increased desire of customers to purchasefrom responsible companies—a particularlyimportant issue, given the rising purchasingpower of those customers.

The pressures from secondary stakeholders haveincluded two broad developments. The first is theincreasing capacity of NGOs and global activists tomobilize their resources for improved corporateresponsibility. Due to the global ease and trans-parency of electronic communication, they are nowbetter 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). Theirefforts have led to improved corporate decisionsconcerning 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 thepotential for harmful business behavior within acommunity or region. In the US, communities andstate governments have become more aware thatcorporations may lack a long-term commitment totheir 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 thelocale, leaving such problems as increased unem-ployment and an eroding tax base in the wake oftheir departure. At the international level, pres-sures for corporate reform have come from suchorganizations 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 257

principles to promote values-based practices amongglobal firms. For example, the UN’s Global Compactpromotes values-based practices concerning humanrights, labor, and the environment.

2.2. The special case of environmentalmanagement

Concerning environmental management specifi-cally, Berry and Rondinelli (1998) noted thatgovernments, customers, employees, and evencompetitors are pressuring corporations to makesocially responsible decisions. Part of the reason isthat governments everywhere, particularly those inthe industrialized world, are facing public pres-sures to assure a cleaner environment. The resulthas been a rapidly growing array of stringentgovernment regulations with burdensome legalliabilities. As these authors indicate, bNot comply-ing with government regulations is no longer anoption for corporations that seek to be competitivein international marketsQ (p. 39). Industrializedcountries, including the United States, have devel-oped a complex array of environmental regulationsin recent years. For example, in the US alone, thereare more than 100,000 federal, state, and localrules and regulations on environmental issues.Corporations entering global competition simplymust be prepared to address the environmentalconcerns of worldwide markets.

The cost of environmental performance includesboth a reactive and a proactive side. The reactiveside is the expense of complying with existingregulations and the cost of heavy fines (and evenprison sentences) for violations. The proactive siderefers to the investments many corporations arenow making in preventive approaches to improvetheir environmental performance. In particular,several companies, including 3M, Sony, and Procter& Gamble, have recently been recognized foreffective environmental performance. Amongother things, these companies are minimizing orpreventing waste, designing recyclable products,and using full cost accounting to identify theenvironmental costs of ongoing operations.

2.3. Pressures on the corporate governanceprocess

Finally, corporations are facing pressures toinclude non-shareholder stakeholders in the cor-porate governance process. For example, Luomaand Goodstein (1999) found that, compared to 20years ago, corporations are much more likely toinclude such stakeholders as suppliers, customers,employees, and members of the public on their

boards of directors. The researchers concludedthat the reasons for including these stakeholdersare (1) the adoption of statutes in many statesthat give boards of directors the right to considerthe interests of non-shareholder stakeholders, (2)the need for corporations, particularly those inhighly regulated industries, to respond moreeffectively to public and governmental scrutiny,and (3) the increasing size and complexity oftoday’s modern corporation. Concerning the thirdpoint specifically, Luoma and Goodstein said that,bBy virtue of their size, large organizations aremore visible and hence subject to greater atten-tion from such external constituencies as thestate, the media, professional groups, and thegeneral publicQ (p. 4).

3. Corporations have a legal basis forresponding to a wide range ofstakeholders

Despite a lingering belief in U.S. society thatcorporations have a duty mainly to their share-holders, there is considerable evidence that laws,regulations, and court decisions favor a responsibilityalso to non-shareholder stakeholders. This evidenceincludes not only the laws and regulations affectingbusiness activity, but also the pattern of courtdecisions in recent years. It is important to note thatthe blegalQ argument here is not the same as thatmade in 1962 by Milton Friedman (Friedman, 1962),who said that corporate executives should maximizeprofits for stockholders within society’s establishedlegal framework. Rather, the point here is that thoseexecutives now have a legal basis for going beyondsimple profit maximization to respond to thedemands of stakeholders other than stockholders.

3.1. The legal support for a stakeholder view

Concerning laws and regulations, this article hasalready cited Freeman’s (2001) description of legis-lation that affects business behavior concerningcustomers, employees, and the broader community.Included are laws on product safety, discriminatoryhuman resource practices, and pollution preven-tion. Donaldson and Preston (1995) also emphasizedthe role of laws and government regulations insaying that both court decisions and legislation haveweakened the traditional bbusiness judgment rule,Qwhich says that management may conduct thecompany’s affairs b. . . only on the condition thatthe financial welfare of stockholders is single-mind-edly pursuedQ (p. 75). As they note, most states haveadopted statutes that allow boards of directors togive consideration to a wide range of non-share-

R.W. Clement258

holder stakeholders, including employees, custom-ers, suppliers, creditors, and local communities.

Regarding recent court decisions, Marens andWicks (1999) concluded that, although courtshistorically have encumbered corporate managerswith a fiduciary duty toward stockholders, theyhave done so merely to prevent managerial self-dealing. They have not equated that fiduciary dutyto either a managerial responsibility to favorstockholders over other stakeholders or a right ofstockholders to oversee managerial decision mak-ing. These researchers concluded that bNo courtequates this duty with dmaximizing shareholdervalueT. . . What the duty does require is honesty andcandor in the relationship with the stockholder anda general avoidance of using one’s office forillegitimate 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 arebeginning to impose those duties on managerialbehavior directed toward non-shareholder groups.As an example, they cite the Supreme Courtdecision in Varity v. Howe (1996) concerning acompany that had shifted its money-losing venturesinto a subsidiary that later went bankrupt. Thecourt ruled that the company had breached itsfiduciary duty with its employees in that subsidiary.These researchers further noted that stockholderattempts to challenge managerial behavior towardother stakeholders have almost always failed in thecourts. As evidence, they cited cases in which thecourts have allowed corporations, in spite ofshareholder opposition, to invest in economicdevelopment to improve community relations, tobuild a company town to improve employeerelations, and to make charitable contributions inthe spirit of enlightened self-interest.

Boatright (1994) also made a strong case for theresponsibilities of corporations to stakeholdersother than shareholders. As he indicated, corporateofficers and directors are not, legally, in a con-tractual or an agency relationship with sharehold-ers. Specifically, he said that bMany of the fiduciaryduties of officers and directors are owed not toshareholders but to the corporation as an entitywith interests of its own, which can . . . conflict withthose of shareholdersQ (p. 403). He also explainedthat public policy, as determined by the courts andlegislatures, recognizes the fiduciary duties ofcorporations to non-shareholder stakeholders andallows firms to take the interests of those stake-holders into account.

4. Corporations are being led byexecutives no longer guidedby the principles of their professions

According to popular belief, top executives areheavily influenced in their decision making by whatthey learn and experience in their areas of func-tional expertise. For example, accounting execu-tives should be guided by the principles establishedby such professional organizations as the NationalAccounting Standards Board, and legal executivesshould follow the standards of the American BarAssociation and their state and local bar associa-tions. On the contrary, however, recent researchindicates that the decision making of top execu-tives is affected much more by the social influencesthey encounter in their interactions with their peertop executives. In other words, regardless of thefunctional areas in which these individuals begantheir careers, by the time they reach executiveranks, 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 theexecutive beliefs and demographic characteristicsof 371 executives in 58 strategic business unitsacross 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 forthe much weaker influence of functional condition-ing. For example, managers increasingly are gainingexperience in several functional areas in their rise tothe top levels of their companies. In fact, executivesoften are promoted on the basis of their ability tosee beyond functional boundaries. The reason is thatthey need to take a broad view of corporateopportunities and challenges, rather than the morenarrow view that a one-function career would yield.

Chattopadhyay et al. (1999) also cited earlierresearch that further confirms the weak rolefunctional experience can play in influencingexecutive decision making. For example, theynoted 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 includedideas from several functional areas. Beyer et al.(1997) also found that areas of experience unre-lated to an executive’s function can play a majorrole in his or her decision making. They suggested

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that functional experience may unduly restrict anexecutive’s focus of attention, thereby obscuringhis or her view of important non-functionalinformation.

4.2. The important role played by personalrelationships

Brass, Butterfield, and Skaggs (1998) also consid-ered the role of social influences on decisionmaking in organizations. While they acknowledgedthe importance of personal factors, such as one’smoral development, and situational factors (e.g.,the organization’s reward system) in affectingdecision making, the authors also emphasized therole played by relationships that develop amongthe decision makers. Specifically, they suggestedhow both the types of relationships in organizationsand the structure of those relationships can lead tounethical decisions. Concerning the types of rela-tionships that form, they said that the ethicality ofan executive team’s decisions can be influenced byhow strong their relationships are and the extent towhich those relationships extend to multiple set-tings. For example, strong relationships in anorganization culture that values ethical treatmentof stakeholders would minimize the chances forunethical treatment of those stakeholders. Further,executives who interact with each other in multiplesettings (e.g., at work, at the club, in personalfriendships) would have greater influence overeach other than those who interact only at work.The bremindersQ to act ethically would be morefrequent and more obvious. However, for suchpersonal relationships to foster ethical behavior(as opposed to the problematic behavior observedin many companies in recent years), an organiza-tion culture supportive of ethical behavior mustprevail. The company’s leadership, particularly theboard of directors and the CEO, can help to fosterthat type of culture by communicating the impor-tance of ethical practices, rewarding those whoengage in ethical decision making, and modelingethical behavior themselves.

Regarding the structure of relationships thatform within the executive team, Brass et al.(1998) suggested, among other things, that thecentrality of a key individual and the density of therelationship can affect the decision making proc-ess. An executive is bcentralQ when he or she caneasily and directly contact the other members ofthe network. This ease of access would give thatindividual substantial influence over the otherexecutives and, therefore, control over the deci-sion making process. Dense networks are those inwhich the members are highly interconnected: they

are in contact with each other on a continuingbasis. This btightnessQ can often yield ethicaldecisions because it allows for high surveillanceand an increased chance for lost reputation (i.e.,one is more likely to be caught and exposed).

5. Corporations respond to powerfulstakeholders with legitimate, urgentclaims

As mentioned earlier in this article, Freeman’s(1984) seminal work on stakeholder theory defineda stakeholder as bAny group or individual who canaffect or is affected by the achievement of thefirm’s objectivesQ (p. 25). Although this definition isstill widely used throughout the managementliterature, it is perhaps too broad to identify therelative importance of the different stakeholdergroups faced by a corporation. Fortunately, recentresearch has made considerable strides in identify-ing important stakeholder features.

5.1. Power, legitimacy, and urgency: Threeimportant stakeholder characteristics

Mitchell, Agle, and Wood (1997) proposed a modelof stakeholder identification that suggests how toidentify not only the stakeholders on which exec-utives should focus, but also the relative impor-tance of each. Specifically, they said that aconsideration of three stakeholder features—power, legitimacy, and urgency—can provide exec-utives with the ability to decide how and when torespond to their corporation’s many constituencies.In the model, a stakeholder has power to the extentthat it can impose its will in its relationship withthe firm. That same stakeholder has legitimacywhen its actions toward the firm are widely seen asdesirable, proper, or appropriate within the norms,values, and beliefs of the larger society. Forexample, employee attempts to form a uniongenerally would be seen as legitimate in today’sU.S. society, but employee efforts to force a firm toprovide stock options generally would not. Finally,urgency exists b. . . when a relationship or claim is ofa time-sensitive nature and when that relationshipor claim is important or critical to the stakeholderQ(Mitchell et al., 1997 p. 867). In other words,urgency is the extent to which stakeholder effortscall for immediate attention by a firm.

The Mitchell et al. (1997) model further suggeststhat executives should attend to the demands of astakeholder organization to the extent that itmanifests each of the three stakeholder variables.If only one of the three variables (legitimacy, forinstance) is present, the demands of the stake-

R.W. Clement260

holder may not be seen as particularly important,and the stakeholder would be seen as blatentQ orlow in salience. At the opposite extreme, if allthree variables are present, executives shouldrecognize that an immediate and full response isneeded, and the stakeholder should be seen asbdefinitiveQ or high in salience. For example,pension funds with major investments in DisneyInc., recently pressured the Disney board to reducethe authority of Disney CEO Michael Eisner. Becausethe demands of these powerful, legitimate stake-holders were seen as urgent, the Disney boardremoved Eisner as chairman and assigned that postto board member and former U.S. Senator GeorgeMitchell (Gunther, 2004).

5.2. First power, then urgency, thenlegitimacy

Agle, Mitchell, and Sonnenfeld (1999) found sup-port for the Mitchell et al. (1997) model in a surveyof the CEOs of 80 companies. However, they alsofound that, of the three stakeholder variables(legitimacy, power, and urgency), urgency was thebest predictor of executive response. Finally, theyfound that the traditional bproduction functionQstakeholders (shareholders, employees, and cus-tomers) were seen as the most important ones bythe executives who responded to their survey. Theyconcluded that a stakeholder class exists in today’sbusiness world, in which shareholders, employees,and customers are privileged, while governmentagencies and communities are not.

Despite the emphasis of Agle et al. (1999) on theprominent role of urgency, it seems likely thatpower also plays a major role in determiningwhether and how executives will respond to stake-holder demands. First, urgency is unlikely to beseen as a critical factor unless a stakeholder alsohas the power to successfully take action againstthe firm. Second, other research has made a strongcase for the critical role for power in stakeholderrelationships. For example, Frooman (1999) con-trasted power with legitimacy and suggested thatthe appropriateness of a stakeholder’s claim maynot 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 theresources controlled by those stakeholders. Forinstance, investors wishing to purchase high-inter-est junk bonds might have power over the firmsoffering such bonds because those firms carryreduced investment ratings (and therefore maynot have access to other sources of capital).Frooman also said that stakeholders with such

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 mayuse the resources. The first approach might be usedwhen the stakeholder wishes to prevent a certainaction by the firm, and the second might be likelywhen the stakeholder wishes to encourage certainbehavior by the firm.

Rowley (1997) took the power issue a stepfurther by noting that the relationship between afirm and a stakeholder may be more than a simpleframework of dyadic (i.e., firm-to-stakeholder)ties. He suggested instead that the relationshipinvolves a network of influences in which stake-holders have multiple and direct relationships notonly with the firm but also with each another. Hesaid the resulting network of stakeholders will bepowerful to the extent that the network is denseand the focal firm holds a position that is central tothe network. According to Rowley’s notion of abdenseQ network, the stakeholders have many tiesamong themselves, thereby yielding shared expect-ations, efficient communication, and easy coalitionformation— all of which make action against thefirm more effective. The bcentralityQ of the firmrefers to its position within the firm-to-stake-holders network. For example, a firm that caneasily contact all the stakeholders and whichfurther can act as a gatekeeper for informationwithin the network is highly central and, therefore,in control of the network. In Rowley’s words, thefirm b. . . is able to influence behavioral expect-ations and manage information flows so that itsactions either go unnoticed or are presented in aself-serving fashion. . .Q (p.900).

5.3. Even bfringeQ stakeholders can now gainaccess to power

Finally, Hart and Sharma (2004) emphasized theimportance 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. andthe rural poor in developing countries. Hart andSharma said that many of these types of stake-holders have more power in today’s business worlddue to the influence of globalization and theexpanding role of the Internet. Particularly whenthey can gain the support of non-governmentalorganizations and civil society groups, they cancommunicate quickly and effectively in marshallingtheir forces against corporate action. An example isthe 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-nology and become a leading global life sciencecompany. Although Monsanto had responded to theconcerns of all salient and seemingly importantstakeholders and had even received governmentapproval of its products and technology, it hadfailed to grasp the importance of certain fringestakeholders. In particular, the company had notconsidered the reaction of the millions of smallfarmers in India who protested in the streetsagainst its new technology, fearing that Monsanto’sdiscovery, called bthe terminatorQ by one NGO,would prevent them from propagating the seedfrom their own crops. The efforts of these types offringe stakeholders, along with related protestsfrom around the world, eventually forced Monsantoto abandon its efforts in genetically modifiedseeds.

Hart and Sharma (2004) suggested that firmsneed to respond to the demands of their fringestakeholders with an approach they called bradicaltransactivenessQ, which includes going beyond thefirm’s traditional approaches for dealing withstakeholders to gain an understanding of this fringecategory. The authors called this process bfanningoutQ, and said that it includes identifying thesefringe stakeholders, preempting their concerns,and generating innovative responses to them. Anexample is Dupont’s Biotechnology Advisory Panel,which has considered the divergent views of stake-holders from India, Africa, and Latin America in itsformulation of a strategy for biotechnology devel-opment. This effort has exposed Dupont’s seniormanagers to radically new perspectives, therebyyielding not only new ideas for the company’sstrategy of biotechnology commercialization, butalso an improved ability to respond to the needs ofthese fringe stakeholders.

Radical transactiveness also calls for bfanningin,Q which means developing the managerialcapacity to empathize with fringe stakeholders,understand their language and culture, and buildrelevant business models. When Cemex, Mexico’slargest cement company, decided to enter thehuge market of low-income potential homebuild-ers in developing countries, it first studied how todo business with the poor in Mexico. The companycreated a new business model through a programcalled bPatrimonio Hoy,Q which provided savingsclubs to allow prospective homebuilders to accu-mulate the funds to build their own houses. Inexchange, Cemex provided not only storage facili-ties for the required building materials, but alsoarchitectural support to ensure that the homeswould be designed well and built in sensiblestages. With its success so far, the company plans

to reach a million families in Mexico within 5years.

6. Corporations can improve the bottomline by responding to stakeholderconcerns

Until recently, there was much controversy in themanagement literature about the likelihood of aconnection between a company’s response to itsstakeholders and its resulting financial perform-ance; that is, there was little consensus that arelationship existed between corporate social per-formance (CSP) and corporate financial perform-ance (CFP). However, many of the earliest studieson this topic had used questionable measures notonly of corporate response to stakeholders (i.e.,CSP), but also of corporate financial performance.A review by Waddock and Graves (1997) found thatmany of them had relied on surveys of stakeholdersthat had yielded very low and unreliable responserates. Others had used the Fortune magazinerankings of corporate reputation, which actuallymeasure overall management performance and notjust CSP. Still others had relied on case analyses of afew companies, at best, thereby yielding aninsufficient look at behavior in the broader corpo-rate world. Waddock and Graves concluded that thebest studies have recognized that CSP is a multi-dimensional variable, calling for the measurementof multiple behaviors across a wide range ofcompanies and industries.

Concerning the measurement of financial per-formance, Roman, Hayibor, and Agle (1999) foundthat many studies have used such indicators asadvertising expenditures, asset age, and executivecompensation, none of which are true measures ofa firm’s financial performance. These researcherssuggested that established accounting measuressuch as return on assets and return on equity wouldbe more valid and useful measures. They recog-nized, however, that market-determined indicatorssuch as stock returns and changes in shareholderwealth could also be effective measures of finan-cial performance.

7. The conclusion of recent, validstudies: CSP and CFP are related

Studies that have used valid measures of both CSPand CFP have tended to find a positive relationshipbetween the two variables, indicating that appro-priate corporate responses to stakeholders canimprove the bottom line. In perhaps the mostthorough study of this issue, Waddock and Graves

R.W. Clement262

(1997) examined the evidence from 467 firms fromthe Standard and Poor’s 500, using a measure ofCSP that was based on eight social performancevariables rated by Kinder, Lydenberg, Domini (KLD).KLD is an independent rating service that assessescorporate social performance across many varia-bles related to stakeholder concerns. Its ratingscheme is a major improvement over earlier ratingmethods because it ranks all companies in the S&P500, it uses a single group of raters who areindependent of the companies rated, and it appliesits CSP criteria consistently across the S&P compa-nies with data gathered from sources both internaland external to those companies.

Of the eight KLD variables that Waddock andGraves (1997) used to develop their measure of CSP,five emphasized corporate relationships with pri-mary stakeholders: community relations, employeerelations, environmental performance, treatmentof women and minorities, and product character-istics (e.g., product safety). The other threevariables, while less directly related to primarystakeholder groups, did concern areas in whichcompanies have received external pressures. Thosethree included military contracting, participationin nuclear power, and involvement in South Africa.To measure financial performance, Waddock andGraves used three accounting variables: return onassets, return on equity, and return on sales.Finally, they established controls in their study forthree non-stakeholder variables that can affectboth financial and social performance, and there-fore interfere with the measurement of theirrelationship. Those three variables were companysize, managerial attitude toward risk, and industrytype. To control for company size, they measuredtotal assets and total sales. As a measure ofmanagerial attitude toward risk, they used theratio of long-term debt to total assets. Finally, theyused the four-digit SIC industry code as the controlfor industry type.

Results indicated not only that CSP leads toCFP, but also the reverse: that improved financialperformance can yield improved social perform-ance. Specifically, the authors found throughregression analysis not only that financial perform-ance led to improved CSP one year later, but alsothat the improved CSP led to even better financialperformance after a further one-year lag. As theyexplained, the relationship in which CSP leads toimproved financial performance has been calledthe bgood managementQ theory, because it indi-cates that appropriate managerial responses tostakeholders can improve financial performance.The reverse relationship, in which CFP leads toCSP, has been referred to as the bslack resourcesQ

theory. It says that firms with abundant resourcescan use their bslackQ resources to respond tostakeholder demands (e.g., by purchasing equip-ment to protect the environment). Waddock andGraves (1997) concluded that b. . . it may pay togive attention to dimensions of management thatare normally outside of strict financial, produc-tivity, and efficiency considerations. . . That is,good management and its reflection in financialoutcomes may also encompass the nature ofproducts produced, a company’s posture withrespect to the natural environment, [and] itsrelations to employees, including women andminorities. . .Q (p. 315).

Other reviews of the more recent and validstudies of CSP and CFP have also found a positiverelationship between the two variables. For exam-ple, Roman et al. (1999) reviewed 52 such studiesand found 33 reporting a positive relationshipbetween CSP and CFP, only 14 reporting a negativerelationship, and five reporting no relationship.Also, Frooman (1997) found a relationship betweenCSP and CFP in his review of 27 beventQ studies,which focus on the response of the stock market toa single important event (e.g., a product recall).Specifically, he found that, for firms engaging insocially irresponsible and illicit behavior, the effecton shareholder wealth is negative and substantial insize.

Most recently, Verschoor and Murphy (2002) usedthe Business Week financial rankings of U.S.corporations and the Business Ethics rankings ofcorporate social performance to test for a relation-ship between CSP and CFP. The Business Weekfinancial rankings are based on a three-yearaverage of total return to shareholders. The Busi-ness Ethics rankings of CSP are based on sixdimensions of the KLD database described above:community relations, minorities and women,employees, environment, non-U.S. stakeholders,and customer relations. Verschoor and Murphyfound b. . . unbiased and rather conclusive empiricalevidence that [firms] committed to social andenvironmental issues that are important to theirstakeholders also have superior financial perform-ance. . .Q (p. 378).

8. The firm must address btrueQstakeholder issues, not just bsocialQissues

Hillman and Keim (2001) found that some types ofcorporate responses to stakeholders are moreimportant than others; specifically, their analysisof S&P 500 firms revealed that, while stakeholder

The lessons from stakeholder theory for U.S. business leaders 263

management leads to improved shareholder value,mere participation in social issues (e.g., makingcharitable contributions) can detract from thatvalue. They used nine CSP variables tracked by theKLD database, viewing five of these variables as truestakeholder issues and the remaining four as merelybsocial issues.Q The five stakeholder variables wereemployee relations, diversity issues, product issues,community relations, and environmental issues. Thefour social issue variables included military con-tracting, involvement in alcohol, tobacco, or gam-bling activities, involvement in nuclear energy, andinvestment in countries involved with human rightscontroversies. As a measure of corporate financialperformance, they used market value-added (MVA),which is the difference between the value themarket places on a company and the total debtand equity invested in the company. Finally, likeWaddock and Graves (1997), they controlled for theeffects of industry size, managerial attitude towardrisk, and industry type.

Hillman and Keim found that effective manage-ment of btrueQ stakeholder issues, such asemployee relations and environmental protection,can lead to improved financial performance, asmeasured by market-value added. In contrast, theyfound that merely participating in social issuesleads to diminished financial outcomes. They con-cluded that, when the corporation’s societal effortsare b . . .directly tied to primary stakeholders, theninvestments may benefit not only stakeholders butalso result in increased shareholder wealthQ(p.135). However, when those efforts are directedat social issues beyond the direct stakeholders, theresult is likely to be a reduction in shareholderwealth. In short, simply being bsocially responsibleQwill not improve the bottom line.

9. Conclusion

The literature on stakeholder theory, which hasaccumulated for 20 years now, holds several clear-cut lessons for today’s business leaders. This articlehas presented what appear to be the most impor-tant ideas from that literature for the businessworld. It seems clear that corporations are facingincreasing pressures to respond to their stake-holders, with the pressure becoming even greatersince the recent discovery of unethical and illegalbehavior in the business world. Corporate leadersmight be somewhat comforted to find that theyhave a legal basis for adopting a stakeholder view intheir strategic planning. Both the existing laws andregulations and the recent pattern of court deci-sions support this view.

An unexpected finding from the research onstakeholder theory is that corporate executives arenow guided in their decision making by theinfluence of their peer executives more than bythe principles of their functional areas. Althoughthis finding may concern some observers of thebusiness world, others may see it as an avenue toimprove corporate behavior concerning stakehold-ers. Specifically, if boards of directors and CEOs willcommunicate the importance of ethical practicesand reward ethical decision making, the topexecutive team will be more likely to demonstrateappropriate behavior toward stakeholders.

The stakeholder literature further indicates thatcorporations are responding primarily to powerfulstakeholders with legitimate, urgent claims on theactivities of those corporations. Although thisapproach to stakeholders might seem effective tomost business leaders, it still behooves them toensure that they are not ignoring the demands ofbfringeQ stakeholders who, although lacking inpower, may have urgent, legitimate claims thatthey can pursue by banding together.

Finally, the evidence from the literature onstakeholder theory indicates quite clearly thatcorporations rely on responses to stakeholders thatwill yield improved profits. Although this stancecertainly seems legitimate, given that firms shouldbe allowed to make a profit, business leaders needto be sure that they are not making decisions solelyon the basis of the almighty dollar. As the literatureon stakeholder theory indicates, society expectsmuch more than that from its business leaders.

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