A Response to Tony Fratto on Stakeholders

On August 21, Tony Fratto posted a long thread on Twitter about stakeholders and their role in the corporation. He made a number of errors both conceptual and factual. My objective here is to correct his mistakes. In fairness to Mr. Fratto, I have posted a PDF version of his thread below. Thanks to Threadreaderapp.com for providing this service.

Mr. Fratto begins by talking about how shareholders are not all the same. He adds that they have a wide ranging views about what maximizing returns means to them. These points are obvious. What he failed to do was note that both points are largely irrelevant.

First, shareholders generally will hold a portfolio of securities. Those portfolios have the risk return characteristic that the investor desires. To some degree, the specific companies in the portfolio are irrelevant. What matters is the covariance of their rates of return. This is basic capital asset pricing model material that Mr. Fratto certainly knows.

Exit voice loyalty

(Click for larger image)

My second point dates from 1970. That’s the year when Albert O. Hirschman published his famous monograph Exit, Voice, and Loyalty.[1] As applied to the stock market, stockholders have three choices. They can remain loyal, accepting the firm’s current strategies. Or they can speak up, writing letters and attending shareholder meetings. Or they can sell the stock, the exit option. The question is why shareholders who are concerned with the risk return characteristics of their portfolio should be burdened by the concerns of other stockholders about various other so-called stakeholders. Remember, in the context of their portfolio stockholders largely do not care about the specific identities of the companies.


Mr. Fratto’s final point is … well, see for yourself:

Also a corruption of capitalism is the idea that firms should be indifferent to their employees. It’s also dumb.

Here’s the problem. I don’t know anyone who is making this silly argument. Certainly no economists are.

Mr. Fratto is correct that human capital will gravitate to firms that “meet their [the employees’] desires.” Those desires presumably include wages, salaries, and benefits. But, sadly, he then makes the mistake of assuming that every firm fits into the Michael Porter model of Competitive Advantage.[2] As Mr. Fratto puts it, “Collecting the best talent in the industry is the most important factor for successful firms.” That is absolutely false because it ignores the wage rate. If the equilibrium wage rate for the best talent exceeds those workers marginal revenue product in your firm, then you do not hire the best talent. Firms attempt to assemble a portfolio of workers in much the same way that stockholders assemble a portfolio of firms. But the notion that employees somehow deserve a voice in running the firm that is equivalent to the owners of the firm-the stockholders-is just plain silly.

[1] Albert O. Hirschman, Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States (1972). Harvard University Press, Cambridge, MA ISBN 9780674276604.

[2] Michael E. Porter, The Competitive Advantage: Creating and Sustaining Superior Performance (1985). NY: Free Press, 1985. (Republished with a new introduction, 1998.)



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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.