Shareholder Vs Stakeholder Theory

As many of you are aware, there has been a constant debate on the Shareholder Vs Stakeholder theory. Various academics and professionals have joined this debate, however are these the only two options available? Today I will be analysing both theories and discussing the enlightened value maximisation view.

Shareholder Theory

Anglo –American companies are known to take a shareholder view.  In fact, over the last 200 years it has been argued that society is best served by businesses focusing on returns to the owner. Their assumed objective of corporate finance states that companies should make investment and financing decisions that maximise the wealth of its shareholders.   Adam Smith (1776) is a true supporter of this view. He submits that by acting in our own interests it will effectually benefit society.  Further support can be seen with Hayek and Friedman. Hayek argues the “only specific purpose corporations ought to serve is to secure the highest long term return.”  Friedman also supports this view, stating that companies do not have any moral obligations or social responsibilities other than to maximise their own profit. All three academics are in agreement; making shareholders’ interests the paramount objective will benefit both the firm and society .Why? Well, in practical terms how does this benefit companies? Firstly shareholders take on the most risk, it therefore seems reasonable that the owners should be entitled to any surplus returns.  Secondly, focusing solely on the benefits of shareholders allows a clear investment decisions to be made, making the decision making process easier and more efficient.  Finally, if they are unhappy with the way the company is being run, they have the right to sell their shares. This could cause a series of problems and could leave the company susceptible to a potential takeover. In practical terms you could argue that this is the way forward, should all companies adopt this view?

Stakeholder Theory

The stakeholder theory focuses on the importance of other stakeholders. The idea basis for this theory is the acknowledgement of a company’s responsibility to a number of interested parties. This not only includes shareholders but also customers, employees, suppliers, distributors, those concerned with the environment and the local community. Stemberg is a true believer stating that the business should be run to serve all of their stakeholders. Arguably, following this approach might lead to confusion and conflict with regards to the company’s objectives as each group of stakeholders have different needs. This could cause problems and as a result it could have negative effects on a company’s performance. However, Freeman argues that the groups and individuals who are affected by the company have legitimate interests that need to be taken into account. Furthermore, corporations who opt to place a strong emphasis on wealth maximisation risk upsetting stakeholders. Ignoring the needs of important stakeholders’ could have a detrimental effect on the business’ overall performance.  Is it beneficial to ignore the other stakeholders in order to achieve wealth maximisation?  . The case of General Motors (GM) demonstrates the impact that neglecting stakeholders can have.

General Motors: Case Study

In the 1970s GM discovered that the position of the fuel tanks in their cars caused an engineering failure which would result in the death of the passenger. GM calculated that repositioning the fuel tank would cost the company $8.59 per car, whereas paying compensation for those 500 casualties would cost the company $2.40 per car. Focusing on shareholder maximisation, GM went for the second option as it would reduce costs.  This information was made public and you can obviously imagine what those customers’ reactions would be.  The case was taken to court, however, surprisingly the court ruled in favour of GMs actions concluding that the company had acted in the interests of their shareholders.. Is this acceptable behaviour for such a large corporation?  If this were to occur today, it is likely that the negative press surrounding such a situation would have a devastating effect on the company’s share price and their customer base.

Maximisation Enlightenment Value

It is clear that both views have their advantages as well as their limitations, is it therefore possible to combine the two? Jensen brings an interesting view on both theories known as enlightened value maximisation.  This view is critical of both theories but acknowledges the importance of each one.  Jensen argues that shareholder value cannot be created if stakeholders are ignored.  However, Jensen then disputes this by saying that sometimes companies go too far in balancing all the stakeholder interests.  This theory recognises the importance of long-term value for the shareholders but utilizes much more of the structure of the stakeholder theory.   Is this the answer to the debate? It can be argued that most companies listed on the FTSE 100 follow this approach. Their mission statements and objectives focus on their stakeholders; however, they still aim to achieve long-term value.  An example of this can be seen with Xstrata plc objectives.

Xstrata plc

Xstrata plc is recognised as one of the best managed companies in the world. The reason behind this is due to its clear objectives:

We will grow and manage a diversified portfolio of metals and mining businesses with the single aim of delivering industry leading returns for our shareholders.”

We can achieve this only through genuine partnerships with employees, customers shareholders, local communities and other stakeholders, which are based on integrity, co-operation, transparency and mutual value-creation.

The example above supports Jensen’s theory; however it should by highlighted that a company’s objectives should be clear and not confused with their strategy. Companies who successfully implement this can achieve long-term value for its shareholders, whilst acting in the interest of its stakeholders.