The motivational effect of the two stakeholder management approaches
We can expect a firm's stakeholder management approach to affect the motivation to create value of the stakeholders currently associated with the firm; e.g., how hard employees work or whether customers spend time on providing feedback on the firm's products. Research in social psychology and behavioral economics suggests that this motivational effect depends on whether a stakeholder is reciprocal or self-regarding.
More specifically, the empirical evidence gathered by social psychologists and behavioral economists indicates that the positive relationship between a fair treatment of stakeholders and value creation hypothesized in the existing stakeholder literature only holds for reciprocators: reciprocal stakeholders will indeed create more value for firms that adopt a fairness approach than for firms that adopt an arms-length approach. In line with the assumption in the stakeholder literature, reciprocators value fairness per se. In contrast, self-regarding stakeholders do not. Liebrand et al. (1986) and De Dreu and Boles (1998) found that reciprocators view behaviors as varying on a ‘moral’ dimension (what is good or bad), whereas self-regarding individuals tend to interpret behaviors along the ‘effectiveness’ dimension (what works). This distinction is reflected in their emotional reactions to situations in which others are not willing to cooperate. Stouten et al. (2005) found that reciprocators' emotional reactions to noncooperation are linked to the violation of the norm of fairness itself but that self-regarding individuals' emotional reactions arise from effectiveness concerns. In contrast to reciprocators, self-regarding individuals are no longer upset when it becomes clear that their individual payoffs are unaffected by others' noncooperation.
Because reciprocators value fairness per se, a fair treatment motivates reciprocal stakeholders to create more value, even if their contribution is not fully compensated in the form of a personal economic benefit. This is illustrated by behavioral economists' findings regarding reciprocation in the relationship between employees and employers (e.g., Fehr and Falk, 1999; Fehr, Klein, and Schmidt, 2007; Fehr and Schmidt, 2000, 2004; Gächter and Falk, 2002). In a series of experiments, reciprocal employees reciprocated employers' generous wage offers by selecting effort levels significantly higher than the minimum level, even when employers had no possibility to punish or reward employees as a function of their effort (Fehr, Gächter, and Kirchsteiger, 1997).
Conversely, reciprocators are likely to infer hostile intentions from the choice of an arms-length approach and to respond to these perceived hostile intentions by contributing less to value creation than if the firm chooses a fairness approach. Findings from laboratory experiments show that the use of financial rewards or sanctions in formal contracts damages reciprocators' voluntary contributions to value creation (e.g., Fehr and Falk, 2002; Lubell and Scholz, 2001; Tenbrunsel and Messick, 1999). Reciprocators seem to interpret financial rewards or sanctions as a signal of hostile intentions and distrust, which leads them to lower their effort (Fehr and Falk, 2002; Fehr and Rockenbach, 2003). Therefore, a firm's use of an arms-length approach will, at best, limit reciprocal stakeholders' level of contribution to what is necessary to secure personal payoffs. In fact, the negative impact on reciprocal stakeholders' contribution to value creation is likely to be even larger. If firms adopt the hard bargaining that is central to an arms-length approach, the strong reciprocators among a firm's stakeholders may actively destroy value. Behavioral economists have found that strong reciprocators are willing to sacrifice significant amounts of resources (money, time, effort) to punish perceived unfairness (Fehr and Gächter, 2002). This is consistent with findings from justice research that when treated unfairly a small fraction of employees react by engaging in counterproductive work behaviors such as not cooperating, stealing, and damaging firm property (Greenberg, 1990, 1993; Harder, 1992; Skarlicki and Folger, 1997).
In contrast to reciprocators, self-regarding stakeholders are motivated to create value from a purely self-serving concern. These stakeholders are driven primarily by their personal monetary benefits and costs. The motivations of self-regarding stakeholders are consistent with the assumptions that traditional economic approaches such as agency theory and transaction cost economics make about human behavior. Self-regarding stakeholders do not value fairness per se, and a fair treatment therefore will not motivate them to contribute to value creation beyond what is rewarded by the firm. Self-regarding stakeholders will create more value when a firm applies an arms-length approach to stakeholder management, as, by definition, an arms-length approach uses strong economic incentives to tie stakeholders' contributions closely to stakeholders' personal payoffs (Bebchuk and Fried, 2004).
Note that a fair treatment could, in principle, also make stakeholders' personal payoffs conditional on their contribution. Deutsch (1975) identified three fairness principles: equity, equality, and need. Of these three, the equity principle (i.e. allocating proportionally to one's merits) prescribes relating stakeholders' payoffs (e.g., pay, prices, or profits) to their inputs (e.g., effort, time, cognitive resources, or money). However, in practice maintaining feelings of equity is not compatible with monetary incentives that very tightly align stakeholders' contribution and personal payoffs, as an arms-length approach does. The equity principle calls for appraising fairness by examining the ratio of one's inputs and outcomes and comparing this ratio to the input-to-outcome ratio of referent others (Adams, 1965). This social comparison with others' payoffs has repeatedly been shown to lead to payoff compression in order to preserve feelings of fairness (Akerlof and Yellen, 1990; Frank, 1984; Güth et al., 2001). The explanation that has been offered for this phenomenon is that fairness appraisals are based on subjective evaluations of one's own and others' inputs and outcomes, rather than the objective inputs and outputs (Adams, 1965) and that people typically overestimate their own inputs compared to those of others (Meyer, 1975; Ross and Sicoly, 1979).
Together, these arguments lead us to formulate the following propositions about the effect of the two approaches to stakeholder management on the contribution to value creation of reciprocal and self-regarding stakeholders:
Proposition 1: A reciprocal stakeholder contributes more to value creation if the firm adopts a fairness approach toward this stakeholder than if it adopts an arms-length approach.
Proposition 2: A self-regarding stakeholder contributes more to value creation if the firm adopts an arms-length approach toward this stakeholder than if it adopts a fairness approach.
We have so far considered how a firm's treatment of a specific stakeholder affects the motivation to contribute to value creation of that particular stakeholder. But the motivation of a focal stakeholder to contribute to value creation may also be affected by the way in which the firm treats other stakeholders. In particular, reciprocators are not self-centered when appraising the firm's fairness and reciprocating its behaviors. They positively value the firm's fairness toward third parties they care about (e.g., Goldstein, Griskevicius, and Cialdini, 2011). In consequence, reciprocators' fairness appraisals and motivation to contribute to value creation will be influenced by how these third parties are treated, even when this treatment has no direct impact on their personal payoffs (Engelmann and Strobel, 2004).
There is a lot of evidence that some stakeholders show concern not only for how they are treated themselves (e.g., customers asking higher product quality) but also for how other stakeholders are treated (e.g., customers boycotting products of firms using child labor). For instance, customers who deem a layoff procedure unfair are less likely to buy the firm's products (Skarlicki, Ellard, and Kelln, 1998). Some stakeholders' reactions to the unfair treatment of others can even lead to value destruction: strong reciprocators have been found to punish at a cost to themselves those who behave unfairly toward a third person they care about (Fehr and Fischbacher, 2004a, 2004b; Fehr, Fischbacher, and Gächter, 2002; Fehr and Gächter, 2002).
In other words, treating a reciprocal stakeholder fairly is not enough to motivate fully this stakeholder to contribute to value creation because the perception that the firm treats some other stakeholders in an arms-length way will have a negative impact on a reciprocal stakeholder's motivation. This leads us to propose:
Proposition 3: A reciprocal stakeholder contributes more to value creation if this stakeholder perceives the firm as adopting a fairness approach toward all its stakeholders, rather than adopting a fairness approach toward some stakeholders and an arms-length approach toward others.
In contrast to reciprocators, self-regarding stakeholders do not value fairness per se and so do not care about how other stakeholders are treated as such. How others are treated will only affect their behavior if it influences their expectations of how their own contribution will be rewarded. In other words, self-regarding stakeholders' contribution to value creation will not depend directly on whether the firm treats other stakeholders fairly or in an arms-length way.
The sorting effect of the two stakeholder management approaches
Considering how the firm's stakeholder management approach affects the motivation of the stakeholders currently associated with the firm is not enough to grasp fully the impact of stakeholder management on value creation. It is also necessary to adopt a dynamic view of stakeholder relationships that takes into account the sorting effect of the firm's stakeholder management approach.
A first sorting mechanism is stakeholders' self-selection: in the longer run stakeholders can join or leave a nexus of relationships (cf. Freeman, Wicks, and Parmar, 2004; Freeman et al., 2010; Venkataraman, 2002). Prospective stakeholders who expect a satisfactory treatment from a firm may join it, while current stakeholders dissatisfied with their treatment can exit: customers can take their business elsewhere, employees can quit their job, and shareholders can sell their stocks (Hill and Jones, 1992). Venkataraman (1997, 2002) has argued that an important function of the entrepreneurial process is to give stakeholders a choice of which nexus of relationships to associate with. In the short to medium term, entrepreneurship acts as a weak equilibrating force by creating alternatives for individual stakeholders who are not satisfied with their current nexus (Venkataraman, 1997, 2002). And if, in the longer term, the redeployment of individual stakeholders does not work freely and efficiently and serious stakeholder dissatisfaction accumulates within firms and societies, entrepreneurship will act as a strong equilibrating force by bringing about a fundamental qualitative change in relative stakeholder power through the introduction of innovative products, methods, and forms (Venkataraman, 2002).
Stakeholders' motivational type influences the extent to which they are attracted to a firm with a fair or an arms-length approach to stakeholders and, thus, the extent to which they want to enter, maintain, or end a relationship with the firm. In that sense, stakeholder management can be a source of differentiation in the competition among firms for stakeholders. In particular, stakeholders driven by reciprocity will tend to end their relationship or avoid entering into a relationship with firms that consistently favor an arms-length approach to stakeholder management, or with firms that are not consistent over time and repeatedly switch between a fair and an arms-length approach. For example, Evans and Davis (2011) found that job applicants who were higher in other-regarding value orientation were less inclined to join a firm that scored poorly on corporate social responsibility than individuals who were more self-regarding. Thus:
Proposition 4: A reciprocal stakeholder is more likely to join and stay with a firm that adopts a fairness approach than with a firm that adopts an arms-length approach or a firm that switches from one approach to another over time.
Self-regarding stakeholders will similarly self-select and will tend to choose the firm with the stakeholder approach that brings them the highest personal payoffs. We can expect self-regarding stakeholders with high bargaining power to be attracted to firms that stick to an arms-length approach to stakeholder management because such firms allow them to use their bargaining power to secure higher personal payoffs than would be the case if value were divided on the basis of fairness criteria. This argument finds supports in the literature on the sorting effects of compensation schemes as a function of employees' ability, which is one source of employees' bargaining power. This literature shows that, compared to less able self-regarding employees, more able ones are much more likely to select compensation schemes that tightly link personal payoffs to individual performance because their higher ability enables them to earn high personal payoffs with such schemes (e.g., Cadsby, Song, and Tapon, 2007; Lazear, 2000). This leads us to propose:
Proposition 5: A self-regarding stakeholder with high bargaining power is more likely to join and stay with a firm that adopts an arms-length approach than with a firm that adopts a fairness approach or a firm that switches from one approach to another over time.
For self-regarding stakeholders with low bargaining power, the self-selection effect is more complex. As argued above, these stakeholders are more motivated to create value in a firm with an arms-length approach than with a fairness approach. In fact, heterogeneity in bargaining power does not matter for the motivational effect summarized in Propositions 1–3: all self-regarding individuals, regardless of their level of bargaining power, create more value under strong performance-based individual incentives than under weak ones (Cadsby et al., 2007). However, when given a choice about which firm to join, self-regarding stakeholders with low bargaining power may prefer a firm that treats its stakeholders fairly because their low bargaining power means low payoffs in a firm with an arms-length approach. In other words, for self-regarding stakeholders with low bargaining power, the motivational and self-selection effects of the two stakeholder management approaches may diverge. Weighing their personal costs and benefits, they may prefer to join a firm with a fairness approach.
This brings us to the second sorting mechanism: the selection of stakeholders by firms. Whatever their preferences may be, self-regarding stakeholders with low bargaining power may have to settle for firms with an arms-length treatment of stakeholders. Firms that adopt a fairness approach will want to avoid entering or maintaining relationships with self-regarding stakeholders in order to maintain feelings of fairness among their reciprocal stakeholders. They must have mechanisms in place to select in stakeholders who have a reputation for fair behaviors and to avoid or dismiss stakeholders who exhibit self-regarding behaviors (Jones, 1995). While reciprocators might perceive a firm without such selection mechanisms as kind, their sense of fairness also requires that those who free ride on others' contributions are sanctioned. In fact, research has shown that the exclusion of individuals who do not contribute much to the collective good is one of the solutions to maintain high contributions over time (Kollock, 1998).
Combining the arguments for the selection and self-selection of stakeholders, we expect the following for self-regarding stakeholders with low bargaining power:
Proposition 6: A self-regarding stakeholder with low bargaining power is more likely to join and stay with a firm that adopts an arms-length approach or a firm that switches from one approach to another over time than with a firm that adopts a fairness approach.
In line with these arguments, Southwest's employees are screened on the basis of attitude, following the philosophy that ‘you hire for attitude and train for skills’ (Box and Buys, 2009). Southwest's selection procedures are time-consuming and aimed at identifying prospective employees who are ready to cooperate with others to get the work done and who are ready to go above and beyond the call of duty (Gittell, 2005). In addition, managers watch newcomers carefully to correct potential hiring mistakes: new hires who do not adopt Southwest's teamwork approach are fired or counseled out (Gittell, 2005). As former Southwest's CEO, Herb Kelleher, said ‘There is a lot of altruism, an ‘everybody-pitches-in’ attitude, a sense that life should be enjoyed. There's a lot of tolerance, but one area where there's no compromise is values. An employee who compromises on those is out’ (Sisodia et al., 2007: 213). Propositions 5 and 6 highlight that, in contrast to firms like Southwest, a firm applying an arms-length approach does not need costly tools to select stakeholders according to their social value orientation. It will automatically tend to attract self-regarding stakeholders: self-regarding stakeholders whose large potential contribution to value creation gives them high bargaining power and self-regarding stakeholders with low bargaining power who do not have the option to join a firm with a fairness approach.
Propositions 4–6 imply that firms applying one of the two stakeholder management approaches consistently over time are likely to end up with a set of stakeholders that is relatively homogeneous in terms of motivational type. This homogeneity will positively affect value creation at the individual and firm level. At the individual level, the more reciprocal (self-regarding) stakeholders a firm applying a fairness (arms-length) approach has, the higher the average individual contribution to value creation on the basis of the motivational effects described in Propositions 1–3. Higher individual contributions from stakeholders should, most of the time, also lead to higher value creation at the firm level, as individual contributions from stakeholders belonging to the same group are usually additive or superadditive (e.g., economies of scale coming from more customers' purchases) and individual contributions from stakeholders belonging to different groups are likely to be complementary.
In contrast, firms that regularly switch between the two approaches will be attractive neither to reciprocators, who will fear a switch from a fair to an arms-length treatment, nor to self-regarding stakeholders with high bargaining power, who will fear a switch from an arms-length to a fair treatment that would lower their personal payoffs. For value creation at the firm level, this leads us to propose that:
Proposition 7: Compared to an arms-length or an inconsistent approach, a consistent fair treatment of stakeholders over time increases the proportion of reciprocal stakeholders among the firm's stakeholders, which, in turn, has a positive effect on value creation.
Proposition 8: Compared to a fairness or an inconsistent approach, a consistent arms-length treatment of stakeholders over time increases the proportion of self-regarding stakeholders among the firm's stakeholders, which, in turn, has a positive effect on value creation.
Environmental change, consistency, and sustaining value creation
Sustaining value creation not only requires motivating and sorting stakeholders, but also seizing opportunities and deflecting threats in the firm's competitive environment. It has been argued in the stakeholder management literature that a fair treatment of stakeholders provides a better basis for responding to external changes, turbulences, and crises than arms-length relationships (e.g., Harrison et al., 2010; Russo and Fouts, 1997). This argument is consistent with the sorting and motivational effects of stakeholder management on reciprocal stakeholders. A firm with a consistent fair treatment of stakeholders will have a high proportion of reciprocators among its stakeholders, whom it can expect to reciprocate its investments in fair relationships when help is needed to address external changes. Reciprocal stakeholders can help the firm to seize opportunities by investing more in value creation (e.g. employees working overtime) or to recover from a crisis by serving as advocates for the firm and by providing crisis-mitigating resources, even if the crisis affects them negatively (Ulmer, 2001). In contrast, a firm with a consistent arms-length treatment of stakeholders should not count on its stakeholders' support to deflect threats or seize opportunities: self-regarding stakeholders, as well reciprocators in an arms-length relationship with the firm, are likely to decrease their contribution and leave the nexus when the firm faces an external change that negatively affects their personal outcomes. On this basis, we propose:
Proposition 9: In the face of external changes, reciprocal stakeholders of a firm that adopts a fairness approach will increase their contribution to value creation more, or decrease their contribution less, than self-regarding stakeholders and reciprocal stakeholders of a firm that adopts an arms-length approach.
What the literature has not yet acknowledged is that successfully adapting to external changes may be at odds with maintaining a fair treatment of stakeholders. While a firm that has invested in fair relationships with stakeholders can benefit from reciprocal stakeholders' goodwill when faced with unexpected events, the need for a consistent fairness approach also constrains the firm's capacity to take actions to respond to external changes. In particular, maintaining fair relationships is likely to be incompatible with strategic actions such as lowering employees' compensation when unemployment is high, switching suppliers to get access to the latest technologies, or outsourcing activities to partners in low-cost countries. Reciprocators have been shown to consider such actions as unfair and to sanction the firm for these actions by decreasing their contribution to value creation (Charness and Levine, 2000; Kahneman, Knetsch, and Thaler, 1986). Moreover, they are likely to experience much more intense feelings of betrayal and anger if these actions come from a firm historically known for its fair treatment of stakeholders than if they are in an arms-length relationship (Morrison and Robinson, 1997). These arguments lead to the following proposition:
Proposition 10: Faced with firm actions that they perceive as a breach of fairness, reciprocal stakeholders of a firm that adopts a fairness approach will increase their contribution to value creation less, or decrease their contribution more, than self-regarding stakeholders and reciprocal stakeholders of a firm that adopts an arms-length approach.
Proposition 10 implies that a firm that has consistently treated stakeholders fairly has a more limited repertoire of actions it can take to respond to environmental changes than a firm that has adopted an arms-length approach. If environmental events call for actions that may be perceived as unfair by reciprocators, the firm's response to these external events is likely to unleash negative reactions from reciprocators. These negative reactions will hurt value creation more than the negative reactions of self-regarding stakeholders, who will simply modify their behavior so as to protect their personal payoffs, or the negative reactions of reciprocators in an arms-length relationship with a firm, because these stakeholders were already expecting an unfair treatment. This leads us to propose the following for value creation at the firm level:
Proposition 11: In the face of external changes, a consistent fair treatment of stakeholders will lead to more value creation than an arms-length approach as long as responding to these changes does not require actions that would be perceived as a breach of fairness by reciprocal stakeholders.
Proposition 12: In the face of external changes, an arms-length treatment of stakeholders will lead to more value creation than a fairness approach when responding to these changes requires actions that are perceived as a breach of fairness by reciprocal stakeholders.