This paper is divided into three sections. The first section is a review of academic research and studies on corporate theories, positions and counter-positions. The second part discusses the two theories – stakeholder value theory and shareholder value theory. This section evaluates key arguments associated with each theory. In the third part, the paper evaluates why value-driven stakeholder approach should be embraced by managers of corporations. The paper finalizes the discussion by concretizing the arguments in a summary and offering submissions for future managers.
This paper hypothesizes that profit maximization is no longer the only priority of organizations; other non-economic features that add economic and non-economic values have become equally important. Besides, economic actions of corporate firms have effects on non-economic stakeholders in the community. So, the firm must take responsibility for this actions. Consequently, stakeholder value theory has taken over as the most applicable and preferred instrument for most corporations. Technological innovation as a feature cannot be escaped by firm managers because it enhances productivity. Likewise, the same stakeholder’s activities may be progressive or retrogressive depending on how they are handled by managers. A balancing act as a skill is required to determine when to engage each stakeholder.
Today, the global world has made it possible for companies to work inter-dependently at the business and societal levels. The decision-making process for company managers is now affected by distant forces like international agreements, new civil society organizations and business contexts in the local community. Businesses face more public scrutiny than before from shareholders and stakeholders of firms who are now more vigilant on demands for ethical and social sanity (Ho, 2010). Each stakeholder focuses on the actions of the managers and the effect they will have on the vested interests. The stockholders’ concern is to receive their bonuses and capital increase, personal wealth and personal security of their time. For the customers, their main concern is to get quality and value for their money. On the other hand, suppliers need fair compensation for their products and services. Moreover, the government is concerned with protection of the public good. In essence, managers of corporations need to understand the complex inter-stakeholder interests and balance their actions to satisfy all of them (Lawrence & Weber, 2014, p. 12).
Studies and scholars on corporate profit firms have condensed literature on theory and research which supports the premise that businesses should maximize profits. For the ownership (shareholder) theory of the firm, the sole purpose of firm’s existence is to increase longevity of their market value and maximize profits for its shareholders. Conversely, other scholars opine that businesses should involve all stakeholders in order to realize optimal maximization (Merton, 1976). Apart from market profit making, the firm should create value in other sectors of society such as innovatively create products for consumers and promote career advancement for their employees. The main focus should be to maintain the trust of all stakeholders (Lawrence & Weber, 2014, p. 6). It is the wish of many researchers and business shareholders to find ways to balance between creating shareholder value and contribution to society.
Milton Friedman’s classical perspective opines that the sole social responsibility for businesses is to engage in activities that creates profits as long as those activities stay within the regulations set by the law. One feature that Friedman notes is that firms’ social and environmental costs should apply pursuance and fulfilment of the law. Secondly, with self-interest as the main influence, the inherent drive in people to earn profit will maximize efficiency and value for society. The corporation is also advantaged to access a nexus of contracts from which it can select those with the ability to contribute to high profitability which can increase the value economically and socially (Friedman, 1970).
Furthermore, Jensen (2001) notes that the value and profitability of a product or service must satisfy consumers’ current needs, but not at the expense of future needs. Value is created when more buyers are willing to purchase products at a higher price than the actual price. When the latest technology is employed to enhance efficiency, the cost of products and services drops, and this attracts more consumers to buy such products and services. Additionally, when technology is embraced, it is most likely that it will lower prices and increase both social and economic values. In this manner, corporatation’s maximization of profits and social value is most likely to be attained in the shortest time possible (Jensen, 2001).
Moreover, creating value for the stakeholders may take various forms. By promoting professional development, the employee will contribute more to the profitization objective. In other words, this calls for more commitment. The managers have to battle with maintaining high quality products, meeting multiple government regulations and finding ways to retain talented employees or compensating suppliers handsomely to maintain solid business relations (Lawrence & Weber, 2014, p. 6).
On the other hand, anti-stakeholder empowerment advocates have raised concerns on expansion of stakeholder influence on corporate decision making. The concerns are out of fear that such stakeholders may undermine board discretion on some matters that do not need stakeholder interference (Sen, 1977). Other scholars have argued that when shareholders propagate for stakeholder interests, it could turn out that some directors could sell interests of certain stakeholders, and this could be detrimental to the shareholders class. Furthermore, promoting stakeholder interests could divide boards of management and corporate managers on business issues which could derail the corporation’s sole duty of maximizing profits (creating wealth creation) (Ho, 2010).
Besides, scholars with conflicting opinions opine that great shareholder power puts stakeholders in a better position to contain and observe corporate directors within the confines of the law (Lee, 1995). So, it is impossible for such directors or stakeholders to divert corporate interests. Furthermore, the changing investment practices has empowered shareholder voices more than ever, because they can aggressively hedge funds, create complex financial investments capable of separating voting rights and economic rights (Lee, 1995). Another thinking is that advantages towards shareholders like empowerment and capacity building could provide an opportunity to gang against directors aligned with management and sway decisions that are detrimental to non-shareholders.
Two competing theories about the sole purpose of the corporation have been advanced by scholars with respective arguments and counter-arguments. The two theories – shareholder value theory and stakeholder value theory provide a framework for examining corporate governance procedures, policies, executive compensation and economic or social performance of business firms (Ho, 2010).
The shareholder value theory (ownership theory of the firm) proponents propagate for the economic perspective in which the sole purpose of the firm is to generate wealth for shareholders. In this case, owner’s preferences take primacy than other interests (Lawrence & Weber, 2014, p. 6). The end result should be to limit interactions with outside non-business activities. The theory is drawn from Adam Smith’s (1776) Wealth of Nations’ notion which perceived the purpose of the shareholder theory to maximize shareholder wealth. According to Milton Friedman, the main features of stakeholder value theory are that the human, social and environmental costs of doing business are internalized. Secondly, self-interest is the prime human motivator and the corporation engages only with contracts that impact greatly in terms of profitability. Financial returns according to classical economists is to maximize financial returns for the shareholders (Sen, 1977).
Conversely, the stakeholder value theory broadens the classical perspective by taking cognizance of the importance for creating wealth for the shareholders. Other constituent groups of shareholders, creditors, employees, consumers, suppliers and the larger outer society that are not directly related to business benefit from wealth creation. A key component of the shareholder theory is that business organizations rely heavily on the stakeholders for success because the stakeholders have some stake in the organization (Ho, 2010).
As argued by Freeman (1984), managers subscribing to the stakeholder approach have a moral obligation of balancing between shareholder interests and societal interests. They are purposed to coordinate shareholder interests. The new supporters of the stakeholder theory extend the perception of ownership of the firm beyond the traditionally held position of legal and economic ownership (Freeman, 1984). The traditional understanding of the stakeholder theory is that it includes those stakeholders who have a significant effect on profits (Sen, 1977). In the stakeholder approach, maintaining good relationships with stakeholders in the form of employees, shareholders, suppliers, consumers and communities has the ability to increase shareholder wealth. The increase emanates from the need of the firms that champions the development of assets that later on improve the competitive advantage of the firm.
The shareholder approach was confronted in the 1980s by philosophers, psychologists, sociologists and management scholars on the need to generate competitive advantage by moving beyond shareholder's accounts. According to recent scholars, corporations’ central roles are generating shareholder wealth, obeying established legal frameworks, and observing ethical considerations that corporations’ activities affcets (Sen, 1977). Today, the stakeholders have influence on capital (financiers), product (suppliers or consumers) and organization (employees) (Sen, 1977).
Additionally, in the current context, firms should find ways to strike an equilibrium between shareholder value and societal value and learn how to handle stakeholders depending on individual context. In most cases, firms prefer some stakeholders over the others in a particular context. For instance, a consumer threatening to boycott products and an activist group lobbying for the stoppage of an investment on environmental grounds could only be determined based on the balancing skill. Current transformation of the stakeholder aspects now has integrated public relations and communications disciplines with environmental aspects. There is a convergence of scholarly literature on the fact that customers, clients, suppliers, competitors and media are inter-dependent on each other (Ho, 2010).
On the other hand, in the social capital theory, shareholders are expected to put interests of others above their very own that are self-seeking and pursue a much broader objective. The theory argues that it is paramount to have co-operation among the personnel and owners. The attention of the firm today should be directed onto positive identity, positive leadership, compassion and positive social capital. Furthermore, the corporate social responsibility (CSR) approach dwells on the principle that businesses have an obligation in society. The approach fosters economic development, social justice and environmental integrity. The aim, therefore, is to pursue policies that are compliant with an established standard (Carroll, 1999).
One would then ask which approach organizations should take. One of the fundamental reality today in organizations is that all organizations drive towards profitability and creating wealth as the main goal. Another reality is that all the activities of wealth creation in corporations happens within communities and societies and that they have effects on all those involved. It is, therefore, prudent for the managers to balance between optimal profitability and social responsibility. It is impossible to create wealth at the expense of the community because every stakeholder needs attention depending on the context (Lee, 1995).
Stockholder management as a corporate strategy always brings out best financial results. A good mixture of stakeholders and management of their interests brings out good results that satisfy everyone. Therefore, a stronger relationship between stakeholders and corporations is an asset to the entire establishment for growth. A category of market stakeholders like suppliers, bankers, shareholders and human capital will be more supportive if their interests are well taken care of. Communities will also support firm’s investment decisions if their future concerns are considered by the firm managers in their investment plan (Lawrence & Weber, 2014, p. 7).
Another asset is in the form of human capital (employees) who bring forth their knowledge and skills in exchange for wages, benefits and opportunities for personal fulfilment. The suppliers on the other hand benefit from the payment in the form of cash for thier raw materials and other services. Retailers and wholesalers maintain good transactional relationships with consumers for products from the corporations. A good manager will know that exploiting stakeholders for individual corporate gain is suicidal because each stakeholder is important. Losing any of them would harm the organization (Lawrence & Weber, 2014, p. 8).
Furthermore, other stakeholders like the government do not pursue the market directly, but provide a level playing field for corporations to realize their set goals and targets. Other stakeholders like activist groups or community lobbyists may not be concerned with direct market transactions but could make or break the corporations’ ambitions depending on how they are handled. They can for instance block an investment plan based on environmental safety concerns.
Furthermore, power play between stakeholders is crucial to manager’s success. Managers should have skills and knowledge on when to engage each stakeholder depending on the power they wield. Studies and experts have recognized that there are four powers that corporation managers need to take into consideration. Economic power rests with customers, suppliers and retailers. The customers have the purchasing power; they could boycott products and services. Suppliers could refuse to bid for orders while retailers may take products from competitors. In essence, employees and customers hold legal power. Employees have the ability to cause legal tussles based on injuries while consumers could stop investments for ecological concerns. In line with this, stockholders (shareholders) wield legitimate power.
As the quest for corporate growth takes center stage, managers have a duty to satisfy expectations of all stakeholders and the entire society in general. Finally, governments have political power that could be exercised through laws, regulations and lawsuits (Lawrence & Weber, 2014, p.12). Managers with a skill to manage the various interests will always realize their long term value creation and profitability. Corporate success cannot be attained in the absence of technological innovations. Technology now influences and drives lives of all stakeholder interests. Managers who embrace technology will achieve expected results sooner than they imagine (Lawrence & Weber, 2014, p. 265).
In summary, there is a convergence today in corporations concerning the purpose for existence that is driven by creating wealth solely for business and societal aspects. The global village and information era now affects decision-making processes for corporation managers on issues like international agreements, new civil society organizations and business contexts in the local community. There is more public scrutiny of public and private corporations from shareholders and stakeholders of firms; they demand ethical and social sanity from corporations. The vigilance is out of experiences of fraud and other scandals committed by shareholders in conjunction with rogue directors such as Enron and World Com or Hewlett-Packard (Ho, 2010).
It is the wish of many researchers and business shareholders to find ways to balance between creating shareholder value and contribution to society. The tendency now is to find ways to engage all stakeholders depending on the powers they wield and contexts that suits particular settings. Friedman and other classical theorists have stuck to the mere fact that profit maximization in corporations should be fulfilled as long as it meets requirements set in the law. The main drive for profit maximization is self-interest that is inherent in people who seek to maximize efficiency and value for society.
Some scholars feel that shareholder value theorists have propagated against stakeholder empowerment on corporate decision making for fear that such stakeholders may undermine board discretion. However, stakeholder value proponents hold that creating wealth for the stockholders at the same time creating value for other constituent groups is more rewarding and empowering – leading to expanded value creation.
In the current context, corporations should find ways to integrate between stakeholder and shareholder value theories depending on the context. In most cases, firms prefer some stakeholders over the others in a particular context. Current transformation of the stakeholder aspects now has integrated public relations and communications disciplines with environmental aspects. A good mixture of stakeholders brings out convincing results that satisfy everyone. Therefore, a stronger relationship between stakeholders and corporations is an asset to the entire establishment for growth.
Furthermore, power play between stakeholders is crucial to manager’s success. Managers should have skills and knowledge on when to engage each stakeholder depending on the power they wield. Economic power rests with customers, suppliers and retailers. Employees and customers may hold legal power. Stockholders (shareholders) wield legitimate power.
On this note, this paper submits that corporation managers should find ways to balance between creating value for shareholders and stakeholders. There is a need to broaden activities for value creation to include all stakeholders because they too add value to the organization. If this is not taken into consideration, there could be disastrous consequences. In addition, technological advancement should be integrated in firms because it helps to ease stakeholder satisfaction of interests. Finally, all stakeholders wield power. Therefore, it is essential for managers to learn how to utilize these segments of stakeholders, balancing cautiously, depending on contexts and the power they wield. Then, more value and wealth could be created.
In conclusion, this paper has reviewed two theories: the stakeholder value theory and the shareholder value theory. There is a debate on whether organizations should prioritize economic profiteering or balanced socio-economic value creation. This paper has shown that today, most corporations champion broadening the profiteering approach, as well as embracing more stakeholders. Adam smith’s classical approach is narrow minded and limiting to the organization. The paper adopts the premise that the sole purpose of firms has broadened from profit maximization that is economically driven to other non-economic features that add economic and non-economic value.
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