Evaluation of shareholder and stakeholder theory

‘Stakeholder theory and shareholder primacy have both been shown to be lacking in significant ways and should be rejected as a basis for any corporate governance system.’ Critically discuss.


In recent years corporate governance has attracted extensive discussions and debates relating to managerial powers, responsibilities, its abuse and how to solve these problems. In the UK several proposals have been produced in an attempt to resolve these issues for e.g. Cadbury, 1992; Greenbury, 1995; Hampel,1998; Turnbull, 1999; Higgs, 2003. [1] The central issue in these debates has been on what should be the priority of the directors - to maximize shareholder interests or that of the stakeholders as providing effective corporate governance regulation and controls is a contemporary challenge to all law makers where there is a need to restore investor confidence while encouraging enterprises. [2] 

This paper reflects on the traditional choice between shareholder versus stakeholder models of corporate governance and suggests that these are inappropriate in the light of emerging new theories and the need for an approach that is more practical and sound. Firstly I shall emphasise on the shareholder and stakeholder theory and their inadequacies thereafter the emergence of a new theory to see if there is a possibility of adopting an approach wherein both interests can be reconciled.


There are various questions that arise in corporate governance like what is the purpose of business or the moral responsibilities and the answer to these by the neo-classiscal economists has been that in favour of maximising shareholder value. [3] This great debate dates back from the emergence of the public corporation as a powerful business form in the early twentieth century but for several decades neither the champions of shareholder primacy, nor the defenders of stakeholder interests, enjoyed the upper hand. This changed when the modern corporation emerged and was further developed along with the aggregate theory advocated by the German jurisprudent Rudolf von Jhering and the American jurisprudent Wesley N. Hohfeld asserting that the corporation as a legal group is created by the state and is no more than a private association of shareholders. Since shareholders are the owners of the corporation, the corporation has legitimate obligations and the managers have a fiduciary duty to act in the interest of the shareholders and that if a corporation uses profits for any social purpose beyond the shareholders’ interest, this could be interpreted as managers’ abuse of power. Furthermore Hayak goes on to argue that shareholders’ property rights and control in the corporation must be fully protected. [4] Eventually in the 1970s with the rise of the “Chicago School" of economists the proper goal of corporate governance was established as making shareholders wealthy. [5] Nobel-prize winner Milton Friedman argued in New York Times Sunday magazine that “because shareholders “own" the corporation, the only “social responsibility of business is to increase its profits" [6] , but reversely it is a naked assertion, that the corporation belongs to the shareholders, as they only own the stocks and have limited rights. Another argument provided by Frank Easterbrook and Daniel Fischel is that shareholders are the sole residual claimant which again is incorrect as they are considered that only during bankruptcy. [7] Nonetheless according to this thesis, corporate managers only job is to maximize the wealth of the shareholders and this view appealed to numerous scholars for offering a description of what corporations are supposed to do and by 1990 this theory was accepted by all. [8] Therefore we see that the traditional theory had two aims, i.e., the company should maximise shareholder wealth; and shareholders should have ultimate control of the company [9] and looking at the present practise, it seems that the theory is capturing the markets of UK, Australia and also Japan with the view that it is beneficial for all as this way managers are made accountable and maximising profits ultimately provides more jobs and goods for consumers. [10] 

In later years good part of the academic literature, both before and after the corporate collapses, submitted that corporate governance practices have been affected by the shareholder-centred ideology among the businesses and that the resulting convergence is marking the “end of the history" for company law. [11] One kind of criticism provides that employees and creditors, also bear significant residual risk, and proposes a ‘team production’ approach where each team member will make ‘firm-specific’ investments and has managed to explain the downsides, which led to corporate collapses such as Enron and WorldCom. Nonetheless, it has been in turn criticised by a literature which has proposed a partly different model: a “directors’ primacy approach which too has been ridiculed. [12] The stock market decline of 2001 and 2002 and the concerns raised by Bratton about the "dark idea of shareholder value," or by Blair that the "... study of corporate governance must focus on more than just how to get management to maximize value for shareholders" compels a response and its proponents has given reasons in its support that the goal of maximizing shareholder value is pro-stakeholder as it creates appropriate incentives for managers to assume entrepreneurial risks, provides one objective function making governance easy, it is easier to make shareholders out of stakeholders than vice versa and in the event of a breach of contract or trust, stakeholders, compared with shareholders, have protection through contracts and the legal system [13] and that this theory has often been misstated as urging managers to do anything to make profits but the truth is it urges to make profits only in a legal way and that it is geared towards short term profits whereas if enlightened self interest is embraced, it would lead to long term orientation. [14] Nonetheless, there are various lessons that the Enron scandals has taught the world for it was typically the case where managers, acted in their own interests, defying their duties to shareholders and thereby inflicting harm on other stakeholders and that is why it is held by few that the shareholders should be given importance and designated as watchdogs which can benefit all. [15] In recent years, scholars have noted the rise of ‘shareholder primacy’ and have argued that it has an injurious impact upon the interests of corporate employees because business organisations strive for increasing shareholder value, by reorganising the business and as a consequence there are job losses or poorer working conditions and responsibility for corporate restructuring ultimately lies with company directors who are considered the agents of shareholders thereby promoting their interests. However, it is also clear that directors as such owe no obligations to the shareholders but to the company as whole and recent Australian Government enquiries states that directors are accountable in some aspects to the shareholders but that does not mean that

the stakeholders interests will be overlooked. [16] To this I would like to cite the views of Dodd who argues that if the corporation can be viewed as an entity separate from its shareholders, then it has citizenship responsibilities and the role of management could not be restricted to that of carrying out its shareholder responsibilities, but rather would be that of a trustee with citizenship responsibilities to all constituencies. [17] Regardless of the criticisms the proponents of shareholder primacy are increasingly putting forward new justifications for example that it is the most effective way to foster managerial accountability which has been contested as it leads to partial disconnection from accessing to internal knowledge leading to deceptive behaviours on the part of corporate insiders. [18] Over the past decade the Delware Supreme Court has discussed the issue of director’s duties to shareholders, like in ‘Unocal Corporation vs Mesa Petroleum co’. [19] discretion were given to consider stakeholders interests but the decision was short lived as in, ‘Revlon Inc. vs McAndrews & Forbes Holdings,Inc.’ [20] and in ‘Paramount Communications Inc. v QVC Network Inc.’ [21] shareholders interests were prioritized. Hence under Delware cases shareholders were given benefit. [22] Another scholar Greenfield argues that distributing a corporation’s wealth “fairly" among those who contribute to its creation would make firms more successful as stakeholders would be more willing to make valuable firm-specific investments and second, workers who believe they are treated fairly tend to work harder and be more loyal to their employers. [23] Moreover it is unfair to favour stakeholders who do not have contractual rights and there will be illegitimate transfer of value, at the expense of the shareholders. [24] 

Some institutional investors are beginning to use their influence to monitor performance by companies across a range of social issues which impact upon stakeholder perceiving that companies which disregard stakeholder concerns are also putting shareholder interests at risk. Over the longer term we should not be surprised to see a clearer articulation within UK corporate governance of the importance of creating long-term stakeholder value. Managers may try to convince shareholders that stakeholderism is also in their long-term interests who may be prepared to accept this logic. By these means, shareholder primacy could be transformed into a mechanism favouring a stakeholder-orientated approach. But there is nothing predictable about this outcome and it remains the exception as the Company Law Review, while making some concessions to stakeholder concerns in the form of new reporting requirements for companies, rejected calls for changes to the law governing directors’ duties. Even in the United States, the Sarbanes-Oxley Act post Enron affair, has ignored stakeholders and in the UK, the Higgs review shared its philosophy of shareholder primacy. Meanwhile there are signs that the shareholder value is exerting a growing influence on other systems, in particular Germany. It is therefore not surprising that the fundamental issues of corporate ownership and control have now been settled in favour of the shareholder value model. [25] The growing support for shareholder primacy is also gaining ground in the traditionally more socially democratic and stakeholder-friendly countries of Continental Europe. At the international level, the OECD and the World Bank have been vigorously promoting the shareholder-oriented corporations and while much continues to be written about the ways in which everyone allegedly and rather abstractly benefits from shareholder primacy, very little has been written about the composition of the ‘shareholder class’ which directly benefits from it. It is precisely because of the growing power of finance and the capital-owning that the shareholder primacy norm is likely to continue to strengthen in the future. As this happens, it will continue to be claimed by the neo-liberal that this benefits ‘us all’, ‘in the end’, by promoting economic efficiency and maximising aggregate social welfare. But the strengthening of the norm is not producing a state in which everyone is better off. It is, rather, contributing to ever greater levels of inequality, both internationally and nationally - particularly in places like Britain and the US where neo-liberalism and the Anglo-American model of corporate governance have been so enthusiastically embraced [26] leading to proclamation in 2001 by certain scholars of the end of history for corporate law but I think even then the question as to whose interests should be considered is still open for debate. [27] 


Scholars have continuously called for the creation of a new theory which would more accurately describe firm behaviour by focussing on stakeholder relationships. Adam Smith's identification of external interests to the firm may be viewed as an early recognition of the stakeholders. Barnard suggested that ‘employees were an important factor in a firm's success and, as such their interests should be carefully assessed.’ Management executives turned CSR advocates, such as Frank Abrams and Richard Eells, argued that the corporation is ``accountable to many different sectors of society'' [28] In the USA pharmaceutical such as Merck developed Codes of conduct, which underlined the Corporation’s goal to serve public health which is a sample of Corporations’ respect for other constituents. [29] However it was only in 1984, Edward Freeman proposed the stakeholder theory, focusing more on “who and what really counts" as opposed to just the stockholders. Stakeholder theory seemed to be the ideal ‘compromise’ on stockholder theory as identifying other groups will help them monitor competition, keep up on current manufacturing, design technologies, and result in environmentally friendly production all of which is being increasingly scrutinized by customers. An interesting example of how social responsibility can benefit the organization can be shown by the company Starbucks, who chooses not only the “best" coffee from around the world, but invests in those communities, looking after the best interest of the people that are growing and producing the coffee beans. This has a threefold benefit: it is great publicity for Starbucks and people opt to pay higher premium for coffee beans knowing that they are supporting the respective communities, Starbucks is guaranteed exclusive contracts for taking an interest in the community and the communities themselves are benefiting from the investments that encourage plantations to work together to produce high quality products. Another way that stakeholder theory differs significantly from stockholder theory is that it includes government bodies as investors in the organization. Although they may not be direct investors but they do lay out the rules for importing, exporting, minimum wage etc. without which the organization would be blind to huge changes in the market place and could miss out on great opportunities. Within stakeholder theory, there are other sub theories that define the modern view of it. The most modern view of stakeholder theory includes a “resource-based" as well as a “market-based" view. [30] However Freeman's theory has been criticized in four ways, firstly, inadequate explanation of the process where he suggests that profit and efficiency explains firm behaviour which in turn explains its relationship to stakeholders, if this is the case, then other principles might work just as well such as Wood's corporate social performance model. Secondly, incomplete linkage of internal and external variables suggesting that stakeholders can be identified as separable entity, which is false, rather their interests can be identified. Thirdly, insufficient attention to the system within which business operates and fourthly inadequate environmental assessment for it does not provide an understanding of how to manage change. Therefore in order to create a theory four components need to be added, they are by providing a logic for understanding the concept of “affected by'', linking the externalities and internalities of the firm by developing the application of contract theory to stakeholder relationships, by defining the system in which the firm operates and by incorporating environmental variables such as the impact of time into the system and the relationships identified. [31] 

Donaldson and Preston argues that stakeholder theory explicitly or implicitly contains theory of three different types- descriptive, instrumental, and normative. Descriptive are intended to explain how firms or their managers actually behave. Instrumental theory purports to describe what will happen if managers behave in certain ways. Normative theory is concerned with the moral propriety of the behaviour of firms. Proponents of stakeholder theory strive to describe what managers actually do with respect to stakeholder relationships, what would happen if managers adhered to stakeholder management principles, and what managers should do. [32] It is all about balancing the interests which involves “assessing, weighing and addressing the competing claims of those who have a stake in the organization" [33] and any inequality between stakeholders would only be acceptable if it improved the

situation. [34] Thus, Stakeholder theory is a theory which is being used as a basis for translating business ethics to management practice and strategy. [35] It is distinct because it addresses morals and values as a central feature of managing organizations. Managing for stakeholders involves attention to more than simply maximizing shareholder wealth attending to the interests and well-being of those who can assist or hinder the achievement of the organization's objectives. In this way it is similar with alternative models of strategic management such as resource dependence theory. Some have suggested that stakeholder theory provides managers with an excuse to act in their own self-interest by claiming that the action actually benefits some stakeholder group as rightly stated by Sternberg that stakeholder theory, "effectively destroys business accountability . . . because a business that is accountable to all, is actually accountable to none". But again from other end it can be argued that having to answer all will increase accountability rather than mitigate it as those stake-holders against whose interests the manager has acted will certainly have reasons for doubting the actions making the manager answerable. [36] According to Donaldson and Preston, it is a model in which "all persons or groups with legitimate interests obtain benefits, and there is no prima facie priority of one set of interests and benefits over another". It rejects the idea that the enterprise exists to serve the interest of its owners, rather is based on the idea that the enterprise exists to serve the many stakeholders who have an interest in it or who may be harmed by it. While the general perspective of Stakeholder Theory may be conceivable, there are cracks in the conceptual and empirical foundation on which it rests. These flaws weaken it and mask some of its implications and serious questions can be raised concerning the validity of any moral conclusions it offers. Stakeholder Theory is ultimately about the control and governance of business activities. However the terms enterprise and corporation tend to be used interchangeably, confounding what are actually two distinct concepts. This obscures differences in the range of ways in which business activities can be governed, and makes the control of enterprises seem more problematic than it is and also defines the enterprise as an entity through which diverse participants accomplish multiple purposes confusing the enterprise and the interests of its owners with those parties. Furthermore it does not provide an alternative answer to the question of who, or what, produces economic value but focuses on the distribution of the outcome assuming value is produced by the enterprise itself and that stakeholders have a claim on the value because the enterprise is a creature of society. Hence it needs to be reformed addressing how the diverse interests of stakeholders could be reconciled. Furthermore it leaves open the question of what sort of theory would determine whose interest is stronger, and to which interests managers should respond where stakes conflict. It fails to address how to resolve conflicting interests within a category of stakeholders. There are serious cracks in its foundation and the harder one pushes it toward a normative theory the more serious are the implications. If one is to challenge the conventional model of the enterprise that serves its owners interests, one need to advance an alternative view of a society. [37] Therefore what is commonly known as stakeholder theory is fundamentally flawed because it violates the proposition that any organization must have a single-valued objective as a precursor to purposeful behaviour as it is logically impossible to maximize in more than one dimension at the same time. In particular, it is argued that a firm adopting stakeholder theory will be handicapped in the competition for survival because stakeholder theory politicizes the corporation, and it leaves its managers empowered to exercise their own preferences in spending the firm's resources. Thus, telling a manager to maximize current and future profits, market share etc. will leave that manager with no way to make a reasoned decision. The result will be confusion and lack of purpose that will fundamentally handicap the firm in its competition for survival. The question then becomes whether share-holders should be held in higher regard than others but considering the facts, the real issue is what firm behaviour will result in the least social waste. Since stakeholder theory provides no criteria for what is better or worse, it leaves boards of directors with no criterion for problem solving and firms that try to follow the theory will eventually fail if they are competing with firms that are behaving so as to maximize value. With no criteria for performance, managers cannot be evaluated in any principled way. Therefore, stakeholder theory plays into the hands of self-interested managers allowing them to pursue their own interests at the expense of society. Nevertheless there is a way out of the conflict between value maximizing and stakeholder theory for those interested in improving management, organizational governance, and performance. It lies in melding together what is called enlightened value maximization and enlightened stakeholder theory. [38] Even then it is yet to be clarified as to who are the stakeholders? Variety of definitions has been provided; few very narrow while few very broad. One such definition is provided by Prof. Max Clarkson where he regarded them as those who has economic stake as a result of investing in a firm and many commentators have distinguished between primary and secondary stakeholders and it has been endorsed by few. But again giving a broad definition makes it difficult to tap the legitimate interests whereas a narrow version embraces important ethical considerations of business behaviour to be addressed. [39] Drawing on the various criticisms a new and refined stakeholder model is proposed, ‘the stake model’, incorporating minor changes to Freemans theory and new concepts of stake-watchers and stake-keepers have been introduced. [40] Yet in recent years, the firm is understood as a nexus of both explicit and implicit contracts providing a solid economic foundation for the revitalization of a stakeholder theory of the firm in strategic management and the need for property rights theory with the goal of maximizing total economic value [41] but this strategic management too has its dark sides as taking in account stakeholders is a complex task where managers have more scope for personal benefits and paradoxically, where SM is used opportunistically an unethical economic double cost can arise. [42] Moreover the recent clashes between the organization and the stakeholders have led to establishment of forums to enhance stakeholder communication like AZKO-Nobel has introduced Euroforum and ABN-AMRO has created an intranet site called Values. [43] 

Some take the view that shareholder primacy damages the interests of stakeholders and this forms the basis for a legitimate claim that these stakeholders needs to be considered. The huge mining corporation, BHP Billiton, has acknowledged this and states that it seeks a competitive advantage by engaging in relationships with its key stakeholders. Besides this, Freeman and Philips have argued for the theory on the basis that stakeholders deserve protection as they have property rights and that they are not able to obtain protection due to lack of bargaining power, ignorance or insufficient funds to pay necessary costs. [44] The stakeholder theory school seem to argue that it is clearly more reasonable and beneficial to take into account all as for a corporation to thrive it must, produce competitive returns for shareholders; satisfy customers in order to produce profits; recruit and motivate excellent employees; build successful relationships with suppliers [45] and this will have an overall benefit to all. Even though the US, UK and other Anglo-American jurisdictions have been said to embrace shareholder primacy, there are many who feel that some of these jurisdictions are moving towards a stakeholder approach to corporate governance. This is due to a number of factors such as : the enactment in the US of constituency statutes, the growth of literature advocating stakeholderism , the advent of the concept of enlightened shareholder value in the UK‟s Companies Act 2006, the cases in the US which specifically held that no duty is imposed on directors to maximize shareholder wealth, the handing down in the past five years of two critically important decisions of the Supreme Court of Canada [46] which appeared to reject the idea of shareholder primacy and the comments of some writers concerning the fact that the dominance of the shareholder primacy theory might be problematic due to recent developments in law and finance. However in 2000 it was proclaimed that the Anglo-American corporate governance system based on shareholder primacy had become paramount but since then we have had the collapse of Enron and have seen the demise of major banks such as Northern Rock in the UK and Lehman Bros in the US. On the other hand, stakeholder theory presupposes the fact that directors will, when making decisions and running the corporation, balance the interests of all stakeholders as they will often have conflicting interests but again there is lack of direction which is further exemplified by the Supreme Court of Canada in the recent case of ‘BCE Inc v 1976 Debenture holders’ [47] where it said that there is no legal principle that one set of interests should prevail over another. Then the Court said that which set prevails depends on the situation that is before the directors, and they have to use their business judgment providing no guidance whatsoever especially concerning what weight is to be given to particular interests. [48] Some assert that directors are obliged to consider stakeholder interests in order to fulfil implied promises made to stakeholders which is a misconception as no such promises are generally ever made to stakeholders. [49] Now the question is whether stakeholder theory should overtake shareholder primacy? Personally I feel none of the theories are fit to be the basis of corporate governance as they both are deficient in major areas. Indeed the goals of both theories may be maximum profit but both lacks to consider various aspects which need attention for we all know that a corporation is more than just shareholders and we need one specific guideline rather than multiple views which causes inconsistency.

The failure of the two theories has led to the development of the Enlightened Shareholder Value [50] which has been incorporated in section 172 of the UK Companies Act 2006, paying attention to typical stakeholder interests as a means of fostering long-term shareholder wealth where they are to act in good faith and to promote the success of the company. While the provision ensures the maintaining of the shareholder-centred paradigm, at the same time, in appropriate circumstances, it considers a wider range of interests. [51] But once again this too has been held to be flawed for it does not clarify which interests are to be regarded by the directors especially when they conflict and how to calculate good faith? For example, in ‘Charterbridge Corp Ltd v Lloyds Bank Ltd’, [52] it was noted that the duty to act in good faith in the interest of the company could be impugned where what the directors did was something which no intelligent and reasonable man could have reasonably considered to be in the company's interest. While s.170(4) of the Companies Act 2006 does provide that regard shall be had to the corresponding common law rules in applying the new statutory duties, the explicit words of s.172 suggest only a subjective standard, which leads to a position of ambiguity. [53] 


Here we see that the ESV very much is dependent on the success of section 172 and indeed it is a good innovation to resolve the debate but even then there are certain jurisdictions which are hesitant to adopt the policy due to it being vague at certain points. Some commentators argue that it favours shareholders but there are those who see UK inclining towards stakeholder. But what is often overlooked is that the CLRSG [54] , which pioneered section 172 and ESV in the UK, expressly dismissed pluralism, embracing shareholder value. Nevertheless some believe that ESV is an emerging third way,

somewhere between shareholder primacy and stakeholder theory [55] and it may prove to beneficial in numerous ways such as taking stakeholders interests to foster corporate profits considering long terms interests and that it does not require the directors to balance various interests preventing self interest. [56] 

There are still important lessons that can be drawn as s.172 of the Companies Act signals the importance of corporate social responsibility in underlining the fact that corporate decisions impact a wide variety of stakeholders and those jurisdictions that are reluctant to adopt their own version of s.172, sector-specific legislation imposing duties and penalties on directors could be pursued together with increased public education as an alternative where the principle of corporate social responsibility may be made to flourish. [57] Lastly even if it was claimed in 2000 that shareholder primacy rules Anglo-American jurisdictions, the later developments have indeed changed the course of direction for corporate governance and there is a lot more yet to be accomplished, which only time will tell.