The Empty Case for Stakeholder Capitalism and ESG Investing


Instead of promoting responsible behavior, these practices undermine the principles of good corporate governance.

Larry Fink, the chairman and CEO of BlackRock, is selling the idea that the world economy must embrace stakeholder capitalism and environmental, social, and governance (ESG) investing. Don’t worry, though, he wants you to know that stakeholder capitalism is just like capitalism because it is “driven by mutually beneficial relationships” that will help firms, customers, suppliers, and the broader community prosper. Fink suggests that stakeholder capitalism is necessary because “a company must create value for and be valued by its full range of stakeholders.”

Serving stakeholders is not simply the right thing to do, either; it’s also profitable. According to Fink, “it is through effective stakeholder capitalism that capital is efficiently allocated, companies achieve durable profitability, and value is created and sustained over the long-term.”

Fink’s arguments are not unique among ESG advocates, but his being chairman and CEO of the world’s largest asset manager does make his endorsement of stakeholder capitalism noteworthy. Unfortunately, his prestigious position does not make his view any more correct.

To start, if stakeholder capitalism were nothing more than capitalism (as it is traditionally defined), then there would be no need to embrace a new approach. That ESG proponents advocate adopting new governance and investing paradigms contradicts their assertions that stakeholder capitalism is just like shareholder capitalism of the type with which we are all familiar.

It is true that many customers do want to purchase products consistent with ESG principles. Others may like to as well but find that the products are too expensive or inferior. Others may find no value in these products at all. Under free-market capitalism, businesses and entrepreneurs are empowered to satisfy these diverse wants and needs.

Yet Larry Fink and other ESG proponents aren’t advocating this sort of arrangement. Instead, they’d like to command a coercive exchange wherein activists define what will be produced and who will benefit from that production.

A system that selects winners and losers based on political preferences rather than who best serves consumers is not capitalism, it is crony capitalism. Crony capitalism is an unjust and unsustainable economic system that inevitably harms families — particularly low-income families — who cannot afford the inevitable costs and mandates imposed to ensure the crony capitalists’ preferred outcome is achieved.

Stakeholder capitalism also circumvents (and thus undermines) the democratic process by attempting to make important public-policy decisions through the corporate boardroom rather than, directly or indirectly, through the legislature. It is neither appropriate nor effective to set important social and policy issues for the nation through corporate board meetings.

Take as an example the attempts to implement environmental policies through ESG activism. While global climate change is a problem, there are significant economic and social trade-offs attendant to adopting, say, cap-and-trade regulations and carbon taxes. Multiple congresses and presidents have had many opportunities to implement these politics and ultimately have chosen not to do so.

Such decisions reflect an understanding of the enormous economic cost and de minimis impact on global climate change that would result from those policies. Unhappy about this political result, ESG advocates are trying to create the same outcome by pressuring companies to act as if these policies were the law.

The claim that companies must answer to all stakeholders is just as troubling. When used in ESG circles, the term stakeholders include a company’s shareholders, employees, customers, and the broader community.

Of course, arguing that companies are responsible to shareholders, employees, and customers isn’t exactly new. Businesses’ raison d’être is to serve their customers to earn a profit for shareholders. Achieving this goal also requires businesses to account for their employees’ needs as they are essential for fulfilling the mission. Ensuring companies have these parties’ interests in mind doesn’t require a whole new theory of “stakeholder capitalism.”

Nor is a whole new theory necessary to address environmental, health, or other externalities that can affect local communities. These issues are already addressed through the political and legal systems.

The entire purpose of introducing the term stakeholder capitalism, then, is to create new responsibilities for businesses to the broader community. Yet the broader community has no interest in the performance of the company, the welfare of its workers, or the quality of the products produced. This fundamental misalignment of incentives ensures that policies that add value to the broader community will come at the expense of shareholders or employees.

The individuals that make up the broader community also hold different values and beliefs. With such divergent positions, value will be added only to the noisiest in the community, often at the expense of rest of the community.

The supposed financial premium that ESG funds provide investors is another oft-repeated justification for stakeholder capitalism. ESG funds do perform better for asset managers. A Morningstar report found that the expense ratio for ESG funds was 0.61 percent compared with 0.41 percent for traditional funds. Whether investors are better off is less clear.

Overall, there is no evidence that ESG funds outperform over the longer term. There are some funds that have performed better recently. For those who have been outperforming over the past year or two, their holdings tend to be skewed toward information technology and away from manufacturing and mining.

While information-technology stocks performed well in 2021, in large part due to the unique effects of the Covid-19 pandemic, that will not always be the case. Indeed, the extreme volatility that they’ve experienced in early 2022 is a case in point. ESG funds’ greater exposure to these stocks implies that their returns will suffer more relative to their peers should these trends persist.

It is also important to note that ESG funds differ substantially from one another. Some ESG funds have passive investment strategies whose only restriction is against investing in energy-drilling companies. Others are actively managed funds operating under stringent selection criteria. Conflating the returns across these very different types of investments promotes misinformation about the expected performance.

Despite its lofty rhetoric, the case for ESG investing and stakeholder capitalism falls short. Instead of promoting responsible behavior, these practices undermine the principles of good corporate governance. If adopted widely, the result would be less innovation, slower income growth, and diminished economic prosperity.

WAYNE WINEGARDEN, Ph.D., is a Senior Fellow in Business and Economics and the Director of the Center for Medical Economics and Innovation at the Pacific Research Institute.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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