Corporate Governance Principles And Social Responsibility: Shareholder Vs. Stakeholder Approach

Purpose

Discuss about the Corporate Governance Principles and Social Responsibility.

Corporate governance is the set of activities and regulations by which board of directors direct and manages the operations of a company and ensures fairness, responsibility, and transparency in corporations while dealing with its stakeholders. The stakeholder of a firm includes consumers, government, shareholders, investors, creditors, environment, community and many others. Many modern organisations have adopted corporate social responsibility policies to ensure the satisfaction of multiple stakeholders but, many experts believe that it reduces a corporation’s performance and growth. The stakeholder approach is based upon various theories of justice, ethics, and morality and it has a positive impact on the society.

Many experts support the stakeholder approach by stating that company is not a profit machine, it has several moral duties towards society and stakeholders. There are several stakeholders’ theories that can be applied by the directors; these theories focus on fulfilling the requirements of multiple stakeholders. This report will analyse various articles on shareholder and stakeholder approach to understand their influence and importance in a corporation’s growth. The impact of stakeholder approach over society will be discussed in the report as well. Further, the report will evaluate multiple theories of justice and corporate governance to understand their impact on a company.

The key purpose of this report is to analyse the articles provided by multiple experts regarding shareholder and stakeholder approach. The primary focus of the report will be in the articles submitted by Milton Friedman and R. Edward Freeman (and others) regarding the stakeholder and shareholder approach. Further, the report will also discuss benefits of implementing a broader view by a firm. The report will evaluate various theories of justice to determine the social role of a company towards the development of society. The report will analyse multiple corporate social responsibility theories that can be applied by directors in a firm for the fulfillment of their social responsibility. The report will provide few suggestions that can be implemented by directors for effective implementation of corporate governance.

The report primarily focuses on articles, journals, books or studies provided by experts regarding shareholder and stakeholder theory. The articles submitted by Milton Friedman and R. Edward Freeman will be the primary focus of the report. Many other opinions and researches conducted by theorist will be discussed to understand the role of corporate governance in a firm

A shareholder is an individual, corporation or any other institution that invest its money in the shares of a company, the shareholders are considered as the owner of an organisation, and they benefit and loss based on the performance of the enterprise. As per Ayuson and Argandona (2009), the directors are responsible towards shareholder, and they must maximise the value of shareholders. Many theorists believe that the primary objective of a company is to maximise the profits for its shareholders. However, many articles and academic journal assert that modern corporations prefer to adopt a stakeholders strategy. The shareholder theory has been widely challenged in previous few years; many experts believe that solely focusing on profit maximisation is wrong and immoral. The concept of corporate social responsibility is prominent in between modern companies; the CSR theory provides that a company has moral duties towards its multiple stakeholders. Smith (2003) argued that both stakeholder and shareholder theories are normative concepts that mean they contain a provision regarding what corporation role ought to be. According to Cooper (2017), today’s modern firms can expand their business in different companies and their actions considerably affect various sections of society, therefore, implement stakeholder policy is an oversimplification of the complex role of organisations.

Scope

Friedman (2007) argued that it is wrong to consider that a company has “social responsibilities” towards the society, a firm is an artificial person and it has artificial responsibilities. The primary role of a corporation is to satisfy their shareholders’ needs because they invest in the enterprise and face the risk of loss. The purpose of directors should be clear; they should perform actions by complying with the common law to maximise the value of shareholders. Friedman (2007) stated in his article that unless a company is incorporated for a particular non-profit purpose, such as a hospital, welfare institute or school, its primary focus should be profit maximisation. According to Fisch (2005), if director implement the social responsibilities approach, then company’s primary focus shifted from profit making to the welfare of society, which can be detrimental to the development of an enterprise. The shareholders face major risk in an organisation because they invest their capital in company’s stock. Therefore, the directors should only focus on enhancing the shareholder value. As per Friedman (2007), the stakeholder’s interest should be secondary in a company because without fulfilling the benefit of the shareholder, the company cannot satisfy its objectives.

Friedman (2007) argued that the concept of corporation’s “social responsibility” is provided by the trade unions and activist groups to justify the transaction of a company which will not be otherwise benefited from its interest. Boatright (2006) provided that for achieving the growth in business, it is necessary that the company fulfills the requirement of stakeholders, but, he argued that it is not the duty of directors to create policies regarding the same. The directors are an agent of shareholders, and their primary focus should be improving the value of shareholders, the interest of other stakeholders should not be the concern of directors. If the shareholders’ value increases in a company, the interest of other stakeholders fulfilled through the market. According to Boatright (2006), the directors should not formulate corporate policies for the stakeholders; they can achieve that by focusing on shareholders interest. A different theory was given by Freeman, Harrison, and Wicks (2007); they provided the importance of stakeholders in a company and its positive impact on the company’s operations. The growth in corporations increased their impact on the society; the companies have a moral duty to satisfy the interest of various sections of the community.

Freeman, Harrison, and Wicks (2007) stated that it is the responsibility of directors to ensure that actions of the company are fulfilling the interest of various stakeholders. Effective policies of corporate governance are necessary for a company to ensure satisfaction of their stakeholders, and directors should formulate plans to ensure satisfaction of multiple stakeholders. Many theorists have also provided different theories from shareholder and stakeholder approach. Bainbridge (2005) presented a theory called ‘Director Primacy Model’ which provides that directors are responsible for the activities of corporate governance, therefore, they should be in the center of a firm. To maximise shareholder value, directors should be able to decide in a corporation without review from any other parties; the shareholders should not have the power to review the decision of directors since it retrains their power to operate a business efficiently. Another similar theory was provided by Million (2010) called ‘Enlightened Shareholder Value’. The theory focus on improving the shareholders’ worth by providing absolute power to the directors of a firm, the director’s power is original, and it cannot be delegated to any other parties.

Literature Review

According to Parmar et al. (2010), the director’s best understand business, therefore, they should be able to decide the relevancy of each shareholder and formulate policies according to such relevancy. These theories did not popularise because there have several flaws, such as the theory did not consider the interest of creditors or give them relevance. There is lack of proper safety mechanism if directors decide to take unfair advantage of their powers and there is no method of measuring “good faith” of directors. As per Jensen (2002), it is not beneficial and productive for a company to argue over the importance of shareholder and stakeholders, both parties are depending upon the performance of an organisation which can be achieved by implementing stakeholders’ approach. Stout (2013) argues that the directors should focus on value maximisation of stakeholders and formulate policies achieve such objectives. The role of modern corporations has increased due to the advancement of technology, regulations, and governments. The directors should ascertain their moral duty towards society and formulate corporate policies to achieve such objectives.

Many theorists criticise the shareholder approach and enforce the implementation of stakeholders approach in modern corporations and provide that without fulfillment of stakeholder’s interest a company cannot achieve growth. As per Laplume, Sonpar, and Litz (2008), a stakeholder includes individual, organization or any other institute that has a financial interest in the operation of a firm or gets affected by the practices of the company. The example of stakeholders includes employees, consumers, government, environment, creditors, shareholders and many others. The stakeholders are categorised into three parts: primary, secondary and territory. The primary stakeholder is an integral part of a company; they have a financial interest in the performance of a firm and loss or gain based on the return of an enterprise. The example of primary stakeholders’ includes consumers, employees, shareholders, creditors, investors and many others.

The secondary stakeholders did not have any financial interest in business operations, but they get influenced by the performance of a company, they are also called external stakeholders. The secondary stakeholders include media, community, public and many others. According to Sweeney and Coughlan (2008), the tertiary stakeholders’ neither have any financial interest in a company, nor they get affected by its operations but their opinions positively or adversely influence the company’s performance. The example of tertiary stakeholders includes activist groups, government, environment and many others. A significant part of society gets covered in primary and secondary stakeholders, which prove that actions of a company influence a large section of society. Modern corporations are focusing more on stakeholders’ interest due to the popularity of corporate social responsibility provisions, the concept of a company being profit making machine is changing slowly in the market. The corporate social responsibility principles ensure that directors formulate policies regarding the satisfaction of multiple stakeholders’ interest.

As per the study of Martin (2010), two variables cannot be satisfied at a single time that means a company cannot meet consumer and shareholder interest at the same time. The satisfaction of shareholders will hurdle in benefit of consumers and vice versa. Usually, directors prefer to fulfill the interest of shareholders because it attracts more shareholders’ investment, but according to Martin (2010), that is a wrong approach. The dividend of shareholders is provided after the reduction of statutory payments such as salaries, the interest on loans and taxes. The shareholders focus on future profit of a company instead of present value, for attracting a large number of shareholders the companies are required to sustain their growth. As per Greenwood and Van Buren (2010), it is impossible for companies to maintain their development for an indefinite period; therefore they should focus on improving stakeholder’s value instead of enhancing shareholders worth. The improvement in stakeholders’ value will allow the companies to attract a large number of investments from the shareholders which will assist in sustaining the growth of the business.

Manners (2008) stated that the normative ethics is related to the philosophical ethics which focus on examine the moral and ethical practices. The normative ethics analyses the rightness and wrongness of an ethical belief, it performs an empirical study into the view of peoples. For example, if individual beliefs that conducting fraud is wrong that the normative ethics evaluate that whether it is right or wrong to hold such an opinion by a person. The justices are defined as “fairness” by Rawls (2009); he stated that justice is divided into two parts. The first part provides that society should be strutted in a way to ensure that each section has equal liberty; another party must not infringe the rights of a person. The second part prohibits the discrimination between individuals in a society unless it is necessary to discriminate a minority party to provide them benefits. Rawls (2009) also ensures that the person who possesses power must not prohibit the opportunity of another party for gaining such strength.

According to Bowie (2017), the ‘Kantian View’ theory by given by Immanuel Kant which focuses on the equal status of stakeholders’ in a company, the directors should ensure that company is formulating necessary policies for the satisfaction of all stakeholders’. These theories focus on director’s responsibility towards stakeholders and the requirement of better social responsibility policies in a company. The theories focus on the moral responsibility of directors and the role of stakeholders’ in a company. Many theorists have provided opposite views over the same matter, for example, Jeremy Bentham’s Utilitarian theory. As per Renouard (2011), the Utilitarian theory provides an opposite view over the Kantian theory which provides that instead of focusing on achieving stakeholders’ interest, the director should perform their duties within the law. The maximisation of shareholders’ value assists in satisfaction of the interest of other stakeholders; directors are not required to formulate specific policies for different stakeholders. Numerous experts have criticised the Utilitarian theory; they believed that this approach could not be applied to modern corporations since it does not have any practical use.

According to Rawls (2009), by distributing the wealth more equally (not evenly) between stakeholders’, a company can sustain their future development. If the company only focus on improving shareholders’ value than the resources will only be provided to the shareholders, and it creates a problem of discrimination. The discrimination between stakeholders’ reduces the growth of a company because it reduces its reputation and business. By efficiently implementing corporate governance principles, the directors can satisfy the interest of stakeholders. As per Zakhem (2008), the directors have a duty of care toward multiple stakeholders that means it is their responsibility to ensure that equal protection is given to each stakeholder. The directors have a fiduciary duty towards the company which requires them to perform their actions morally and in good faith of the corporation. Directors should avoid the discrimination in an organization, and strict policies should be implemented to prevent any mistreatment of stakeholder. Laczniak and Murphy (2012) stated that each stakeholder is a crucial part of a corporate structure and directors are morally responsible towards them; the corporate social responsibility principles ensure that directors analyse the requirement of stakeholders and formulate policies to meet such requirements. The duty of care must be fulfilled by the directors while performing their responsibilities of corporate governance.

To ensure the fulfillment of their duty of care, the directors can implement various approaches to corporate governance which provide proper achievement of stakeholder’s interest. According to Lee (2008), in modern times, the principle of corporate social responsibility is significantly popular between the corporations. The corporate social responsibility allows companies to incorporate policies of environmental and social welfare into the business structure. The CSR policies are self-regulated by the enterprises and directors construct such systems into corporation’s business structure. The CSR regulations assist companies in complying with various national and international laws regarding moral, ethical and legislative matters. Carroll (2008) stated that the CSR policies did not just focus on compliance of statutory rules instead it emphasis on the social responsibilities of a company towards the society. The CSR policy is benefited for international corporations since they deal with different domestic and international regulations and it ensures that the company fulfills each stakeholder’s interest. Mele (2008) provided that by implementing an efficient CSR model, a company can achieve various advantages such as positive reputation, improved trading, international brand recognition, better financial performance, and improved employees’ productivity. It also benefits enterprise in recruitment and retention process since it attracts and retains talented employees, the procedure of accessing investment also become more accessible for companies.

Bocken et al. (2016) provided that a company can adopt a ‘circular economy’ approach for improvement of business operations; it benefits the company in various ways such as reduction of wastage in raw material, saving of energy, and improved employees productivity. The company can achieve that by implementing various methods such as recycling, reuse of material, building long-lasting products, proper maintenance, and repair of machinery. According to Porter et al. (2011), the ‘Creating shared value’ approach is another theory which benefits directors into establishing a positive environment for the stakeholders. The CSV policy creates a link between competitive strategy and CSR principles, it allows in creating a healthy competitive environment in the industry. As per Banerjee (2008), the CSV value creates equal opportunities for different stakeholders and develops each section of society; it allows company into identifying and capitalise the financial and social development in the industry. These strategies allow the companies to fulfill their moral duties towards society and assist in the growth of the company. The role of modern corporations has enhanced, and the directors are responsible towards multiple stakeholders, by implementing these theories, the director can ensure the equal satisfaction of stakeholder’s interest in the company which benefits the society as well.

Conclusion and Recommendations

From the above observations, it can be concluded that the modern corporations have duties towards different stakeholders’. The benefit of stakeholders can improve the growth of a company, and it benefits various sections of society. Many theorists argued that stakeholders approach is detrimental to the growth of a company since it shifts the focus from profit maximisation. But, many studies have provided that stakeholder approach benefits enterprise in several ways which sustain its development such as improved reputation, positive brand recognition, and easy availability of investment. A company should adopt a broader view of business structure because it benefits various parts of society and assists the enterprise in fulfilling their social responsibilities. Various theories of justice also provide that directors have a duty of care towards its stakeholders, and they should formulate policies to satisfy the interest of stakeholders’. Directors can adopt many theories for the satisfaction of stakeholders’ interest such as CSV, CSR, and circular economy. These approaches assist modern corporations in fulfilling their social responsibilities and provide various benefits to the section of society.

As per my recommendation, a company should adopt stakeholder approach rather than shareholder primacy theory; it will assist in overall development of the firm and sustain future growth of the business. Before implementing stakeholders’ approach, the directors should analyse the number of stakeholders in the company and analyse their interest and requirements. The corporate policies should be according to the interest of stakeholders; the policies must equally cover the requirement of each stakeholder. Directors must ensure proper implementation of policies in the corporations, and they have to monitor the organisational environment constantly. The policies should be changed in case any external or internal factors affect the interest of stakeholders’. By implementing this approach, a company can fulfill its moral responsibility and assist in the development of society.

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