CALIFORNIA MANAGEMENT REVIEW

Vol. XXV, No.3, Spring 1983

Copyright © 1983, The Regents of the University of California

Stockholders and
Stakeholders: A New
Perspective on
Corporate Governance
R. Edward Freeman David L. Reed

The purpose of this article is to show how the concept of stakeholders in an

organization canbe usedto understand the tasks ofthe boardofdirectors. The
authors argue thata volunteeristic approach to questions ofcorporate govern-
ance which focuses on effective director behavior is preferable to structural
change via legislation.
Management thought has changed dramatically in recent years. There
have been, and are now underway, both conceptual and practical revolu-
tions in the ways that management theorists and managers think about
organizational life. 1 The purpose ofthis article is to understand the implica-
tions of one of these shifts in world view; namely, the shift from "stock-
holder" to "stakeholder. "

The Stakeholder Concept

It has long been gospel that corporations have obligations to stockholders,
holders of the firm's equity, that are sacrosanct and inviolable. Corporate
action or inaction is to be driven by attention to the needs of its stock-
holders, usually thought to be measured by stock price, earnings per
share, or some other financial measure. It has been argued that the proper
relationship of management to its stockholders is similar to that of the
fiduciary to the cestui que trustent, whereby the interests of the stock-
holders should be dutifully cared for by management. 2 Thus, any action
taken by management must ultimately be justified by whether or not it
furthers the interests of the corporation and its stockholders.
There is also a long tradition of departure from the view that stock-
holders have a privileged place in the business enterprise. Berle and
Reprinted with permission from Proceedings of Corporate Governance: A Definitive Explo-
ration oftheIssues, C. I. Huizenga, editor, UCLA Extension, 1983.
88

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 STOCKHOLDERS AND STAKEHOLDERS 89
Means were worried about the "degree of prominence entitling (the corpo-
ration) to be dealt with as a major social institution.'? Chester Barnard
argued that the purpose of the corporation was to serve society, and that
the function of the executive was to instill this sense ofmoral purpose in the
corporation's employees. 4 Public relations and corporate social action have
a history too long to be catalogued here. 5 However, a recent development
calls for a more far-reaching change in the way that we look at corporate
life, and that is the good currency of the idea of "stakeholders. "
The stakeholder notion is indeed a deceptively simple one. It says that
there are other groups to whom the corporation is responsible in addition
to stockholders: those groups who have a stake in the actions of the
corporation. 6 The word stakeholder, coined in an internal memorandum at
the Stanford Research Institute in 1963,7 refers to "those groups without
whose support the organization would cease to exist." The list of stake-
holders originally included shareowners, employees, customers, sup-
pliers, lenders, and society. Stemming from the work of Igor Ansoff and
Robert Stewart (in the planning department at Lockheed) and, later,
Marion Doscher and Stewart (at SRI), stakeholder analysis served and
continues to serve an important function in the SRI corporate planning
process.
From the original work at SRI, the historical trail diverges in a number of
directions. One recent author was forced to claim, "The precise origins of
stakeholder theory are impossible to determine.?" In his now classic
Corporate Strategy: An AnalyticApproach toBusiness PolicyforGrowth and
Expansion, Igor Ansoff makes limited use of the theory.
While as we shall see later, "responsibilities" and "objectives" are not synonymous,
they have been made one in a "stakeholder theory" of objectives. This theory
maintains that the objectives of the finn shouldbe derived by balancingthe conflicting
claims of the various "stakeholders" in the finn: managers, workers, stockholders,
suppliers, vendors. 9

Ansoff credits Abrams and Cyert and March with a similarview, 10 but goes
on to reject the stakeholder theory in favor of a view which separates
objectives into "economic" and "social" with the latter being a "secondary
modifying and constraining influence" on the former.
For the most part the development of the stakeholder concept was slow
during the late sixties and early seventies, except for the continued work at
SRI by a number of researchers and consultants. A notable exception is the
work of Eric Rhenman in Sweden, who applied the concept to industrial
democracy. 11
In the mid-1970s, researchers in systems theory, led by Russell Ackoff
"rediscovered" stakeholder analysis, or at least took Ansoff's admonition
more seriously. 12 Propounding essentially an open systems view of organi-
zations, Ackoff argues that many social problems can be solved by the
redesign of fundamental institutions with the support and interaction of
stakeholders in the system.

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90 R. EDWARD FREEMAN & DAVID L. REED

A second trail from Ansoffs originalreference is the work ofWilliam Dill,

who in concert with Ackoff, sought to move the stakeholder concept from
the periphery of corporate planning to a central place. In 1975 Dillargued:
For a long time, we have assumed that the views and the initiative of stakeholders
could be dealt with as externalities to the strategic planning and management
process: as data to help management shape decisions, or as legal and social con-
straints to limitthem. We have been reluctant, though, to admitthe ideathat some of
these outside stakeholders might seek and earn active roles with management to
make decisions. The move today is from stakeholder influence towards stakeholder
participation. 13
Dill went on to set out a role for strategic managers as communicators with
stakeholders and considered the role of adversary groups such as Nader's
Raiders in the strategic process. For the most part, until Dill's paper,
stakeholders had been assumed to be nonadversarial, or adversarial only in
the sense of labor-management relations. By broadening the notion of
stakeholder to "people outside . . . who have ideas about what the
economic and social performance of the enterprise should include," Dillset
the stage for the use of the stakeholder concept as an umbrella for strategic
management.
A related development is primarily responsible for giving the stake-
holder concept a boost; namely, the increase in concern with the social
involvement of business. The corporate social responsibility movement is
too diverse and has spawned too many ideas, concepts, and techniques to
explain here. 14 Suffice it to say that the social movements of the sixties and
seventies-civil rights, the antiwar movement, consumerism, environ-
mentalism, and women's rights-served as a catalyst for rethinking
the role of the business enterprise in society. From Milton Friedman to
John Kenneth Galbraith, there are a diversity of arguments. However, one
aspect of the corporate social responsibility debate is particularly relevant
to understanding the good currency of the stakeholder concept.
In the early 1970s the Harvard Business School undertook a project on
corporate social responsibility. The output of the project was voluminous,
and of particular importance was the development of a pragmatic model of
social responsibility called "the corporate social responsiveness model."15
It essentially addressed Dill's question with respect to social issues: "How
can the corporation respond proactively to the increased pressure for
positive social change?" By concentrating on responsiveness instead of
responsibility, the Harvard researchers were able to link the analysis of
social issues with the traditional areas of strategy and organization.
By the late 1970s the need for strategic management processes to take
account of nontraditional business problems in terms of government,
special interest groups, trade associations, foreign competitors, dissident
shareholders, and complex issues such as employee rights, equal op-
portunity, environmental pollution, consumer rights, tariffs, government
regulation, and reindustrialization had become obvious. To begin to de-

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 STOCKHOLDERS AND STAKEHOLDERS 91
velop these processes, The Wharton School began, in 1977 in its Applied
Research Center, a "stakeholder project." The objectives of the project
were to put together a number of strands of thought and to develop a
theory of management which enabled executives to formulate and imple-
ment corporate strategy in turbulent environments. Thus, an action re-
search model was used whereby stakeholder theory was generated by
actual cases.
To date the project has explored the implications of the stakeholder
concept on three levels: as a management theory; as a process for practi-
tioners to use in strategic management; and as an analyticalframework.
At the theoretical level the implications of substituting stakeholder for
stockholder needs to be explicated. The first problem at this level is the
actual definition of stakeholder. SRI's original definitionis too general and
too exclusive to serve as a means of identifyingthose external groups who
are strategically important. The concentration on generic stakeholders,
such as society and customers, rather than specific social interest groups
and specific customer segments produces an analysis which can only be
used as a background for the planning process. Strategically useful infor-
mation about the actions, objectives, and motivations of specific groups,
which is needed if management is to be responsive to stakeholder con-
cerns, requires a more specific and inclusive definition.
We propose two definitions of stakeholder. a wide sense, whichincludes
groups who are friendly or hostile, and a narrow sense, whichcaptures the
essence of the SRI definition, but is more specific.16
• The Wide Sense ofStakeholder. Any identifiable group or individual who
can affect the achievement of an organization's objectives or who is
affected by the achievement of an organization's objectives. (Public
interest groups, protest groups, government agencies, trade associa-
tions, competitors, unions, as well as employees, customer segments,
shareowners, and others are stakeholders, in this sense.)
• The Narrow Sense ofStakeholder. Any identifiable group or individual
on which the organization is dependent for its continued survival.
(Employees, customer segments, certain suppliers, key government
agencies, shareowners, certain financial institutions, as well as others
are all stakeholders in the narrow sense of the term.)
While executives are willing to recognize that employees, suppliers, and
customers have a stake in the corporation, many resist the inclusion of
adversary groups. But from the standpoint of corporate strategy, stake-
holdermust be understood in the wide sense: strategies need to account
for those groups who can affect the achievement of the firm's objectives.
Some may feel happier with other words, such as influencers, claimants,
publics, or constituencies. Semantics aside, if corporations are to formulate
and implement strategies in turbulent environments, theories of strategy
must have concepts, such as the wide sense of stakeholder, whichallowthe

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92 R. EDWARD FREEMAN & DAVID L. REED

analysis of all external forces and pressures whether they are friendly or
hostile. 17 In what follows we will use stakeholder in the wide sense, as our
primary objective is to elucidate the questions of corporate governance
from the perspective of strategic management.
A second issue at the theoretical level is the generation of prescriptive
propositions which explain actual cases and articulate regulative principles
for future use. Thus, a posthoc analysis of the brewing industry and the
problem of beverage container legislation, combinedwith a similaranalysis
of the regulatory environments of public utilities have led to some simple
propositions which serve as a philosophical guidelinefor strategy formula-
tion. 18 For example:
• Generalize the marketing approach: understand the needs of each
stakeholder, in a similar fashion to understanding customer needs, and,
design products, services, and programs to fulfill those needs.
• Establish negotiation processes: understand the political nature of a
number of stakeholders, and the applicability of concepts and tech-
niques of political science, such as coalition analysis, conflict manage-
ment, and the use and abuse of unilateral action.
• Establish a decision philosophy that is oriented towards seizing the
initiative rather than reacting to events as they occur.
• Allocate organizational resources based on the degree ofimportance of
the environmental turbulence (the stakeholders' claims).
Other prescriptive propositionscan be put forth, especially with respect to
issues of corporate governance. One proposition that has been dis-
cussed is to "involve stakeholder groups in strategic decisions," or
"invite stakeholders to participate in governance decisions." While proposi-
tions like this may have substantial merit, we have not examined enough
cases nor marshalled enough evidence to support them in an unqualified
manner. There are cases where participation is appropriate. Some public
utilities have been quite successful in the use of stakeholder advisory
groups in matters of rate setting. 19 However, given the breadth of our
concept of stakeholder we believe that co-optation through participation is
not always the correct strategic decision.
The second level of analysis is the use of stakeholder concepts in
strategy formulation processes. Two processes have been used so far: the
Stakeholder Strategy Process and the Stakeholder Audit Process. The
Stakeholder Strategy Process is a systematic method for analyzing the
relative importance of stakeholders and their cooperative potential (how
they can help the corporation achieve its objectives) and their competitive
threat (how they can prevent the corporation from achieving its objec-
tives). The process is one which relies on a behavioral analysis (both actual
and potential) for input, and an explanatory model of stakeholder objectives
and resultant strategic shifts for output. The Stakeholder AuditProcess is
a systematic method for identifying stakeholders and assessing the effec-

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 STOCKHOLDERS AND STAKEHOLDERS 93
Table 1. Classical Grid

Power Stake Formal or Voting Economic Political

Equity • Stockholders
• Directors
• Minority interests

Economic • Customers
• Competitors
• Suppliers
• Debt holders
• Foreign
governments
• Unions

Influencers • Consumer
advocates
• Government
• Nader's Raiders
• Sierra Club
• Trade associations

tiveness of current organizational strategies. 20 By itself, each process has

a use in the strategic management of an organization. Each analyzes the
stakeholder environment from the standpoint of organizationalmission and
objectives and seeks to formulate strategies for meeting stakeholder
needs and concerns.
The use of the stakeholder concept at the analyticallevel means thinking
in terms which are broader than current strategic and operational prob-
lems. It implies looking at publicpolicyquestions in stakeholder terms and
trying to understand how the relationships between an organizationand its
stakeholders would change given the implementation of certain policies.
One analytical device depicts an organization's stakeholders on a two-
dimensional grid map. The first dimension is one of "interest" or "stake"
and ranges from an equity interest to an economic interest or marketplace
stake to an interest or stake as a "kibitzer" or influencer.>' Shareowners
have an equity stake; customers and suppliers have an economic stake;
and single-issue groups have an influencer stake. The second dimensionof
a stakeholder is its power, which ranges from the formalistic or voting
power of stockholders to the economic power of customers to the political
power of special interest groups. By economic power we mean "the ability
to influence due to marketplace decisions" and by politicalpower we mean
"the ability to influence due to use of the political process. "22
Table 1 represents this stakeholder grid graphically. It is ot course
possible that a stakeholder has more than one kind of both stake and
power, especially in light of the fact that there are stakeholders who have
multiple roles. An employee may be at once shareholder, customer,
employee, and even kibitzer. Table 1 represents the prevailing world
view. That is, shareholders and directors have formal or voting power;

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94 R. EDWARD FREEMAN & DAVID L. REED

Table 2. "Real World" Stakeholder Grid

Power Stake Formal or Voting Economic Political

Equity • Stockholders • Dissident

• Directors stockholders
• Mmonty interests

Economic • Suppliers • Local governments

• Debt holders • Foreign governments
• Customers • Consumer groups
• Unions • Unions

Influencers • Government • EPA/OSHA • Nader's Raiders

• SEC • Government
• Outside directors • Trade associations

customers, suppliers, and employees have economic power; and govern-

ment and special interest groups have politicalpower. Moreover, manage-
ment concepts and principles have evolved to treat this "diagonal case."
Managers learn how to handle stockholders and boards via their ability to
vote on certain key decisions, and conflicts are resolved by the procedures
and processes written into the corporate charter or by methods which
involve formal legal parameters. Strategic planners, marketers, financial
analysts, and operations executives base their decisions on marketplace
variables, and an entire tradition of management principles is based on the
economic analysis of the marketplace. Finally, public relations and public
affairs managers and lobbyists learn to deal in the politicalarena. As long as
the real world approximately fits into the diagonal, management processes
may be able to deal effectively with them. A more thoughtful examination,
however, reveals that Table 1 is either a straw man or that shifts ofposition
have occurred. In the auto industry, for instance, one part of government
has acquired economic power in terms of the imposition of import quotas or
the trigger price mechanism. The Securities and Exchange Commission
might be looked at as a kibitzer with formal power in terms of disclosure
and accounting rules. Outside directors do not necessarily have an equity
stake, especially those women, minorities, and academics who are be-
coming more and more normal for the boards of large corporations. Some
kibitzer groups are buying stock and acquiring an equity stake, and while
they also acquire formal power, their main source of power is still political.
Witness the marshalling of the political process by church groups in bring-
ing up, at annual meetings, issues such as selling infant formula in the Third
World or investing in South Africa. Unions are using their politicalpower as
well as their formal clout as managers of large portions of pension funds to
influence the company. Customers are being organized by consumer advo-
cates to exercise the voice option and to politicize the marketplace. In
short, the real world looks more like Table 2. (Of course, each organization
will have its own individual grid.) Thus, search for alternative applications

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 STOCKHOLDERS AND STAKEHOLDERS 95
of traditional management processes must begin, and new concepts and
techniques are needed to understand the shifts that have occurred and to
manage in the new environment.
The second problem which Table 1 illustrates is the complexity of some
issues and the lack of clear solutions, which make it necessary to adapt the
tricks of the trade of one box on the diagonal to a different box. Thus, Ian
MacMillan has argued that elements of strategic planning such as
"Strengths, Weaknesses, Opportunities and Threats Analysis" can be
applied to the pure political case. 23 There is a long tradition of applying
economic analysis to policy questions, 24 and we are beginning to see the
application of political concepts to economic questions, via recent discus-
sions of codetermination and quality of working life.25
Finally, there is a need to develop new and innovative management
processes to deal with the current and future complexities of management
issues. At the theoretical level, stakeholder analysis has been developed to
enrich the economic approach to corporate strategy by arguing that kibitz-
ers with political power must be included in the strategy process. At the
strategic level, stakeholder analysis takes a number of groups into account
and analyzes their strategic impact on the corporation. Tables 1 and 2
suggest two additional applications. The first is the analysis of the policy
questions in corporate democracy, the subject of the next section; and the
second is the analysis of the complex issues of conflicts in ownership
interests and the resulting generation of policy and strategic alternatives.

Stakeholder Analysis and Corporate Democracy

The debate on corporate governance and, in particular, corporate democ-
racy has recently intensified. Proposals have been put forth to make the
corporation more democratic, to encourage shareholder participation and
management responsiveness to shareholder needs, and to make corpora-
tions more responsive to other stakeholder needs and, hence, to encour-
age the participation of stakeholders in the governance process. Reforms
from cumulative voting to audit committees have been suggested. 26
Corporate democracy has come to have at least three meanings over the
years, which prescribe that corporations should be made more demo-
cratic: by increasing the role of government, either as a watchdog or by
having public officials on boards of directors; by allowing citizen or public
participation in the managing of its affairs via public interest directors and
the like; or by encouraging or mandating the active participation of all or
many of its shareholdrs. The analysis of the preceding section has implica-
tions for each of these levels of democratization.
The propositions of stakeholder analysis advocate a thorough under-
standing of a firm's stakeholders (in the wide sense) and recognize that
there are times when stakeholders must participate in the decision-making
process. The strategic tools and techniques of stakeholder analysis yield a

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96 R. EDWARD FREEMAN & DAVID L. REED

method for determining the timing and degree of such participation. At the
absolute minimum this implies that boards of directors must be aware of
the impact of their decisions on key stakeholder groups. As stakeholders
have begun to exercise more politicialpower and as marketplace decisions
become politicized, the need for awareness to grow into responsiveness
has become apparent. Thus, the analyticalmodel can be used by boards to
map carefully the power and stake of each group. Whileit is not the proper
role of the board to be involved in the implementation of tactical programs
at the operational level of the corporation, it must set the tone for how the
company deals with stakeholders, both traditional marketplace ones and
those who have political power. The board must decide not only whether
management is managingthe affairs ofthe corporation, but indeed, what are to
count as the affairs of the corporation. This involves assessing the stake
and power of each stakeholder group.
Much has been written about the failure of senior management to think
strategically, competitively, and globally. Some have argued that Ameri-
can businesspersons are "managing [their] way to economic decline. "27
Executives have countered the critics with complaints about the increase in
the adversarial role of government and in the number of hostile external
interest groups. Yet if the criteria for success for senior executives
remains fixated on economic stakeholders with economic power and on
short-term performance on Wall Street, the rise of such a turbulent
political environment in a free and open society should come as no surprise.
If the board sees itself as responsive only to the shareholder in the short
term, senior management will continue to manage towards economic
decline. 28 We have argued that the problem of governing the corporation in
today's world must be viewed in terms of the entire grid of stakeholders
and their power base. It is only by setting the direction for positive
response and negotiation at the board level that the adversarial nature of
the business-government relationship can be overcome.
If this task of stakeholder management is done properly, much of the air
is let out of critics who argue that the corporation must be democratized in
terms of increased direct citizen participation. Issues which involve both
economic and political stakes and power bases must be addressed in an
integrated fashion. No longer can public affairs, public relations, and
corporate philanthropy serve as adequate management tools. The penal-
ties of only "doing good" and "having a positive image" are enormous in the
wake of OPEC, Love Canal, and OSHA. The sophistication of interest
groups who are beginning to use formal power mechanisms, such as proxy
fights, annual meetings, the corporate charter, to focus the attention of
management on the affairs of the corporation has increased. 29 Respon-
sive boards will seize these opportunities to learn more about those
stakeholders who have chosen the option of voice over the Wall Street
Rule. As boards direct management to respond to these concerns, to
negotiate with critics, to trade off certain policies in return for positive

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 STOCKHOLDERS AND STAKEHOLDERS 97
support, the pressure for mandated citizen participation will subside.
In addition to the implications of the stakeholder concept for proposed
policy change in corporate democracy and in the context whichstakeholder
theory sets for the role of the boards, we believe that our analysis has
implications for the current state of the art in the board room.

Conflicting Interests and the Board

The implications of stakeholder analysis for the practical affairs of the
corporation and its advisors can perhaps best be illustrated by exploring
examples of conflict within the ownership groups of corporations. We
believe that stakeholder analysis can be as valuable in addressing these
conflicts as in dealing with groups external to the corporation who are
seeking increased voice in its operations.
Given the significance of the voting machinery within the corporation, it
is not surprising that many ~f these internal corporate conflicts take the
form of the traditional proxy ,ght. Over the past two decades, however, a
number of techniques have been developed in contests for corporate
control. These tactics include: direct appeal to shareholder economic
interests through tender offers, issuance ofblocks of shares to employees,
employee stock ownership plans or other "friendly" holders, "secondary"
boycotts of organizations represented on a corporation's board, and "freez-
ing-out" certain board members from crucial decisions.>? While these
tactics span a broad area of the law and are not usually lumped together,
from the perspective of the analysis presented here, they share the aspect
of a conflict within the ownership group of the corporation. Such a conflict
raises fundamental questions of the affairs of the corporationandmore funda-
mentally of the identity of the corporation and presents especially thorny
issues for the board of directors, its advisors and counselors. For the present,
the variety of these conflicts will be analyzed to show the strengths and
weaknesses of these techniques.

Conflicts within the Board

Over the past few years a number of examples of disputes on boards of
directors have been serious enough to erupt into the press. The most
notorious of these disputes, perhaps, occurred at Beatrice Foods, a huge
Chicago-based food conglomerate, in the context of a transition of chief
executives. 31
Beatrice Foods had been rather slow over the years in reorganizing its
board of directors away from the insider-dominated board of the past. A
company that grew largely by acquisitions, first under William G. Karnes
and then under Wal1ace N. Rasmussen, Beatrice owed much of its success
to the strength and character of its chief executives and presented them
with hand-picked boards to do their bidding. In 1978, facing a Securities
and Exchange Commission investigation into kickbacks to dairy customers

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98 R. EDWARD FREEMAN & DAVID L. REED
and the impending retirement of Rasmussen, the Beatrice board began to
consider how to restructure itself from eleven insiders and eight outsiders
to ten outsiders and six insiders. A committee of the board, composed of
Rasmussen and three outside directors, took responsibility for the re-
organization and for pickingRasmussen's successor. For his own reasons,
Rasmussen objected to the choice of successor, preferring his own pro-
tege to the outside directors' choice, and objected to the new board
structure. He managed to rally the insiders around his position, and the
reorganization proposal and nominated chief executive were defeated. (A
postscript: Rasmussen's protege, James L. Dutt, has quietly dismantled
Rasmussen's influence and reinstated the board reorganization proposal
with generally favorable results. In addition, he seems to have reversed
Rasmussen policies on divestitures and other strategic moves.)
The Beatrice Foods story raises interesting questions of corporate
governance and control. Beatrice's shareholders returned Rasmussen's
insider-dominated board to power even while the disputes over reorgan-
ization of the board were spread through the press, and the decision to
support Rasmussen was quite successful. Yet Rasmussen's activities on
the board were sufficientlydistasteful that two of the outside directors on
the board resigned in response to his maneuvers.
The Beatrice Foods case brings into sharp focus the arguments for and
against insider domination of the board. Insiders consistently maintainthat
their intimate knowledge of the organization, its personnel, and culture are
the critical elements in, sound policy decisions. Outsiders argue that in-
siders work without direct consideration of the needs of the shareholders
(and, possibly, the other corporate stakeholders) and therefore use tactics
which are unacceptable. Regardless of whether suitable goals are
achieved, from a public policy viewpoint one should ask, "What sorts of
factual information would be helpfulin resolving this debate?" "Could such
factual background be accumulated?" We maintain that the manifest dif-
ficulties in accumulating this empirical support (or even in designing a
proper research program to obtain it) indicate that focusing attention in
mandating outside directors may be misplaced. The interests of corporate
governance will be better served by efforts to improve the functioning of
boards rather than in mandating structural changes with little or no reason
to expect that such changes will make a significant difference. Two other
examples of board conflict will be helpfulin showing that board structure is
not necessarily the key to board conduct.
Fairchild Industries' attempt to acquire Bunker-Ramo took an unusual
turn when Bunker-Ramo decided not to be acquired. 32 Having purchased
20.6 percent of Bunker-Ramo's stock from Martin Marietta Corporation,
Fairchild was able to elect its chairman and another director to the Bunker-
Ramo board under Bunker-Ramo's cumulative voting rules. Animosity
between Fairchild's chairman, Edward Uhl, and Bunker-Ramo's chief
executive, George Trimble, led to an attempted freeze-out of the Fairchild

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 STOCKHOLDERS AND STAKEHOLDERS 99
directors. Stating that he was protecting his company from conflicts of
interest and potential misuse of inside information, Trimble insisted that
the Fairchild directors be limited in their access to information as to
Bunker-Ramo's business. (Later, however, Trimble and Uhl, who had
been friends for years prior to the episode, reestablished their ties, and the
Fairchild directors were given significant committee assignments on the
Bunker-Ramo board. Further acquisition talk has been started. Bunker-
Ramo has expanded its board to accommodate the two directors replaced
by UbI and his fellow Fairchild director.)
As in the Beatrice case, provocative issues of corporate governance are
raised by the Bunker-Ramo story. There was a limited acceptance of the
notion during the height of the battle that, at least de facto, the majority of
the board could freeze-out the minority. Do directors have a right to
information about their company? What are the limits of such a right? What
is a plausible position for a director on such a board who is affiliated with
neither of the contesting parties? Should the fact that this dispute, too,
resolved itself be taken as a significant indication of the strength of the
current system? Or was this a classic example of "behind the scenes"
infighting without consideration for the needs of outside shareholders?
One final example of conflicts within the board of directors will serve to
illustrate the impact that current legal constraints can have on such activ-
ity. At a recent annual meeting of the Michael Baker Corporation.P a
director who attempted to nominate and vote in his own slate of directors,
in opposition to management, was served with process notifying him that
the company was suing him for organizing a "voting group of shareholders"
controlling more than 5 percent of the corporation's shares without filing
the disclosures required by Section 13 of the Securities Exchange Act. 34
As is well known among securities lawyers, the circumstances which call
for disclosure of the formation of a "group" are very broad. 3S The freedom
of a major shareholding director to engage in the kinds of struggles
described here, at least without disclosure, is therefore likely to be some-
what less than that of a total outsider.

Outside Attacks
In contrast to a struggle between members of the board, perhaps repre-
senting splits within the shareholder group, recent years have also seen
attacks on boards designed to further the interests of parties outside the
boardroom. One of the most notable is the attempt by the Amalgamated
Clothing and Textile Workers' Union (ACTWU) to isolate effectively J. P.
Stevens and Company within the business community.
The initial conflict between J. P. Stevens and the ACTWU goes back
many years and has continued through disputed union election proceedings
before the National Labor Relations Board and in the courts. 36 Frustrated
by their inability to defeat J. P. Stevens with the legal tools available, the

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100 R. EDWARD FREEMAN & DAVID L. REED
ACTWU has sought to apply pressure to J. P. Stevens' board of directors
to alter corporate labor relations policies. The union has used its financial
leverage in threatening to direct its pension funds out of Manufacturers
Hanover Trust, where James Finley, J. P. Stevens' ex-chairman, was
elected a director. The union has also threatened to run its own candidate
for the board of directors of Metropolitan LifeInsurance Company, a major
lender to]. P. Stevens. Recently, as a result ofthe pressure on Metropoli-
tan Life and, indirectly, on J. P. Stevens, Stevens has acquiesced and
signed its first collective-bargaining agreement withthe ACTWU.
The implications of the J. P. Stevens case are as yet dimly perceived.
The mere threat by the union to contest the election of directors at
Metropolitan seems to have been sufficient to catalyze this major insur-
ance company (which held over 35 percent of J. P. Stevens debt) into
action. The threat required only twenty-five signatures to com-
mence and might have cost Metropolitan five to seven million dollars to
fight. On this account, it might seem that the ACTWU has found a huge
lever to apply against a firm. On the other hand, many knowledgeable
observers trace the turning point of the seventeen-year fight to the single
election victory by the union in 1974 when union organizers were able to
make much of the fact that the low stock market values of that time had
eaten away at the profit sharing and ESOP benefits which]. P. Stevens had
granted to its employees.
The union turned to use of leverage in the board of directors of J. P.
Stevens and on the boards of allied corporations as, more or less, a last
resort. It is likelythat most unions and unionmembers prefer an adversar-
ial position vis-a-vis their employer. The plusses and minuses of union-
management cooperation have been bandied about a great deal in recent
years, particularly in connection with the government bail-outof Chrysler
in which the union was guaranteed a seat on Chrysler's board. Manage-
ment must become aware, however, that when the union does pressure
the board of directors and uses the machinery of corporate governance,
they will not ask permission to do so or request that their views be heard.
Such power, if acquired by the unions, will exercise control over manage-
ment. Furthermore, it is doubtful that there are legal tools available to
prevent such activities by unions or others without thoroughly stifling
corporate democracy. Management and boards will have to learn to nego-
tiate in a new environment.
Although the type of situation posed by the J. P. Stevens affair may seem
broad enough in itself to cover many corporations and labor-management
disputes, in fact it represents only a small fraction of the potential for
attacks from without on the board. One need only note the increasing
demand that beneficial owners of voting securities be empowered to
control the voting of their securities to see the potential extent of this
problem. An examination of the Stevens affair shows how that issue
extends beyond mere voting policies since Metropolitan's holdings ofJ. P.

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 STOCKHOLDERS AND STAKEHOLDERS 101
Stevens securities were mostly nonvoting. For tax and other reasons, a
great deal of the capital flowing to corporations in the U.S. comes from
intermediaries, such as pension funds and insurance companies. To the
extent that these investments are or are presumed to be "held in trust" for
the beneficiaries, it is almost inevitable that the trustees of these funds will
come under pressure to use the voting power or sheer economicclout that
they represent to do the beneficiaries' bidding. 37 In certain cases, this is
mandated by law, such as in ESOPs of ten closely held companies, but
there is no need of a legal grant of power where substantial economic
strength is manifested. In this broader view, the problem extends beyond
private firms and corporate governance to the indisputable effect that
public employee pension fund purchases of state and local government
obligations will have on the governance of these politicalbodies. 38
It is probably safe to say that the beneficiaries of a pension fund would
not desire the investment policies of the fund be modified unless a truly
unusual situation developed. On the other hand, employees truly polar-
ized by management might indeed take such steps. Much of the necessary
power is already in their hands; additional legislation will merely
strengthen their position. In these cases, once again, there will be no
requests to management or the board for voice or representation.

Stakeholder Management for the Board

Up to this point we have tried to show how the lay of the land in corporate
governance has changed in recent years with shifts in the stakes held and
the power wielded by various corporate stakeholders. We have argued
that some of the most successful and problematic of these shifts have come
to rest within the ownership group of the corporation as well as the more
highly publicizedstructural changes via government and special interest
participation. We have also argued that the parallels thus demonstrated
between conflicts which arise in the usual stakeholder confrontation
(where an individual group uses political power to request or mandate a
change in corporate policy) and the more classic stockholder confrontation
(where economic power or voting control is exercised by individuals or
groups to influence corporate policy) require that techniques developed in
dealing with the former case be applied to the latter. Stakeholder manage-
ment applies not only to the typical "us against them" confrontation with
labor or environmentalists but to the cases where it is much harder to see
"us" and "them. "

The Focal Organization

The starting point of any stakeholder analysis is identification of the focal
organization. It is in relation to this focal point that stakes are established
There is no single "right answer" to the choice offocal organization. In the
usual case of the corporation versus kibitzers, management or the board

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102 R. EDWARD FREEMAN & DAVID L. REED
views itself as a focal organization and analyzes the problem from the
viewpoint of the corporation's objectives. If, as in the Beatrice Foods or
Bunker-Ramo cases, the board is split badly enough, it may not be practical
to choose the board of directors or the corporation as the focal organiza-
tion. In other cases, such as the J. P. Stevens case, sufficient coherence
may obtain at the board level to justify its choice of focus. On the other
hand, if the split in the board is severe enough, a smaller group, such as the
group of outside directors, may be the appropriate focal organization. The
consequences of this selection will be discussed below; as a preliminary,
we wish to justify the "relativistic" nature of our position.
With sweeping language, the American Bar Association's Code of Pro-
fessional Responsibility defines the responsibilities of a lawyer who is
counsel to a corporation:
A lawyer employed or retained by a corporation ... owes his allegiance to the entity
and not to a stockholder, director, officer, employee, representative or other person
connected with the entity. In advising the entity, a lawyer should keep paramount its
interests. 39

While the general thrust of this admonition may be clear (although we

confess that it is anything but clear to us), it certainly provides no guidance
when competing interests represent, or colorably claim to represent, the
"entity." Nor does it help a lawyer advising a corporation where conflicting
interests of the entity are proposed. And such an admonition would be of
even less help to board members attempting to resolve an internal conflict
within their corporation.
In fact, when courts have been presented with cases where the status of
the corporation as client was raised, they have gone far beyond the
"entity" philosophy of the Code of Professional Responsibility. In Garner
v. Wolfinberger the court was called upon to rule on the right of the
corporation (management) to claim attorney-client privilege in a derivative
action (it should perhaps be noted that the ABA, as amicus, argued
extensively in favor of granting absolute privilegel.w The court, although
stating that corporations, in general, have the power to establish attorney-
client privilege, also held that they do not have an absolute right to do so,
and stated that "conceptualistic phrases describing the corporation as an
entity separate from the stockholders are not useful tools of analysis."
Management does not manage for itself. The court went on to hold that
given the particular relationship between the corporation and its share-
holders and the nature of the derivative action in question (that the
corporation acted inimically to the stockholders' interests), the absolute
attorney-client privilege could not obtain.
The court in Garner v. Wolfinberger embarked on a search for the focal
organization in assessing the relationship between the attorney, the cor-
poration, and the shareholder. It should be noted that the court's analysis
took specific cognizance of the type of conflict between corporation and
shareholder. This type of analysis will produce different results under

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 STOCKHOLDERS AND STAKEHOLDERS 103
different types of circumstances-and this is as it should be. Similarly,
members of the board and their advisors must take a pragmatic approach in
searching for a focal organization in situations of conflict.

Summary
The preceding analysis has addressed some of the implications of stake-
holder theory for the corporate governance debate. The focus of attention
has been on the board of directors in its current circumstances, that is,
given the regulatory, economic, and politicalclimate in which it finds itself.
We have hesitated to suggest particular strategies for directors that find
themselves in one of the conflict situations we have explored. Our goal has
been, rather, to counterbalance the great weight of attention expended
upon changing the (perceived) status quo and mandating certain types of
board structure or behavior with attention placed on a realistic appraisal of
the current situation and a sensitive elaboration of the potential lines of
action currently available. Thus, while stakeholder theory sets a realistic
context for analysis and development of policy alternatives, we have
stopped short of claiming that it lends either theoretical or practical sup-
port for a number of proposals recently explicated.
To those who advocate one of the many types of reform in the name of
corporate democracy, we offer this caveat. The possible combinations of
voting power, economic power, and political power available under the
status quo to various interested parties in the corporate governance de-
bate has barely been explored, as the]. P. Stevens case should indicate. It
is important that, in the rush to make improvements in the corporate
governance process, the full impact of each change be thoroughly under-
stood. It is equally important that corporate directors and their advisors
understand the current environment and act accordingly. Too often, di-
rectors opt for a convenient low profile, which, in its passivity, ignores
strategies which are available and which may result in benefits to all the
parties concerned: those with equity, economic and political stakes, and
power bases.
Legislation to modify the structure of corporate governance acts to
mandate certain alliances and coalitions and thereby eliminates certain
paths of action from the director's repertoire. In so doing, such legislation,
in effect, performs an elaborate balancing act, weighing and ranking the
interests of the participants in these conflicts. We have attempted to show
that a sensitive analysis of these cases frequently reveals a situation in
which there are competing legitimate ownership interests within the cor-
poration which have the effect of at least temporarily dissolvingthe corpo-
ration as an effective entity. In these circumstances it is extraordinarily
difficult to weigh and balance the interests in a particular case, let alone in
the whole corporate economy. The motivation behind the legislation,
however, is clear. In too many cases corporate boards, either through lack

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104 R. EDWARD FREEMAN & DAVID L. REED

of tools and techniques or through lack of courage or stamina, have taken

passive attitudes and allowed management to strike its own bargains.
In recent months, a number of courts have begun to increase their
surveillance of the activities of boards of directors through a trend toward
discarding certain aspects of the so-called business judgment rule. 41 Over
the same period, the Corporate Democracy Act received some modest
support in Congress. It is clear that corporate boards and their advisors are
not persuading the other interested parties in the corporate governance
arena that their stewardships of corporations is satisfactory. We contend
that much of this failure is due to a lack of systematic processes for
developing strategies to deal with these admittedly intricate situations,
and, further, that the approach presented here, carried out by experienced
practitioners, offers hope for improving the practice of strategy formula-
tions and the more effective functioningof the board in makinggovernance
decisions.
References
1. One problem which plagues management theorists is the tendency for the field to become
compartmentalized and fragmented. Thus, we have no confidence that any two people who
read this article will agree that there is a discipline of management or what that discipline
contains. Thomas Kuhn's The Structure of Scientific Revolutions, 2nd edition (Chicago:
University of Chicago Press, 1970) and the resulting literature in philosophy of science-
see 1. Lakatos and A. Musgrave (eds.), Criticism and the Growth of Knowledge (Cam-
bridge: Cambridge University Press, 1970) and G. Gutting (ed.), Paradigms and Revolu-
tions (Notre Dame: University of Notre Dame Press, 1980)-are of some help. We prefer
the locution "conceptual revolution" to "paradigm shift" to signify that paradigms aren't the
tidy little animals they are sometimes believed to be.
2. A. Berle and G. Means, The Modem Corporation and Private Property (New York:
Commerce Clearing House, 1932), pp. 220-221. For a discussion of the implications for
corporate governance see W. Evan, Organization Theory (New York: John Wiley and Sons,
1976), pp. 89-107.
3. Berle and Means, op. cit., p. 3.
4. C. Barnard, The Function of theExecutive (Cambridge, MA: Harvard University Press,
1938).
5. For an excellent history see F. Sturdivant, Business and Society (Homewood, IL: R. D.
Irwin, 1977), pp. 1-125.
6. Throughout our analysis one may substitute "organization" for "corporation," since
other organizational forms have stakeholders as well. Our emphasis is on the business-for-
profit organizational sector. For interesting recent discussions of the special problems of
nonprofit organizations, see R. Clark, "Does the Nonprofit Form Fit the Hospital In-
dustry, " Harvard Law Review, vol. 93, no. 7 (May 1980), pp. 1417-1489; andH. Hans-
mann, "The Role of Nonprofit Enterprise," The Yale Law Journal, vol. 89, no. 5 (April
1980), pp. 835-901.
7. We wish to thank an anonymous referee for Applications ofManagement Science for this
point, as well as subsequent correspondence with William Royce, senior management
consultant at SRI International, Mr. Royce has been quite helpful in tracking down the
development of the concept at SRI where "stakeholder analysis" is a thriving ongoing
concern. Stakeholder appears in Webster's as "one who holds the stakes in a gamble." It
does not appear in the OxfordEnglishDictionary.
8. F. Sturdivant, "Executives and Activists: A Test of Stakeholder Management," Cali-
fornia Management Review, vol. 22, no. 1 (Fall 1979), pp. 53-59. The present authors

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 STOCKHOLDERS AND STAKEHOLDERS 105
deserve a great deal of the blame for this comment through informal conversations with
Sturdivant, having been led astray by a reference in R. L. Ackoff, Redesigning theFuture,
NIhb~ Jlu'U1¢ LwhniwlY"\xn:ra1.'; maue ttle ongm or'uie term "difficult to determine.t'For a
complete history of the concept, see R. E. Freeman, Strategic Management: A Stakeholder
Approach (Marshfield, MA: Pitman, 1983), ch, 2.
9. See I. Ansoff, Corporate Strategy (New York: McGraw-Hill, 1965),33-35.
10. F. Abrams, "Management Responsibilities in a Complex World," in T. H. Carroll
(ed.), Business Educationfor Competence andResponsibility (Chapel Hill, NC: University
of North Carolina Press, 1954); R. M. Cyert and I, G. March,ABehavioralTheoryofthe
Firm (Englewood Cliffs, NJ: Prentice-Hall, 1963).
11. E. Rhenman, IndustrialDemocracy and Industrial Management (London: Tavistock
Publications Limited, 1968).
12. R. L. Ackoff, RedesigningtheFuture (New York: John Wiley and Sons, 1974).
13. W. R. Dill, "Public Participation in Corporate Planning: Strategic Management in a
Kibitzer's World," LongRangePlanning (1975), pp. 57-63.
14. See F. Sturdivant, Business and Society: A Managerial Approach (Homewood, IL: R.
D. Irwin, 1977), and T. A. Klein, Social Costs andBenefits ofBusiness (Englewood Cliffs,
NJ: Prentice-Hall, 1977).
15. See R. W. Ackerman, "How Companies Respond to Social Demands," Harvard Business
Review, vol. 51, no. 4 (1973); idem, The Social Challenge to Business (Cambridge, MA:
Harvard University Press, 1975); and R. W. Ackerman and R. A. Bauer, Corporate Social
Performance: The Modem Dilemma (Reston, VA: Reston, 1976) as well as other books and
articles.
16. We do not believe definitions can be constructed and justified in isolation. They should
be descriptive of current use, and in emerging theories, prescriptive of linguistic change.
While we offer two definitions in order to ease the linguistic change, we are ultimately
wedded to the wide inclusive sense of stakeholder. The authors wish to thank Dr. Marvin
Olassky of DuPont for the suggestion of different levels of definitions.
17. The importance of external forces for business strategy is explored in R. Charan and
R. E. Freeman, "Planning for the Business Environment of the 1980s," TheJournal of
BusinessStrategy, vol. 1, no. 2 (Fall 1980), pp. 9-19.
18. The initial results of the Wharton Stakeholder Project have been described by J. R.
Emshoff and R. E. Freeman in "Stakeholder Management," Working Paper 3-78 (The
Wharton Applied Research Center) and have been published as "Who's Butting Into Your
Business," The Wharton Magazine (Fall 1979), and "Stakeholder Management: A Case
Study of the U. S. Brewers Association and the Container Issue, " forthcoming in R. Schultz
(ed.), Applications ofM~ Science (Greenwich:JAI Press, 1981). Freeman, op. cit.
19. J. A. Baude, et al., Perspectives on LocalMeasured Service (Kansas City: Telecom-
munications Industry Workshop Organizing Committee, 1979).
20. For another stakeholder technique, see H. L. Lee and R. L. Banker, "StakeholderDecision
Analysis," WorkingPaper 20880 (The WhartonAppliedResearch Center); and R. E. Freeman,
R. L. Banker, and H. L. Lee, "A Stakeholder Approachto Health Care Planning," in C. Tilquin
(ed.) Systems Science inHealth Care (Toronto: Pergamon Press, 1981).See Freeman, op. cit.
21. William Dill first used kibitzer to refer to external groups who try to use the political
process to influence the affairs of the corporation. Its use is not meant perjoratively.
22. Some have argued that markets and politics are inherently connected. We agree. Our
distinctions are useful, however, in order to understand how and why they are connected.
The analyses of Lindbloom, Politics and Markets (New York: Basic Books, 1977), and
Hirschman, Exit, Voice andLoyalty (Cambridge, MA: Harvard University Press, 1970), do
not pay adequate attention to the positions of shareholders and directors and hence, to
questions of corporate governance. Yet another way of phrasing our distinction is to
differentiate between stakeholders who classically exercise voice. Here, the curiosity of
shareowners and directors is apparent for, despite the WallStreet Rule, each exercises a
mix of exit and voice.

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106 R. EDWARD FREEMAN & DAVID L. REED

23. I. MacMillan, Strategy Formulation: Political Concepts (St. Paul: West Publishing
Company, 1978).
24. See especially the work of G. Becker, The Economic Approach to Human Behavior
(Chicago: University of Chicago Press, 1976).
25. L. Davis and A. Cherns (eds.), The Quality of Working Life, vols. I and II (New York:
The Free Press, 1975).
26. For a sample of the issues see W. Dill, Running theAmerican Corporation (Englewood
Cliffs, NJ: Prentice-Hall, 1978); T. BradshawandD. Vogel(eds.), Corporations andTheir Critics
(New York: McGraw-Hill, 1981); and R. Ferrara and M Goldfus, Everything You Ever
Wanted toKnow AbouttheFuture ofFederal Influence in Corporate Governance (Washing-
ton, D.C.: Financial, Government and Public Affairs, 1979).
27. R. Hayes and W. Abernathy, "Managing Our Way to Economic Decline," Harvard
BusinessReview, vol. 58., no. 4 (1980).
28. It is arguable whether responsiveness to nonmarket stakeholders is in the long-term
interest of the corporation. We believe that there is no need to appeal to utilitarian notions
of greatest social good or altruism or social responsibility. Rather, the corporation fulfills its
obligations to shareholders in the long term only through proper stakeholder management.
In short, we believe that enlightened self-interest gives both reasons why (personal
motivation) and reasons for (social justification) taking stakeholder concerns into account.
The development of this argument is, however, beyond our present scope.
29. For an interesting discussion of this point with respect to dissident stockholders, see
D. Vogel, Lobbying theCorporation (New York: Basic Books, 1978).
30. For the use ofissuance of stock to ESOPs, see Klaus v. Hi-Shear Corp., 528 F. 2d 225
(9th Cir. 1975); for the issuance of stock to friendly holders see CareCo. v. Treadway
Corp., __ F. 2d __ (2dCir. 1980). The other techniques are described below in detail.
31. The Beatrice Foods story was widely chronicled in the business press. See WallStreet
]ournal (7 May 1980), p. 22; idem (21July 1980), p. 1; BusinessWeek (9 April1979), p. 36;
idem (10 September 1979), p. 76; Barrons (14 January 1980), p. 76.
32. The Bunker-Ramo story is chronicled in the WallStreetjournal (31 March 1980), p.
12; idem (23 April 1980), p. 12; idem (5 May 1980), p. 21; idem (11 June 1980), p. 37.
33. See Wall Street]ournal (24 April 1980), p. 31.
34. 15U.S.C. §78m(d).
35. The classic case is G. A. F. Corp. v. Milstein, 453 F. 2d 709 (2d Cir. 1973).
36. A complete history of this struggle would require a paper itself. For useful surveys see
W. Buzzard, "How the Union Got the Upper Hand on J, P. Stevens," Fortune (19 June
1978), p. 86; K. Kovachs, "J, P. Stevens and the Struggle for Union Organization," Labor
Law]ournal (May 1978), p. 300. The union's victory is chronicled in WallStreet]ournal(20
October 1980), p. 1.
37. For private firms, the Employee Retirement Investment Security Act (ERISA), 29 U.
S. C. §§ 1001-1381 (1976) governs the investment of these funds. See H. R. 14138, 95th
Congo 2d Sess. for a public employee version of ERISA. See also Hutchinson & Cole,
"Legal Standards Governing Investment of Pension Assets for Political Goals," Un~ of
Pennsylvania LawReview, voL 128(1980), p. 1340, for a detailed discussion ofthese issues under
current law.
38. See, for example, Withers V. Teachers' Retirement System ofNew York, 447 F. Supp,
1248 (S.D.N.Y., 1978) affd, 575 F. 2d 1210 (2d Cir. 1979) in which the teachers'
retirement system investment in New York City's obligationwas upheld against a challenge
of imprudence.
39. EC 5-18, Code ofProfessional Responsibility.
40. 430 F. 2d 1093 (5th Cir. 1970).
41. See, for example, Maldonado v. Flynn, 413 A. 2d 1251 (Del. Ch. 1980), Maher v.
Zapata, F. Supp. (S.D. Tex. 1980). But see Treadway Cos. v. CareCorp., 490 F. Supp,
669 (S.D.N.Y. 1980), Panter». MarshaIiField&Co., 486F. Supp, 1168 (N.D. Ill. 1980).

Copyright © 2001 All Rights Reserved