Theory Part 3: With Whom Do Companies Create Value? (Freeman)

The article “The Social Responsibility of Business Is to Increase Its Profits” raised by Friedman in 1970 was not a simple argument that “companies should only pursue profits.” What Friedman questioned was the fundamental issue of corporate governance: To whom are corporate managers responsible?

To what extent can managers, entrusted with management by shareholders, justify diverting company resources to social purposes based on their own judgment? Is it the corporate manager who decides social policy, or is it the government that has gone through democratic procedures? Friedman's question remains unresolved even half a century later.

However, the environment surrounding companies has changed significantly since then. Corporate activities have crossed national borders, and supply chains have become complex. Corporate decision-making has come to affect not only shareholders but also employees, customers, business partners, local communities, government, civil society, and even future generations.

Faced with this reality, the question of “to whom are companies responsible” is no longer enough to capture the full picture of corporate management.

Another question becomes necessary.

With whom do companies create value?

The person who placed this question at the center of management strategy is R. Edward Freeman.

Published in 1984, “Strategic Management: A Stakeholder Approach” became the starting point for subsequent stakeholder research. Today, research surrounding stakeholder theory has developed into a wide range of fields, but the book is still positioned as the work that set the direction for that discussion.

However, I would like to clear up one misunderstanding first. Freeman is not the person who invented the word “stakeholder.” His achievement lies in elevating a concept that already existed to the core of management strategy.

Where did the word “stakeholder” come from?

In Chapter 2 of his 1984 book, “The Stakeholder Concept and Strategic Management,” Freeman traces the history of the stakeholder concept.

According to that description, the word “stakeholder” in a management context appeared in an internal memo at the Stanford Research Institute in 1963. The Stanford Research Institute is the current SRI International. According to Freeman, this word was used to broaden the idea that the only parties managers should consider are shareholders, or “stockholders.”

At the time, a stakeholder was defined as “those groups without whose support the organization would cease to exist.” In other words, “groups without whose support the organization would cease to exist.” They attempted to view not only shareholders but also employees, customers, suppliers, financial institutions, and society as entities that support the survival of the company.

However, this 1963 internal memo itself is not a publicly available document that can be easily referenced. Therefore, the explanation that it was “first used in a 1963 SRI document” is based primarily on the conceptual history presented by Freeman in his 1984 book, as far as can be confirmed at present.

Chapter 2 of the same book, published by Cambridge University Press, also notes that the term “stakeholder” in management literature appeared in an internal memo from the Stanford Research Institute in 1963, and that its purpose was to generalize the idea that only stockholders should be the subjects to whom managers respond.

What did the SRI's idea try to change?

The SRI's initial way of thinking is important not simply because it “increased the number of stakeholders.” It contained an idea that sought to change the unit for understanding a company.

If you view a company only as the property of shareholders, the first party managers should look at is the shareholders. However, if you think that the survival of a company is supported by the labor of employees, the purchases of customers, the cooperation of suppliers, the credit of financial institutions, and the acceptance of local communities, then a company cannot be explained solely by its relationship with shareholders. A company survives while obtaining resources, cooperation, trust, knowledge, and legitimacy from multiple entities. It was precisely this point that the SRI definition focused on.

Admittedly, that definition is relatively limited. Under the criterion of “entities without whose support the company would cease to exist,” the focus is on entities that provide direct resources or cooperation to the company. For example, shareholders, employees, customers, suppliers, and financial institutions.

On the other hand, people who are affected by corporate activities but do not necessarily provide direct support for the company's survival are not sufficiently captured by this definition. Residents around a factory who are affected by environmental impacts, workers in production areas whose living conditions change due to corporate procurement activities, and future generations who are affected by the long-term impact of products and technologies are not necessarily clearly included in the initial SRI definition.

Freeman expanded this definition.

Freeman's Definition

Freeman defined a stakeholder as: "a stakeholder is any group or individual who can affect, or is affected by, the achievement of a corporation’s purpose. Stakeholders include employees, customers, suppliers, stockholders, banks, environmentalists, government and other groups who can help or hurt the corporation." In Japanese, this is “A stakeholder is any individual or group that affects or is affected by the achievement of an organization's purpose. Stakeholders include employees, customers, suppliers, shareholders, banks, the environment, activists, the government, and other groups that can support or harm the corporation.”.

At first glance, this is very concise. However, it contains two directions that change the view of a corporation.

One is can affect—entities that influence the corporation.
Customers influence the corporation through their purchases, and employees influence it through their labor, knowledge, and creativity. Suppliers influence the corporation through quality, price, technology, and delivery times, while investors and financial institutions influence it through the provision of capital and their evaluations. The government influences the corporation through legal systems and policies. The media and civil society influence the corporation through social evaluation and the formation of issues.

The other is is affected—entities that are influenced by the corporation's activities.
The parties that management should look at are not just those who provide the resources necessary for the company's success. They also include those whose rights, lives, environment, future, and opportunities are affected by the company's decision-making. In other words, stakeholders cannot be defined solely by whether they are useful to the company. The fact that they are affected by the company also makes them subjects for consideration in corporate management.

While the initial definition of SRI focused on "entities that support the corporation," Freeman expanded the concept to include both "entities that influence the corporation" and "entities that are influenced by the corporation." Through this expansion, stakeholders ceased to be merely a "list of important parties" and became a framework for understanding the two-way relationship between the corporation and society.

Written as Strategy, Not CSR

There is another important point. "Strategic Management: A Stakeholder Approach" is not a book that discusses corporate social contribution. As the title suggests, this is a book on strategic management. What Freeman addressed was not whether companies should contribute to society out of goodwill. It was that the environment surrounding companies had changed, and the conventional framework of strategic management was no longer sufficient to explain the problems managers face.

The number of entities involved in corporate decision-making—such as governments, competitors, consumer groups, employees, customers, suppliers, and local communities—is increasing. Their expectations differ from one another and often conflict. In such an environment, it is not enough for managers to simply analyze the market and beat their competitors. They must identify the entities surrounding the company, understand their relationships with each, and translate those relationships into concrete actions. For Freeman, stakeholders were not a moral add-on. They were a realistic condition for making strategy work.

Cambridge University Press's introduction to the book also positions it as a foundational work for understanding corporations and capitalism as "a mechanism for creating value for and with stakeholders."

Stakeholder theory is not a general ethical theory that says, "Let's consider people other than shareholders." The success of the corporation itself depends on its relationships with diverse stakeholders. Therefore, relationships with stakeholders are not social contributions to be considered after profits are generated. They are the very process of creating value, realizing strategy, and ensuring the survival of the corporation.

Did Freeman Deny Friedman?

Freeman is often placed on the opposite side of Friedman.
Friedman emphasized shareholders.
Freeman emphasized stakeholders.

For this reason, the two are sometimes explained as a simple conflict between "shareholder capitalism vs. stakeholder capitalism." However, is this characterization accurate? The question Friedman asked was, from whom is authority delegated to managers, and to whom are they accountable? In contrast, the question Freeman asked was, through relationships with whom does a company realize its strategy and create value?.

Friedman's central concern was managerial authority and corporate governance.
Freeman's central concern was the relationships surrounding the company and strategic management.

However, if you treat Freeman merely as an "opponent of Friedman," you lose sight of his contribution as a strategist. What Freeman demonstrated was not a denial of the importance of shareholders. Shareholders are also important stakeholders for a company. The problem is to always view the value of shareholders and the value of other stakeholders as a zero-sum relationship.
If a company cannot provide value to customers, it cannot generate sales.
If employees cannot demonstrate their abilities, the company cannot produce products or services.
If the relationship with suppliers is unstable, quality and supply cannot be maintained.
If the company is not accepted by the local community or the government, it will be difficult to continue operations.
Long-term shareholder value cannot be realized in isolation from these relationships.

Therefore, the question is not "shareholders or stakeholders?" It is, how do we create value through relationships with stakeholders, including shareholders?.

Freeman Changed the Way We Look at Corporations

What Freeman changed was not just the number of parties managers should look at, but the way we look at corporations themselves. In the conventional image of a corporation, it is easily depicted as an entity that invests capital, produces goods and services, and returns profits to shareholders. In this model, shareholders are at the center of the corporation, and customers, employees, suppliers, and others may be positioned as means to achieve corporate objectives.

Freeman's view of the corporation is different. A corporation is a mechanism of relationships where diverse entities cooperate to create value for each other. Customers are not merely sources of revenue, employees are not merely labor costs, and suppliers are not merely procurement sources. Furthermore, local communities are not merely business environments; each is an entity with its own unique goals, values, rights, and expectations. Moreover, corporate management is not just the job of coordinating these relationships. It is the job of creating new value through these relationships.

From this, the understanding of corporate value also changes. Value is not completed solely within the company. Value is not yet determined just because a company makes a product; it is only realized through these relationships: investors evaluate the potential and provide capital, customers recognize the necessity, employees find meaning, suppliers cooperate, the local community accepts it, and society grants legitimacy to its activities.

Rather than a company unilaterally 'providing value,' value is established by the company and its stakeholders bringing their respective resources, knowledge, judgment, and trust to the table. It is interesting that Freeman also looked at what U.S. companies could learn from the management of Japanese companies. In 1984, it was widely recognized in the West that Japanese companies were enhancing their competitiveness based on relatively long-term relationships with employees, business partners, financial institutions, and others. For Freeman, the experience of Japanese companies was one piece of evidence for considering the limitations of explaining a corporation solely through its relationship with shareholders.

However, this should not be simplified to 'Japanese companies were already practicing stakeholder theory.' Japanese-style management, while having the strength of long-term relationships, can also have problems such as closedness, the fixation of relationships, and the exclusion of entities that find it difficult to speak up. Nevertheless, it is noteworthy that the perspective of viewing corporate success through long-term cooperation with diverse stakeholders resonated with Freeman's problem awareness.

Western stakeholder theory and Japanese management philosophy do not have a relationship where one directly created the other. However, from different historical and institutional backgrounds, they were approaching the common question that corporations exist within relationships with society and create value.

Theory after Freeman

Freeman's 1984 book did not provide final answers to all problems. Rather, it generated many new questions. Is stakeholder theory a theory for explaining real-world companies, a means for producing excellent management results, or a theory indicating the ethics that companies should follow? Who should be recognized as a stakeholder? Should all stakeholders be treated equally? When different interests conflict, who should be prioritized? What ethical principles are necessary for the relationship between a company and its stakeholders?

Subsequent researchers such as Donaldson and Preston, Mitchell, Agle, Wood, and Donaldson and Dunfee developed the theory in response to these questions.

A corporation is not a machine that uses other entities to deliver profits to shareholders. A corporation is a mechanism of relationships where diverse entities cooperate to create value for each other. A corporation influences society and, at the same time, is influenced by society.

A company can propose value. However, whether that proposal is realized as value depends on its relationships with customers, employees, suppliers, investors, local communities, government, and civil society. Might a new world come into view by placing this bidirectionality at the center of management strategy?

The original text for this session

R. Edward Freeman (1984)

Strategic Management: A Stakeholder Approach
Boston: Pitman.

When reading this book, the first thing to note is not 'stakeholder theory,' but the title, Strategic Management.

Freeman's starting point was the awareness that conventional strategic management was not adequately responding to changes in the corporate environment.

Part 1 reviews the conventional view of the corporation and presents the history and basic framework of the stakeholder concept. Part 2 discusses the process for analyzing stakeholders, forming strategies, and moving to concrete action. Part 3 examines what the stakeholder approach means for managers and each functional department.

Therefore, this book is not just a book that introduces concepts. It is a practical strategy text that deals with how managers understand complex environments, with whom they build relationships, and how they execute strategies. Chapter 2 of the book organizes the stakeholder concept from multiple research fields, including corporate planning, organizational theory, corporate social responsibility, systems theory, and strategic management.

If reading in Japanese

Strategic Management: A Stakeholder Approach has no published full Japanese translation as far as can be confirmed.

When reading Freeman's ideas in Japanese, the following books are useful.

By R. E. Freeman, J. S. Harrison, and A. C. Wicks
Representative Translator: Mizuho Nakamura
"Managing for Stakeholders: Survival, Reputation, and Success"
Hakuto Shobo, 2010

Original work Managing for Stakeholders: Survival, Reputation, and Success

This book moves away from the binary choice of "shareholder interests versus stakeholder interests" and presents Freeman's mature perspective in a relatively accessible way: creating value in a manner that allows customers, employees, suppliers, communities, and financiers to succeed in the long term. The Japanese edition was published by Hakuto Shobo in 2010.