arguments for and against shareholders theory
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Answer:
The stakeholder theorists smell blood. Scandals at Enron, Global Crossing, ImClone, Tyco International and WorldCom, concerns about the independence of accountants who are charged with auditing financial statements, and questions about the incentive schema and investor recommendations at Credit Suisse First Boston and Merrill Lynch have all provided rich fodder for those who question the premise of shareholder supremacy. Many observers have claimed that these scandals serve as evidence of the failure of the shareholder theory — that managers primarily have a duty to maximize shareholder returns — and the victory of stakeholder theory, which says that a manager’s duty is to balance the shareholders’ financial interests against the interests of other stakeholders such as employees, customers and the local community, even if it reduces shareholder returns. Before attempting to declare a victor, however, it is helpful to consider what the two theories actually say and what they do not say.
Both the shareholder1 and stakeholder theories are normative theories of corporate social responsibility, dictating what a corporation’s role ought to be. By extension, they can also be seen as normative theories of business ethics, since executives and managers of a corporation should make decisions according to the “right” theory. Unfortunately, the two theories are very much at odds regarding what is “right.”
Shareholder theory asserts that shareholders advance capital to a company’s managers, who are supposed to spend corporate funds only in ways that have been authorized by the shareholders. As Milton Friedman wrote, “There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it … engages in open and free competition, without deception or fraud.”2
On the other hand, stakeholder theory3 asserts that managers have a duty to both the corporation’s shareholders and “individuals and constituencies that contribute, either voluntarily or involuntarily, to [a company’s] wealth-creating capacity and activities, and who are therefore its potential beneficiaries and/or risk bearers.”4 Although there is some debate regarding which stakeholders deserve consideration, a widely accepted interpretation refers to shareholders, customers, employees, suppliers and the local community.5 According to the stakeholder theory, managers are agents of all stakeholders and have two responsibilities: to ensure that the ethical rights of no stakeholder are violated6 and to balance the legitimate interests of the stakeholders when making decisions. The objective is to balance profit maximization with the long-term ability of the corporation to remain a going concern.
The fundamental distinction is that the stakeholder theory demands that interests of all stakeholders be considered even if it reduces company profitability. In other words, under the shareholder theory, nonshareholders can be viewed as “means” to the “ends” of profitability; under the stakeholder theory, the interests of many nonshareholders are also viewed as “ends.”7
Unfortunately, shareholder theory is often misrepresented in several ways. First, it is sometimes misstated as urging managers to “do anything you can to make a profit,” even though the shareholder theory obligates managers to increase profits only through legal, nondeceptive means.8 Second, some criticize the shareholder theory as geared toward short-term profit maximization at the expense of the long run. However, more thoughtful shareholder theorists often refer to a need for “enlightened self-interest,” which — if embraced — would lead a corporation’s managers to take a long-term orientation. Third, it is sometimes claimed that the shareholder theory prohibits giving corporate funds to things such as charitable projects or investing in improved employee morale. In fact, however, the shareholder theory supports those efforts — insofar as those initiatives are, in the end, the best investments of capital that are available.
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