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Freeman and Evan: Stakeholder Theory in the Original Position

Published online by Cambridge University Press:  23 January 2015

James W. Child  and
Alexei M. Marcoux
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Abstract:

We argue that the Rawlsian social contract argument advanced for stakeholder theory by R. Edward Freeman, writing alone and with William M. Evan, fails in three main ways. First, it is true to Rawls in neither form, nor purpose, nor the level of knowledge (or ignorance) required to motivate the veil of ignorance. Second, it fails to tailor the veil of ignorance to the fairness conditions that are required to solve the moral problem that Freeman and Evan set out to solve (whereas Rawls’s own use of the device surely tailors the veil of ignorance to the problem of designing a just social order). Third, the argument, considered apart from its claimed Rawlsian pedigree, fails to bolster the stakeholder theory because it fails to demonstrate the rationality of adopting the institutional rules that Freeman and Evan favor.

Type
Articles
Information
Business Ethics Quarterly , Volume 9 , Issue 2 , April 1999 , pp. 207 - 223
Copyright
Copyright © Society for Business Ethics 1999

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References

Notes

1 R. Edward Freeman and William M. Evan, “Corporate Governance: A Stakeholder Interpretation,” Journal of Behavioral Economics 19 (1990): 337–359.

2 R. Edward Freeman, “The Politics of Stakeholder Theory: Some Future Directions,” Business Ethics Quarterly 4 (1994): 409–421.

3 Freeman, p. 417.

4 Ibid., p. 416.

5 Ibid.

6 Ibid.

7 Ibid., p. 417.

8 Ibid.

9 Ibid.

10 John Rawls, A Theory of Justice (Cambridge, Mass.: Harvard University Press, 1971).

11 Oliver Williamson, “Corporate Governance,” Yale Law Journal 93 (1984): 1197–1230.

12 See, generally, Williamson, pp. 1207–1215. See, also, the earlier discussion of intrafirm contracts and interfirm contracts in Williamson, Markets and Hierarchies (New York: The Free Press, 1977), pp. 96–98 and 106–109, respectively. Another author who has discussed transactional models of the firm is Herbert Simon. See, e.g., his The Sciences of the Artificial, 2nd ed. (Cambridge, Mass.: MIT Press, 1981), pp. 48–52.

13 Freeman and Evan, p. 343.

14 Ibid., p. 353.

15 Ibid.

16 Ibid.

17 Ibid.

18 Rawls, A Theory of Justice, p. 252.

19 Ibid., p. 120.

20 Ibid., p. 119.

21 Ibid., p. 259.

22 Freeman and Evan, p. 353.

23 Rawls, p. 137.

24 Ibid., p. 255.

25 Freeman and Evan, p. 353.

26 Freeman, p. 416.

27 Freeman and Evan, p. 353.

28 Rawls’s theory of rationality as regards choice in the original position is the maximin rule: maximize the minimum resources one can be given at the outset. Socially, this leads to maximizing the size of the minimum holding. See Rawls, pp. 142–161. This view has been subjected to extensive commentary, criticizing it, inter alia, for excessive risk-aversion. See, e.g., R. M. Hare, “Rawls Theory of Justice,” in Norman Daniels, ed., Reading Rawls (Oxford: Blackwell, 1978), pp. 81–107; Chandran Kuthakas and Philip Pettit, Rawls’ ‘A Theory of Justice’ and its Critics (Cambridge: Polity, 1990), pp. 37–43; and Robert Paul Wolff, Understanding Rawls (Princeton, N.J.: Princeton University Press, 1977), chap. 15.

29 Freeman and Evan, p. 353.

30 Suppose that the costs are in the form of harmful working conditions—tort law is a recourse. If the costs are in the form of rigged accounting and cheating on piece rate work, the employees can sue in contract, or for fraud in tort. If the employees are unionized, a union contract or a strike are obvious remedies. If they are not unionized, a less obvious but available remedy is to recruit a union to organize them. (Even though unionism appears on the wane, this threat remains very real to most corporate managements and sets a floor on the treatment of workers below which firms cannot go without facing a union election. Hollywood typically portrays modern fictional labor disputes as if the Wobblies, Molly MacGuires, and Pinkerton Men were still the rule. In fact, the National Labor Relations Board (NLRB) rules are so protective of the right to organize and the NLRB is so powerful that any work force that really wants to organize itself will organize.)

Furthermore, extant government regulations, both state and federal, protect working conditions, establish fair wages and hours, and the like. While Freeman and Evan express dubiety at new regulation (Freeman and Evan, p. 343), do they mean to repeal what protections are already there? Almost certainly not. Most states have departed from the rigors of the employment-at-will doctrine, extending to employees rights against termination without cause and other due process rights. Finally, in the media-saturated world in which we live, a grossly unfair employer, especially one that threatens the safety, health, or dignity of its employees, will almost certainly pay a fearsome public relations cost. Freeman and Evan cannot mean to ignore these powerful protections of at least this important class of stakeholders. And indeed, we are sure that they do not ignore them. However, Freeman and Evan do mean for their deliberators to be ignorant of these protections when deliberating about what fair contracting will be for their firm, behind the veil of ignorance. As we argue in part III, however, Freeman and Evan are not entitled to design their veil of ignorance such that stakeholders are ignorant of these protections.

31 Freeman, p. 416.

32 Ibid., p. 421, n29.

33 Ibid.

34 Recall that stakeholders are attempting, in part, to keep coalitions of other stakeholders from imposing costs on them. “[I]t would be irrational to give up any chance for voice, since other parties to the multilateral contract that is the firm, could unilaterally decide to institute policies detrimental to that stakeholder. They could externalize all of the cost of safeguards to that stakeholder.” (Freeman and Evan, p. 353, emphasis added.)

35 Of course, this understanding can be inarticulate and intuitive, like the native speaker’s understanding of the grammar of his language, but it must be there.

36 Freeman, p. 416.

37 This problem is of some moment, and Williamson provides a clue as to why: “The study of corporate contracting is complicated by interdependencies within and between contracts; changes in one set of terms commonly require realignments in others.” (Williamson, p. 1201, emphasis added.) In other words, firms typically have many contracts, and the contracts that they have fit together in a way that implements a particular long-term corporate strategy. However, a change in the terms of one of the contracts alters the structure of the firm’s commitments and may require changes in other contracts in order to maintain a rational strategy. Of course, some changes in the terms and course of contracts are expected, but the remedial provisions of the Principle of Externalities threaten to make the execution of rational business plans and strategies exceedingly difficult. The parties to and terms of a contract are forever up for grabs. As a result, negotiating and carrying out even a single contract is fraught with uncertainty and danger (for at any moment a C-situated party may demand to become a party to the contract and renegotiate), let alone negotiating and administering a set of contracts. Now, if we are to understand the firm as a set of contracts (as both Williamson and Freeman and Evan urge), and if we are to understand each of those contracts as being subject to the Principle of Externalities (as Freeman urges), then how, given Williamson’s insight into the interdependencies among the contracts of the firm, are firms to function at all? People enter into contracts in order to specify, determine, and delimit the normative relationship that exists among or between them; allowing them to foresee and plan the future. Freeman’s Principle of Externalities makes it impossible for contracts to perform this function, for the part of the future that the contract is supposed to settle is forever in danger of being radically altered by the entry of unwanted parties and the renegotiation of terms.

38 Consider another case. Suppose that the present authors are so disgusted by Nine-Inch Nails’s “Big Man with a Gun” that every sale or purchase makes them feel worse, or would if they knew about it. Ought we to have the right to veto each sale? If we are now parties to the contract and unanimity is the rule (as Freeman’s Principle of Governance suggests), then it seems that we should have such a right—and with Freeman’s blessing.

39 The relevant contract may provide a mechanism, but that is of little use because the aggrieved party—the sufferer of the negative externality—is ex hypothesi not a party to the contract, and hence, (by Freeman’s Principle of Governance) not bound by determinations made in accordance with that mechanism. In other words, the aggrieved party and the contractors, in order to have their dispute resolved, must avail themselves of exogenous safeguards, e.g., the court system, in order to determine whether the aggrieved party may become a party to the contract—i.e., share in the endogenous safeguards. But of course, making such a determination is virtually identical to adjudicating a claim of tort liability in a régime that lacks endogenous safeguards. Now, if sufferers of negative externalities need to avail themselves of exogenous safeguards in order to determine whether their costs entitle them to share in the endogenous safeguards of the contract (by operation of the Principle of Externalities), then the question is raised why one would think it rational to adopt endogenous safeguards in the first place, as a general rule.

40 Indeed, the incentive for C-situated parties to engage in strategic bargaining is considerable. On strategic bargaining, see James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962), pp. 68–69 and passim.

41 Freeman and Evan, p. 353.

42 Ibid.

43 Freeman, p. 416.

44 Ibid.

45 Ibid.

46 They would be rational to do so for the same reason that the public choice theorists argue that voters are rational to refrain from educating themselves on the issues and even from voting. Educating oneself on the issues and going to the polls is costly. It is therefore worthwhile only if the expected utility to be derived from casting an informed vote exceeds those costs. The problem is that the total utility to be derived from casting a vote in the right way must be discounted by the probability that the vote will determine the outcome of the election to arrive at the expected utility. As the probability that one’s vote will determine the outcome of the election is 1/n (where n = number of voters), and n is large for virtually all elections, the expected utility to be derived from educating oneself on the issues and casting a vote is for almost everyone dwarfed by the costs involved. Hence, it is rational to vote in ignorance or refrain from voting altogether. Similarly, the expected utility to be derived from exercising one’s “voice” in the formulation of a firm’s policies is dwarfed by the costs that attend it—especially if the constituencies that have a voice have been expanded, as the stakeholder theory demands that they be. On rational voter ignorance, see Geoffrey Brennan and Loren Lomasky, Democracy and Decision: the Pure Theory of Electoral Preference (Cambridge and New York: Cambridge University Press, 1993).

47 Certainly for incidental consumer items (and perhaps for all purchases) one is far more rational and better protected by trusting to market protections. If Corn Flakes start to taste awful or are contaminated with filth, the rational response is to buy Wheaties or Total—not to write to the consumer representative on the board of directors.

48 Another argument might be that the representatives of the stakeholder groups will begin to act in their own interests and less in the interests of the stakeholder groups they represent. In other words, agency costs might get so high that this “endogenous” approach is frustrated. Those familiar either with the actual performance of corporate boards or with public choice theory will immediately recognize the problem.

Freeman and Evan are at least aware of these problems, as they reject the proposal that government could serve these interests on the grounds that “such power is not in the hands of any particular stakeholder, and suffers from the well known costs of collective action.” (p. 353) Why, then, do they not apply the same analysis to stakeholder representation? Surely stakeholder representation—which is, after all, representation of a collective entity—carries with it the same collective action costs. Therefore, it stands as no obviously superior alternative to the collective action problems attendant to government, absent some argument that it possesses superior qualities.