The Shareholder And Stakeholder Theory Management Essay

“Governance helps us do the right thing, the right way – for our shareholders and our customers, employees, suppliers, local communities and the environment. Our governance is focused on how to get it right, not only in the board room but also across the business…” (Page 46)

Statement 2

“Our aim is to build a sustainable business through consistent, profitable growth and to make sure that our customers and wider stakeholders can always trust us to do the right thing. We aximizat that creating shareholder value is the reward for taking acceptable risks.” (page 54)

Required

From a finance perspective the main objective of a firm is to aximiza shareholder wealth. However from the two statements above it appears that in reality companies don’t just focus on shareholders.

To what extent do you agree that shareholder wealth aximization should be a superior objective over stakeholder interest? Discuss your answer with relevant supporting literature. You may also back up your discussion with relevant real life examples from any where in the world.

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(40 marks)

Answer:

The issue whether managers should apply shareholder theory or stakeholder theory is opens for debate. Some theorists believe that maximize shareholder profit is the highest objective of firm. However, there are many articles and academic journals assert that stakeholder theory is the modern management methods. Personally, each position has its own reasons. In the following assignment, I would like to analyze these options and present my view about two theories.

Before we argue about two theories, it is helpful to get some definitions of shareholder, stakeholder and to consider what theories say about.

The “Businessdictionary.com” defines shareholder as “Individual, group, or organization that holds one or more shares in a firm, and in whose name the share certificate is issued. It is legal for a firm to have only one shareholder. Also it called stockholder”. Also follow this website, stakeholder is “a person, group, or organization that has direct or indirect stake in an organization because it can affect or be affected by the organization’s actions, objectives, and policies. Key stakeholders in a business organization include creditors, customers, directors, employees, government (and its agencies), owners (shareholders), suppliers, unions, and the community from which the business draws its resources”.

Mentioned about the Shareholder Theory, Milton Friedman who got the Nobel winning economist asserts that managers should only focus to maximize the firm’s shareholders value. He stated, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it … engages in open and free competition, without deception or fraud”(Friedman, 1962). Nearly, according to H. Jeff Smith (2003), shareholder theory indicates that shareholder advances capital to a company’s managers, who are supposed to spend corporate funds only in ways that have been authorized by the shareholders.

According to the Stakeholder Theory, the focus of theory is connecting in two core questions (Freeman, 1994). First, it mentioned about the purpose of the firm, the vital purpose of the company is to serve and coordinate the interests of not only shareholders but also its various stakeholders. Second, stakeholder theory asks, what responsibility does management have to stakeholder? The managers are represented of all stakeholders and have two responsibilities: to protect the ethical rights of stakeholders and to consider the legitimate interests of the stakeholders as they make decisions. They have to balance between the maximization of profit and the long-term ability of the corporation growth.

The fundamental difference is that the stakeholder theory requires that the stakeholders interests be balanced even it reduces firm profitability.

There are always many arguments around two theories about social responsibility, and one of the most important causes is that both of theories are misunderstood in several ways. From the shareholder theory, some people hold the opinion that managers try to “do anything you can to make a profit”, even though the shareholder theory compels managers to increase profit only through legal, non-decretive means (Friedman, “Capitalism and Freedom”). Also, the shareholder theory is criticized because of gearing toward to maximize the short-term profit at the expense of the long operate. However, the shareholder theorists often refer to the corporation’s management look at the shareholders’ interest to take a long-term orientation. Besides that, they also claimed that the shareholder theory prevent using corporate funds to donate some project or invest in improved employee environment. In fact, the shareholder theory supports the employee efforts such as those initiatives because it increases indirectly the shareholders’ wealth.

Similarly, the first misunderstanding of stakeholder theory is that it is claimed the theory does not demand that a firm focus on profitability. However, the highest objective of stakeholder theory is balancing the interests of all stakeholders, including shareholders, whose interests are usually addressed by profit. Second, there are many stakeholder theory description provide no formula for examine the stakeholders’ interests; some of the theories provide no guidance in this regard.

Agree with stakeholder theory, in 2003, Waxenberger and Spence illustrated that stakeholder theory has become an important tool help to translate the business ethics to management practice and strategy. Similarly, there is an increasing interrelation between the corporate responsibility and business ethics (Valor, 2005; Garriga and Melé, 2004). The stakeholder theory has become the “grille de lecture” as analyzing the company’s responsibility (Attarca & Jacquot, 2005). In 1976, Michael Jensen and William Meckling explored the “principal-agent” definition, disputing that managers often fail to maximize profits if shareholders did not invest their time and money to create appropriate encouragement.

By contrast, Colin Grant indicates that managers should “concentrate obsessively on profitability, and that the ethics should be marginalized” (1991). In 2003, McAleer also assert that firm’s responsibility is only to maximize for shareholders’ wealth. Silver (2005) seek and offer “the promotion and protection of autonomy” like an improvement in Friedman framework because Silver said that a manager with his moral obligations would be a bureaucratic machine that automatically decides to make as much money as it can without lying or breaking the law. Sundaram and Inkpen on “The corporate objective Revisited” (2004) said “Governing the corporation requires purposeful activity. All purposeful activity, in turn, requires goals” and in the modern company, “maximizing shareholders value” is the only appropriate goal for managers.

The stakeholder theorists have strong interpretations when they mention about shareholders’ responsibility in some scandals at Enron, ImClone, Global Crossing, Tyco International and WorldCom. It concerns about the business ethics between the independence of accountants who take responsibility for auditing financial statements, and the investor recommendation at Credit Suisse First Boston and Merrill Lynch. Besides the social responsibility, they often argue about the “maximizing shareholder profit” that is not the long term purpose of corporation. For instant, the fall horse of Stan O’Neal, the ex-CEO of Merrill Lynch, often mentions like an expensive lesson in business management. His autocratic management had brought the impressive profits to Merrill Lynch from 2003 to 2007. He optimized profit through minimize the cost by dismissing the employees and closing many inefficient branches. His altitude and autocratic management make the dissatisfaction of employees and cause for the later failure.

These scandals not only reveal serious weakness of shareholder theory but also stakeholder theory about the social responsibilities of business because of lacking prohibitions against fraud and deception. According to Thomas L. Carson (2003), there are four important points. Firstly, recent scandals highlight the stakeholder theory is very naïve and unrealistic hopes and expectations for managers. Secondly, recent events do not constitute an objection to the shareholder theory about the firm’s social responsibilities. Nevertheless, these scandals make evident the implausibility of strong versions of the invisible hand theory. Next, schemes of payment and reward often create perverse incentives for individual to engage in unethical conduct. Finally, both two theories need to add a constraint that prohibits managers from pressuring, enticing, or permitting professionals.

In my opinion, I agree with shareholder theory. Firstly, there are some misunderstood that I interpretation above, the managers do not “do everything to maximize profit”. Comeback to some main business objectives that are achieving a target market share, keeping employee agitation to a minimum, survival, creating an ever-expanding empire, maximization of profit and maximization of long-term shareholder wealth (Glend Arnord, “Corporate financial management”, fourth edition). Connecting with shareholder theory, the highest objective of firm should not understand “maximization of profit”, we need to approach with the widen definition – the maximization of the shareholder wealth. This definition reflects three key variables directly affect shareholders’ wealth: timing of cash flows, magnitude of cash flows and the risk of the cash flows that investors expect a firm to generate overtime.

Secondly, the shareholder who gives capital or equity for invests or remains the development of corporation. They also obtain many operating risks and financial risks, and if the company is bankrupted, shareholder would be the last person get the return. Therefore, the main firm’s objective must be maximization of shareholders’ value in order to compensate for their risks. The next reason is optimization the stockholders’ value is the same meaning that the corporation has to optimize the productive process, supply chain, delivery and personnel. These actions help corporate structure become effectively and orderly. It differ from “do anything you can to make a profit”, and in some situations, managers should balance the shareholder wealth maximization with stakeholder interest. A firm cannot maximize value, Jensen (2000) writes, if it ignores the interests of its stakeholders.

According to Michael Poster – father of competitive theory, the fundamental firm’s objective is getting the higher ROIC – Return On Invested Capital; rest of all is the secondary objective. In conclusion, shareholder wealth maximization is a superior objective over stake holder interests. However, in order to keeping the long-term stable growth, the managers not only focus to maximize the shareholders’ value, but also balance with stakeholders’ interests.