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After many business leaders had committed decades to maximizing short-term shareholder returns, the Business Roundtable’s August 2019 Statement on the Purpose of a Corporation1 declaring that companies should serve the interests of all stakeholders — not just investors, but also customers, employees, partners, suppliers, and society at large — signaled a major shift. This change represents a key challenge, and not just for the nearly 200 CEOs of major companies who signed the Roundtable’s statement.
How are leaders supposed to manage the trade-offs between conflicting stakeholder interests? Consider, for example, the tension between the interests of short-term shareholders and the need to support a robust societal response to pandemics or other crises that can threaten a company’s business model. Those who have pursued long-term growth strategies that benefit a broad set of constituents understand that they must focus rigorously on their companies’ long-term value. Specifically, it’s important to assess which stakeholders create — and which deplete — long-term shareholder value. This enables companies to avoid value-destroying traps and develop win-win compacts with value-creating stakeholders.
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To help executives do this work, we present a framework in which long-term shareholders are separated out from other stakeholders. It’s based on our experience working with boards of directors on stakeholder issues that affect the value of the company. The framework has been tested in workshops for specific corporate boards and in a program for high-performance boards at IMD. In both contexts, it has helped directors recognize five common traps and develop strategies to integrate shareholders’ interests with those of other stakeholders, turning the emerging support for stakeholder capitalism into reality. It builds on research and thinking that we and others have done about the benefits of balancing those interests2 and about how top management and boards should avoid undermining the corporate culture by extracting value from some stakeholders to achieve short-term gains.3
In this article, we look at the five traps and describe how leaders can avoid them, citing examples of companies that have struggled and those that have fared better. In particular, we highlight the experience of Royal DSM, a Dutch biotech sustainability trailblazer with a market capitalization of about $22.2 billion, which shows how the approach we propose can play out over multiple iterations. Although we have not worked with DSM directly, our colleagues Jean-Pierre Jeannet and Benoit Leleux did work with DSM executives in strategy and leadership programs and on DSM case studies in the 1990s and 2000s.4 We draw on their observations to illustrate the benefits of classifying stakeholders and focusing on shared long-term interests.
Five Short-Term Traps
Consider the following questions:
- Who are the company’s most important value-creating stakeholders?
- Which stakeholders are getting the best deals from the company?
- Which ones are getting the worst deals?
- Which ones are the most dangerous?
- Who are the most threatening intermediaries between stakeholders and the company?
If you are unable to answer any of these questions, your company risks falling into one of the following traps.
1. Misjudging stakeholders’ potential value. The stakeholders most likely to create long-term value for shareholders are those that are poised to have the biggest impact on future long-term cash flows. While some stakeholders are likely to generate short-term cash flows, others will yield longer-term value through the skills and expertise they provide, for example, or through their ability to access environmental resources in a sustainable way.
The stakeholders that are the likely cash-flow generators should be at the front end of cash distribution, but they are not necessarily shareholders.5 Still, many companies, large ones especially, have been treating shareholders as their most critical stakeholders. Over the past five years, S&P 500 companies have spent close to 100% of their operating earnings on dividends and share buybacks.6
This might make sense in the short run, because shareholders can drive down the share price and related executive compensation if they don’t like the distribution policy. Yet, apart from activists, shareholders of established companies have little impact on the future cash flows that determine long-term value.
Boards and executive teams often don’t know the stakeholders most likely to drive future cash flows. Identifying potential value creators is complicated by macro factors, like the technological revolutions that produce unfamiliar new value creators. Executives trap their companies, sometimes fatally, by not accurately identifying and prioritizing value-creating stakeholders or by underestimating the cultural change required to create value with those stakeholders.
Consider this: The rapid shifts in visual content distribution exemplify how today’s industry leaders can misjudge tomorrow’s critical stakeholders. When Netflix entered the video realm, neither Blockbuster’s board nor activist investor Carl Icahn recognized that online consumers would become major new value creators; Blockbuster maintained its focus on distributors, much to its own detriment.7 And recently, when Apple TV+, Amazon Prime, HBO, and Disney entered the video streaming market, Netflix did not see them as serious competition and did not anticipate that content providers would be the new value creators, but it has since adapted very rapidly.8
2. Underestimating backlash from weak stakeholders. It’s risky today to rely on business models that extract value from weak or unsuspecting stakeholders to shore up immediate shareholder payouts. A resulting lack of financial flexibility can turn into an existential threat when liquidity dries up during economic or societal crises. Think about the increasing role of social media in building or destroying companies’ reputations and the NGOs who stand ready to highlight the plight of exploited stakeholders. Don’t underestimate the risk of a potential stakeholder backlash. Reputational damage, not to mention legal battles and fines, can bring companies down. When Boeing fast-tracked the development of the 737 Max, it apparently underestimated the risk that safety had been compromised and discounted the cost of a potential backlash from its traveling public and airline customer stakeholders.9
In tech, it is widely recognized that the monetization of user data by Amazon, Facebook, Google, Twitter, and other companies has generated large financial returns, augmented by aggressive tax minimization. The public backlash is growing, however, with calls for privacy protection and compensation for the use of personal data. In Europe, governments are closing international tax loopholes in response to complaints that American internet giants don’t pay their fair share and that citizens are carrying most of the load.10
3. Subsidizing free riders at the expense of long-term shareholders. Free riders are stakeholders that receive more benefits from the business than they provide, thus undermining the company’s long-term value. Boards and executives sometimes devote resources to a part of the business that saps resources. For example, a free rider could be an underperforming division that is tied to the founders’ roots or a business unit whose losses are not separated out and are subsumed in the profitability of a large division. If the company continues to devote resources to a free rider, it loses the chance to devote those resources to long-term value creation.
Subsidization of zombie divisions has been common in conglomerates. For instance, in the project division at now-defunct Carillion, a U.K. infrastructure conglomerate that went bankrupt, revenues were recognized early and large cost overruns recorded only much later.11
4. Compromising with predators. Predators engage in willful value destruction for their benefit at the expense of other stakeholders. They often pretend to be promoting value creation. A classic example is vulture capitalists, who claim to be on the investors’ side and then dismember the company, regardless of its long-term potential.
When private equity firm BC Partners bought British retailer Phones 4U in 2011, it financed the purchase with 200 million pounds in cash and a 205 million-pound loan bond and then paid itself a dividend of 223 million pounds. Phones 4U collapsed in 2014, closing 362 stores and laying off more than 1,500 employees, shredding the value of the bonds, and BC Partners walked away from the liquidation with 18 million pounds in profits.12
5. Underestimating the role of intermediaries. Intermediaries standing between the company and its stakeholders have their own agendas, often not congruent with the company’s goals. Companies run risks if they underestimate the way intermediaries might increase the power of other stakeholders.
The relationship with intermediaries can be fraught. Investment banks, for example, not only take IPOs to market but also advise their corporate clients in the process. This advice can be biased by the fees the banks stand to earn from the IPO, as may happen during aborted IPOs.
Yet intermediaries also can nudge companies to turn victims into value creators. After NGOs like Médecins Sans Frontièrs and Oxfam started criticizing them, 39 pharmaceutical companies dropped their suit to prevent the South African government from allowing local companies to produce generic AIDS drugs.13 The negative publicity made it difficult for the drug companies to proceed with their lawsuit. But it also pushed the companies to serve longer-term interests of other stakeholders, such as patients and society at large — and this most likely served the businesses’ long-term financial and reputational interests.
Aligning Stakeholders With Long-Term Shareholder Value
Maximizing the long-term value of a company requires a differentiated and adaptive approach for each type of stakeholder. Leaders must determine which stakeholders are victims, subject to value extraction that benefits shareholders, with uncertain risk of a stakeholder backlash; which ones are free riders, inclined to extract more value than they contribute; which are predators, who destroy company value for their benefit and to everyone else’s detriment; and which are creators of value, driven to promote win-win initiatives for themselves and the company. (See “Classifying Stakeholders” for help with this assessment.)
Companies should strive to shift as many stakeholders as possible into win-win positions — targeting not just those who are already critical value creators, but also targeting victims and free riders that have the potential to contribute and realize greater value. At the very least, they should prevent these stakeholders — and the predators — from undermining the company’s value.
Building on this important classification work, leaders can then adopt the five strategies outlined below to avoid the stakeholder traps described earlier. To illustrate how this can be accomplished, we’ll highlight DSM as an extended example and briefly touch on the experiences of other companies. DSM has undergone two major transformations over the years: from coal mining to base chemicals and later from base chemicals to biotech products. Today, it is a nutrition, health, and sustainability leader. Since it listed on the Amsterdam Stock Exchange in 1989, DSM has outperformed the AEX index consistently and recorded a compound annual growth rate (including dividends) of 13%, compared with 8% over the same period for the AEX index.14
Here are the five strategies:
Block value destruction by predators. Predators such as disruptive partners, short-term activists, corrupt stakeholders, and rogue executives may emerge periodically. They represent the most urgent risk and must be dealt with first. Apart from strengthening the company’s risk management systems, leaders must be on the alert for unusual activity. Identifying and neutralizing predators before they can weaken the company requires early, decisive executive action.
DSM has been particularly effective at anticipating and neutralizing potential predators. Before activist investors could attack during its transformation from bulk chemicals to biotech, DSM placed a transient cash surplus in a separate foundation with the mandate that the cash could be deployed only in support of the company’s strategic vision.15 Later, when activist investor Third Point called for the company to be split in two to deliver immediate value to shareholders,16 then-CEO Feike Sijbesma dismissed the call. Instead, he implemented a new cost-savings strategy, divested DSM’s stake in a plastics and resins unit that was not part of the new strategy, and invested the proceeds in the development of the new biotech business. These moves blunted a predator’s influence while devoting DSM’s resources to building long-term value.
A similar approach was taken by French giant Pernod Ricard, the world’s second-largest wine and spirits company, when it announced major cost reductions very soon after activist investor Elliott Management signaled its interest in taking a stake.17
Stop subsidizing free riders to avoid eroding long-term shareholder value. Subsidization of free riders can persist as a result of strategic inertia. But companies pay dearly over the long run when they transfer value to parties that can’t or won’t reciprocate, such as unprofitable business units, overpaid executives, philanthropists unaligned with long-term shareholders, and overdue debtors. Cutting these ties can free up resources for long-term value creation with other stakeholders.
Stakeholders that once created value can turn into free riders when circumstances change. During its time as a chemicals company, DSM lost money when the bulk chemical markets fell. The executives, employees, and state stakeholders associated with that side of the business moved from being value creators to being free riders. In response, DSM management recommended that the Dutch state float its company shares on the market. Then DSM sold its bulk chemical operations and transformed its main production site into an industrial park hosting 113 companies.18 The sale gave DSM the capital needed to create long-term value in a new field: biotech.
Sometimes a free rider becomes a value creator when moved to a different context. In 2018, for example, Swiss industrial multinational ABB sold its low-margin power grid business to Hitachi for $11 billion. The move improved ABB’s market capitalization and helped Hitachi become a global leader in power grids.19
Develop compacts with the value creators. Leaders must mobilize value creators through win-win initiatives to maximize the company’s long-term value. Value creators can be employees, intrapreneurs, customers, partners, venture capitalists, government agencies — any parties willing to work toward shared interests. Fruitful partnerships with such stakeholders require agreements supported by trust, involving expectations of economic returns, a positive working culture, and psychologically safe interactions with management.20
These compacts are not public relations gestures. Developing a culture that supports these relationships requires committed and effective change management, which involves increasing stakeholder rewards up to the point where no additional long-term value is created for the company. If the initiatives correlate with lower reported profits or lower dividends and buybacks in the short run, management must explain to shareholders and other stakeholders how these efforts fit into a long-term strategy aimed at maximizing the value of the business.
DSM’s first compact was with the Dutch state, which allowed the company to exploit coal deposits and (later) gas fields as long as it agreed not to exploit workers or local communities in the process. Then, when DSM became a biotech company, its new value creators were the managers leading the transformation of its business portfolio toward health care products. DSM leaders held dialogues with these stakeholders and signed a strategic value contract based on mutually agreed-upon key performance indicators reflecting how the development of new business would shape their compensation.21
Chobani, the U.S. yogurt maker, has compacts with its employees, its consumers, and the communities where it operates to fuel environmentally friendly growth. In addition to hiring refugees and gifting ownership shares to employees,22 the company has installed a reverse osmosis system at its Idaho plant to recover and recycle water used during manufacturing and cut energy consumption by 17% at its plants from 2014 to 2019.23
Minimize value extraction from victims. There may be a temptation to increase short-term gains at the expense of victims — whether they be easily replaceable employees, customers, partners, creditors, natural resources, or society. But leaders must remember the reputational, legal, and operational risks of doing so. Extracting value from victims with little market power,24 such as non-unionized workers, can easily undermine a company’s values and its competitive edge. Another consideration: the threat to the company’s market value, given that asset managers are increasingly using environmental, social, and governance indicators as risk management metrics.
The ideal way to mitigate such risks is to convert victims into value creators, as Nespresso did with its coffee producers by providing agronomist training and advice to enhance the value of both their crops and the coffee.25
When DSM closed its coal mines in the 1960s and 1970s, it reskilled some of the 25,000 miners for employment in its chemicals division, found others employment in the nearby DAF car and truck factory, and created two clothing workshops to employ miners’ families. More recently, DSM has moved the environment from a potential victim to a focus of sustainable value creation. DSM remunerates its 300-some executives with short- and long-term compensation — half of which is in the form of bonuses and stock options tied to sustainability goals, such as the percentage of the innovation pipeline and ongoing business that should be environmentally friendly.26
DSM also provides social aid linked to its biotech strategy. Since 2007, it has partnered with the World Food Programme to distribute its vitamins, nutrient mixes, and fortified food to malnourished people. According to Fokko Wientjes, DSM’s sustainability director when the aid started, “This makes DSM an attractive employer [and] helps us understand needs in different countries.”27
Enlist intermediaries as promoters. This tenet applies to external influencers such as lobbyists, NGOs, regulators, analysts, commentators, consultants, bankers, and auditors.
In recent years, for example, Microsoft’s “corporate foreign policy” has laid out guidelines for interacting with governments and regulators worldwide. These include proposing an international treaty to protect citizens from state-sponsored cyberattacks and rallying 17 countries and eight technology companies to eliminate violent extremist online content.28
It is also important to exclude intermediaries when they encourage stakeholders to take a short-term view. Over the years, DSM has done this in various ways. For instance, it rejected a proposal from a consultancy designed to maximize near-term shareholder wealth as too short-sighted. Its leaders also resisted investment bankers’ advice to increase shareholder returns by taking on more debt, because they were managing debt conservatively to survive the fundamental shifts from mining to chemicals and then to biotech.
To ensure that aggressive shareholders and their advisers didn’t undermine the company’s long-term value, DSM also had to be flexible. The late Peter Elverding, CEO and chair of the managing board from 1999 to 2007, noted that leaders resisted buybacks as much as possible, but admitted, “Sometimes we bought back a small amount if the pressure became too high.”29 More recently, DSM announced a 1 billion euro share buyback and regular repurchase program in 2019 to cover share distribution plans and stock dividends.30
Pursuing Long-Term Value Creation
The experiences cited above show how long-term value creation for shareholders may require substantial strategic shifts to adapt to changing industry conditions. To negotiate these currents, executives must identify and mobilize existing and future value creators, forge purpose-driven compacts with them, and build a supporting culture. They must also pay attention to the welfare of vulnerable stakeholders with potential to create value, such as workers who might otherwise become victims of transformation, and, where possible, involve them in win-win initiatives.
Doing all this while preventing other stakeholders from undermining the company’s value requires a careful assessment of who creates long-term value now and who has the potential to do so. That assessment provides a basis for developing differentiated and adaptive approaches to each of the stakeholder groups so companies can avoid the short-term traps that trip up so many organizations. The focus on shared long-term interests allows executives to responsibly and ethically meet their fiduciary duties to the business without succumbing to the common but mistaken belief that leaders have a legal obligation to maximize short-term returns for shareholders.
In the end, DSM has been clear about the importance of creating long-term value for shareholders as well as for other stakeholders. “When you mean to have a socially positive impact, it is not a blank check. You are still facing the dilemmas of any business,” said Geraldine Matchett, DSM CFO and co-CEO, last year. The company’s leaders, she added, understand that “you have the privilege of being a purpose-led organization if — and only if — you deliver on financial performance.”31
2. H.J. Smith, “The Shareholders vs. Stakeholders Debate,” MIT Sloan Management Review 44, no. 4 (summer 2003): 85-90.
3. P. Strebel and S. Cantale, “Is Your Company Addicted to Value Extraction?” MIT Sloan Management Review 55, no. 4 (summer 2014): 96.
4. J-P. Jeannet and H. Schreuder, “From Coal to Biotech: The Transformation of DSM With Business School Support” (Berlin Heidelberg: Springer Verlag 2015); and B. Leleux and J. van der Kaaij, “Darwinians at the Gate: Sustainability, Innovation, and Growth at DSM,” IMD case study IMD-3-2355 (Lausanne, Switzerland: IMD, 2013).
5. P. Strebel, “Big Business Models Are Back-to-Front: Create Long-Term Value by Putting Shareholders at the Back-End of Cash Flow Distribution,” The European Business Review, January-February 2019, 69-70.
6. E. Yardeni, J. Abbott, and M. Quintana, “Corporate Finance Briefing: S&P 500 Buybacks and Dividends,” Yardeni Research, March 27, 2020, www.yardeni.com.
7. G. Sandoval, “Former Rival’s Advice to Netflix: ‘Don’t Let Icahn Get to You,’” CNet, Nov. 6, 2012, www.cnet.com.
8. T. Poletti, “Netflix Finally Admits the Obvious: Competition From Apple and Disney Will Hurt,” MarketWatch, Oct. 19, 2019, www.marketwatch.com.
9. A. Gregg and C. Davenport, “Boeing Had a Best-Selling 737 and a Growing Global Market. Now After Two Crashes, Its Reputation Is at Risk,” The Washington Post, March 12, 2019.
10. W. Horobin and A. White, “How ‘Digital Tax’ Plans In Europe Hit U.S. Tech,” The Washington Post, Dec. 3, 2019.
11. House of Commons, Business, Energy and Industrial Strategy and the Work and Pensions Committees, “Carillion: Second Joint Report,” HC769 (London: House of Commons, May 16, 2018).
12. J. Armitage, “Phones 4U Owner BC Partners Walks Away with £18 Million Profit,” Evening Standard, Sept. 18, 2014, www.standard.co.uk.
13. R.L. Swarns, “Drug Makers Drop South Africa Suit Over AIDS Medicine,” The New York Times, April 20, 2001, www.nytimes.com.
14. “DSM Celebrates 30 Years as a Listed Company,” DSM press release, Feb. 6, 2019, www.dsm.com.
15. Royal DSM N.V. Annual Report 2002, Feb. 11.
16. Bloomberg, “Activist Hedge Fund Third Point Buys $3.5 Billion Stake in Nestle, Eyeing Opportunities in Europe,” Japan Times, June 26, 2017, www.japantimes.co.jp.
17. D. Vidalon, “Pernod Ricard Vows to Lift Margins After Activist Elliott’s Arrival,” Reuters, Feb. 7, 2019, www.reuters.com.
18. Jeannet and Schreuder, “From Coal to Biotech.”
19. D. Proctor, “Hitachi Acquires ABB Power Grids Business in $11 Billion Deal,” Power, Dec. 17, 2018, www.powermag.com.
20. P. Strebel, “The Change Pact: Building Commitment to Ongoing Change” (London: Financial Times/Prentice Hall, 1998).
21. Jeannet and Schreuder, “From Coal to Biotech.”
22. S. Strom, “At Chobani, Now It’s Not Just the Yogurt That’s Rich,” The New York Times, April 26, 2016, www.nytimes.com.
23. “2019 Sustainability Report,” Chobani, n.d.
24. Strebel and Cantale, “Is Your Company Addicted to Value Extraction?”
26. E. Fry, “This Former Chemical Company Went ‘Green’ and Its Stock Took Off,” Fortune, Sept. 12, 2017, www.fortune.com.
27. A. Beard and R. Hornik, “It’s Hard to Be Good,” Harvard Business Review 89, no. 11 (November 2011): 88-96.
28. “The Redmond Doctrine: Lessons from Microsoft’s Corporate Foreign Policy,” The Economist, Sept. 12, 2019.
29. Jeannet and Schreuder, “From Coal to Biotech.”
30. “DSM Commences €1 Billion Share Buy-Back and Announces Regular Repurchase to Cover Share Plans and Stock Dividend,” DSM press release, March 14, 2019, www.dsm.com.
31. A. Lowenstein, “Ten Ways Leading Companies Turn Purpose Into Strategy,” EY Beacon Institute, Sept. 19, 2019, www.parthenon.ey.com.