The Death of Shareholder Primacy and the Rise of the Stakeholder

A view of mountains in the distance

“It is widely-recognized that “The Age of Easy Oil” is over, and companies are entering more inhospitable environments – both politically and geologically-speaking – than ever before in the quest for the Black Gold.”


Since the late 1970s, the Business Roundtable, a nonprofit association based in Washington, D.C. whose members are chief executive officers of major U.S. companies, has endorsed principles of shareholder primacy—that corporations exist principally to serve shareholders. But in August 2019 the organization took many by surprise when it revised its stance with a statement[i] outlining a modern standard for corporate responsibility. Signed by 181 CEOs of some of America’s largest corporations, the statement affirms “the essential role corporations can play in improving our society when CEOs are truly committed to meeting the needs of all stakeholders.” The principle of shareholder primacy bit the dust.

My Personal Journey

I’ve been waiting over forty years for this moment.

My introduction to big business was in the mid-1970s. I was engaged by a senior vice president of a Fortune 500 high-tech company to teach one of his senior computer engineers to “play nice in the sandbox.” When I first met the man, I assumed he was referred to me for treatment of an emotional, behavioral, or mental disorder. My practice was squarely in the mental health space. Consequently, I used all my diagnostic tools to assess the presence of one of those disorders. After three sessions and a battery of psychological tests, I concluded that he was not diagnosable. He might be difficult and rather nasty to his coworkers, but that behavior didn’t qualify him as having a mental, emotional, or behavioral disorder.

I vividly recall my last session with him. He was sitting across my desk with his arms crossed. After listening to what I had to say, he said, “Another psychologist told me that in 1954. Anything else, doctor?” And without further comment, he dismissed me, stood up, and left my office.

The next day I called the SVP who had sent him to me and said, “I really appreciate your trying to build my practice and for referring your employee to me, but I can’t treat him. He’s not diagnosable.” His reply was one I’ll never forget. He said, “Not diagnosable? The hell he isn’t. I’ll diagnose him. He’s a pain in the ass!”

He went on to explain that this engineer was one of the most brilliant computer minds in the world but was worth nothing to the company because “I can’t get anyone to work with him. Secretaries quit after two months. His peers refuse to travel to meetings with him. I can’t get access to his talent.”

Then he turned serious. “Look. You told me once that you were an expert in changing people’s behavior. This man needs his behavior changed.” Then he said something that changed the direction of my entire career. He said, “You’re a bright, young psychologist. Figure out something!” So I did, and thus began my career as a consultant in leadership effectiveness.

For nearly forty-five years I have been advising and coaching executives at the top of big businesses—often the CEO, but if not, typically someone in the C-Suite. For all these years I have lived in the business climate of Western capitalism. All business organizations have their share of unwritten rules and informal norms that illustrate the set of underlying values they embrace. I have had a front-row seat where I could observe the expression of these values firsthand. I have seen the expression from senior leaders of integrity, responsibility, forgiveness, compassion, and concern for all stakeholders move from being the norm in the 1970s to very nearly becoming extinct by the beginning of the 21st century.

How and When Did Capitalism Turn Toxic?

There have always been the bad actors. Certainly Henry Ford was no exemplar of the above principles, nor was John Rockefeller. Their abuse of employees is well documented. But this was not the norm in the 1970s. The corporate leaders who emerged after WWII, when several businesses evolved into large entities run by professional managers, saw themselves as stewards for all stakeholders. Certainly they were concerned about shareholder return, but many placed employee welfare and the customer experience at the same level as the shareholder. This was the norm. [ii]

But that all changed in 1970 when Milton Friedman, the Nobel Prize winning economist and advisor to presidents, published The Social Responsibility of Business Is to Increase Its Profits[1] arguing that the only social responsibility of business is that it “use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Friedman, the most influential economist of the second half of the 20th century, shaped political philosophy and most of the financial policies of the Reagan administration.

Friedman’s assertion, combined with the disastrous economic conditions that followed the Nixon era and the worldwide oil crisis at the end of the decade, further weakened corporate America’s dedication to these norms as stewards for all stakeholders and gave rise to an economic doctrine that shareholder’s return trumps everything else. Friedman also likely laid the groundwork for the new set of norms that emerged following the publication of “Theory of the Firm” in the Journal of Financial Economics[2] by William Meckling and Michael Jensen, who received his Ph.D. at the University of Chicago school of economics where Friedman was a professor.[iii]

Citing Adam Smith, who believed that managers would not be as careful and vigilant in protecting the assets of an employer as they would be of their own property, [iv] Jensen and Meckling argue that professional managers are not motivated to protect the interests of the owners (i.e., shareholders) but instead are self-focused and motivated for their own gain. According to them, managers are inherently dishonest and self-interested.

I believe that Adam Smith as well as Jensen and Meckling held a negative unconscious bias about human nature. It seems clear that Smith, and two hundred years later, Jensen and Meckling, assumed that the default position for professional managers is to be dishonest and steal—that humans are inherently flawed and sinful. They are not to be trusted because they are primarily self-focused.

In contrast, Doug Lennick and I argue in Moral Intelligence [3] that humans are born with a strong need to connect with others and their default setting is to care for others, even at the expense of the individual’s own life. Humans are also born with a need to defend themselves, which can sometimes be expressed as self-focused greed, but this is not inherently the nature of humans.

Jensen and Friedman, however, assumed that greed is hardwired into human nature.

Their solution for dealing with the greedy and untrustworthy managers was to align the motivations of the agent (professional manager) with the motivations of the principal (shareholders). This became known as “agency theory” and soon was taught in many business schools—first at the University of Rochester, then the University of Chicago and the University of Southern California. These schools integrated the theory into their core curriculum, and when Jensen moved to Harvard, it became the most popular course in the business school.

Agency theory became the new “gospel” for business education. As Rakesh Khurana describes in his book From Higher Aims to Hired Hands[4], “Students were now taught that managers, as a matter of economic principle, could not be trusted. In the words of Oliver Williamson, they were “opportunistic with guile.”

The Jensen and Meckling paper became a turning point, transforming managerial capitalism into a toxic breed of financial capitalism and ushering in four decades of self-focused greed that has dominated the business world ever since.

Agency Theory’s Impact on Executive Compensation

If greed was inherent in human nature, then according to Jensen and Meckling, the best way to align the interests of the agent (professional manager) and the principal (shareholder) was to issue preferred stock options.[5]

Their argument, with its complex and profusely academic formulae and conclusions, can be distilled into the following: A professional manager is motivated by self-interest that is at odds with the interest of the shareholders (owners). However, it is too difficult to accurately police and keep track of the financial complexity in order to catch the unscrupulous manager in the act of stealing. Therefore, the motivation of managers must be changed so that their interests fully align with the interests of the shareholders—thus, the concept of stock options was created!

Once that genie was out of the bottle, it didn’t take long before executive compensation soared. When Jensen and Meckling’s paper was published, the average CEO’s compensation was about 35 times more than the average employee’s compensation. Today, the average CEO’s compensation is 287 times greater than the average employee’s.[6]

The dominoes began to quickly fall. By the early 1980s, the age of the “star” leader was born. Almost overnight, compensation consultants (who are paid a percentage of their client’s first-year compensation) swarmed into board rooms and easily convinced the board to provide key executives with stock options, hence ensuring the executive’s motivation was aligned with shareholders. This led to many egregious examples in the ’80s and ’90s where leaders did, in fact, take advantage of the shareholders and in several cases destroyed the company. Michael Milken, the original junk bond trader, held an annual “Predator’s Ball” in Las Vegas, where Wall Street financiers who excelled at hostile takeovers attended in droves. Milken later was convicted of fraud and served time in prison. Then there was the collapse of Enron, followed by WorldCom and Tyco.

In 2012, the Institute for Governance of Private and Public Organizations, a nonprofit based in Quebec, released a policy statement entitled Pay for Value: Cutting the Gordian Knot of Executive Compensation.[7] Detailing the history of the various stages executive compensation has gone through since 1985, it draws a compelling conclusion: “It was a major mistake, and a source of many shenanigans, to make stock options a large component of executive compensation. It may have seemed a simple, tax-efficient and effective way of tying the interest of management to the interest of shareholders. In practice, however, stock prices are very volatile, and are driven by numerous factors beyond the control of management. It is time to cut the Gordian knot of a compensation system largely based on stock options, a system that prevails only since the 1990s and has wreaked havoc on many companies.”

The Big Picture

When I stand back and look at the big picture over the past forty-five years, it goes something like this:

  • Starting from a biased negative view of human nature, the Jensen and Meckling paper created a “solution” (i.e., stock options) that was bound to fail.
  • It placed senior managers into the role of working only for a financial transaction, failing entirely to realize that most managers (even today) work for many other reasons than just their financial compensation, often including altruistic reasons.
  • Realizing that the shareholders held this negative view of them and that the social contract (retirement; job security) that had existed for decades before was no longer honored, managers undoubtedly realized that they were, indeed, on their own.
  • Given that they were more or less forced into a place of extreme self-interest, is it any wonder that senior managers began to see themselves as free agents in the talent market and therefore hired compensation consultants to arrange the best “deal” for them?
  • When put into this position, it was a short leap for some senior managers to game the system or otherwise take huge risks in hope of a massive personal payoff from their options (and of course, there was also the back-dating scandal of options!) Evidence of some of these “short leaps” was exposed with the failure of Enron, WorldCom, Tyco, and numerous others, and then the meltdown in 2008 of the financial markets. And it doesn’t end with 2008—witness the Wells Fargo fiasco and the Volkswagen emission scandal.

When given the imprimatur of “truth” by Jensen’s and Meckling’s paper, Friedman’s disastrous belief of shareholder primacy ironically created the very the outcomes economists were trying to avoid.

Examples of executive fraud and stealing from the company before Friedman’s statement were most certainly few and far between. Did this occur? Of course, but the dollar cost to American corporations for executive fraud was negligible.

However, now forty years later, the executive compensation practices extract millions and millions of dollars from the shareholders—and all because of the wrong assumptions about human nature. Oh my, when will we learn?

In addition to the dollar cost of executive compensation practices, there are also other negative side effects. When a CEO extracts $20M in one year (as does the CEO of General Motors) while the rank-and-file workers struggle to make a decent living, it certainly impacts productivity and worker motivation. And this effect is not restricted to the rank-and-file. The windfall of millions for the CEO falls off rather quickly as one goes down a step or two on the organizational ladder.

What Now?

The Business Roundtable’s revised commitment to delivering value to all stakeholders “for the future success of our companies, our communities and our country” is a tipping point that will have a major positive impact on the expectations society has for leaders to be people of strong character. We should use this moment in history to change how business schools teach their students and provide a required course that focuses on the inner development of the leader. Schools could offer a course that provides a 360 view of the student’s character habits and assists in changing and strengthening them—one that encourages self-examination and connection with peers and builds the next generation of values-driven leaders.

The 360 character reputation scores of all the new MBA students could be combined to provide a beginning overall score for the class. Two years later, after embracing the required course, we would expect that most student’s character reputation score would increase, yielding an overall higher score for the class. The business school which graduated an entire class of strong-character leaders would attract a lot of attention from potential employers. Plus, these leaders would be prepared to deal with the real world of ethical challenges embedded in many business decisions.

This goal is aligned with KRW International’s mission, which is to inspire a movement that forever changes people’s expectations of leadership and performance in organizational life (both business and nonprofit)—a world where people demand character-driven leadership because it consistently delivers higher value to all stakeholders and just because it’s the right thing to do.

Our research on character and business performance found that strong-character leadership teams deliver nearly five times more to the bottom line, have a reduced risk profile, and enjoy a significantly higher level of employee engagement than do the weak-character teams.[8] That research became the basis for my book Return on Character. When it was published four years ago, there were only a few articles in the business press about the impact of empathy and compassion on business success. Now they are too numerous to count.

Today, I believe more than ever in what I wrote then in my book:

We can no longer allow the fear-based, self-interested, self-focused leaders to be the norm. We need high-character leaders to take over and provide thoughtful, skilled leadership for these challenging times. That kind of shift will be monumental, but it won’t happen all at once. Like any significant change in social norms, a new expectation and attitude about strong leadership must begin in the hearts and minds of each of us, as individuals. As we replace each of our old ideas with a new understanding, society shifts slightly toward cultural norms that reflect the change, just as each grain of sand in an hourglass marks the passing of one moment into another. Even though those incremental movements can be hard to notice individually, together they can form the kind of seismic transition that changes everything.”

[1] Friedman, Milton. (1970, September 13). The Social Responsibility of Business Is to Increase Its Profits. The New York Times Magazine, Section SM, 12.

[2] Jensen, Michael C. and Meckling, William H. (1976, October). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3, No. 4, 305-360.

[3] Lennick, Doug, and Kiel, Fred, Ph.D. (2005). Born to Be Moral. Moral Intelligence: Enhancing Business Performance and Leadership Success. (pp. 19-36). Upper Saddle River, NJ: Wharton School Publishing.

[4] Khurana, Rakesh. (2007). From Higher Aims to Hired Hands: The Social Transformation of American Business Schools and the Unfulfilled Promise of Management as a Profession. Princeton, NJ: Princeton University Press.

[5] Jensen, Michael C. and Meckling, William H. (1976, October). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3, No. 4, 307.

[6] Campbell, Alexia F. (2019, June 26). CEOs made 287 times more money last year than their workers did. Vox.

[7] Allaire, Yvan. (2012). Pay for Value: Cutting the Gordian Knot of Executive Compensation. Institute for Governance of Private and Public Organizations.

[8] Kiel, Fred. (2015). Return on Character: The Real Reason Leaders and Their Companies Win. Boston, MA: Harvard Business Review Press.


[i] The Business Roundtable. (2019, August 19). Business Roundtable Redefines the Purpose of a Corporation to Promote “An Economy That Serves All Americans.