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ACC320-Concept Of Social Contract Between The Company

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Question

Should corporate governances focus more on fulfilling the interest of shareholders or should it focus more on stakeholders? Discuss. 

 

Answer:

Introduction:

Should corporate governances focus more on fulfilling the interest of shareholders or should it focus more on stakeholders? This is one of the challenges faced by most of the companies. The challenge started following the introduction of idea of sustainable reporting. Determining the answer to this question would be handy not only for academic purposes but also for companies wishing to know the direction they should take.

Practical Motivation:

Ability to answer the question as to whether corporate governance should focus more on fulfilling the interest of shareholders or whether it should focus more on stakeholders is very crucial to companies, accountants, shareholders and all stakeholders. This is because shareholders and business managers are increasingly faced with a double imperative (Carlsson 2007) to integrate a creation of immediate financial value for shareholders (or Shareholders) and creation of comprehensive and sustainable value for stakeholders (or stakeholders). The lifting of this contradiction requires them to master eclectic models in the fields of economics and law, but also sociology and ethics (Carlsson 2007). Aligning their decisions, discourses and behaviours with CSR repositories implies a reconfiguration of their governance system. The corporate governance (corporate governance) covers all the institutions, rules and practices that legitimize the power of leaders (Carlsson 2007).

Theoretical Motivation:

 The current research will expand and perhaps give some recommendation on how the current theories should be adjusted to meet the new demands brought about by the issue of sustainable reporting. According to the traditional approach, it assumes that the incentive and control systems of the latter depend in particular on the firm's financing structure, and more particularly on the composition of its shareholding (Porta et al., 1997). According to the extended approach to governance, supported in particular by Charreaux and Desbrieres, (1998), the problem of the effectiveness of governance systems can only be posed within the framework extended to all stakeholders. It must be studied from a systemic perspective, considering the firm's concrete value creation processes. This prescription responds to the criticisms made by Rajan and Zingalès (2001) against the purely shareholder view of governance, which they believe is inappropriate for new forms of enterprise. Through "responsible governance", directors and company leaders must seek to integrate economic goals, social and environmental intentions (Perez, 2005). The new model would be based on modifying and tailoring the existing theories to match the new needs of corporate governance theory. This is because there are gaps on how the need to focus on shareholders and the need to focus on stakeholders should be reconciled.  

Literature Review:

The notion of corporate governance is based, according to Donaldson and Preston (1995), on the concept of "social contract" between the company and its direct stakeholders (shareholders, employees, suppliers, customers, etc.) and indirect (administrations, local communities, interest groups, opinion leaders, civil society ...). It is defined by the European Commission as companies voluntary integration of social and environmental concerns into their business activities and relationships with their stakeholders "(Green Paper, 2001). It was notably translated by the notion of Triple Bottom Line (Elkington, 1998), which is based on three pillars respectively economic (the search for profitability and sustainability of the company), social and societal (the quest for social equity and respect for human rights) , and environmental (the desire to protect the environment and preserve natural resources). Carroll (1991) proposes a four-tier pyramid of corporate CSR: economic responsibilities, which force the company to produce and make profits; legal responsibilities that require the company to comply with applicable legislation and standards; philanthropic responsibilities, which reflect the company's desire to improve the well-being of society; ethical responsibilities.

The contractual theories and the instrumental approach to agency theory offer great proximity in that they focus on a single managerial objective, namely value creation, analyzed in the first case according to a purely shareholder and, in the second case, a partnership approach (Bradley, Schipani, Sundaram and Walsh 1999). Stakeholder’s theory differs from the first in the sense that it is the social integration of the economic entity that takes precedence over the creation of financial value. Societal information is of intrinsic value here in that it explains the impact of the company's activity and therefore its way of carrying out transactions or exchanges with its environment. As such, the societal reporting fulfils a justification function, that is to say that it is interested in the role of the company in these exchanges: how does the company respond to the expectations expressed by the actors in society and what does it get in return? Societal reporting is used as a mechanism for clearing and maintaining the social contract that authorizes and organizes exchanges between the company and the various actors of society (Bradley, Schipani, Sundaram and Walsh 1999). Although the instrumental view of stakeholder theory opposes the goal of maximizing value creation for shareholders alone, advocated by agency theory, it nonetheless advocates cost-effective management which favors the continuity of the operation and thus the maintenance of the jobs and the respect of the contractual conditions concluded with the suppliers, the customers and the creditors. Its ambitions thus seem consistent with those of the theory of dependence on resources, according to which social responsibility must be combined with financial logic, via considering the firm's strategy the stakeholder requirements it needs to survive (Pfeffer and Salancik, 1978). Only social and environmental actions facilitating access to new resources therefore seem to have to be privileged. 

 


Alignment with these frames of reference implies a reconsideration of the theory of governance, because it partially calls into question the purpose of the company, defined by the classical theory (Freeman 1984), which aims to reduce agency costs, securing the investor's capital and seeking profit in the short term. This alignment extends the company's responsibilities both over time (in the long term) and in the socio-economic space (stakeholders). Blair (1995) the concept of pluralistic enterprise (or plural firm) open to its partners, to that of monist company centered on its shareholders. This pluralistic representation of the firm implies a redefinition of the theory of value creation. Milgrom and Roberts (1992) propose to substitute the notion of partnership value for that of shareholder value, to share this value among all the stakeholders according to the contributions of each to the process of value creation. They observe that this distribution has a direct influence on the process because of the transaction costs of unavoidable conflicts between partners. Each of them bears a residual risk associated with its specific investment in the company. Donaldson and Preston (1995) find that "ingrained" leaders in the firm play a central role in the equitable distribution of created value. Such approaches, according to Charreaux and Desbrière (1998), simply contractual, but also co-constructed in duration and space. They recommend assessing the governance system in terms of its ability to create partnership value and reduce the loss of value due to conflicts between stakeholders.

In attempting to find out what is more valuable to company’s corporate governance, Adams, Licht, and Sagiv (2011) delved specifically in analysing specific variables that have influence on whether the CEOs will support shareholders or stakeholders. They explored the variables related to stakeholderism and shareholderism. Some of the variables they explored include shareholderism, conformity, tradition, universalism, self-direction, power, security, gender, employee rep, age, CEO, equity holding. The findings revealed that board members are more likely to make decision that favours shareholders rather than stakeholders. The findings further shows that board members tend to follow internal goals rather than external goals.

Evidently, most of the variables that have been tested in previous studies focus on stakeholderism and shareholderism. They include conformity, tradition, universalism, self-direction, power, security, gender, employee rep, age, CEO, equity holding. The findings revealed that board members are more likely to make decision that favours shareholders rather than stakeholders. The findings further shows that board members tend to follow internal goals rather than external goals. The existing studies are always inclined towards the sharaholder’s value rather than the socio-economic value. For example, the agency theory (Jensen and Meckling, 1976) states that the priority of any company must remain the maximization of shareholder value. With this in mind, societal reporting must enable financial players to have a better understanding of the risks that the company faces in the medium and long term (natural as well as - and above all - legal) risks. This design corresponds to the current trend of better identifying off-balance sheet liabilities, which are related to the sustainability of the resources needed to produce, as well as those related to potential conflicts associated with restructuring. To consider the question of sustainable development from the point of view of contractual theories thus presupposes that social and environmental actions are likely to create additional value, or at least to avoid the occurrence of potential social or environmental risks, which could lead to a reduction in cash. In other words, societal dimensions would participate in the process of value creation and should therefore be considered in sharing this value. That is why overreliance on agency and stakeholder theory is no longer recommendable in the modern era because success of businesses is no longer determined by the economic benefits alone.  There is therefore a need to determine whether the value obtained by focusing on shareholders is more important than the value obtained by focusing on stakeholders

Hypotheses:

Hypothesis 1: Companies that focus more on stakeholders are likely to perform better than companies that focus more on shareholders

Hypothesis 2: There is no significant difference between stakeholder value and shareholder value in terms of their impact on the success of the company 

 

List of References

Adams R, Hermalin B, Weisbach M (2010) The role of boards of directors in corporate governance a conceptual framework and survey, Journal of Economic Literature 48 (2010), pp.59-108

Adams, RB, Licht, AN and Sagiv L (2011) Shareholders and Stakeholders: How Do Directors Decide? Strategic Management Journal, 32 (12), pp. 1331-1355

Agle BR, Mitchell RK, Sonnenfeld JA (1999) Who matters to CEOs? An investigation of stakeholder attributes and salience, corporate performance, and CEO values, Academy of Management 42 (1999) pp. 507-525

Blair MM (1995) Ownership and Control: Rethinking Governance for the Twenty-First Century , The Brookings Institution.

Bradley M, Schipani CA, Sundaram AK, Walsh JP (1999) The purposes and accountability of the

Carlsson RH (2007) Swedish corporate governance and value creation: owners still in the driver's seat, Corporate Governance: An International Review 15 (2007), pp.1038-1055

 Carroll AB (1991) "The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders," Business Horizons , Vol. 34, pp. 39-48.

Charreaux, GJ and Desbrieres, B (1998) Corporate Governance: Stakeholder Value Versus Shareholder Value, Available at SSRN: https://ssrn.com/abstract=262902 or https://dx.doi.org/10.2139/ssrn.262902

 corporation in contemporary society: corporate governance at a crossroads, Law and Contemporary Problems 62 (1999), pp.9-86

Donaldson T. and Preston LE (1995), "The Stakeholder's Theory of the Corporation: Concepts, Evidence and Implications," Academy of Management Review , Vol. 20 (1): 65-91.

Elkington J (1998), Cannibals with Forks: The Triple Bottom Line of 21st Century Business , New Society Publishers.

Freeman E (1984), Strategic Management: Stakeholder Approach, Massachussetts, Pittman Publishing Inc.

Jensen M and Meckling W (1976), "Theory of the firm: managerial behavior, agency costs and ownership structure," Journal of Financial Economics, 3(1976), pp. 305-360.

Milgrom P., Roberts J. (1990), Bargaining costs, Influence Costs and the Organization of the Economy Activity , Cambridge University Press, pp. 57-59.

Perez R (2005): "Some Reflections on Responsible Management, Sustainable Development and Corporate Social Responsibility", Journal of Management Science, Vol. 211-212 (January-April): 29-46.

Pfeffer J and Salancik GR (1978) The External Control of Organizations , New York, Ed. Harpers and Row.

Porta et al. (1997), "Trust in Large Organizations," American Economic Review, Papers and Proceedings.

Rajan RG and Zingale L (2001), "The Influence of Financial Revolution on the Nature of the Firm", American Economic Review, 91(2001), 2.

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