The Fallacy of Stakeholder Management

Ethical blog - Sat, 02/28/2015 - 22:12

Stakeholder theory represented by Edward Freeman and others says that business should consider the interests and claims of the stakeholders and manage its activities accordingly. In this view the effective management of stakeholders is a strategic activity that is necessary for business success as it adds value to shareholders and ensures the long-term survival and sustainability of the firm. Ignoring stakeholders is dangerous, not just because it is morally inappropriate, but also because it does not make economic sense.

We see two interrelated problems with this approach. (i) the narrow conception of stakeholders, and (ii) the fallibility of the stakeholders concerning their own well-being. 

In business context the set of stakeholders are usually defined in narrow sense. Only the owners, the managers, the employees, the creditors, the suppliers, and the local communities are considered as stakeholders of business. The narrow definition of the set of stakeholders is often a clear receipt for disaster of business itself.

Ian Mitroff  argues that defining the set of stakeholders narrowly and/or not picking up the right stakeholders necessarily leads to solving the wrong problems precisely. This is especially striking in new situations. When managers confront a problem at the edge, and especially a novel problem or a case outside of the bounds of accepted thinking, they are either stymied to the point of paralysis, or fall back on the only resource they have, reducing a novel or unique situation to a problem that they already know how to solve.

Systems theory suggests that the overall performance of a business organization is determined by the adequateness of the basic assumptions on which it functions and on the way the system is capable of pursuing its objectives. Problems indicate that the basic assumptions are inadequate and/or the system is incapable of performing adequately.

Business should dissolve rather than solve problems by redesigning the relevant systems to eliminate the problems and preclude their reappearance. Business leaders should conceptualize problems and opportunities in the largest possible context. They should take into account the effects of any proposed actions on all of the relevant stakeholders. So it is not enough to do things right: business should also do the right things.

Psychology and behavioral economics discovered that human agents are rather week in predicting their own future well-being. They are fallible what they will like in the future and how they will feel themselves in future states of affairs.

Psychologist Daniel Kahneman suggests to differentiate between experienced utility and predicted utility. The experienced utility of an outcome is the measure of the hedonic experience of that outcome. The predicted utility of an outcome is defined as the individual’s beliefs about its experienced utility at some future time. Predicted utility is an “ex ante” variable, while experienced utility is an “ex post” variable in the decision-making process.

If experienced utility greatly differs from predicted utility then this may lead to sub-rational, or even irrational choices. The problem of predicted utility raises the question: “Do people know what they will like?” The answer is a definite ”No.” The accuracy of people’s hedonic predictions is generally quite poor.

Experimental studies suggest two conclusions: (i) people may have little ability to forecast changes in their hedonic responses to stimuli; and (ii) even in situations that permit accurate hedonic predictions, people may tend to make decisions about future consumption without due consideration of possible changes in their tastes.

Discrepancies between retrospective utility and real-time utility are also important. This leads to the question: “Do people know what they have liked?” The answer is again a definite “No.” Psychological experiments show that retrospective evaluations should be viewed with greater distrust than introspective reports of current experience. Since individuals use their evaluative memories to guide them in their choices toward future outcomes, deceptive retrospective evaluations may lead to erroneous choices.

Managing for the narrowly defined set of stakeholders is not a guarantee that the whole business ecosystem is sustainable in ecological sense and beneficial for society at large including future generations. Considering the interest of the stakeholders solely on the basis of their own calculation may lead to unacceptable outcomes. Business should expand the set of stakeholders and look beyond the self-interest of its stakeholders.