This essay has been submitted by a law student. This is not an example of the work written by our professional essay writers.
Published: Fri, 02 Feb 2018
It used to be thought that the company’s primary goal is or ought to be maximizing the interests of the shareholders. Nonetheless, more problems are increasingly raised concerning the shareholder primacy theory, such as chasing short-term interest or pursing shareholder interest at the expense of environment and local community, all of these would definitely impair the interest or even the long-term interest of the company.
As a result, the stakeholder approach nowadays seems to be an alternative way of corporate governance nowadays. This means that directors of the company should consider more on various stakeholder groups instead of merely just focusing on shareholders’ interests. It would facilitate directors to take more considerable deliberation on their decisions as shareholder is no longer the only factor they need to give thought to, and this can avoid short-term profit maximization behavior to a large extent.
However, opponents such as Sternberg, claim that there are too many defects in the stakeholder theory and believe this approach would be unworkable in practice. Then, is the stakeholder approach a possible way for serving the best interest of the company as a whole? This essay attempts to argue that the stakeholder approach is indeed an essential and reasonable way than the shareholder primacy. Even though there are some existing unanswered questions or some disadvantages in the stakeholder theory, none of them are unsolvable or insurmountable.
Ⅱ. Stakeholder Approach
The Interest Of The Company
First of all, it is essential to consider whether the interest of the company is that of the shareholders? Notwithstanding debate has continued on the interest of the company, due to the separation of corporate personality, it is evident that these two concepts would not be identical—namely the interest of the company is boarder than the interest of the shareholders. Therefore s.171 (1) of the Company Act requires directors to regard to the other stakeholder groups’ interests (although it did not go far enough). This is also why in Pericvial v Wright and some other similar cases, even if the directors’ behavior caused shareholders’ strong dissatisfaction, the courts still hold up the directors’ behavior because they are at the best interests of the company. In other words, directors are not afraid of the court when they safeguard the interest of stakeholder (non-shareholder groups).
Hence, it seems that the interest of the company cannot be displaced by the interest of the shareholders, the former interest means more than that of the shareholders’. It is also the fundamental reason of why the shareholder primacy theory is thought to be unjustifiable in the context of pursuing the interests of the company as a whole.
Stakeholder theory was first raised by R. Edward Freeman as an antithesis to the theory that directors of the company are only accountable to the shareholders. Stakeholders include employees, providers of credit (such as banks and financial institutions), suppliers, customers, local communities, environmental groups and government and their interests out to be taken account of by the directors of the company. According to Freeman, each stakeholder has a right to be treated as an ends to just a means or an instrument. In other words, all stakeholders’ interests should be considered by directors of company, even if in some circumstances where it might go against the short-term optimum value of the shareholders.
The Superiority Of Stakeholder Approach
Firstly, as Parkinson suggests that both the internal mechanism of governance (i.e. general meeting and non-executive director) and the external form (i.e. hostile takeover bid) are ineffective, stakeholder governance could be an approach to improve the level of corporate governance.
Secondly, it would reconcile the relationship between the non-shareholder groups and the company. Take rank and file employees for example, viewing them as partnership rather than an means would ultimately create a more cooperative and productive relationship between the employees and the company, it is essential for companies to have qualified and well-motivated employees to survive and to succeed especially in the intensive competitive world nowadays.
Thirdly, the development of a company must include the local communities and environment. Taking them as stakeholders would avoid to purchasing a short-term profit at their expense, which in turn will definitely be detrimental to the long-term interest of the company. Moreover, external regulations like environmental protection rules reflect society’s judgment, it suggests doing it actively rather than passively would win reputation and benefit company more.
Last but not least, directors of the company could have more freedom to take a decision for a far-sighted decision rather than being limited in profit maximization only (usually short-term), because more facts are needed to be considered. Directors need not mechanically be the agents of shareholders, rather, the agent of the company as a whole according to the stakeholder approach.
Ⅲ. Justification For Stakeholder Approach
1. The Agency Problem
Opponents to the stakeholder theory states that without the shareholder primacy, it is difficult to control the behavior of the directors since there is a lack of measurable and concrete financial criteria, i.e. profit maximization. It is true to some extent that in the context of the stakeholder theory, it becomes harder to judge the performance of the directors. Take a simple example, director may take account of the interest of the local community but instead of moving the factory to a developing country with cheap labor and then give up some profit. It seems hard to estimate whether it is a good decision or not in this circumstance.
Nonetheless, Parkinson argues that it can be solved by setting up a two-tier board structure—the supervisory board can supervise the executive board even without the solo standard of profit maximization. This means that though parallel boards system, which both boards are selected in general meeting, to confer the supervisory board powers to track the accountability of the executive directors. Further, as stakeholders participate more in the company or even in the board, the directors will be monitored by more eyes, thus it would also be less likely that those directors could easily find an excuse to pay themselves a perk or alike. In other words the stakeholder approach would not exacerbate the agency problem, on the contrary, it may help to improve the level of supervision to a large extent.
2. The Effect On Investment
It is also argued by opponents that due to the stakeholder approach would undoubtedly subordinate the role of shareholders from the most significant place, and it would subsequently discourage investors pouring more capital into the company.
However, this might not be the case nowadays. Since firstly the role of institutional investors play an increasingly more important role in the board, and most of them, if not all, would focus on the level of corporate governance and social responsibility of the target company which they tend to invest, therefore it requires directors of the company to take enough account of rank and file employees, local community, environment and such stakeholder groups (regardless of whether accepting the stakeholder approach or not); secondly good corporate governance would usually promise a more stable performance of a company from the analysis above, stakeholder approach could make sure a relatively better corporate governance which would attract investors.
3. The Efficiency And Multiple Objectives
Another opposition is that the efficiency of the company would be impaired since there are too many factors to think about, and the worse is that these multiple objectives mean that the directors need to trade-off different demands and interests of various stakeholder groups. This is really a strong point of the protesters. The single criterion of maximization of shareholder profit is easier for the directors to meet and to be monitored.
Nevertheless, more time and energy to be spent on balancing different sort of demands are absolutely not a bad thing. It is worthwhile to sacrifice some efficiency for a comprehensive and far-sighted evaluation, and further, non-shareholder stakeholder groups have more common points than divergence, especially for long-term development, all groups definitely wish the company to have a sustainable and successful growth.
Company is far more than a bundle of assets, actually every constituency puts a ‘firm specific investment’ to he company. Blair and Stout also claim that taking a company as a team may solve the problem of free-rider and rent-seeking. It is therefore fair to weight other groups in the company more, because they commit their own contribution to the company through different formations. Therefore although shareholder groups are the last one to receive the residual profits, they are insider the company, have more information and stay at a better position than other constituencies of the company, so it is just to consider the interest of the non-shareholder shareholder groups more in the current circumstance.
Stakeholder approach has many advantages and can help enhance corporate governance as mentioned above. While shareholder primacy would generate opportunism to some extent and induce directors of the company tends to make short-term maximized profit which would in turn affect their bonus or perk, it seems the stakeholder approach is a good alternative way to change this situation. At the same time, it can lead a more cooperative and productive relationship between the stakeholders and the company, which can definitely benefit the long-term development of the company.
Although there are still some oppositions that stakeholder theory itself has defects, but form the analysis above, some of them are just misunderstandings or no longer the case nowadays such as ‘discouraging investment’; others can be solved such by introducing a new supervisory board, none of them are insurmountable, and the advantages of stakeholder approach is far outweigh its disadvantages. Further more, notwithstanding difficulties and complexities exist in the reformulates, it is by no means that we should retain the current system simply because it is hard, the society will not progress if it fears of any resistance.
1. Mallin C, Corporate Governance (2nd edn OUP, Oxford 2007)
2. Dignam A and Lowry J, Company Law (Core Text Series, 5th edn OUP, Oxford 2009)
3. Parkinson J, ‘Company Law and Stakeholder Governance’ in Kelly G, Kelly D and Gamble A (eds), Stakeholder Capitalism (Macmillan, Hampshire 1997) 142-154
4. Wheeler S, ‘Works Councils: Towards Stakeholding?’ (1997) 24 JLS 44-64
5. Blair M and Stout L, ‘A Team Production Theory of Corporate Law’ (1999) 85 VLR 247-328
6. Jensen M, ‘Value Maximization, Stakeholder Theory, and the Corporate Objective Function’ (2002) 12 BEQ 235-256
7. La Porta R, Lopez-de-Silanes F and Shleifer A, ‘Corporate Ownership around the World’ (1999) 54(2) JF 471-517
8. Donaldoson T and Preston L, ‘The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications’ (1995) 20(1) AMG 65-91
Cite This Essay
To export a reference to this article please select a referencing style below: