STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE

R. Edward Freeman and Robert A. Phillips

Abstract: The purpose of this paper is to suggest that at least one
strain of what has come to be called "stakeholder theory" has roots
that are deeply libertarian We begin by explicating both "stake-
holder theory" and "libertarian arguments " We show how there are
libertarian arguments for both instrumental and normative stake-
holder theory, and we construct a version of capitalism, called
"stakeholder capitalism," that builds on these libertarian ideas
We argue throughout that strong notions of "freedom" and "volun-
tary action" are the best possible underpinnings for stakeholder
theory, and in doing so, seek to return "stakeholder theory" to its
managerial and libertarian roots found in Freeman (1984).
^"^uine
V^expe
/. Introduction
(1960) once wrote that "sentences do not confront the tribunal of
'experience alone." And, he might have added, "nor do arguments and theo-
ries?' Sentences, as well as arguments and theories, always import their
background conditions and related theories with them. Context plays a crucial
role in social phenomena, and sometimes we need to resist the efforts of greedy
reductionists (Dennett. 1995)' to set context aside and focus on the precision of
hypotheses, the collection of data, and the rituals of method. Sometimes it is
important to point out a feature of the everyday landscape which is often taken
for granted, because in doing so, we can come to see new relationships and new
features that previously were hidden (Wisdom, 1970),^ Such is the role of what
has come to be called "stakeholder theory," and its relationship to our under-
standing of business activity.
The interpretation of business activity can be approached in several ways.
One way is to take for granted the usefulness (others might say "truth" or "moral
legitimacy" here) of a way of understanding value creation and trade (or busi-
ness activity), whereby individuals are presumed to be nakedly greedy, responsible
to others for the effects of their action only in so far as they are caught doing
harm, and the legitimacy of a state that pervasively regulates all aspects of
value-creation and trade, from rules governing the height of ladders to thou-
sands of pages of the tax code. Let us call this way of understanding value
2002 Business Ethics Quarterly Vblume 12. Issue 3. ISSN I052-150X pp 331-349
332 BUSINESS ETHICS QUARTERLY
creation and trade, or business activity, "the Standard Story" or "Shareholder
Capitalism," or "Cowhoy Capitalism," and let us make the requisite academic
changes and disclaimers to include sophisticated agency relationships, transac-
tion costs, and other assorted modifications of the standard story so as not to be
accused of the Straw Man Fallacy.
Within business ethics it is fairly well accepted that the standard story is the
main way that we understand business and capitalism. A great deal of interest-
ing work has emerged that tries to point out various places where the standard
story fails a variety of ethical tests.^ These ethical tests are, for the most part,
developed outside of the standard story, and indeed, outside of much consider-
ation for value creation and trade, or business activity, at all.
Yet another group of scholars has developed a critique of the standard story
that goes like this. The standard story is fine as far as it goes, but it doesn't go
far enough. We need to add the idea that the collections of individuals that we
call "corporations" need to understand the social effects of their actions. And,
we need to link the social effects of corporate action to the economic effects.
The background conditions and theories of the standard story simply need to be
broadened to include a set of ideas about "social" and its link to "economic.""*
Yet another way to understand business activity would be to change the back-
ground conditions of the standard story itself. Such a method might ask how
value creation and trade takes place in a world in which individuals have a
complex psychology, where individuals and groups of individuals desire to be,
and mostly are, responsible for the effects of their actions on others (good and
bad), and where many are, or certainly ought to be, deeply skeptical of the view
that the state looks out for their interests. Rather, individuals see the state as
mostly pervasive and intrusive without particular insights into either the best
height for ladders or the most effective means for building a just society. The
standard story would have to be reformed to take account of these questions,
and such reform would have to go well heyond the external critique of business
ethicists, and the broadening of "economic" proposed by business and society
scholars. It would have to include specific appeals to practice and a notion of
"best practice" from the real world of value creation and trade. It would neces-
sarily include examples of businesses that voluntarily manage key relationships
and thrive. In short such a revisionist account of the background conditions of
the standard story should be firmly enmeshed in business, i.e., in the practice of
value creation and trade.
However haltingly it has been presented, this latter narrative has been at
work in the background (some might say "deep background") in the develop-
ment of what has come to be called "stakeholder theory." In the following sections
we want to refocus "stakeholder theory" toward its "Libertarian" background
conditions. In section II we briefly summarize what has come to be called "stake-
holder theory." In section III we set out what makes a particular theory
"libertarian," and what kinds of arguments could roughly be called "libertarian
arguments." In section IV we construct some libertarian arguments for a variety
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 333
of forms of stakeholder theory. These arguments seek to change the background
conditions of the standard story and they lead to a revised understanding of
capitalism called "stakeholder capitalism." Finally, in section V we generalize
the ideas in the previous sections and construct an argument for understanding
capitalism in both stakeholder and libertarian terms, a view which we call "stake-
holder capitalism,"
//, Stakeholder Theory
Stakeholder theorv' is a managerial conception of organizational strategy and
ethics (Donaldson and Preston, 1995; Evan and Freeman., 1993; Freeman, 1984,
1994,1996; Freeman and Evan, 1990; Hill and Jones, 1992; Jones, 1995; Mitch-
ell, Agle, and Wood, 1997; Orts, 1992, 1997; Phillips, 1997; Rowley, 1997).
The central idea is that an organization's success is dependent on how well it
manages the relationships with key groups such as customers, employees, sup-
pliers, communities, financiers, and others that can affect the realization of its
purpose. The manager's job is to keep the support of all of these groups, balanc-
ing their interests, while making the organization a place where stakeholder
interests can be maximized over time. The identification of stakeholder groups
IS currently among the central debates in the scholarly and popular literature
(Mitchell, et al., 1997; Phillips, 1997). but most scholars would include em-
ployees, customers, suppliers, financiers, and local communities, at a minimum.
Contributions to stakeholder theory have come from, among others, such
disciplines as:
Ethics (Boatright, 1994; Burton and Dunn, 1996; Donaldson and
Dunfee, 1999; Goodpaster, 1991: Phillips, 1997; Phillips and
Reichart, 2000; Starik, 1995: Wicks, Gilbert and Freeman, 1994;
Van Buren, 2001);
Strategy (Berman, Wicks, Kotha, and Jones. 1999; Carroll, 1993;
Clarkson, 1994, 1995; Freeman, 1984; Frooman, 1999; Mitch-
ell, Agle. and Wood, 1997):
Law (Lampe, 2001; Orts, 1992, 1997);
Economics (Alkhafaji, 1989; Barton, Hill and Sundaram, 1989;
Freeman and Evan, 1990); and
Organization theory (Donaldson and Preston, 1995; Freeman
1994, 1996; Evan and Freeman, 1993; Hill and Jones, 1992;
Jones, 1995; Rowley, 1997; Williamson and Bercovitz, 1996).s
Stakeholder theory has also received significant attention in the discourse of
political economy, particularly in the U.K. (e.g., Hutton, 1995; Kelly, Kelly,
and Gamble, 1997; Plender, 1997). These authors propose a "stakeholder
economy" that features a large-scale role for government in the process of value
creation and trade. They argue that, while the stakeholder concept was origi-
nally applied to the private sector as a theory of organizational ethics (Phillips
and Margolis, 1999), expanding the concept to include public institutions and
334 BUSINESS ETHICS QUARTERLY
the entire national or world economy is a conceptual advance (Rustin, 1997;
Barnett 1997). This has led some to claim that the stakeholder approach comes
from a socialist worldview. One goal of this paper is to clearly differentiate this
brand of stakeholder theory from stakeholder theory in general, and our own
conception in particular.
We do note, however, that even though we disagree with this "stakeholder
economy" approach, the strategy of these thinkers is a central one to the stake-
holder project similar to that employed by Freeman and others. Change the
background conditions of the standard story. Revise our understanding of capi-
talism accordingly. See what works. On the "stakeholding" account, these
background conditions revolve around the articulation of "liberal" principles
instead of libertarian ones, and therefore encourage a large role of the state.
The disagreement between liberal and libertarian versions of stakeholder capi-
talism may turn out to be less over fundamental ethical principles and more
over what actually works in the world of value creation and trade.
Finally, it is a mistake to tar all stakeholder theory with the same broad
brush. Freeman (1994) suggests that the theory is better understood not as a
monolithic theory, but rather as a genre of stakeholder "theories." While the
very nature and definition of "stakeholder theory" is itself a contentious issue,
the idea is quite simple. A "stakeholder theory" is one that puts as a primary
managerial task the charge to influence, or manage, or balance the set of rela-
tionships that can affect the achievement of an organization's purpose.
///. Libertarian Arguments
What makes an argument a "libertarian" one?* This is a question that is quite
controversial, even among libertarians. While they come in many colors and
shapes, most libertarians agree that "liberty" or "personal freedom" or "free-
dom" has intrinsic value. Some might say that such an idea is definitional of
humans, or shows us at our best. Others might say that developing "an attitude
of liberty" is the only hope for human society.'' Other libertarians put the matter
in terms of "rights" or "natural rights" and concentrate on "negative rights."
They claim that one human being has the right not to be interfered with by
others, where "interfered with" is parsed in terms of physical harm. Most liber-
tarians argue from freedom and liberty as primary to suggest that a strong system
of individual property rights is the best means to preserve freedom and liberty.
Property rights become an extension of the right to one's own physical body
and its movements, so long as these movements don't interfere with others
(Locke, 1690/1952). After all, the argument goes, if one can't have the right to
use one's body the way one wants to, it is difficult to see how one can be free,
in any meaningful sense of "free."
Typically, libertarians do not want to trade off "equality" with "freedom,"
especially when "equality" is understood in terms of the distribution of wealth
in society. And, they believe that the existence of a "more than minimal
nightwatchman state" that redistributes wealth cannot be justified (Nozick, 1974).
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 335
Rawls's first principle of justice is a paradigm case of a libertarian principle.
He claims that "each person is to have an equal right to the most extensive basic
liberty compatible with a similar liberty for others" (Rawls, 1971: 60). "Basic
liberty" here refers to "political liberty, freedom of speech and assembly;
liberty of conscience and freedom of thought; freedom of the person along with
the right to hold personal property, and the freedom from arbitrary arrest and
seizure as defined by the concept of the rule of law" (Rawls, 1971: 61).
However, Rawls is no libertarian, given his extensive arguments for a redis-
tributive state or his second principle of justice.^ (Some libertarians like John
Hospers would quarrel with Rawls's list of basic liberties and argue that most
are actually reducible to property rights.) Indeed Robert Nozick takes Rawls's
first principle as a starting point for a libertarian theory. Jean Hampton (1997:
145) argues that:
In a sense he [Nozick] agrees with the importance and priority of Rawls's
first principle of justice, but in Nozick's view that first principle, re-
quiring equal liberty for all, has implications for the kind of conception
of justice that can be endorsed by a liberty-loving society. It must be
one thai allows people maximal (and equal) freedom to do with their
property what they choose to do, without being subjected to interfer-
ence by the state.
Nozick's argument is roughly: pick any redistribution that you want. No
matter how perfect, people would undertake trade to improve their lot, thereby
necessitating more redistribution, negating the effects of the voluntary trades.
It is a hallmark of libertarian views that voluntary acts among consenting adults
ought to count as morally permissible, provided that they impose no substantial
costs on any third party.
So, libertarian theories are often contrasted with liberal theories.^ According
to Alan Ryan (1995: 296) the line is not an easy one to draw.
Both are committed to the promotion of individual liberty; both rest
most happily on a theory of human rights according to which individu-
als enter the world with a right to the free disposal of themselves and
their resources. The hne of cleavage lies between the libertarian view
that government is not a necessary evil but a largely (and for so called
"anarchocapitalists" a wholly) unnecessary evil and the liberal view
that government power is to be treated with caution, but like any other
instrument may be used to achieve good ends.
It is interesting to note here that the difference between libertarian theories
and liberal theories may well be a difference in what actually happens in the
real world. Libertarians may believe that the best means to promote liberty,
etc., are markets and limited, at most, governments, while liberals may believe
that the best means to promote liberty include the welfare state. While the dif-
ferences in theory are not always so obvious, political philosophers have done a
good job of actually ignoring what we might call "differences of fact."'o
336 BUSINESS ETHICS QUARTERLY
Alternatively, libertarianism can be contrasted with utilitarianism, Jean Hampton
has put the point quite contentiously: "Whereas utilitarianism might be said to
allow individuals to be held hostage to the well-being of the community, liber-
tarianism might be said to allow the community's well being to be held hostage to
the rights, and in particular the property rights, of individuals" (Hampton, 1997).
While the focus of libertarian theory has been on some form of freedom/
liberty, some analysis of rights, property rights in particular, and some argu-
ments for the limited role of government, there is also another less obvious
tenet of most libertarian thought. Most libertarians must have strong beliefs
about personal responsibility.
First of all, on any libertarian account, persons are responsible for them-
selves. The equal liberty principle makes no sense if A may do whatever she
likes to B. The "compatible with a like liberty for all" clause is crucial. The
libertarian must assume that people are capable of controlling their actions so
that they do not harm others. Second, when such boundary crossings or harms
occur, the offending party must make some attempt at reparation. The alterna-
tive to this strong notion of individual responsibility is making some collective
like the state responsible for repairing any damage that is done, but the whole
point of the minimal state is that such "collective responsibility" carries severe
"freedom denying" penalties. So, libertarians do or ought to accept some vari-
ant of a principle about responsibility. The Responsibility Thesis says:
The basis for ethics or the moral point of view is that most people,
most of the time, take or want to take responsibility for the effects
of their actions on others. And, if they did not, then what we call
"ethics" and "morality" would be meaningless.*'
Now there may well be a particular libertarian version of such a principle
which specifies the necessary and sufficient conditions under which a person must
make someone that she has harmed "whole," But it is hard to conceive of a liber-
tarian theory that doesn't have some version of the responsibility principle.
We claim that an argument is a libertarian argument if it (1) relies on free-
dom, liberty, the equal liberty principle, or some kindred notion; (2) relies on
basic negative rights, like those defined by Rawls's first principle, and includ-
ing individual property rights; (3) allows for the creation of positive obligations
through various voluntary actions (e.g., contracting and promising); (4) coun-
tenances at most a minimal state, as defined by Nozick and others; and, (5)
assumes that human beings are largely responsible for the effects of their ac-
tions on others.
IV. Some Libertarian Arguments for Stakeholder Theory
Now, we want to suggest that in the background of stakeholder theory are
libertarian arguments that draw on these five ideas. There are at least two branches
of "stakeholder theory" or "managing for stakeholders" that we need to take
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 337
into account. The first branch is based on what Freeman (1999) has called "the
Instrumental Thesis." This thesis suggests:
To maximize shareholder value over an uncertain time frame, man-
agers ought to pay attention to key stakeholder relationships.
It is easy to see libertarian assumptions running in the background here. We
might assume that the corporation is the private property of the shareholders,
and that managers have been hired by the shareholders to do what's best for the
shareholders. Shareholders must be responsible for the uses of their property,
even by their agents, according to the responsibility part of libertarian theory
(respondeat superior). So, managers who are boundedly rational and acting un-
der real uncertainty, must take the interests of stakeholders into account, else
they might misuse shareholders' property to harm others and violate their right
to freedom. This argument says nothing about treating all stakeholders equally,'-
nor does it suggest, even remotely, that managers should take from one stake-
holder group and give to another. Rather, the argument recognizes that the
stakeholder framework is largely managerial, in the sense that Donaldson and
Preston (1995) have pointed out (cf. Freeman, 2000).
Why is it important to point out the libertarian roots of the argument for the
instrumental thesis? In Strategic Management: A Stakeholder Approach.. Free-
man suggested, in a section entitled "A Plea for Voluntarism," that a growing
tendency to look outside the firm for the causes of decline masked the fact that
managers had it within their power to influence the external environment (cf.
Pfeffer and Salancik, 1978). Only by seeing stakeholder relationships subject to
managerial influence could managers actually begin to do their jobs of leading
the corporation toward its purpose, whatever that purpose may be. He suggests:
Such a philosophy of management [the stakeholder one, as interpreted
as the instmmental thesis] must be based on the idea of voluntarism, if
it is to be implemented in U.S. based companies. Not only is voluntarism
the only philosophy which is consistent with our social fabric, but the
costs of other approaches are simply too high. Voluntarism means that
an organization must on its own will undertake to satisfy its key stake-
holders. A situation where a solution to a stakeholder problem is imposed
by a government agency or the courts must be seen as a managerial
failure (Freeman, 1984: 74).
Today we might add that it is because of bounded rationality and uncertainty
that we cannot tmst that a governmental solution will continue to be optimal,
even though it might look more favorable than one that deals directly with key
stakeholders. Give the state power over a particular area, and it rarely relin-
quishes control. Again, we appeal to libertarian principles to get this voluntarism
argument off the ground. The prominence of responsibility in libertarian thought
is reflected in this early discussion of the motivational structure of managing
for stakeholders. So, we conclude that the Instrumental Thesis can have a decid-
edly libertarian flavor, even though it need not, i.e., there are certainly
338 BUSINESS ETHICS QUARTERLY
non-libertarian arguments for the instrumental thesis, for it does not depend on
the idea of exclusive private property rights or the limited state.
The second branch of stakeholder theory is based on what we might call
the "Normative Thesis." It claims:
Managers ought to pay attention to key stakeholder relationships.
There is no starting point of property rights of shareholders here. In fact
some have claimed that the normative thesis must be defended from the pure
starting point of ethical theory. While we are skeptical of such claims, we do
believe that such a defense can be offered on libertarian grounds.
The first defense argues that in fact we do live in a world of property rights.
If shareholders are in fact the owners of the corporation in some sense, then
managers must respect the property rights of shareholders, unless they are trumped
by more important liberty rights of other stakeholders (or shareholders them-
selves). Most libertarians would argue that property rights are fairly basic, and
rarely tmmped by other considerations, indeed that most other considerations
can be reduced to property rights. Therefore, if we add the ingredients of bounded
rationality, uncertainty and responsibility, the argument for the normative the-
sis looks a lot like the argument for the instrumental thesis even where we have
not assumed that managers are the explicit agents for the shareholders.
A variant of this argument suggests that each stakeholder has property rights.
Consumers have the property right to their wealth. Suppliers have the prop-
erty right to the supplies that they sell to the corporation. Employees have a
property right to their labor. Communities have a property right to public
goods. 13 jn order to respect these property rights, managers must pay atten-
tion to stakeholders."
Yet another variant of this argument relies on the notion of voluntary action.
On one interpretation, the firm is a nexus of contracts or the centerpiece of an
ongoing multilateral agreement, based on voluntary consent. As indicated above,
libertarian theory is not antithetical to the notion of positive obligations among
actors. Rather, the argument is that no such duties exist apart from the voluntar}'
actions of actors. There is no natural right to a job, for example, though actors
can create reciprocal obligations based on the voluntary action of entering into
an employment contract. If there is a weak presumption that the agreement is
ongoing, managers must take the interests of all parties to the contract, or the
nexus, into account.
In addition to consent- or contract-based obligations, Phillips (1997) has
argued for obligations of stakeholder fairness derived from the voluntary accep-
tance of the benefits of a mutually beneficial cooperative scheme. Such obligations
are also consistent with libertarianism inasmuch as they countenance neither a
natural nor a hypothetical basis for organizational obligations to stakeholders,
but rather one based on voluntary' actions of the organization (or its manage-
ment). Relying, then, on the responsibility principle, we would expect managers
to try to keep the joint interests of stakeholders in balance in any instance where
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 339
positive obligations have been created through consent, contract, voluntary accep-
tance of benefits, or any other voluntary action.
In a series of papers, Evan and Freeman made such a libertarian argument
in which they went further and tried to set forth conditions under which it
would be in the interests of each stakeholder group to conceptualize the firm
as such a voluntary agreement. A little-noticed condition in that paper was
that such an agreement ought to be enforceable without depending on a spe-
cific state regime. Hence, the agreements were to be self-enforcing in order to
limit the role of the state.
The classical role of the state to solve coordination problems (a la Prisoner's
Dilemma), provide or regulate pubhc goods, and serve as a court of last resort,
was to be usurped by these voluntary agreements, precisely to limit the involve-
ment of the state in the affairs of the corporation. Evan and Freeman relied on
a Rawlsian-like veil of ignorance to make the argument, but it was one with
strong libertarian, instead of liberal, background assumptions, Evan and Free-
man stipulated (by tacit appeal to libertarian background conditions) that the
agreements which came out of the veil must work in any set of conditions, and
could not depend on particular kinds of state regimes. Indeed, if Evan and
Freeman had perhaps more carefully set out who these hypothetical stakehold-
ers were who were trying to set forth ideal conditions for fair agreements,
perhaps they would have explicitly made them (1) holders of the equal liberty
principle; (2) committed to negative rights, especially property rights; (3) able
to create and accrue positive commitments and obligations among members of
private associations; (4) distmstful of the state in any guise; and (5) committed
to being responsible for the effects of their actions on others. In short they
would have been libertarians.
Despite the libertarian arguments that can be adduced for both the instm-
mental and normative branches of stakeholder theory, ultimately we have to
come to see stakeholder theory as managerial. According to Donaldson and
Preston (1995), stakeholder theory is managerial in the sense that it recom-
mends courses of action for managers and deals at once with normative,
instrumental, and descriptive claims. They write.
The stakeholder theory is managerial m the broad sense of that term. It
does not simply describe existing situations or predict cause-effect
relationships: it also recommends attitudes, structures, and practices
that, taken together, constitute stakeholder management. Stakeholder
management requires, as its key attribute, simultaneous attention to
the legitimate interests of all appropriate stakeholders, both in the
establishment of organizational structures and general policies and in
case-by-case decision making. This requirement holds for anyone man-
aging or affecting corporate policies, including not only professional
managers, but shareowners, the government, and others. Stakeholder
theory does not necessarily presume that managers are the only right-
ful locus of corporate control and governance. Nor does the requirement
of simultaneous attention to stakeholder interests resolve the
340 BUSINESS ETHICS QUARTERLY
longstanding problem of identifying stakeholders and evaluating their
legitimate "stakes"" in the corporation. The theory does not imply that
all stakeholders (however they may be identified) should be equally
involved in all processes and decisions (1995: 75-76).
To further fill out the conception of stakeholder theory as managerial, we
would add that to see stakeholder theory as managerial is to see it as intimately
connected with the practice of business. First and foremost, stakeholder theory
is about business and capitalism. And it is here that the libertarian background
assumptions of stakeholder theory come out the strongest.
Business is that human institution that is about value creation and trade.
Libertarian theorists point out that value creation and trade are older than the
idea of governments, and that both have gone on independently and in spite of
specific state regimes. Note that this is not the claim that the state has no impact
on value creation and trade, but the claim that it need not. Value creation and
trade take place across state regimes, and among actors who live in a multiplic-
ity of different state regimes. Indeed, as trade becomes increasingly global in
scope, the regulatory power of any single government is diminished.
Like Follett (1994) and Barnard (1938) before. Freeman (2000) has argued
that the engine of value creation and trade is the human desire to create. It
comes from the many values that we hold that drive us to take a stand and do
something with our lives. It comes from what Harold Bloom calls the "strong
poet," the person who shows us how to live differently. Freeman also argues
that the desire for solidarity fuels capitalism, the desire to come together and
build something which no single person can accomplish. Now both of these
desires emerge in theory when we admit a complex psychology of human be-
ings. There is no reason for libertarians to deny such a complex psychology,
though often one finds libertarian analyses which assume that most people are
narrowly economic, or self-interested, etc.
If we come to see stakeholder theory as concerned with the practice of
value creation and trade, we are led back to "the plea for voluntarism." Re-
gardless of the purpose of the firm, since managers are boundedly rational,
and since the world is uncertain, they must pay attention to the consequences
of their actions on others. To ignore these others is to put oneself and one's
company beyond the pale of morality and ethics, conceived of as liberal,
Kantian, Utilitarian, or libertarian.'^
V. Erom "Stakeholder Theory" To A Libertarian Stakeholder Capitalism
The arguments of the previous two sections give rise to the question of whether
there can be a systematic way to understand business activity that is both liber-
tarian in spirit and attends to the managerial interests inherent in the stakeholder
approach. We want to argue that there are a number of principles that any such
stakeholder capitalism would have to satisfy.
STAKEHOLDER THEORY: \ LIBERTARIAN DEFENSE 341
The hallmark of libertarian theorj' is one of consent and agreement. Free people
have the right to make agreements with others, even if some of these agreements
limit their own freedom.'* The first three criteria for what makes a theory a
libertarian one are freedom, rights, and the creation by consent of positive obliga-
tions. Our underlying notion of why capitalism works is ultimately due to these
three ideas and how they interact. Business is founded (and businesses are cre-
ated) on this idea of making agreements with each other. And we are free to make
these agreements because others are not permitted to interfere (so long as they are
not substantially affected).^^ Entrepreneurs see the possibility of creating value
where others do not. They contract with suppliers, employees, suppliers of fi-
nance, and customers, as well as others, to start and build firms. In other words
they create a set of positive obligations among those parties that are affected. We
might capture these intuitions in the following principle:
The Principle of Stakeholder Cooperation says that value is created
because stakeholders can jointly satisfy their needs and desires by
making voluntary agreements with each other.'^
Value creation and trade is not a zero-sum game. Capitalism works because
entrepreneurs and managers put together and sustain deals or relationships among
customers, suppliers, employees, financiers, and communities. The support of
each group is vital to the success of the endeavor and the outcomes are synergis-
tic. This is the cooperative common-sense part of business that every executive
knows. It is deeply libertarian since it is rooted in the notion that voluntary
action is the well-spring of capitalism. When stakeholders pool their resources
to create something, no one has the right to prevent their actions, provided they
do not impose substantial harms on innocent third parties.
Having the freedom to make agreements is as important for customers who
purchase products as it is for employees who agree to take direction and work
for some corporate objectives in return for money, satisfaction, knowiedge, or
whatever the particular agreement authorizes. More subtly, communities are
also a part of the agreement structure of business, since they provide air, water,
schools, roads, protection from harm, and other so-called "public goods,"'^
Whether these agreements among stakeholders are to be understood as bilat-
eral agreements or multilateral agreements is an interesting question. However,
if these agreements are to be sustainable over time, they must include some
element of faimess, as Freeman (1994) has argued. There are many different
conceptions of fairness that may be applied here. And there are many kinds of
agreements that can be termed "fair." Freeman (1994) suggests one method
based on Rawls's theor\' of justice (cf. Phillips andMargolis, 1999), called "the
doctrine of fair contracts,"' but there are others that would work equally well
(Deutsch, 1975). In a relatively free and open society, if agreements are not
fair, parties to the agreement will seek alternatives, and may well seek state
intervention and recompense.
342 BUSINESS ETHICS QUARTERLY
In addition to basic fairness, and prior to it from a libertarian perspective is
the question of whether parties to an agreement must be responsible for the
outcomes of that agreement. We have suggested above that a strong notion of
responsibility is necessary for libertarian theories to be tractable, and if parties
to an agreement are responsible, the question of faimess may well become sub-
sidiary. Again, the failure of a notion of responsibility to find a place at the
center of our understanding of business is perhaps the reason for the large regu-
latory role played by government and the courts in our current economy. If
liberty is to be preserved, then stakeholder capitalism must include a principle
that ensures that parties to the agreements will be responsible for the effects of
their actions.
The Principle of Stakeholder Responsibility claims that parties to an
agreement must accept responsibility for the consequences of their
action. When third parties are harmed, they must be compensated,
or a new agreement must be negotiated with all of those parties who
are
Responsibility is a tricky concept. It is easy to find simple counterexamples
using vague terms like harm (suppose I am "harmed" when you wear pink shirts,
for example.). Such examples (see Marcoux and Child, for instance) are a func-
tion of the vagueness of "harm" or "responsibility" and count no more against
our use of these central moral ideas than against anyone else's use of them. So,
regardless of the weaknesses of our best current theory of "responsibility," our
claim is that some notion of responsibility is central to the development of
stakeholder capitalism.
A second feature of this principle is that it applies reciprocally to all stake-
holders. If an entrepreneur, manager, or firm has responsibility for the effects of
its actions, so too, do customers, communities, suppliers, financiers, and employ-
ees. Firms are not the sole carriers of responsibility in today's world. Customers
have a duty to use products as they were intended, or else take reasonable care,
including the burden of responsibility, when they do not. Employees have a re-
sponsibility to support their employers within reason. Suppliers have the duty to
do their best to make the supply chain work properly and be efficient.^i And
shareholders have a responsibility to elect responsible directors who will take
seriously their "duty of care" to manage "the affairs of the corporation,"
The first two principles of stakeholder capitalism ground business in the
freedom of individuals to make agreements, and in the concomitant responsibil-
ity that comes with exercising such freedom. The alternative to these two principles
is a view that capitalism rests on the idea that "anything goes" and "let the buyer
beware," Long a part of the common parlance of capitalism, it is high time to
put these ideas to rest. The only possible outcome of these principles is a belief
by people that "in business what you do is what you can get away with" and that
we need the state to protect citizens from the naked self-interest of business.
The resulting "bad public relations" for capitalism and the growth of the modern
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 343
state are both a testament for our argument that we need to return to the basics
of how business can and should operate.--
Out of this bad reputation for capitalism comes the idea that in business
people act solely in their own self interest, and often they go further and act
narrowly in a selfish manner. Thus, the popular and scholarly press is filled
with "horror stories" about yet another egregious infelicity involving some large
multinational. Recently, Werhane (2000) has suggested that most of these cases
look like the story of Rashomon, where the description of what happened de-
pends on the point of view that you have. While there are some undoubtedly
real "horror stories,'" it is the assumption that business people must be narrowly
self-interested that is really doing the damage. After all, one response to the
"horror stor\'" scenario is that in fairness, if business is tarred with the bad, it
must at least be feathered with the good consequences. But even this response
misses the point. What is missing is a complex psychology of the actors in
business. Surely, some are self-interested, and, just as surely, some are other-
regarding. Managers, entrepreneurs, and stakeholders must have as complex a
psychology as ordinary human beings, for the simple fact that they are ordinary
human beings. Once we remove the narrow view of business required by the
non-stakeholder story, we can open up the complex entities that are involved.
People have many and varied values. These values cause them to pursue
their hopes and dreams in a number of ways. At least some of these pursuits
(what Freeman and Gilbert [1988] called "personal projects") involve collabo-
rating and contracting with others to create something of value. Stakeholder
capitalism must rest on something like the following principle:
The Principle of Complexity claims that human beings are complex
psychological creatures capable of acting from many different val-
ues and points of view.
This principle may well seem trivial. But, we argue that the current back-
drop of business makes it necessary to spell it out. We are not just self-interested
narrowly economic maximizers. The discussions of self-interest vs. altruism,
which seem embedded in literatures such as corporate social responsibility, as
well as finance, simply miss the mark. Sometimes we are selfish and sometimes
we act for others. Many of our values are jointly determined and shared. Capi-
talism works because of this complexity, rather than in spite of it. A central task
of managers and entrepreneurs is to determine an answer to fundamental values
questions that may bind together a business entity. There are no obvious "right"
answers here. There are many different ways to engage in value creation and
trade and also be "an ethical person."'^ Such a principle might rely on the back-
ground assumption that free and responsible people who respect each other's
freedom will develop complex interests and values, which will lead to many
options for themselves and those with whom they form relationships. Capital-
ism, on this view, becomes the voluntary associations of free, responsible,
cooperating, consenting, and complex adults.
344 BUSINESS ETHICS QUARTERLY
The final two principles are subsidiary to the first three. They are necessary
to correct the mistaken impressions left by the standard story of capitalism.
Perhaps it is possible to construct a stakeholder capitalism without these prin-
ciples, but let them serve as explanatory of the kinds of behaviors that will
result from such a new story.
The Principle of Continuous Creation says that business as an insti-
tution is a source of the creation of value. Cooperating with
stakeholders and motivated by values, businesspeople continuously
create new sources of value.
Schumpeter's old saw is "the principle of creative destruction." It claims that
at the center of capitalism is the emergence of new value that necessarily de-
stroys old value. We believe that this principle focuses too much attention on
capitalism as a closed system. While value destruction does in fact take place,
the genius of the corporate form, combined with the genius of entrepreneurship
is that such destruction need not destroy businesses. Corporations can (some
would say have the duty to) continuously create value. Obviously, continuous
creation is possible because of the three principles outlined above, sharing the
libertarian roots of these ideas.
In short, the principle of continuous creation claims that the creative force
of humans is the real engine of capitalism. One creation doesn't have to destroy
another, rather there is a continuous cycle of value creation which raises the
well-being of everyone. People come together to create something, be it a new
computer program, a new level of service, a way to heal the sick, or simply to
work together. It is the creative spirit that results from freedom-loving people
that makes capitalism work.
Finally, The Principle of Emergent Competition says that compe-
tition emerges from a relatively free society so that stakeholders
have options. Competition emerges out of the cooperation among
stakeholders, rather than being based on the primal urge to "get
the other guy."
This principle seeks a corrective measure in the now largely dominant idea
that capitalism is first and foremost about "anything-goes competition." In a
relatively free and open society, people are "free to compete," or "free to offer
alternatives." The entrepreneurial process ensures that there is an outside "equili-
brating force" that adds pressure for managers to manage for stakeholders. When
they don't, yet another stakeholder network is capable of forming (Venkataraman,
2002). Competition is important in Stakeholder Capitalism, but it is an emer-
gent property. The psychological connection between the desire to create and
achieve and the desire to competeto beat othersis an interesting question.
Perhaps in the end, both are necessary, or connected in important ways. Suffice
it for our purposes to call attention, once again, to the creative force and the
complex human psychology that is necessary to combine libertarian ideas of
freedom with managerial ideas of stakeholder theory.
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 345
Stakeholder capitalism invokes a focus at the level of how value is created,
rather than at the societal level of value distribution, or the accrual of large
amounts of capital and control over it. Capitalism in this sense has little to do
with nineteenth-century robber barons, the emergence of institutions for trad-
ing stocks, or the ability to accumulate and make available to entrepreneurs
large supplies of capital. All of these issues are important, but they are subsid-
iary to the value-creation process. Our five principles form a basis for assessing
the most basic nature of business, or value creation and trade. How far the
enactment of our current story is from these principles is a matter for further
debate for academics and policymakers at both the corporate and societal levels.
Our suggestion is that, by focusing on these principles, we can reorient capitalism
toward an ethics of freedom and responsibilityone that inherently marries
business and ethics.
Stakeholder Capitalism requires that freedom-loving human beings be at the
center of any process of value creation and trade. It underscores the responsibil-
ity thesis that common decency and fairness are not to be set aside in the name
of playing the game of business. It suggests that we should demand the best
behavior of business, and that we should enact a story about business that cel-
ebrates its triumphs, admonishes its failures, and fully partakes of the moral
discourse in society as a routine matter. Yet, Stakeholder Capitalism is no pana-
cea. It simply allows the possibility that business becomes a fully human
institution. There will always be businesspeople who try to take advantage of
others, just as there are corrupt govemment officials, clergy, and professors.
Stakeholder Capitalism bases our understanding and expectations of business
not on the worst that we can do, but on the best. It sets a high standard, recog-
nizes the common sense practical world of global business today, and asks
managers to get on with the task of creating value for all stakeholders.
Notes
' Dennett (1995) distinguishes betvveen "reductionism'' and "greedy reductiomsm'"
'Wisdom (1970) argues that philosophy's unique contribution to intellectual life is to
illuminate such hidden features.
3 See for instance the work of Bowie. Brenkert, Donaldson and Dunfee. Solomon. Werhane
to name but a few
* See for instance the work of Carroll. Cochran, Post, Wood. Waddock and others
5 Many of the works exemplifying the various categories are cross-disciplinary, so neither
the works cited nor the categories themselves should be construed as mutually exclusive.
f> We owe a great debt to Gordon Sollars in the following paragraphs, though this interpre-
tation of what counts as libertarian is our own
' See the work of James Buchanan Buchanan argued that developing an "attitude of liberty''
was the central hope for democratic societies at a Liberty Fund Conference at George Mason
Umversity in 1986.
346 BUSINESS ETHICS QUARTERLY
^ There have been many thousands of journal pages devoted to Rawls's second principle.
The Difference Principle, but relatively little attention paid to the Equal Liberty Principle, the
first pnnciple This is quite odd given that the first principle is supposed to be lexically ordered
with the second, i.e., there is an absolute prionty of equal liberty over the difference principle.
It is interesting to speculate that if one fully works out the best mechanisms for assuring equal
liberty, those same mechanisms may also promote equality as far as possible. Get the first
principle right, m the details, and one may not need the second principle. This is the spmt of the
argument of Lomasky (1987).
' Some libertarians take issue with the distinction between liberalism and libertarianism
claiming that the term "liberal" originally applied to what is today termed libertarianism and the
advocates of current "liberalism" co-opted the term from "classical liberals" (i.e., libertarians)
like Locke. See Lomasky, (1987). For the sake of clarity we will employ the more common
contemporary usage.
'0 To say there are differences of "fact" is not to countenance the fact-value distinction.
More carefully we might say that libertarians and liberals tell different stories about our rela-
tionship to our history, and indeed, even write quite different histories.
' ' We need appeal to nothing more here than a standard Darwinian account, a la Daniel
Dennet, (1995) that the "responsibility meme" is evolutionarily stable. However there is a
deeper connection worth explonng among libertarians, existentialists, and pragmatists.
12 Cf. Marcoux (2000) and Sternberg (2000).
'3 Now any libertarian would severely constrain the interpretations of this statement, but
however it turns out, even if it is analyzed away as public goods are turned into private goods
the point still stands, as some system of property rights will hold sway.
'''This seems to be the general approach of Donaldson and Preston, 1995.
'5 That business is m fact "beyond the pale" at least in its perception is precisely the claim that
the Separation Thesis is at the heart of this debate about the proper role of stakeholder theory.
1^ The limiting case of whether or not a libertarian theory countenances "selling oneself into
slavery" is beyond our scope here, and is probably uninteresting.
17 We use "substantially" here because we note that counterexamples are easy to come by,
but as Rawls. cautions us, we shouldn't always give in to them.
i^The following sections contain some paragraphs from R. Edward Freeman, "Stakeholder
Capitalism." Financial Times, July 26, 1996. We are grateful to the editors and publisher for
permission to use this material here
''Whether these goods could be provided by private means, as some libertarians argue, is
not at stake here.
-0 We are grateful to an anonymous referee for the suggestion of this principle.
^' Recent attention to "sweat-shop" working conditions in the developing world has raised
questions regarding the responsibility of corporations for the actions of their sub-contractors
as well those farther removed m the supply chain (sub-sub-contractors) both "upstream" and
"downstream." This is an interesting stakeholder question, but one outside the scope of the
present inquiry.
-- Some might argue that we have committed the naturalistic fallacy herethat we have
mistaken how businesses do act with how they should. To begin, we pragmatists will have
none of the prescriptive-descriptive, or fact-value distinction Wicks and Freeman (1998) tries
to outline how such a pragmatist view of management theory would work. The story of
business that is deeply embedded in our society is not the story of stakeholder capitalism. Thus,
it is important to clearly set forth the underlying principles on which this new story, the story of
stakeholder capitalism, rests.
STAKEHOLDER THEORY: A LIBERTARIAN DEFENSE 347
-^ That there are many ways to run a business is the insight behind the often ignored idea of
"enterprise strategy" and its theoretical analog "normative core'" It is a separate story whether
or not "being an ethical person" makes any sense in isolation from the ideas of value creation
and trade. If value creation and trade are fundamental to the human experience, then separating
out "ethical person"' as the above sentence does, is also illegitimate. Another way to say this is
that our analysis points out the need for a political philosophy or a conception of ethics where
value creation and trade, rather than the state, play a central role
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