Corporate Governance Policies: Shareholder And Stakeholder Approach

Purpose

Discuss about the Corporate Governance Policies.

The corporate governance policies implemented by a company ensure that the corporation is fulfilling interest of each stakeholder. The directors are responsible for ascertaining the importance of each stakeholder, and they have to formulate regulations that are focused on the satisfaction of their interest. Traditionally, the theorists provides that maximisation of shareholders interest in the primary goal of an enterprise. Shareholder theory asserts that the shareholder faces the primary risk in a firm by investing their capital, therefore, it is the moral duty of directors to maximise their return. The stakeholder theory ensures that the directors do not violate the moral rights of different stakeholders in a firm and equal balance should be maintained between the interest of shareholders and stakeholders. A company can benefit a large section of society by implementing a broader approach. This report will analyse various article on shareholder and stakeholder approach to determine their role in the development of company and community. The benefit of stakeholder approach over the society will be discussed in the report as well. Further, the report will evaluate theories of justice to analyse the moral duties of directors towards the stakeholders and provide a few suggestions for better implementation of stakeholder approach.

The main purpose of this report is to review the articles on shareholder and stakeholder approach to analyse their impact on a company. Mainly the report will focus on theories given by R. Edward Freeman and Milton Friedman to understand the social responsibility of an organisation towards different stakeholders. Further, the report will examine the influence of adopting a stakeholder approach by an enterprise over the welfare of society. Many theories of justice will be discussed in the report to understand the moral and ethical duties of the company towards its stakeholders. The secondary purpose of this report is to analyse various theories of corporate social responsibilities and provide recommendations to directors for better implementation of stakeholder theory.

Mainly, the report will focus on studies of R. Edward Freeman and Milton Friedman regarding shareholder and stakeholder approach and its impact on corporation’s performance. Various other theories of corporate governance will be included in the report to understand the responsibility of directors towards stakeholders. The thematically approach is adopted in the report to review various studies of the theorist.

According to Ferrell & Fraedrich (2015), a company is an artificial person created by the association of peoples to carrying on a commercial activity, the capital of the corporation is divided into small parts called shares, and people who invest their money into companies business is called shareholders. Previously, it was considered that a firm is liable towards its shareholders because they face the primary risk in an enterprise. Therefore, the directors should prioritise the interest of shareholders and formulate strategies to maximise the value of shareholder’s stock; this theory is called ‘shareholders’ primacy’. As per Shah & Bhaskar (2007), due to the advancement of technology, regulations, and policies, modern companies did not prefer to implement a shareholder primacy model. For decades, maximising shareholders return was the primary focus of companies, this goal has been an inextricable factor of legislation in modern communities. In recent years, the growing popularity of stakeholder approach has challenged the perception of shareholder primacy model. The companies adopt stakeholder approach rather them shareholder primacy model because it assists firm in fulfilling their social responsibilities. According to Smith (2003), the fundamental distinction provides that company should always focus on fulfilling the interest of stakeholder even if it reduces the corporation’s profitability.

Scope

Friedman (2007) argued in his paper that the theory of stakeholder interest is against the growth of an enterprise, it is disadvantageous for the future progress of a firm. A company is an artificial person, therefore, it has “artificial” responsibilities, only human beings are socially responsible towards the society. Friedman (2007) stated in his article that the policy of stakeholder approach is started by trade unions and socialist groups to justify the activities of a company which is against its core values. A company is formed to satisfy the requirement of shareholders since they face the primary risk in a firm. Friedman (2007) provided that executives are the agent of shareholders and their primary responsibility is towards them. Boatright (2006) gives a similar theory in his article by providing that managers are not liable towards stakeholders, the directors failed to appreciate the benefit of shareholder primacy and how it benefits the interest of other stakeholders. Boatright (2006) argued that it is not the responsibility of directors to formulate stakeholder-based policies in the firm, the shareholder primacy model automatically benefit the interest of multiple stakeholders.

Freeman, Harrison, & Wicks (2007) argued that the directors are not just answerable to shareholders, it is their duty to consider the interest of each individual or group to which affected by the operations of an organisation. The role of corporations is not just “doing business” anymore; the process of manufacturing has changed by the advancement of technology such as assembly line, which requires specialisation and hard work on employees to work correctly. According to Post (2003), while operating business in domestic or international markets, company has to follow new regulations provided by the government. The ownership of companies has become more dispersed because the corporations have the option to raise capital from different sources such as banks, financial institutes, and shareholders. Freeman, Harrison, & Wicks (2007) stated that it is necessary that directors satisfy their employees, unions, government, investors, and shareholders to become successful, therefore, effective stakeholder management policies are required in a company. The ‘managing of stakeholders’ means creating as much value as possible for multiple stakeholders, without resorting to compromises. The directors manage the corporate governance of a company, therefore, it is their duty to formulate policies for the satisfaction of multiple stakeholders’ interest.

Jensen (2002) argued that stakeholder theory should not be considered as valid because it does not focus on the satisfaction of fundamental corporate principles of a company. There is clarity in having a single objective model, such as shareholder primacy theory because stakeholder approach creates confusion, dispute, unproductivity and competitive failure of the company in the market. Another concept of ‘Director Primacy Model’ is provided by the Bainbridge (2005), this model provides that directors are responsible for establishing corporate governance objectives, therefore, they should have the power to ensure relevancy of each stakeholder. The shareholders should not review the director’s decision and the directors should focus on maximising shareholder stock value. This model has multiple flaws such as lack of review mechanism, no preference to creditors’ interest and no method to measure good faith of directors. According to Coelho, McClure & Spry (2003), the modern corporations are not just profit machines; they have a social responsibility towards different sections of society and directors should formulate policies for the satisfaction of stakeholders’ interest. The growth of an enterprise is directly linked to the satisfaction of stakeholders’ interest; the directors should fulfill their ethical duties by satisfying the benefit of stakeholders.

Literature Review

The stakeholders in a corporation can be defined as individual or group who influenced or get affected by the achievement and failure of a firm. According to McVea & Freeman (2005), a stakeholder invests money into firm’s operations and gets directly or indirectly affected by the actions of the enterprise. Stakeholders are divided into three categories: primary, secondary and excluded. The primary stakeholders have economic relationships with the firm, and they directly affected by the practices of a corporation. The primary stakeholder includes shareholders, employees, creditors, consumers and many others. The secondary stakeholders did not have any financial interest, but they get affected by actions of a firm. The example of secondary stakeholders is society, media, public and many others. The excluded stakeholders neither have a financial interest, nor they get affected by company’s actions, but their opinion has significant influence over enterprise’s operations. The excluded stakeholders include government, socialist groups, environment and many others.

The primary and secondary stakeholders include a large part of society, and they assist company into attracting a large number of shareholders. It is necessary that directors satisfy the stakeholders’ interest to benefit various sections of society. As per the research of Martin (2010), a company cannot satisfy consumer and shareholder at once because it is impossible to meet two variables. The director’s preferred shareholders approach but the satisfaction of stakeholders’ interest attracts a large number of a shareholder in a company. Zhang, Dawes & Sarkis (2005) provided that the return of shareholders is determined after reduction of statutory payments such as taxes, wages and interest on debts; therefore, shareholders focus on future profits rather than present value. The directors can attract shareholders by enhancing future profits of a company which can only be achieved by fulfillment of stakeholders’ interest. The stakeholders approach equally distributes the capital between a society which assists in the development of communities and corporation, and it is the responsibility of the firm to satisfy the interest of stakeholders.

As per Ekvall, Tillman & Molander (2005), the normative ethics examine the beliefs of a person; they are part of theoretical ethics. The normative ethics inspect the rightness or wrongness of an opinion, for example, if a person believes that stealing is incorrect than normative ethics analyse is it correct to hold such beliefs. Rawls (2009) describe justice as “fairness” of the acts; he further provided two concepts of justice. The first principle provides that equal freedom should be given to each individual and second provision retrain discrimination between parties unless it is the necessary to the benefit of minorities. The company should consider the interest of each stakeholder as equal, and directors should avoid discrimination to ensure proper implementation of justice theories. In shareholders primacy model, a company uses the peoples (other than shareholders) as a “means” to achieve the value maximisation of shareholders, the stakeholders of corporations are a means to an end that is increasing shareholders value.

Benefit of Society by Stakeholder Approach

According to Jones, Felps & Bigley (2007), Immanuel Kant provided that it is morally wrong of a company to use stakeholders merely as a means to an end, the peoples should always be treated as an end. As per ‘Kantian view’ theory, each stakeholder has an equal position in a company and directors should not discriminate in their interest, in order to achieve the benefit of one section, the interest of other parts should not be violated. The Utilitarian theory is opposite of Kantian view model; it provides that it is not the duty of directors to consider the interest of stakeholders. The directors have agent principle duty towards shareholders, and they should perform every such action which is necessary for maximising their value, by following the law.

The stakeholders’ interest will automatically fulfill by maximisation of shareholder value. Many theorists believe that this theory has no practical use in modern corporations since satisfaction of stakeholders assist in shareholders’ value maximisation. Rawls (2009) emphasis on equal wealth distribution between peoples because it assists in the overall development of the society. The directors have a duty of care and loyalty towards different stakeholders, the duty of care is analysing the interest of each stakeholder while formulating corporate governance policies. The duty of loyalty provides that directors should take appropriate actions to avoid the conflict of interest of various stakeholders. These duties force directors to fulfill the moral responsibilities of the company and ensuring that the firm adopts stakeholder approach.

Several theories apply stakeholder approach in a company and assist in the fulfillment of moral duties of a corporation. In recent times, corporate social responsibility approach is significantly popular among modern enterprises. According to Matten & Moon (2004), the corporate social responsibilities implement various environmental and social measures into the framework of a firm which ensures that interest of different stakeholder being fulfilled by the company. The CSR policies focus on fulfilment of statutory principles along with the improvement of the society. There are numerous benefits of implementing CSR policy such as brand recognition, positive image, higher sales, ease in attracting investment and better retention of qualified employees. Another theory is ‘Creating shared value’ model; it focuses on connecting competitive advantage with the CSR principles because it establishes health competition in the market.

Porter & Kramer (2011) stated that the director could apply Creating shared value theory by implementing a specific mechanism, such as reorganisation of objectives, redefining of products, and better serving in markets. The director can also apply a circular economy approach which can be beneficial for the corporation and society. According to Lieder & Rashid (2016), the circular economy implements a regenerative system improve the impact of the company on community and environment. Various methods can be executed by the company, such as recycling, reusing, manufacturing better products, repairing and maintenance, which assists in the reduction of wastage, saving energy and better utilisation of resources. In case of modern corporations, the stakeholder approach is more beneficial since it helps in sustaining the future development of the firm.

Conclusion and Recommendations

In conclusion, adopting a stakeholder approach is beneficial for modern corporations because of its multiple benefits; it also assists companies in fulfilling their duties towards society. The enterprises have numerous responsibilities towards society, therefore, they cannot adopt a shareholder primacy approach since it is discriminating against other stakeholders. Various sections of society are benefited due to the implementation of stakeholder approach by a firm. As per the theories of justice, the directors have a duty of care and loyalty towards stakeholders, and they should ensure that equal benefits are provided to stakeholders. The directors can implement various approaches, such as circular economy, CSV, and CSR, to ensure that company fulfills the interest of its stakeholders.

As per my recommendations, the company should change the focus from shareholders primacy approach by altering the terms such as “maximising shareholders value” to “maximising company’s values”. The proper examination of company’s operations should be performed by the directors to evaluate the number of stakeholders and their requirement. The directors should ensure that an adequate stakeholder approach is implemented by the company to fulfill its moral responsibilities towards the society. The director must analyse any external or internal factor which affects the interest of stakeholder, and proper regulation should be made regarding such elements. The directors should also continuously monitor the corporate social responsibility principles and update them as per the requirements.

References

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Boatright, J. R. (2006). What’s wrong—and what’s right—with stakeholder management. Journal of Private Enterprise, 21(2), 106-130.

Coelho, P. R., McClure, J. E., & Spry, J. A. (2003). The social responsibility of management: A reprise. American Journal of Business, 18(2), 51-56.

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Ferrell, O. C., & Fraedrich, J. (2015). Business ethics: Ethical decision making & cases. Nelson Education.

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Post, F. R. (2003). The social responsibility of management: A critique of the shareholder paradigm and defense of stakeholder primacy. American Journal of Business, 18(2), 57-61.

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