There is currently much discussion of stakeholder capitalism, the proposition that firms should be run in the interests of all their stakeholders, including workers, various types of securityholders, and perhaps customers, and not just shareholders.

My theme is that contract structures—the contracts negotiated among a firm’s stakeholders—address stakeholder interests.

Contracts play a vital role in directing economic activity, but contracts can be costly to write and enforce, and the broader the set of stakeholders included in the contracting process, the more difficult it is for firms to operate efficiently. If all relevant stakeholders have the right to influence a firm’s decisions regarding production and the distribution of profits, agreement about how these activities are to be carried out is unlikely to be achieved at reasonable cost.

A solution in this context is to structure relatively simple contracts whereby almost all stakeholders receive “fixed payoffs” or payment amounts. In return, the firm’s shareholders get to make most of the decisions and enjoy (or suffer) the financial gains (or losses) resulting from the firm’s behaviour. For most firms, the efficient contracting structure involves fixed promised payoffs for most stakeholders, with financial risks largely borne by the shareholders who have most decision rights.