Reforming Capitalism

Abstract

This article offers a formal model of the stakeholder corporation. It starts with the observation that when firms' choices of investment influence the probability distributions of their output, profit maximization and competitive behaviour do not lead to Pareto optimality. This is because firms systematically exert externalities on consumers and employees. We adopt a Coasian approach to this problem, and suggest that "responsible" firms should issue, together with equity shares, tradable property rights for employees and consumers. If managers are instructed to maximize the total value of the firms (i.e. shareholder value plus consumer value and employee value), Pareto optimality of competitive equilibrium is restored when agents are identical. In the more likely case where agents are heterogeneous, reforming capitalism by giving some weight to consumer and employee surpluses always increases social welfare.