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Shareholder Wealth Maximization In A Sustainable Development Accounting Essay

A company belongs to shareholders and its objective is maximization shareholder wealth. According to Arnold (2008), it can be defined as the process of maximizing the purchasing power of the firm’s owners. Shareholders should receive the maximized flow of dividends through time, which is the long term and superior goal of companies. The provision of positive dividend flow in the future in turns affects the share price. Maximization of shareholder wealth is different from maximization of profit which just focuses on the income or interests in the short run.

There are many definitions of stakeholders. One of them is that stakeholders are the entities who are related to the business of a firm, or they can be a number of interested parties including shareholders, employees, managers, creditors, customers and society (Arnold 2008). Donaldson and Preston (1995, quoted in Omran, Atrill and Pointon, 2002, p.318) state that the interests of these groups should be concerned in their own and among them, there’s no dominance. It stands on the opposite site to the point of shareholder theory view.

Hence, the question raised to all executives is that whether they should only focus on maximization shareholder wealth and ignore the concerns of other stakeholders’ benefits. Or they should take it as a priority with considerations of interests of other parties. Or they should set the main target as maximization all stakeholders’ interests.

To reach an answer, from my point of view, the following discussion includes 4 parts:

Consideration of shareholder wealth maximization in a sustainable development.

Looking into some aspects in the performances of the 2 theories.

Evaluation the 2 strategies in crisis contexts.

Examining some firms in practical.

The aim of this report is to discuss whether to maximize shareholder wealth should be the prior target of a company.

Shareholder wealth maximization in a sustainable development

It is unreasonable for companies to apply the shareholder theory when focusing on short-term profit. Managers and owners should act based on the mindset of sustainable growth. As Smith (2003) suggests, shareholder orientation does not imply the company should maximize shareholder value in any way including illegal means. The theory will absolutely fail when managers are encouraged to violate the law in order to pursue temporary benefit and try to hide evidences as long as no one is put into jail. One of the obvious examples of unsuccessful applying the shareholder theory is the financial fraud of Enron. It tries to manipulate accounting data and hides debt in efforts to keep stock price increasing. As a certain result of ignoring long-term value, it ends with bankruptcy.

One of possible solutions for firms achieving the ultimate sustainable goal is “enlightened value maximization”. Jensen (2002) argues that when ignoring or mistreating any important stakeholders, organizations will not maximize long term firm value. Its strategy, purpose and implementation plan should base on the idea of “enlightened value maximization”. Benson and Davidson’s (2010) findings are also consistent with this point of view rather than shareholder oriented theory. Data in their research from 1991 to 2002 is about S&P 500, Domini 400 Social, and Russell 1000 (starting in 2001) companies and taken from KLD Statistical Tool for the Analysis of Trends in Social and Environmental Performance (STATS) database. The data has been done with many robustness tests shows 2 main things:

Maintaining a better stakeholder management will reward firms with higher value.

“If firm value is not a significant predictor of compensation after controlling for endogeneity, then perhaps managers are being directed to pursue value maximization through their relationships with stakeholders, Jensen’s (2001, 2002) enlightened value maximization.” (Benson and Davidson, 2010, p.930).

Moreover, in Danielson, Heck, and Shaffer (2008) opinions, many proponents of the shareholder model get in wrong in the way that they support to crease current stock price. The process of maintaining the share price may ruin the company value in the long run (Jensen (2005) and Danielson and Press (2006), quoted in Danielson, Heck, and Shaffer (2008), p.63). The wrong implementations may include delaying even positive NPV investments, reducing the cost of advertising, R&D or quality management, manipulating accounting data and applying fraud practices. Therefore, it is suggested that executives of the shareholder theory should make decisions based on the long-term view to balance interests of various stakeholders.

Performance of the shareholder and stakeholder theories

In the second part of the essay, we take into account some conclusions about the performance of the 2 theories. Concentration on shareholder theory does not help firms outstanding compared to the ones with stakeholder oriented. Omran, Atrill and Pointon (2002) do many ANOVA and Kruskall-Wallis tests with multiple regressions and conclude that:

Financial outcomes of operations in a company are not affected by mission orientation.

Investor returns between shareholder and stakeholder oriented model are not extremely different.

Therefore, pursuing shareholder focused mode does not result in any superior paying back.

Another analysis of the 3 authors Moneva, Rivera-Lirio & Munoz-Tbrres (2007, quoted from Agle, Donaldson, Freeman, Jensen, Mitchell, and Wood, 2008, p. 156) also comes to similar conclusion that more stakeholder concentrated strategy does not lead to any inferior financial performance compared to the shareholder one.

Shareholder vs stakeholder strategy in crisis management

In addition, stakeholder management seems to be a more rational choice than the shareholder one in critical situations. In the study of Alpaslan, Green and Mitroff (2009), the companies adopting stakeholder management cope better with crisis and disaster-like contexts. The investment in preparation for crisis circumstances is not considered as shareholder wealth maximization. However, it brings out the belief of fair and cooperative managers, which creates more chances for them to approach critical information and resources from stakeholders. As a result, the managing board will have synergy to detect risks early, to recover quickly and to overcome crisis more easily.

Alpaslan, Green and Mitroff (2009) also demonstrate this by the story of the recall of Tylenol products at Johnson & Johnson’s in 1982. This is the highlight of successful crisis solving when caring customers’ safety. Although knowing that recall would burden the firm with cost and the share price would drop dramatically, managers of Johnson & Johnson’s still accepted the lost and were responsible and co-orperative. Ultimately, the good actions and attitude of the executive board led to a fast recovery in the company’s market share and stock price in a short time after that (Marcus and Goodman, 1991 quoted in Alpaslan, Green and Mitroff, 2009, p.46). On the contrary, executives of Firestone knew about their products’ issues for a long time (Power & Simison, 2000, quoted in Alpaslan, Green and Mitroff, 2009, p.46), but they did not recall or be responsible to customers and the government. After being forced to recall (Eisenberg & Zagorin, 2000; Welch, 2001 quoted in Alpaslan, Green and Mitroff, 2009, p.46), the company lost its reputation and could not do anything to prevent the significant and long lasting down of the share price as well as the shareholder value of its mother company, Bridgestone.

Practical evidences

In this section, many practical examples will be examined to see the performance of companies with the long run perspective of business operations in the real world. From the annual reports of Mark and Spencer (2010) we can see that the firm is aware of the balance between taking risks for creating value for shareholders with concerning the interests of stakeholders. It gets the trust from interested parties via the aim to develop a long term and consistent growth. Moreover, many famous and successful organizations in the Fortune 500 state their strategy of sustainable development such as:

The Body Shop gets more friendly with environment, does not do experiments on animals and commits community trade. (Carrillo, 2007).

Ford and General Motors concerns about environment protection with procurement guidelines. Their suppliers should follow criteria of the ISO 14001 EMS (Carrillo, 2007).

Novartis won the Committee to encourage Corporate Philanthropy (CECP)’s pride of the 2004 Excellence in Corporate Philanthropy (Carrillo, 2007)

Efforts in social activities brought Bill & Melinda Gates Foundation the 2006 Principe de Asturias Price (Carrillo, 2007)

Their great achievements in social supporting and environment protection bring them closer to customers, society and governments. This in turns promotes their earnings and the health of shareholder value a lot.

Another big case of successful stakeholder oriented companies is Shell. From the Shell International (1998, quoted in Shell, 2004, p.717), it is stated that integrating stakeholder concerns and interests into the decision-making process, and the balance of the privilege in the short run with the requirements in the long run will lead to better decisions at Shell. First of all, in order to be more transparent to the public, employees and shareholders, Shell Reports provides information about the company’s financial performance as well as its social and environmental activities. After that, it builds up the Sustainable Development Management Framework (SDMF) to incorporate the stakeholder management into its daily business operations and practises. Finally, the Key Performance Indicators (KPIs) not only provide data to external stakeholders but also significantly help executives to set goals, evaluate its performance and improve the businesses. Even in some past years of poor performance, struggling with many financial difficulties, Shell still pursued a balanced and long term business fundamental. It is now a bright illustration of a repetitive and continuous integration stakeholder management into business operations.

In conclusion, I totally do not agree with short-term business operations focusing to maximize shareholder value or purely oriented shareholder theory. I will not criticise or in other words, for me, it is accepted in case that executives try their efforts towards the “enlightened” shareholder wealth maximization. In the future, as a manager in the board, I would follow the balance of shareholder value maximization with stakeholder interests. I would integrate stakeholder concerns into the business development in the long run. It is because conclusions from many studies show that the pure shareholder theory does not provide any outstanding financial returns compared to the stakeholder one. Shareholder focused strategy even performs worse in crisis reactions. However, according to Jensen (2002), one of the weaknesses of the stakeholder theory is that it does not provide any details in actions as the guideline for companies to reach the final goal. Moreover, it breaks the rule that firms should have a prior rational single-valued purpose to target. In the meanwhile, the shareholder theory applied in the long term view is still the best model to equilibrate benefits of current and future stakeholder groups (Danielson, Heck, and Shaffer, 2008). Therefore, beside the main task of maximize shareholder wealth, organizations should pursue sustainable growth by caring to customers, well treating to employers, being responsible to society and environment and being cooperative with governments. It is because building the relationships with the key interested parties will bring firms worthy intangible assets considered as a competitive advantage. Additionally, the maintenance of stakeholder interests eventually increases shareholder value (Hillman and Keim, 2001).


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