Implications On The Business

Published Date: 02 Nov 2017

Introduction

In the last 200 years, business corporations’ influence on the society has grown rapidly and immensely. Two contending theories are eminent when discussing the purpose of the modern business firm. Both theories present a structure for assessing company’s governance procedures, economic and societal performance of a firm. The first, shareholder theory outlines the main concern of managers of a firm is to maximize shareholder value. The second, the stakeholder theory broadens the first view, identifying the relevance of wealth creation in addition to the business’s interactions with its stakeholders. These stakeholders are those without whose participation the corporation cannot survive (Clarkson, 1995).This paper discuss the foundations of these two theories, criticisms, implications as well as government interferences in businesses, and conclusion on how the two theories can be used to create a better effective structure for the role of the modern business firm.

Shareholder Theory

The origins of the ideas shaping shareholder theory are more than 200 years old, with roots in Adam Smith’s (1776), Wealth of Nations. Shareholder theory outlines the major responsibility of managers of a firm as maximizing shareholder wealth (Berle and Means, 1932; Friedman, 1962).

Shareholder theorists call for restricted government and supervisory interference in business, believing that society will also benefit from markets been regulated through the mechanism of the invisible hand, that is, if all businesses work towards their own self-interest by trying to maximize profits.

Some advocates of the shareholder view also were of the view that the invisible hand checks unlawful activities, arguing that the market will discipline or punish firms that involve themselves in illegal or unethical behaviour. They were of the view that too much oversight and regulation of firms is needless.

Macey (1989, 1991) explains that shareholders should be given control since they are residual claimants and that they are people that attach much significance to activities that will benefit organization.

They believed that the state should be responsible for solving social problems. Corporate generosity and other actions not directly connected to creating shareholder wealth are a waste of shareholders’ investments and, possibly, depraved since it amounts to stealing from shareholders.

Sundaram and Inkpen (2004) explained that there is a narrow explanation that is given to the shareholder theory pointing out that governing the business needs a purposeful action and that the only appropriate goal for managers is to maximize shareholders wealth.

Also McCloskey (1998) pointed out that the maximization of the value of shareholders was a scientific theory which was shown properly by economists.

According to Friedman, social and moral development is best handled by the government or by a voluntary organization. Wealth is shifted to issues outside the core expertise of their executives if businesses become tangled in public or social policy issues. If wealth is used inefficiently this way, society will be affected negatively in the long run.

It should also be noted that, Friedman never advocated firms behaving unlawfully, dishonestly, or unethically. Whilst supporting the corporate aim of make best use of shareholder wealth, he argued that it should be done within the ethical, moral and legal confines of society.

Critics of the Shareholder Theory

The main approach on shareholder value has been extensively critiqued (Aglietta and Rebérioux 2005) principally after the financial crisis that hit the world.

The shareholder theory does not offer a clear measure of the involvement of the business in societal concerns like environmental issues, ethical business practices or unemployment problems. Decisions taking by management can lower the well-being of third parties though it might maximize shareholder value while.

Accordingly, Freeman, Wicks and Parmar (2004) have criticized managers who pursue policies aimed at recurrently increasing a business stock price.

Conflicts may arise between managers and shareholders which is referred to as agency problem. Shareholders are been served by managers as agents and it causes hitches inside the organisation and can impede performance.

Keown, Martin, and Petty, 2008; Lasher 2008; Ross, Westerfield, and Jordan, 2008; Brealey, Myers, and Marcus, 2007; Melicher and Norton, 2007 also agreed with the fact that it is understandable to criticize proponents of the shareholder theory in trying to encourage managers to maximize stock prices of firms

Furthermore, the interim attention on shareholder value may be disadvantageous to its long-term shareholder value.

Implications on the business

Despite the reason for the maximisation of share prices, the shareholder model is branded by organisational control and because the companies’ management is directly controlled by its shareholders. The principal-agent problems and the arm’s length control involved in the shareholder theory makes it difficult for them to check if the paid directors the entire time act in their interests. Also, this model is denoted by its short-term orientation.

The view that managers principally have a responsibility of making the best use out of shareholders returns attested for the fall of Enron and various scandals like Imclone, WorldCom and Tyco International. There were various concerns on the freedom of auditors who were charged with the assessing of the financial statements of these companies. There were questions also raised concerning the investor recommendations and incentive schemes at Merill Lynch and Credit Suisse First Boston. These events and occurrences that unfolded dampened advocators of the shareholder theory. This also paved way for people to start questioning the evidence of shareholder supremacy.

Stakeholder Theory

The traditional meaning of a stakeholder is any individual or group who can be affected or affect the attainment of a business goals and objectives (Freeman 1984).

Over the years the explanation for a stakeholder, the purpose of a firm and the responsibilities of managers have been very ambiguous and disputed in various literatures. Freeman, who is the father of the stakeholder concept, reformed his definition overtime. In one of his newest definitions Freeman (2004) defines stakeholders as groups whom are important to the continued existence and success of a business. His publication Freeman (2004) adds a new standard which advocates for the concern of the views of stakeholders themselves, and that, their undertakings is essential to be taken into account when managing a business.

The stated principles of the stakeholder theory are referred to as normative stakeholder theory. This theory enables stakeholders or managers know how they should act. It also serves as a guide for how they should view the purpose of the business, based on some ethical principle (Friedman 2006). There is also the descriptive stakeholder concept which is another approach to the stakeholder theory.

Brenner and Cochran 1991; Jawahar and McLaughlin 2001explained descriptive theory as a theory embedded in organizational behaviour literature and designates the behaviour and features of stakeholders involved in a structure and how an firm interacts with them.

Another concept, instrumental perspective on stakeholder theory addresses this more openly on the assumption that firms that give attention to their main stakeholders will acquire competitive advantage over those that do not (Clarkson 1995; Jones 1995). This means if managers treat stakeholders in accordance to this concept the organization will be more valuable and successful in the long run.

A last branch of stakeholder theory is referred to as corporate social responsibility (CSR). In particular, Carroll A 1979 and Ed Freeman 1984 theorized that a firm could do better if it takes the interest of its stakeholders into account, that is, they would attain better performance than by merely concentrating on interests of shareholders.

Carroll 1979 embedded the four models of CSR into one conceptual theory of Corporate Social Performance (CSP). He noted that businesses have four main responsibilities, that is, economic- to maximize shareholder wealth, legal -to conform to set laws and regulations, ethical -to know that the firm is part of a community, and thus has obligations to and an impact on, others, and discretionary- to engage in generosity. Therefore the stakeholder theorist believe that taking all component groups into account is a better way of increasing overall performance unlike the shareholder theory which emphasizes a business can only increase value on one dimension.

Critics of the Stakeholder theory

Charles Blattberg, the political philosopher critiqued stakeholder theory for supposing that the interests of the several stakeholders cannot work together or be stable against one another. He claimed that this was a product of its prominence on negotiation as the principal way of discourse for dealing with clashes amongst stakeholder interests.

There is also limited headway made in respect to the positive link that exists between increased financial performance of a firm and a more inclusive stakeholder management, because of the inherent difficulty of trying to evaluate the effect of corporate engagements on stakeholders other than shareholders. Assessing a business’s efficiency in its dealings with stakeholders outside the capital markets is very difficult to achieve.

Tirole (2001) took a further negative perspective of the desirability of embracing the stakeholder oriented goal for the business arguing that the welfare of stake-holders cannot be measured reliably.

Implications on Business

The Stakeholder theory challenges small-business owners and leaders of corporations to reconsider their usual ways to running organisations. This theory enable firms move away from the primary concentration of a firm in acquiring profits in the short-run but to focus on the long term success of the business. In this current business world well-defined by advancing globalization, augmented concerns on corporate responsibility and economic insecurity, the stakeholder theory’s core principles can assist as a model for start-ups and succour as a turn-around for waning companies. The stakeholder theory if properly understood will enable firms realize that their business values and it’s relationships with stakeholders are critical to success, inspiring employees, helping managers to make profit and benefiting the society as a whole.

Political and Government Sphere

The political problem which triggers the debate of the ways for businesses are managed has been existent for only about 150 years; society had observed the arrival and the spreading of businesses during this period of time (Chandler, 1977; Luhmann, 2000). In today’s world, firms are everywhere, making it a ‘society of organizations’ (Etzioni, 1964).

Economists have comprehensively been arguing on the two principal questions which businesses pose in the political dialogue since the 1930’s (Knight, 1965; Coase, 1937).

The world has seen a rise in the consciousness of the part that government play in the business enterprise. The government- business connection in countries has been established on the values that, the government legitimate role is to regulate business in the public interest and also to apply firm competition laws to protect adherence to market principles.

Epstein (1969), Lindbloom (1977), McQuaid (1982) have disproved the often past theories of the separation of the political and business grounds. There has always been contention between business and government. Weidenbaum (1980) Criticized the "big government" and argued that an estimation of over $100 billion was to be accounted for the cost of regulation of businesses, and a new analysis of the cumulative costs of six agencies, , ERISA, , EEO, EPA, , DOE FTC and OSHA was assessed at $2.6 billion.

Also, there are also numerous agencies that affect business of today. Examples are the IMF, the O.A.S., World Bank, the U.N., etc. These organizations may affect business in a variety of ways. The policies they propose may sometimes bring constraints on business. An example is the de facto which determined the extent of available credit to some countries to buy goods and services.

In addition, the Legislature of some governments considers quite a lot of laws regularly, which can have severe effects on organizations. Policies of nations change such that, capital creation inducements, tax and depreciation plans and the formation of fresh forms of regulation affect the businesses. Therefore, CEO of today must devote most of their resources and time perturbing about future legislations and policies from these agencies.

Management of firms have different set of issues with governments, and these matters may differ from country to country. There are mainly many rules for businesses who work on a national scale. Fears with taxes and jobs and how to manage the enormous current developments pervade businesses.

A closer look shows that, attacks of businesses on the problems with government are deceptive and that regulatory agencies regularly protect and benefit the businesses that are regulated. Also, some critics argue that markets would have had actual social benefits without government intervention. Wolf 1979, LeGrand 1991 also attested that governments might be subject to failures themselves. Wolf argued that the make-up of failure of businesses provides only limited help in suggesting therapies for government success.

Finally it is unnecessary to say that influence on business by government is not considerable. Epstein (1969) argued that government will act in response to particular happenings and crunches in the short-term but will not play their needed role in the public policy process.

Economic Sphere

In countries with a market economy it is normally decided they pursue economic profitability. Yet, few people would also disagree that organizations also have other definite social obligations. Profitability and responsibility should and can be joined together, though it is clear that they are at slightly conflicting.

Organizations must be more profitable to survive and gain higher returns on equity of shareholders. High stock prices reflect profit for investors which create trust for them; it also helps the business achieve it set targets and goals. The profits acquired by firms should not be seen as just an outcome, but as a basis of the company’s competitive strength and prosperity.

The economic environments around firms play an important part of the value of any company. In order to motivate people and society to work hard for the welfares of the company, there should be a level of trust built with them. Similarly it is also significant for the development of trust between the firm’s external environment like its customers, interest groups, suppliers, government and the organization itself. This trust can only grow from the supposed safety if interests of every stakeholder are taken into account.

In the financial crisis that shook the world, a lot of the executives at that time carried out arrangements that from all external appearances, were of their personal gains rather than maximizing of shareholders wealth. An example, CFO Andrew Fastow of Enron Corp, who made a partnership which was bankrolled with the stock of Enron Corp. which populated with very risky ventures. Though Enron lost money on the deal he made millions quickly, in fees and profits. In fact, Enron entered the state of insolvency and loss more than 500million dollars due those initiatives taken (P. Behr and A. Witt 2002). Likewise, some other CEO’s including Scott Sullivan of WorldCom Inc, Garry Winnick of Global Crossing Holdings Ltd and Kenneth Lay of Enron, were all beneficiaries from stock options and bonuses whilst at that time their shareholders were not happy. In actual fact, that behaviour was inexcusable compared to the shareholder theory as the main idea of the theory is that executives should act only in the shareholders’ interests should be the order of the day not in their own interest.

Corporate Governance: Shareholder vs. Stakeholder Approach

The shareholder model presently dictates mainly in the Anglo-American counties as the UK or US whereas the continental Europe -particularly in Germany- or Japan are popular in stakeholder model.

United Kingdom, United States, Australia and Canada are countries with Anglo-Saxon legal tradition, in these countries; corporate governance usually centres primarily on shareholders.

It is considered well enough so long as the organization makes decent profits yearly and increased the dividend due its shareholders (Cassidy J,2002)

Top managers are likely to be checked by ways of market-based compensation and fines in those countries. For example, in US, where compensation is usually associated to the level of profitability, many firms may be tempted to cut back on labour so as to maintain present profitability. It is very tough under this system for employees to trust top management as their conduct is an issue of constant market scrutiny.

On the other hand countries like Japan and Germany, take primarily stakeholder claims into account when making top management decisions, the core corporate aim is job security. An example is Canon in Japan, has at no time laid off workers in its whole history, in spite of all difficulties which they have faced over the years.

The assumption is that a set of mutually reinforcing institutional elements determines corporate governance.

Debates on Shareholder-Stakeholder theory and how to bridge the gap

A key principle of stakeholder concept unfortunately time and again gets lost in the arguments about its advantages, taking all an organisation’s constituents into account, that is, on some level in the practice of strategy formulation can be financially beneficial for the firm. Time and again, activists of the stakeholder theory often move away from this vital objective, instead concentrating on the significance of non-financial market stakeholders at the detriment of the company’s owners. The good and positive thing about the two theories is that they both detect the significance of a business’s financial success just that they promote different ways to that end. The stakeholder and shareholder theories are both theories that emphasize on creation of value for the firm. They are also both centred on the notion that businesses should as much as they can create value if it is within the confines of the law.

Stakeholder concepts vary from shareholder concepts, nevertheless, in identifying the fact that a business can maximize value by understanding how it is affected by and how it affects all its various constituencies. Also, the shareholder theory is apparently antagonistic toward activities that do not directly have any bearing on the organization’s lowest line, whilst the stakeholder theory rotates round the decision-making of entire workforce and also ethics. Stakeholder theory advocators are of the notion that in running a business there should be thoughts on ethical implications on others and vice versa.

The stakeholder theory can assist firms reach that goal perhaps very successfully than shareholder theory by evaluating variables like the quality of products and services, good business repute, reliable suppliers, cooperative financiers and helpful communities. To be brief, stakeholder theory acknowledges that firms have the potential for maximizing profit by creating a vibrant, long-term reputation amid stakeholders and by addressing interests and of real needs of such parties.

It can be said that stakeholder theory is a continuation of the shareholder theory and that its larger structure and understanding of the organizations relations with society at large can really produce better performance for the firm and thus, create more benefits for society at large. It can be sensible to assume that people can be both self-enlightened and self-interested, thereby generating the prospect for the merging of stakeholder and shareholder concept into one suitable theory.

Conclusion

Building a strong business advantage involves developing interactions with key stakeholders. Stakeholder management may be complementary to shareholder value creation and may indeed provide a basis for competitive advantage as important resources and capabilities may be created that differentiate a firm from competitors. On the other hand, participating in social issues may be seen at best as a transactional investment easily copied by competitors.

Basically, if a specific stakeholder is essential to the success of a business in the future, there should be more attention given to that stakeholder. In the same way, if the success of a business in future will be affected by the government, there should be allocation of resources to deal with it, instead of complaining and expecting that government will leave.

Management must embark on a willing effort to deal with governments in a planned manner, though sometimes it is difficult to do so. If an activity is directly tied to stakeholders, then investments may benefit not only stakeholders but also result in increased shareholder wealth.