“[W]hile it remains incomplete in its current form, stakeholder theory is undeniably instrumental in steering the path for businesses in their goal for value creation, be it for shareholder or societal good.”
A reflection paper by Tan Chun Hsien Shawn, as partial fulfillment of a BBA (Honours) module, “Measuring Success in Philanthropy and Impact Investing”.
For decades, the maximisation of shareholder wealth has been the dominant objective of capitalists and corporations (Lazonick & O’Sullivan, 2000). This objective has been an inextricable component of our laws in modern society, the management practices that govern businesses, and even forms the basis of rational economic theory (Saint & Tripathi, 2006). More recently, this view has been challenged with the growing popularity of stakeholder theory. This paper thus seeks to introduce and identify the conflict between the two concepts, to explain how stakeholder theory has been crucial in causing the gradual transition away from shareholder value theory toward a new equilibrium.
Shareholder Value Theory
Shareholder value theory proposes that the primary duty of management is to maximise shareholder returns (Smith, 2003). The roots of this view can be traced back to Adam Smith and the central tenets within his book The Wealth of Nations (Pfarrer, 2010). The theory was framed in its current form by Milton Friedman, who argued that the only social responsibility of businesses was to increase its profits (Stout, 2012). This thought was further reinforced by a paper by Michael Jensen and William Meckling, who described the firm as a legal fiction in which shareholders were principals and managers were their agents (Jensen & Meckling, 1976), and managers who pursued goals other than maximising the wealth of shareholders were reducing social good by imposing agency costs. Such academic backing led shareholder primacy to achieve dominance by the end of the millennium.
However, in the wake of global scandals and crises, the premises of the shareholder-oriented perspective have been increasingly questioned (Smith, 2003). In particular, Enron, exemplary in its corporate governance for maximising shareholder value by fixating on its stock price, inadvertently collapsed due to bad business decisions and accounting fraud (Stout, 2012). A recent article by Forbes also documents the denouncement of shareholder value maximisation by a number of prominent CEOs and top management (Denning, 2015), citing problems such as a focus on short-term returns, a diversion of resources away from innovation, and causing economic stagnation and inequality. It is against the backdrop of the gradually receding prominence of shareholder value theory that stakeholder theory can be discussed.
In comparison with shareholder value theory, stakeholder theory has a far shorter history. The term stakeholder was first used within an internal memorandum at Stanford Research Institute in 1963. While it received initial flak by Igor Ansoff, who viewed stakeholders as a secondary constraint on the main objective of the firm, the stakeholder concept surfaced in the 1970s in several instances of strategic planning literature (Freeman, Harrison, Wicks, Parmar, & Colle, 2010), with the popularisation of the concept ascribed to Richard Edward Freeman in 1984. Since then, the theory has risen in prominence since 1995 (Laplume, Sonpar, & Litz, 2008), and currently represents a shift in perspective within the on-going debate on corporate purpose.
The stakeholder of an organisation can be defined as a group or individual who can affect or is affected by the achievement of organisational objectives (Freeman, 1984). As such, stakeholder theory suggests that the purpose of the corporation should take into consideration all who have an interest in an organisation’s activity (Greenwood, 2008), including shareholders, customers, employees, and the general public (Fontaine, Haarman, & Schmid, 2006). Thus, the objective of management should be to balance the competing interests of these stakeholders (Sternberg, 1996). As such, the theory is seen as a holistic approach to corporate purpose and provides strategic depth to the management of interests through three different approaches: descriptive (explaining corporate behaviour), instrumental (finding links between stakeholder strategies and performance), and normative (interpreting organisational function from a moral standpoint) (Donaldson & Preston, 1995). These theoretical approaches frame the issue on stakeholder interests for further analysis.
While once dominant, shareholder value theory is now contested by the premises of the stakeholder approach. It is in this light that both can now be compared, assessing the factors for change.
Many arguments have been put forth by proponents of stakeholder theory, countering implications of shareholder value theory. One competitive analysis revealed that companies focusing on stakeholders outperformed others even during times when the focus was on shareholder wealth (Pfeffer, 2009), suggesting practical effectiveness of the theory. Furthermore, as the range of performance measurement tools increases, there is reduced need to rely solely on financial measures as well.
In assessing the arguments for shareholder theory, Lynn Stout pointed out in her book that despite the pervasive extent of shareholder value ideology, it remains a managerial choice, rather than a legal obligation or practical necessity (Stout, 2012). Thus, with the exception of self-enrichment, there is much discretion provided by the law with respect to other corporate goals, such as employee protection and serving the community. These goals can and should be pursued by management.
Indeed, stakeholder theory offers a more holistic approach that includes more parties than shareholder theory. Yet it has its detractors as well. According to economist Michael C. Jensen, stakeholder theory should not be considered a valid competing theory since it does not provide a complete specification of the corporate objective function (Jensen, 2001). Unlike the clarity provided by the single objective of shareholder value theory, stakeholder theory directs managers towards many objectives, creating confusion, conflict, inefficiency, and competitive failure for the organisation (Jensen, 2001). Other authors have concurred with this view, stating that accountability to all stakeholders is not only unworkable, but also so diffuse that the accountability created is non-existent (Sternberg, 1996).
A final argument against stakeholder theory is that it undermines fundamental features of society (Sternberg, 1996). For one, it denies owners the right to dictate the use of their assets, stipulating that assets should be used for the benefit of all stakeholders. Due also to this feature and the added entrustment of assets by owners to managers, agent-principal relationships are compromised as well.
Despite the fervent propositions from both sides, the issue of whether the debate has real implications is a question in itself. A survey conducted in 2005 by the University of Melbourne revealed that ideological acceptance may not transit into practical managerial behaviour. Findings from the study showed that even though shareholder primacy had clout among managers, the proposition that directors will pursue shareholder’s interests at the expense of other stakeholders is illegitimate (Anderson, Jones, Marshall, Mitchell, & Ramsay, 2005). While shareholders continue to be seen as the most important of stakeholders, findings revealed that directors prioritise other stakeholders, such as employees, and their interests as well.
Notwithstanding this phenomenon, it is clear that the global business community is in transition to a new ideological consensus. Both the shareholder value theory and the stakeholder theory are theories of value creation, but with different prescriptions to that end. In evaluation, one of the strongest arguments for stakeholder theory is that taking additional stakeholders into account to some extent can be more financially beneficial for the firm in today’s economic landscape (Pfarrer, 2010), perhaps even more so than in shareholder theory. Although contentions remain that stakeholder theory prioritises non-financial market stakeholders at the expense of the firm, empirical observations through competitive analyses of profitable companies in recent years prove this view to be misconstrued (Pfeffer, 2009). Thus, there seems to be a shift not only in ideology, but also in successful managerial business practices, away from the notion of shareholder value maximisation.
That being said, stakeholder theory as it is forms an incomplete approach on both the firm’s corporate purpose and the measurement of its objectives. Thus, more recent theories on both sides of the argument have attempted to synthesize these two goals. For one, enlightened shareholder value theory proposes that companies should pursue the goal of shareholder wealth maximisation with a long-run orientation, seeking sustainable profits by paying attention to relevant stakeholder interests (Millon, 2010). Enlightened stakeholder theory, on the other hand, uses the premises of stakeholder theory, but uses the maximisation of the long-term value of the firm as a criterion for stakeholder prioritisation (Pichet, 2008). We can observe here that there is an apparent convergence from the initially opposing theories, which points to a potential equilibrium at some point between the two theories.
In conclusion, despite the long historical roots of shareholder value theory, we see that stakeholder theory has gradually yet fundamentally changed the perspective of owners, managers, and society. Thus, while it remains incomplete in its current form, stakeholder theory is undeniably instrumental in steering the path for businesses in their goal for value creation, be it for shareholder or societal good.
 E.g. Southwest Airlines, which never had layoffs despite an industry shutdown after the September 11 attacks.
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