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Shareholder and stakeholder theory: after the financial crisis
Shareholder and stakeholder theory
Terence Tse ESCP Europe, London, UK
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Abstract Purpose – The recent financial crisis has restarted the debate of the value of both shareholder and stakeholder theories. This paper aims to continue this discussion. Design/methodology/approach – The paper reviews existing literature and examines the benefits and problems associated with these frameworks through the lens of the recent events which have taken place during the financial crisis. Findings – The main assertion of this paper is that shareholder theory is in itself a sound theory. Yet, some executives following this theory could have brought disrepute to it. In contrast, the stakeholder theoretical framework has yet to assert its influence because the concept is not yet unambiguously defined, which makes it difficult for the framework to become operational in practical business settings. Research limitations/implications – Future research should seek consensus on the scope and definition of the stakeholder model, as well as who the stakeholders should include. It should also focus on developing the tools and techniques necessary for the incorporation of stakeholder theory into business operations. Social implications – Policy makers could work with industry bodies and business leaders to encourage them to place greater emphasis on the interests of non-shareholders and encourage collaboration between various groups of stakeholders to achieve corporate goals. Originality/value – The paper continues the shareholder and stakeholder theory debate in light of the recent economic crisis. Keywords Shareholder value analysis, Stakeholder analysis, Financial services, Economic theory Paper type Research paper
1. Introduction In June 2009, more than 1,000 MBA students from several top business schools signed an oath that declared the rejection of the shareholder-oriented business approach and vowed to give equal importance to “shareholders, co-workers, customers and the society in which we operate” (Skapinker, 2009). Whether this is a knee-jerk reaction of MBA students to mitigate the blame of the latest economic crisis on senior executives or the pursuit of a new ideal is beyond the scope of this paper. However, it is clear that these students, among many corporate executives, are opting for the main contending alternative to shareholder- stakeholder theory. The debate between these two theories is not unprecedented. The scandals at Enron, Global Crossing, Tyco International and WorldCom sparked fierce debate as to which of these two theories is superior to the other (Smith, 2003). The decline of many seemingly successful UK banks before the latest financial crisis such as Northern Rock, Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS) reminded us that this debate is far from over. Indeed, in view of the various characteristics of the crisis, there is an urgency to continue this discussion. This paper aims to serve this purpose by reviewing some of the existing literature of both shareholder and stakeholder theories and discussing the benefits and problems associated with these frameworks through the lens of the recent financial crisis.
Qualitative Research in Financial Markets Vol. 3 No. 1, 2011 pp. 51-63 q Emerald Group Publishing Limited 1755-4179 DOI 10.1108/17554171111124612
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It concerns particularly the UK banking and financial services sector because this industry is considered to be one of the primary catalysts of this crisis. Perhaps, more importantly, the problems that plague this sector seemingly epitomise the misguided use of shareholder theory. The main assertion of this paper is that shareholder theory is in itself a sound theory and it is likely that some executives following this theory, rightly or wrongly, have brought disrepute to it. The stakeholder theoretical framework, on the other hand, has yet to asset its influence. It has not managed to supplant shareholder theory because the concept is not yet unambiguously defined, which makes it difficult for the framework to become operational in practical business settings. This paper is organised as follows: Section 2 first highlights the advantages of shareholder theory. It then discusses the disadvantages of the theory, primarily from the perspective of how this framework has been misused. Since executive remuneration and earnings benchmarks are connected to the creation of shareholder value, this section also examines how they could have further exacerbated such misuse. In Section 3, the advantages and disadvantages of stakeholder theory are subsequently discussed. The final section provides some concluding remarks, implications to policy makers and practitioners as well as recommendations for future research. 2. Shareholder theory and its criticism 2.1 Benefits of the shareholder approach Shareholder theory asserts that the primary responsibility of a firm is to maximise the wealth of its shareholders (Friedman, 1962). Using the capital that these fund suppliers have advanced, managers should invest in those projects which seek to create the maximum value for these investors. In the past 40 years, shareholder theory has enjoyed widespread support in the academic and industrial communities. One reason for this success is agency cost. Put forward by Jensen and Meckling (1976), the agency cost concept postulates that managers often fail to maximise profits unless shareholders invest time and money to create appropriate incentives and monitor the resulting behaviour. A generally accepted method to align the interests of managers with those of the owners is to measure the performance of management team against share price[1]. This can be achieved by supplying them with financial incentives (such as stock options) to commensurate their efforts in raising the value of the firm, and subsequently its share price. The problem, however, is that managers actually control neither the value of the firm nor share prices. Instead, they have control over those drivers which only indirectly affect share prices, such as strategy, costs, capital investment and human resource deployment, which, in turn, influences revenue, profits and returns on capital, as well as growth (Beinhocker, 2006). As a result, maximisation of shareholder value is often operational in the form of maximisation of the present value of all future cash flows. This can be demonstrated as equation (1) below: CFn r2g where V0 represents the value of the firm today, CFn all future cash flows, r the required return of the funds supplied or cost of capital and g the constant average growth rate. This equation suggests that managers can increase the value of the firm by either: . increasing future cash flows; or . lowering the cost of capital and/or improving growth. V0 ¼
Given that the model has a lengthy time horizon, it implies that shareholder theory carries a long-term goal of creating benefits (Danielson et al., 2008). In this respect, it supports Smith’s (2003) claim that the shareholder model is not, as some critics have claimed, geared towards short-term profit maximisation. This is perhaps why Rappaport (1997) argues that the ultimate test of corporate strategy as well as the only reliable measure of corporate performance is whether a company creates economic value for shareholders. Critics of shareholder theory often point to the fact that this model is restricted to generating benefits for shareholders; it effectively neglects the important role of those players in or around a firm, including employees, suppliers, customers, the government and society as a whole, all of which concurrently contribute to the success of any organisation. Advocates of stakeholder theory, such as Freeman (1994) and DesJardins and McCall (2004), stress that corporations should be managed in a way that serves the interests of all contributors, not solely the shareholders. Countering this proposition, proponents of the shareholder-oriented view, including Sundaram and Inkpen (2004), state that the aim of shareholder value maximisation can be manifestly advantageous to all stakeholders. This is because the cash flows from share ownership are strictly residual claims which are due only after all committed corporate obligations (such as payments to suppliers, wages and salaries to employees, interest and repayments to creditors and taxes to the government) have been met. Moreover, given that only residual cash flow claimants – i.e. shareholders – have the incentive to maximise the total value of the firm, it is natural for managers to obtain the maximum possible value for them. In the process, these managers effectively increase the size of the pie for all the stakeholders, thereby benefiting all constituencies (Sundaram and Inkpen, 2004). Furthermore, since shareholders are residual claimants, they bear most of the business risk within a firm. Consequently, it is perhaps most logical for managers to concentrate on creating value for these investors. 2.2 Problems with the shareholder approach Even though the shareholder model seemingly brings such superior benefits, there has been renewed criticism questioning its value after the financial crisis. As cited in the Financial Times (2009), Jack Welch describes it as a “dumb idea”, whereas Martin (2008), the Dean of the Business School at the University of Toronto, calls for the abandonment of the shareholder value framework. This paper argues that there is no inherent problem with the theory; rather the problem lies with its deployment. Recall equation (1) above, which shows two possible ways of increasing firm value: (1) expand future cash flows; and (2) lower the cost of equity and/or boost growth. Nevertheless, at the same time, as the model indicating to managers how to create shareholder value, it also exposes to them areas of exploitation for potential misuse, if not self-serving purposes. Expanding future cash flows. One of the most popular methods among the UK banks for augmenting future cash flows before the crisis was to increase revenues. Revenue improvement can be achieved in a number of ways, such as expanding asset-base organically and making acquisitions. Aggressive expansion in size for numerous major UK banks was made possible by the availability of easy and inexpensive credits.
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For example, the total assets of Northern Rock grew from £17.4 to £113.5 billion between 1998 – a year after its demutualisation – and 2007, the eve of the credit crisis (Shin, 2009). This represents an annual growth rate of 23.2 per cent. Northern Rock was not alone. The use of cheap credit enabled HBOS to be among the fastest growing banks in the world in the past several years (Armitstead, 2009) and become an established player in the UK mortgage market. By 2006, the bank held as much as 20 per cent of this market (HBOS Annual Report, 2007). These two examples highlight an important growth strategy for many UK banks before their collapse: over-dependence on the use of debt to fund revenues growth. According to the Bank of England (2008), through the use of leverage, major UK banks somewhat tripled their assets between 2001 and 2007. The use of debt therefore plays a fundamental role in the decline of many UK banks, which is discussed next. Lowering cost of capital and/or boosting growth. As shown in equation (1), debt allows companies to lower the cost of capital, leading to an increase in firm value. Fuelled by cheap and easily obtainable credits, banks substantially increased their leverage as a result. For instance, the debt-equity level of RBS increased from 60.1 per cent in 2005 to 86.2 per cent in 2008 (RBS Annual Report, 2008). On the other hand, HBOS raised its debt to equity ratio from 7.5x to 10.6x between 2004 and 2007. In monetary terms, the bank almost doubled the size of its debt between 2003 and 2007, with £112 and £231 billion, respectively. In the same period, total equity rose only from £296 to £436 billion (HBOS Annual Report, 2007), representing an increase of 47 per cent. In other words, growth in assets was not keeping up with the ever-increasing level of debt. In the case of Northern Rock’s aggressive expansion strategy, retail deposit accounted for 60 per cent of the bank’s liabilities (£10.4 billion) in 1998. However, by 2007, it had dropped to only 23 per cent (£24 billion), with the funding gap made up of securitised debt and lending (Shin, 2009). Before its collapse, Lehman Brothers’ debt level rose from $484.3 to $668.6 billion (a difference of $184.3 billion) between 2006 and 2007. At the same time, its level of equity only went up from $19.2 to $23.5 billion, representing a mere $3.3 billion increase (Lehman Brothers Annual Report, 2008). These examples illustrate some of the many cases in which banks were keen to use debt for funding growth. The enduring problem resulting from this is that while the increase in corporate size and cash flows could have created much value for their shareholders in the past decade, these banks appeared to have become overly dependent on credit markets to do so. For instance, HBOS was over-reliant on the debt markets for its growth, particularly the wholesale funding markets (Aldrick, 2008). The bank fell into what Huang and Ratnovski (2008) called the “dark side” of wholesale funding. In this scenario, banks use wholesale funds to aggressively expand their capabilities to lend, but, in turn, the expanded lending compromises credit quality. When the market is calm and measured risks are low, creditors will continue to provide the funding. However, these banks will suffer from liquidity problems when the market turns hostile – news of deteriorating asset quality and questionable longevity of the banks among others – as the wholesale funders withdraw their funding (Shin, 2009). As the markets shut, banks will struggle to make up of the financing gap. This eventually led to the demise of various UK banks, most notably HBOS (Aldrick, 2008; House of Commons Treasury Committee, 2009). A logical question to ask at this point is that given the risk to which the banks are exposing themselves, why have shareholders failed to identify such risk before
the financial crisis? One possible explanation is that shareholders are reluctant to question the actions of the managers when they are gaining substantial returns. This implies that investors are not always rational. Contrary to traditional economics that assumes investors are perfectly and deductively rational, recent studies have argued that investors do not always behave rationally (Lo, 2005). De Bondt et al. (2008) have demonstrated that investors have various biases regarding risk and different behavioural preferences. Basu et al. (2008) further argue that greed, exuberance, fear and herding behaviour have led investors to act in an irrational manner and make irrational decisions. All these observations may explain the fact that 94.5 per cent of the shareholders at RBS approved the bank’s disastrous acquisition of ABN Amro, even though both the acquirer and the target companies had already been in precarious financial situations at the time of entering the transaction (House of Commons Treasury Committee, 2009). 2.3 Incentives and adverse managerial behaviour As stated above, a fundamental mechanism of aligning the interests of shareholders with those of the executives is to link their remuneration to corporate performance. However, the effect of such incentive scheme remains unclear. For instance, prior research including Low (2008) has shown that executives tend to be more risk averse when their incentives are linked to the performance of the firm. In contrast, others such as Rajgopal and Shevlin (2002) and Sanders and Hambrick (2007) have indicated that incentive schemes such as stock options could induce managers to make not only larger bets but also high-variance bets. A corollary of these findings is that in their pursuit of higher share prices, incentive system may lead some managers to seek maximising their own personal gains and disregard the risk to which shareholders are exposed. The case that corporate performance-linked incentives may lead to adverse managerial behaviour can be illustrated by a simple example. Suppose a manager faces two investment opportunities. Both of these opportunities require a £10 investment at t ¼ 0. However, their outcomes in t ¼ 1 are potentially very different: investment A has a 16 per cent chance of obtaining returns of £150; otherwise, she will gain nothing. Investment B, on the other hand, yields a return of £30 with a 90 per cent probability of success and nothing otherwise: ( ( £150ð16%Þ £30ð90%Þ ; IB ¼ IA ¼ £0ð84%Þ £0ð10%Þ Calculating the expected returns for each investment opportunities, investments A and B will produce £14 (£150 £ 16%-£10) and £17 (£30 £ 90%-£10), respectively. Investment B is a more preferable choice since the expected profit is higher. What would happen if the manager receives a 30 per cent bonus of the profit? In this circumstance, the manager may be tempted to choose investment A over B, even though it is not in the shareholders’ interest to do so, because the potential personal gain is much higher. If it turned out to be a success, investment A will provide the manager with a bonus of £42 [(£150-£10) £ 30%], whereas in investment B, the most managers can obtain is £6 [(£30-£10) £ 30 per cent]. Given the higher level of personal enrichment garnered by investment A, the manager may choose to take more risk[2]. This illustration may explain why executives in numerous UK banks and even building societies could have greater incentive to make large bets even though it may not be in the interest of shareholders to do so.
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2.4 Over-confidence and adverse managerial behaviour A further complication is that managers may be more inclined to gamble if they are overly confident about their own abilities. Prior research has suggested that managers often display over-confidence when it comes to difficult tasks and over-estimation of their own abilities (Shefrin, 2007). Self-attribution can also reinforce individual confidence. Self-attribution refers to the “better than average effect”, suggesting that individuals believe they have above-average abilities (Taylor and Brown, 1988). A study by Russo and Schoemaker (1992) has demonstrated that managers have the tendency to believe that they actually possess more knowledge than their counterparts about their respective industries or companies. One potential problem with managerial over-confidence is that executives may have a higher tendency to engage in takeovers in order to expand revenues and pursue growth (Malmendier and Tate, 2008). Such inclination, in addition to the belief of their own capabilities, can be reinforced by their more optimistic predictions of outcomes, particularly when these executives believe that they hold control of these outcomes (Weinstein, 1980). Over-confident executives may also feel that they have superior skills and are more competent than others in extracting value from their acquisitions, which may lead them to either under-estimating the risks or over-estimating the synergistic gains associated with mergers (Doukas and Petmezas, 2007). The two authors further propose that executives with a successful history in acquiring companies may think that they are more experienced in managing acquisitions, which, in turn, might reinforce their tendency towards over-confidence. The financial crisis has shown that the shareholders may also be excessively confident over the abilities of the managers whom they hire. For instance, they may over-estimate the abilities of those managers who have a successful history in acquiring and integrating new firms. Consequently, they grant them more latitude to pursue future acquisitions. One of the best illustrations of over-confidence is RBS’s takeover of ABN Amro. The ability to cut costs in the previous merger of RBS and NatWest had awarded the necessary credentials to Fred Goodwin, then CEO at RBS, to follow an aggressive expansion strategy through acquisitions. The successful acquisition and integration of the three-times larger NatWest enabled the CEO to persuade shareholders to stretch the bank’s capital reserves to absorb ever-larger acquisition targets (Larsen, 2009). Aiming to repeat the success in the merger with NatWest, Goodwin decided to launch the ill-fated takeover bid for ABM Amro in 2007 (Larsen, 2007). An investigative report on the catalysts of the financial crisis by the House of Commons Treasury Committee has cited that such managerial hubris at RBS as a major reason for the disastrous bid for ABN Amro. At the time of the transaction, RBS had failed to recognise the scale of credit problems, as well as the amount of poorly performing assets in the target company. In short, RBS did not conduct proper due diligence and under-estimated the difficulties of absorbing the much larger bank. The ill-conceived takeover of ABN Amro was also attributable to RBS’s over-reliance on debt. Soon after the acquisition, the debt market dried up, leaving the acquirer with a severe funding problem. Previous studies have shown that over-confidence could lead managers to increase leverage (Heaton, 2002; Malmendier et al., 2006). Gombola and Marciukaityte (2007) further suggest that when managers are optimistic with their assessment of the investment outcomes, they are more inclined to finance with debt rather than equity. All these problems point to the fact that lucrative incentives, compounded by over-confidence and managerial hubris, can induce managers to make large and
risky bets. This implies that as long as managers are only lightly punished for doing so (such as merely losing their jobs but retaining all the compensations and bonuses, as in the case of Fred Goodwin) – i.e. a morally hazardous situation – there really is no particular reason for managers to put shareholders’ interest before their own. In other words, the shareholder framework can be opened up for misguided use as these managers can take the model as a convenient pretext to seek personal enrichments, all in the name of shareholder value maximisation. 3. The stakeholder approach 3.1 Benefits of the stakeholder approach The MBA oath mentioned at the beginning of this paper represents a shift from the shareholder-centred view to the stakeholder-centred one. Whereas, in shareholder theory, managers should take decisions that seek to create the most value for equity capital suppliers, the stakeholder framework places shareholders amongst the multiple stakeholder groups that managers must involve in their decision-making process (Clarkson, 1995; Donaldson and Preston, 1995). These stakeholder groups include internal, external and environmental constituents, who, like shareholders, can place demands upon the firm (Ruf et al., 2001). Prior studies have cited various benefits accrued to firms that pay more attention to all stakeholders rather than simply shareholders. For instance, as Choi and Wang (2009) point out, employees will work harder to enhance the firm’s effectiveness in stakeholder-orientated organisations. They also suggest that customers will increase their demand or pay premium prices for the firm’s products, while suppliers will be more willing to engage in knowledge sharing with the firm. Moreover, good relationships with stakeholders can be a valuable source of competitive advantage. Firms that follow the stakeholder approach are likely to develop firm-specific management practices that are customised to their stakeholders’ and organisational objectives (Russo and Fouts, 1997). As a result, stakeholder relationships are idiosyncratic to individual firms, making it difficult for rivals to imitate them in the short run, effectively boosting their competitiveness (Hillman and Keim, 2001). In contrast, managers who fail to establish good relationships with their stakeholders may suffer from certain financial repercussions. For example, companies that fail to fulfil their pension liabilities – the most senior liabilities in a firm’s capital structure – may deprive shareholders of any value created, since any cash generated would go into meeting such liabilities prior to being distributed to the residual claiming shareholders. This is likely to be particularly important after the financial crisis as the shortfall in pension liabilities in many corporations has widened. In this case, firms would need to maintain, if not strengthen, good relationships with all stakeholders to ensure they work harder and collaborate well to generate strong cash flows, which can subsequently be used to fund any pension gaps. All these observations suggest that firms that manage stakeholders will be well-rewarded financially. Findings from past research are also consistent with this view. Reviewing ten studies that tested the stakeholder theory, Laplume et al. (2008) have found seven of them reporting stakeholder management to be positively related to firm financial performance. This contrasts with the remaining three with one reporting negative relationship and two carrying mixed evidence. Additionally, in a more recent study, Choi and Wang (2009) have demonstrated that stakeholder relations are positively associated with the persistence of superior financial performance.
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3.2 Problems with the stakeholder approach Nevertheless, stakeholder theory is not without its problems. For a start, managing multiple stakeholder relations implies the need to have multiple constituencies and simultaneously juggle several goals. This is problematic because having more than one objective is a recipe for potential confusion (Sundaram and Inkpen, 2004). Jensen (2002, p. 238) goes even further and argues that numerous objectives is equal to having no objective at all, because: [. . .] telling a manager to maximise current profits, market share, future growth in profits, and anything else one pleases will leave that manager with no way to make a reasoned decision. In effect, it leaves the manager with no objective.
The second problem is that while there has been extensive research describing and discussing stakeholder theory, there remains a dearth of studies showing managers how they can make it operational. This is an arduous task, not least because there is uncertainty regarding the actual scope of the stakeholder model. As Phillips et al. (2003) put it, despite the fact the term stakeholder is an all-encompassing one, it means different things to different people due to its conceptual breadth. For example, traditionally, stakeholder theory is viewed from the corporate perspective, i.e. taking care of the stakeholders is a managerial issue (Donaldson and Preston, 1995). Yet arguably, unlike the shareholder theory, the stakeholder framework does not necessary rely on a uni-directional relationship. For instance, Frooman (1999) suggests that stakeholders can also manage a firm to enable themselves to achieve their interests, rather than simply responding to the management of the firm. In other words, management does not have a monopoly on the strategy design: the stakeholders can also influence the formulation of a firm’s strategies. In addition to shareholders and stakeholders, it has been proposed lately that there can be a third dimension to consider. This involves viewing and analysing the theory from different vantage points, ranging from the perspectives of the philosophy of Aristotle and the “Common Good”, human rights, environmental protection (Streuer, 2006), social issues (Wood, 1991) and sustainable development (Sharma and Henriques, 2005; Streuer et al., 2005). A conclusion drawing from this cursory inspection of existing literature is that the actual scope of the theory is far from properly defined. Indeed, it is not only troublesome to establish the scope of stakeholder theory, it is also difficult to identify who the stakeholders should actually be. For example, in their comprehensive survey of academic literature on stakeholder theory in the past 20 years, Laplume et al. (2008) have found that there is a wide spectrum as to who the stakeholders ought to be. The range stretches from those who yield power over firms (Frooman, 1999) to non-human entities such as trees (Starik, 2005) and religious Figure (Schwartz, 2006). A further challenge is that even if the scope and the stakeholders are clarified, it remains unclear as to how value created by an organisation can be fairly distributed to the constituents and how to avoid the aforementioned managerial opportunism and adverse behaviour under the rubric of shareholder theory. While these different dimensions of viewing stakeholder framework offer a rich ground for debates, they show that there remains a lack of consistency within stakeholder theory. Consequently, unlike shareholder theory that has a clear recipient and a well-defined goal, it is yet unclear as to how managers can best put stakeholder theory into practice. Indeed, the need to serve the interests of multiple stakeholders
makes this framework inherently difficult to implement (Gioia, 1995; Kaler, 2006; Kochan and Rubenstein, 2000). This is further complicated by the fact that most management tools today are designed for creating shareholder value through direct and indirect control of the drivers that affect share price (Grant, 2009). On the contrary, the necessary tools and techniques to implement and monitor stakeholder management in real business situations are yet to be developed. As Phillips et al. (2003) suggest, it is necessary to introduce new methods to help align the interests of practicing stakeholder managers with those of their stakeholders. These tools and methods are important because without them, there is no guarantee that managers will respect obligations to their stakeholders. Table I summarises the benefits and problems of both theories discussed above.
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4. Implications, future research direction and concluding remarks This paper revisits the continuous debate of shareholder and stakeholder approaches. Similar to major corporate mistakes in the past, the scandals in the midst of the latest economic crisis raise questions about the validity and value of shareholder theory. In many ways, the decline of the major banks in the UK has led many critics of shareholder theory to call for it to be rendered obsolete. This is not surprising as the theory has the potential to encourage managerial hubris, reckless decision making and the excessive use of leverage. Nevertheless, this paper argues that while such a theory has many flaws, it still has validity. It also proposes that the concept of shareholder value itself is not a perpetrator in the financial crisis; instead, the origin of the crisis lies with those managers who misused the concept (Maubossin, 2009). Therefore, to restore confidence in shareholder theory, managers need to reflect on their own mistakes. This does not mean that stakeholder theory is by comparison flawless. It is incontestable that to maximise shareholder value, companies must maintain good relations with all of their stakeholders; however, difficulty remains in applying this Shareholder theory Benefits Clearly defined recipients – shareholders as the residual claimants
All constituents of an organisation – not simply its shareholders – can benefit from the value created by the corporations
Clearly defined goal for the managers – maximise shareholders’ value Problems Temptation for empire building (especially with Multiple recipients require multiple the use of debt) organisational objectives, which can create confusion for managers Reckless use of financial leverage Scope of the theory remains ill defined Excessive risk taking by executives induced by It is unclear who the recipients are managerial compensations, compounded by managerial hubris and over-confidence in one’s own abilities Current management tools and techniques are developed for the shareholder value framework – new ones for stakeholder theory need to be developed
Table I. Benefits and problems of shareholder and stakeholder theories
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theoretical concept to an actual business setting, not least because the scope of the theory is yet to be properly clarified and the stakeholders themselves identified. Consequently, the tools and mechanisms needed to put the stakeholder theoretical framework into practice are yet to be developed. It must be stressed that the need to combine shareholder and stakeholder theories is not merely an academic issue. As Beinhocker (2006, p. 409) said: Questions over whose interests corporations should serve lie at the heart of heated debates over corporate governance reforms, corporate social responsibility initiatives, antiglobalization protests, and the future of the European Union’s economic model.
This suggests that the debate is not only relevant to business executives, but also policy makers. Without properly taking both shareholders and stakeholders into account in the pursuit of company goals, it is possible that improvement in corporate governance and social responsibility, in particular the financial services sector, would be impeded. If this is the case, another financial crisis may occur in the future. To prevent the disaster from repeating itself, policy makers could work with industry bodies and business leaders to encourage them to place greater emphasis on the interests of non-shareholders. They would also do well to develop more collaboration between various groups of stakeholders to achieve corporate goals. Given its broader social implications, especially in the wake of the financial crisis, the effort to try and advance the field would be well spent. Indeed, even though this paper has drawn examples from financial services, the debate should not be confined to this sector; others may also benefit from the inclusion of the stakeholder perspective. For example, of late there appear to be signs that companies can improve corporate performance by taking the stakeholders’ interests into accounts. Paul Polman, the CEO of Unilever, recently commented that, “I do not work for the shareholder, to be honest; I work for the consumers, the customers [. . .] I don’t drive this business model by shareholder value” (Stern, 2010). Despite this claim, Unilever’s share price went from £13 to today’s approximate price of £20 during his last year in power. Taking this at face value, it seems possible for company executives to blend both the shareholder and stakeholder values, thereby creating benefits for all involved. The academic community can also play a vital role in bridging the shareholder-stakeholder gap. Future academic research should seek to develop a specific research agenda that calls for a consensus on the scope and definition of the stakeholder model, as well as an agreement on whom the stakeholders should include. Only then will it be possible to answer other prominent questions such as how to balance and prioritise the interests of different stakeholders. Moreover, as one of the major appeals of the shareholder framework is that it is easily quantifiable and measured through share price, researchers should explore new ways to better quantify stakeholder performance. These figures are likely to be important prerequisites for the development of the tools and techniques necessary for the incorporation of stakeholder theory into business operations. These are undoubtedly enormous undertakings for policy makers, practitioners and academics. However, this may very well be the price of the progress needed to integrate the two theories. It is hoped that the financial crisis and the attempts of MBA programmes to focus their attentions on serving the greater good will take us a step closer to completing this goal.
Notes 1. Technically, it should be the value of the firm. However, investors tend to use share prices as proxy as the information related to the latter are much more convenient to obtain. 2. The opposite can also be true: the manager may refrain from undertaking investment A because investment B provides more certainty that she would be obtaining the bonus. References Aldrick, P. (2008), “HBOS model was too dependent on wholesale funding, says Andy Hornby”, The Telegraph, September 18. Armitstead, L. (2009), “HBOS: how it ran out of road”, The Telegraph, February 14. Bank of England (2008), Financial Stability Report, Bank of England, London, October. Basu, S., Mahendra, R. and Hovig, T. (2008), “A comprehensive study of behavioral finance”, Journal of Financial Service Professionals, Vol. 62 No. 4, pp. 51-62. Beinhocker, E. (2006), The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics, Random House, London. Choi, J. and Wang, H. (2009), “Stakeholder relations and the persistence of corporate financial performance”, Strategic Management Journal, Vol. 39, pp. 895-907. Clarkson, M. (1995), “A stakeholder framework for analyzing and evaluating corporate social performance”, Academy of Management Review, Vol. 20 No. 1, pp. 92-117. Danielson, M.G., Jean, L.H. and David, R.S. (2008), “Shareholder theory – how opponents and proponents both get it wrong”, Journal of Applied Finance, Fall/Winter, pp. 62-6. De Bondt, W., Gulnur, M., Hersh, S. and Sotiris, K.S. (2008), “Behavioural finance: Quo Vadis?”, Journal of Applied Finance, Fall/Winter, pp. 7-21. DesJardins, J.R. and McCall, J.J. (2004), Contemporary Issues in Business Ethics, Wadsworth, Belmont, CA. Donaldson, T. and Preston, L.E. (1995), “The stakeholder theory of the corporation: concepts, evidence, and implications”, Academy of Management Review, Vol. 20 No. 1, pp. 65-91. Doukas, J.A. and Petmezas, D. (2007), “Acquisitions, overconfident managers and self-attribution bias”, European Financial Management, Vol. 13 No. 3, pp. 531-77. Financial Times (2009), “Shareholder value re-evaluated”, Financial Times, March 15, available at: www.ft.com/cms/s/0/293fc3c4-1196-11de-87b1-0000779fd2ac.html Freeman, R.E. (1994), Strategic Management: A Stakeholder Approach, Pitman, Boston, MA. Friedman, M. (1962), Capitalism and Freedom, University of Chicago Press, Chicago, IL. Frooman, J. (1999), “Stakeholder influence strategies”, Academy of Management Review, Vol. 24 No. 2, pp. 191-205. Gioia, D.A. (1995), “Practicability, paradigms and problems in stakeholder theory”, Academy of Management Journal, Vol. 24 No. 2, pp. 228-32. Gombola, M. and Marciukaityte, D. (2007), “Managerial overoptimism and the choice between debt and equity financing”, The Journal of Behavioral Finance, Vol. 8 No. 4, pp. 225-35. Grant, R. (2009), “Shareholder value maximisation must be used appropriately”, Financial Times, March 18, available at: www.ft.com/cms/s/0/0ede1ee8-135f-11de-a170-0000779fd2ac.html Heaton, J.B. (2002), “Managerial optimism and corporate finance”, Financial Management, Vol. 31, pp. 33-45. Hillman, A.J. and Keim, G.D. (2001), “Shareholder value, stakeholder management, and social issues: what’s the bottom line?”, Strategic Management Journal, Vol. 22, pp. 125-39.
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