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Shareholder & Stakeholder Theories Of Corporate Governance

Posted by Corplaw Admin on Jul 16, 2013 9:30:00 AM

6 Shareholder The Cadbury Committee 1992 defined corporate governance as "the system by which companies are directed and controlled." Numerous theories have been proposed on corporate governance best practice, none more popular than the shareholder and stakeholder theories.

Shareholder Theory

The shareholder theory was originally proposed by Milton Friedman and it states that the sole responsibility of business is to increase profits. It is based on the premise that management are hired as the agent of the shareholders to run the company for their benefit, and therefore they are legally and morally obligated to serve their interests. The only qualification on the rule to make as much money as possible is “conformity to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

The shareholder theory is now seen as the historic way of doing business with companies realising that there are disadvantages to concentrating solely on the interests of shareholders. A focus on short term strategy and greater risk taking are just two of the inherent dangers involved. The role of shareholder theory can be seen in the demise of corporations such as Enron and Worldcom where continuous pressure on managers to increase returns to shareholders led them to manipulate the company accounts.

Stakeholder Theory

Stakeholder theory, on the other hand, states that a company owes a responsibility to a wider group of stakeholders, other than just shareholders. A stakeholder is defined as any person/group which can affect/be affected by the actions of a business. It includes employees, customers, suppliers, creditors and even the wider community and competitors.

Edward Freeman, the original proposer of the stakeholder theory, recognised it as an important element of Corporate Social Responsibility (CSR), a concept which recognises the responsibilities of corporations in the world today, whether they be economic, legal, ethical or even philanthropic. Nowadays, some of the world’s largest corporations claim to have CSR at the centre of their corporate strategy. Whilst there are many genuine cases of companies with a “conscience”, many others exploit CSR as a good means of PR to improve their image and reputation but ultimately fail to put their words into action.

Recent controversies surrounding the tax affairs of well known companies such as Starbucks, Google and Facebook in the UK have brought stakeholder theory into the spotlight. Whilst the measures adopted by the companies are legal, they are widely seen as unethical as they are utilising loopholes in the British tax system to pay less corporation tax in the UK. The public reaction to Starbucks tax dealings has led them to pledge £10m in taxes in each of the next two years in an attempt to win back customers.

Enlightened Shareholder Value - A Happy Medium?

Enlightened shareholder value (ESV) states that “corporations should pursue shareholder wealth with a long-run orientation that seeks sustainable growth and profits based on responsible attention to the full range of relevant stakeholder interests”.Essentially, it focuses on generating shareholder value, whilst having regard to the long term external impacts of the wealth generation.

The importance of the concept was recognised in the UK when it was adopted into law in the Companies Act 2006. The move represents an important development in corporate governance and a clear move away from the shareholder theory.

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Topics: Corporate Governance, Shareholders