Stakeholder vs Shareholder Theory

Stakeholder vs Shareholder Theory

Initial Overview

The traditional Anglo American assumptions on finance is that shareholders own companies, they are only liable for the company’s actions to the extent of their investment, and that if the company becomes insolvent then they will not lose more than the amount they invested into the company. Therefore the assumed overall objective according to this view is that a company should strive to create maximum shareholder wealth. In addition, the Financial Times released an article which stated that capital gains plus strong dividends are ultimately what shareholders are interested in (ft.com) – so why is this topic so debated? Is either of these theories solely correct or can they be combined?

Problems with traditional assumptions

The question needs to be asked…what would a shareholder prefer – volatility or stability? How about if profits for both companies were the same?

If I was to invest I certainly know which company I would prefer to invest in! A company with a steady income would be valued highly in comparison with a company with volatility.

Shareholder Theory in detail

This theory was initially introduced by Milton Friedman who suggested that managers and employees are employed as agents for the shareholders and that the sole responsibility of a company is to maximise profits thus creating maximising shareholder wealth (Ronnegard D, 2006). This theory (almost) makes sense as shareholders have more to lose than other stakeholders as they have sacrificed their capital to inject into the company. Therefore, it’s reasonable to assume that the sole interests should be to repay the investors back. Agency Theory goes hand in hand with Shareholder Theory as they both discuss how managers and directors are employed as agents for the shareholders (and therefore in theory act on behalf of the shareholders). Therefore if there is a problem with the shareholder theory there is a problem in the agency theory whereby if managers aren’t acting in the interests in their shareholders then they are not acting as correct agents for their shareholders and therefore they maximising shareholder wealth (Eisenhardt, 1989). However, is this always the correct approach to take or is the alternative better for the company? Is this the best strategy to adopt in order to achieve the maximum potential for a business?

Stakeholder theory

Stakeholder theory originated from Edward Freeman and is much broader as it strives to keep more stakeholders happy as opposed to only one. It states that in order to be successful they need to keep many stakeholders (customers, suppliers, shareholders etc) satisfied and that their interests should be aligned and in the same direction (ft.com). Stakeholder theory has recently been highlighted when the liked of Starbucks attempted to use loopholes in the system to avoid paying higher tax. The scandal has resulted in Starbucks agreeing to pay more tax which society views as ‘the right thing’ to win back customers as some of the public said they would ‘boycott’ some of their outlets (bbc.co.uk). Therefore they are essentially adopting the stakeholder theory as they are not maintaining their old regime whereby they are acting legally but unmorally (paying out less and keeping shareholders happy), they are more interested in enticing customers back by acting in the way which is viewed as morally correct by society.

Enlightened Shareholder Value (ESV)

This is the newest theory which essentially combines both shareholder and stakeholder theory and has now been incorporated into UK Law (Keay A, 2013) Essentially it states that the overall objective should be to maximise shareholder wealth in the long term, but by taking other stakeholders and the relationship with employees and suppliers etc into account (Attenborough D, 2013). ESV has been looked at as a new compromise between Shareholder and Stakeholder Theory. Originally academics and companies who adopted the shareholder approach noted that ultimately it is shareholders who should be rewarded for their investment into the business, however with this ultimate goal in mind it could not be achieved without long term relationships with stakeholders (Keay A, 2013). Take Apple for example - Apple is a successful company which rewards their shareholders generously. However, their success would not be present without a long term relationship with customers and reliable suppliers. Therefore in order to supply shareholders with the maximum wealth they have had to take into account their stakeholders to achieve the success that they have today.

In conclusion

Many people believe that examples like the scandal at Enron and the concerns about the independence of accountants are evidence of a failure of the shareholder theory. Furthermore this would lead to stakeholder theory being more favourable whereby they have all stakeholder interests in mind – even if this results in shareholder returns being less. However, stakeholder theory is also criticised as many academics wonder whether it is actually possible to act in a way which keeps all stakeholders happy.

Overall, taking the above into account I believe that Enlightened Shareholder Value is the best approach to take as it is a combination of both the original theories. By keeping stakeholders content you will achieve:

a more productive workforce as they will be happy to stay within the business





happier customers who will have learnt from experience that the company is a good company to deal with – thus enticing them to come back in the future





happier suppliers as they will realise that the company is a good company to do business with and therefore a business relationship will become apparent.

In theory if these stakeholders are all satisfied then profits will fall into place for the company and shareholders will maximise their wealth.

References

Attenborough, D., (2013). Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance.　The Modern Law Review. 76 (5), pp.940

BBC (2012).　Starbucks agrees to pay more corporation tax. [ONLINE] Available at: http://www.bbc.co.uk/news/business-20624857. [Last Accessed 11/12/2014].

Eisenhardt, K. M., (1989). Agency Theory: An Assessment and Review.　The Academy of Management Review. 14 (1), pp.58

Financial Times (2009).　Shareholder Value Re-Evaluated. [ONLINE] Available at: http://www.ft.com/cms/s/0/293fc3c4-1196-11de-87b1-0000779fd2ac.html#axzz3OWgJiqj2. [Last Accessed 11/12/2014].

Financial Times (2014).　Definition of Stakeholder Theory. [ONLINE] Available at: http://lexicon.ft.com/Term?term=stakeholder-theory. [Last Accessed 11/12/2014].

Keay, A., (2013). The Enlightened Shareholder Value Principle and Corporate Governance. 1st ed. New York: Routledge.

Ronnegard, D., (2006).　Corporate Moral Agency and the Role of the Corporation in Society. 1st ed. England: Lulu.