Economics of Governance and Stakeholder Management - Corporate Governance and Business Ethics

The economics of governance shares the stakeholder theory’s assumptions about the nature of the firm and the management, but formulates them in the terminology of the new organizational economics (Williamson 1996). Seen from this perspective, companies are a nexus of formal and informal contracts through which owners of resources or competencies form a team. Teams are defined as a form of governance of specialized resource owners who combine their respective productivity advantages and thus attain a higher level of gain from cooperation than by deploying their resources individually. Understanding companies as teams or team production means interpreting them as collaborative projects that gain a competitive advantage by pooling resources and competencies in specific ways, which in turn leads to a cooperation rent that can and must be distributed among the team members according to the resource contributions made by each member. This contractual theoretical interpretation includes an organizational-theoretical interpretation of the firm as a team. Essentially, the cooperation between specialized owners of resources and skills goes hand in hand with the interdependence of and the resulting conflicts among these actors. To stabilize the cooperation between the individual resource owners in the long term, it requires appropriate forms and processes of organization. Creating order by means of the legal, economic, and moral responsibility of all involved actors is thus not only a sine qua non of every organization, but also of the contractual constellation preceding it. These forms and processes of order symbolize and stabilize the team as a contractually constituted, distinctive collective actor vis-à-vis its stakeholders. According to the economic logic of advantage, only those who can contribute both organization-specific and transaction-related assets will become team members or, as I will argue, stakeholders. This is true both from the perspective of the already existing team and from the perspective of the potential new member.

Organization-specific assets are assets that contribute to the durability of the form and processes of organization, to the identification with and commitment to the team, and to the adherence to the legal and moral, internal and external rules of the team – in short, the team member’s willingness and ability to exhibit “organizational citizenship behavior”. The ultimate aim of a company as an “entity of its own” is to essentially ensure its permanence, i.e., its existence.

Transaction-related assets, on the other hand, are assets that help identify and successfully perform distinctive economic exchanges under competitive conditions e.g., technical or functional competencies of the team member. These competencies can be general or specific, provided they are related to the transaction.

The reference unit of the economics of governance is, of course, a specific transaction, while the form and process of organization are elements of the governance form for this specific transaction (Williamson 1979). This fundamental theoretical conception can also be applied to the management of stakeholder interests and is reflected in the following definition of the term “stakeholder”:

This definition has consequences for the process of identifying and prioritizing stakeholders as a form of governance of stakeholders. Potential stakeholders are stakeholders who have organization-specific or transaction-specific resources but are not members of the team. They become actual stakeholders, i.e., members of the team, through the process of their identification and prioritization. Identification means answering the question of who is a stakeholder and why. Prioritization means asking which stakeholders represent resources and interests that are seen as worthy of preference in the eyes of the team and its members. Freeman’s concept answers both questions by drawing a distinction between definitional/instrumental and primary/ secondary stakeholders. “Definitional stakeholders” are responsible contract Partners in terms of the process of added value, while “instrumental stakeholders” are not contractual partners but are capable of influencing these contractual partners Positively or negatively. The question of which interests are worthy of receiving preferential treatment is resolved by the normative principle of “stakeholder fairness”. Because firms are the result and means of people’s cooperation, the gains from this cooperation, according to Phillips, first and foremost have to be distributed fairly among the “definitional stakeholders”. “Secondary stakeholders” only possess a derivative legitimacy, i.e., a legitimacy derived from the interests of the “primary stakeholders”. That means that their interests are only taken into account to the extent that they benefit rather than harm the interests of the “primary stakeholders”.

The economics of governance agrees with this distinction between potential and actual stakeholders, but at the same time permits the following specifications:

  1. Stakeholders can only be those who have resources that are relevant either for the team’s durability or for its distinct transactions. Resources can be quite varied, including material resources (e.g., capital, payments) and immaterial resources (e.g., knowledge, social skills), economic resources (e.g., venture capital, raw materials) and moral resources (e.g., character, virtue).
  2. Stakeholders who contribute these resources to a team thus agree to an informal or formal contract that makes them team members. Due to the distinction between formal and informal contracts, both managers and employees (formal contract) and, for example, NGO's or communities (informal contract) can be team members. This is, of course, important for the firm’s boundaries, which, however, cannot be discussed here.
  3. Through their resources and by accepting the contract, stakeholders have to make a contribution to the sustainable generation of a cooperation rent. This contribution can be pecuniary (e.g., reduction of costs, demand) or non-pecuniary (e.g., reputation, risk perception), functional (e.g., specific information, know-how) or structural (e.g., contributions to the organizational culture, business ethics).

These are the central theoretical requirements for a team’s identification and prioritization of stakeholders. It should be added that the stakeholder definition proposed in this article and the criteria to identify and prioritize stakeholders can potentially include all conceivable public interests that may result from the existence and the transactions of a team (e.g., an interest in environmental and social standards). However, this does not mean that actors who formulate and communicate these interests automatically become stakeholders and thus team members. Stakeholders who represent legitimate societal interests but have no resources to realize these interests or who are not willing or able to contribute existing resources to the team in order to make a contribution to the team’s cooperation rent cannot become team members. I would like to propose to call such stakeholders “societal stakeholders”, while team members are “organizational stakeholders”. Let me illustrate this with an example: By arguing that companies should assume social responsibility, NGO's, for instance, formulate a legitimate interest. They communicate this interest publicly and thus contribute to identifying and raising awareness of the social risks of globalization. This contribution can be valuable for both society and its companies, influencing the current or future cooperation rent. But this is not enough to make an NGO a stakeholder of a team. NGO's can only be “organizational stakeholders” if they are able and willing both to contribute resources (note the broad definition of resources!) to the solution of the problems they point out and to take responsibility for the consequences of these solutions. According to the definition proposed in this article, it is this willingness for “shared dilemma” that makes an NGO a potential team member.

Whereas the above-mentioned indicators of team membership, i.e., the availability of organization-specific and transaction-related assets, constitute selection criteria both for the existing team and potential stakeholders, the question of identifying and prioritizing stakeholders entails a change of perspective towards the already existing team. The problem of selecting and ranking stakeholders only makes sense from the perspective of an already existing team, i.e., in the context of a management theory. Obviously, the exact opposite is true from the perspective of a political stakeholder theory, where it is the normative criteria of democratic processes that, from the point of view of society, determine who can or cannot be considered a legitimate stakeholder. Seen from this perspective, companies become stakeholders of society, rightly so, and have to submit to its criteria for identification and prioritization. However, from a stakeholder management perspective in the context of an economics of governance, social groups must be considered to be potential stakeholders of a production team. In any case, teams will, both in the active and passive version, adhere to the two-step process of stakeholder governance proposed here step 1: identification; step 2: prioritization as long as there is a contribution to its cooperation rent. The realm of public or, more precisely, governmental regulation lies outside of this criterion and, as I have already mentioned above, cannot be dealt with in the framework of a stakeholder theory for reasons inherent to this theory itself.

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