Shareholder Theory vs. Stakeholder Theory: A Comparison

Shareholder Theory

In a business organization, the responsibility to efficiently run the business lies with the senior management of the company as they are empowered with taking all the decisions which can benefit the business and the owners. Shareholder Theory states that the only responsibility of the managers is to serve the best interests of the stakeholders using the resources of the organization and generation more profits so that the wealth of the shareholders can be enhanced. The theory further states that such a behavior from the managers without any deception would not only be beneficial to the shareholders but also to the society at large. As per this theory, corporate social responsibility is defined purely in terms of economic profits made by the business.

The shareholder’s theory makes it clear that the management of the company needs to consider the best interest of the shareholders and take every step to ensure that their returns are maximized. It is to be noted that the theory makes it clear that profits of the business needs to be maximized using ethical and legal means only. Another main theory which is developed in such a respect is the stakeholder’s theory which states that the manager’s responsibility to balance the needs of the shareholders as well as the expectations of the stakeholders which cover interests of other stakeholders such as employees, customers and the local community (Castelo 2013. The stakeholder theory makes it imperative for the business to take care of the needs of the stakeholders even if it means to reduce the overall profitability of the business. It is to be noted that both shareholder and stakeholder’s theory are normative theories of corporate social responsibility and both highlights what the role of management should be in an organization. 

In recent times, many critics are of the opinion that Shareholder’s theory does not completely specify the role which company’s executives are to perform. The shareholder’s theory asserts that shareholders invests their capital in the business and therefore managers are supposed to use such funds in a manner which can enhance the returns of the shareholders. In words of Milton Friedman, the primary social responsibility of a business is to use to the resources and engage in activities to enhance the profitability of the firm without engaging in any deception ort fraud.

The main line of criticism for such a theory is that it does not consider the interests of other stakeholders who are directly or indirectly associated with the interest of the business. The shareholder’s theory makes it apparent that non-shareholders can be viewed as “means” to the “ends” for generating high profitability (McWilliams 2015). The opinion of the critics is that the operations of the business also affect the other stakeholders and therefore it is imperative that the management should be accountable to them also. This the main principle of the stakeholder theory in comparison to shareholder’s theory as it considers the interest of all stakeholders even if it means that profitability of the business would reduce.

Stakeholder Theory

There are several aspects where shareholder’s theory is often misrepresented and these are also areas where critics have been skeptical regarding the theory. For instance, one area of the theory which is misrepresented is that urging managers to do anything to enhance the profitability of the business. It is to be noted that the shareholder’s theory obligates managers to follow a legal and ethical framework for enhancing the profits of the business. Managers often drive processes and often engage in unethical means to demonstrate high level of profits and market valuation to the investors (Watson 2015).

There have been scandals like Enron, Worldcom which proves that excessive emphasis on presenting a sound financial report affects the ethical and legal codes of the industry. Further it has been argued that shareholder theory puts more emphasis on short term profits at the expense of long term profits. Managers tend to invest the resources and time to short term operations so that instant results can be shown to the investors in terms of surge in profitability of the business. One other reason that shareholder’s theory is not a proper guideline for the manager is because it prohibits use of corporate funds for charitable or community development activities.  This further proves that the theory instructs the managers to keep the shareholders as their top priority and do not consider the needs of the other stakeholders or the community at large (Mishra and Modi 2016).

In the context of the US economy, survey of 15000 manager’s opinion of different companies show that around 40% agree in modern times that a business should only drive towards profit maximization and keep the interest of the shareholders as the priority. As per legal regulations applicable in US, directors have a duty of care and loyalty. It is stated that as long as the directors follow these two dual duties, they are automatically following the principles of the stakeholder’s theory and thereby looking after the interest of the entire community. Therefore, it is clear that stakeholder’s theory has a wider application and in modern times, a business is required to follow such an approach so that proper balance can be established between the interest of the shareholders and that of the other stakeholders. In the case of US, managers of corporates are advice to leave out the phrase “maximizing profits for the shareholders” and rather the focus should be on “maximizing the value of the company”.

Normative Theories of Corporate Social Responsibility

Following such an approach, the management would be able to respond appropriately to the needs of the investors, other stakeholders and community at large (Faller and zu Knyphausen-Aufseß 2018). Thereby, it can be said that shareholder’s theory has narrow application in modern world and stakeholder’s theory is given much more relevance. The behavior and actions of the managers should be guided by the interest of the company and overall stakeholders of the business which includes everyone who is affected by the operations of the business either directly or indirectly.

Reference

Castelo, B. 2013 "Shareholder Theory", Encyclopedia of Corporate Social Responsibility, pp. 2136-2141. doi: 10.1007/978-3-642-28036-8_31.

Faller, C.M. and zu Knyphausen-Aufseß, D., 2018. Does equity ownership matter for corporate social responsibility? A literature review of theories and recent empirical findings. Journal of Business Ethics, 150(1), pp.15-40.

McWilliams, A., 2015. Corporate social responsibility. Wiley encyclopedia of management, pp.1-4.

Mishra, S. and Modi, S.B., 2016. Corporate social responsibility and shareholder wealth: The role of marketing capability. Journal of Marketing, 80(1), pp.26-46.

The Shareholders vs. Stakeholders Debate 2003. Available at: https://sloanreview.mit.edu/article/the-shareholders-vs-stakeholders-debate/ (Accessed: 14 January 2022).

Watson, L., 2015. Corporate social responsibility research in accounting. Journal of Accounting Literature, 34, pp.1-16.

Corporate Social Responsibility refers to the responsibility which companies have not only for their financial obligations but should be held responsible for social and environmental obligations. The concept states that the management of the company should be accountable to the community as well and contribute towards the welfare of the community. In modern times, most of the companies are engaging in CSR activities so as to demonstrate to the investors that they are also concreted with the development of the community as well. Further, in certain countries, it is mandatory to engage or contribute 1% of the profits to community development programs so that a level of accountability can be maintained (everfi.com 2021). The CSR activities of the business are considered to be important as it would allow the management to create a positive reputation in the market.

As per several research, there are several success stories that a business which appropriately follows CSR strategies are rewarded with high market valuation. In recent times, there are certain steps which management undertake to assess the impact of CSR activities on the business operations. The impact of CSR activities can be measured appropriately by following the parameters which are mentioned below:

1. Benchmark against the Top Performer: One of the best tool which is available to the management to measure the organization’s performance is to consider the top company’s example which utilizes CSR policies to its best effect. Benchmarking is an effective tool which allows the management to ensure that some of the industry’s best CSR practices are identified and implemented so that ample success can be achieved in the market(Rim and Kim 2016). Benchmarking can create a proper roadmap for companies to follow in terms of CSR initiatives and would help the management to ensure that key performance areas are identified. For instance, the business of IKEA entered into a partnership with the entire city of Helsingborg for developing a sustainable community following the examples of Toyota and Apple Inc. Therefore, it is clear that companies can learn from other business for the purpose of development and achieve success of its own.

Criticism of Shareholder Theory

2. Application of KPIs to Measure CSR performance: A business which follows both short term and long term goals tend to rely on KPIs for measuring the performance and ensuring that the business is moving in the accurate direction. In terms of CSR initiatives, KPIs can also be set and when actual performance data is available than it can be measured so that lead and lag factors in performance can be identified(Barnett, Henriques and Husted 2020). The KPIs an organization sets should be considered stepping stones that will eventually lead to achieving the overall desired goal. The KPIs which are set can cover different areas of performance such as environment, social community, and employee development or innovation programs. The management can demonstrate to the people that the company cares about the welfare of the people and taking initiatives to ensure that such development programs can be implemented.

3. Recognized Industry Standards: The CSR performance standards are not very universal in nature and therefore it is possible for different industries to have different CSR performance standards. For instance, for a mining company, CSR contributions would mainly include the environmental conservation and rehabilitation programs implemented and this approach might be different for any other manufacturing industry. Therefore, it is certain that difference in practice exists for companies engaged in different industry(Rawhouser, Cummings and Newbert 2019). However, it is to be noted that there are certain tools which can be used by companies to measure CSR initiatives such as GRI standards, community mark, SASB and other international labor organization frameworks.

Therefore, it can be said that companies have some framework to measure the impacts of CSR activities and accordingly implement processes so that the operations can be improved further. There can be made improvements in the measurement criteria where CSR activities can be rated and this can benefit the organization as a whole.

The prominence of CSR activities have grown immensely over the years as the community also expects companies to contribute towards their welfare rather than just focus on profits. Some of the companies have started maintaining and publishing CSR reports along with it’s along reports so that the people are made aware of the contribution made by the business during the period. One of the future improvements which can be made in the CSR reporting process is to implement mandatorily the GRI standards (Ding, Ferreira and Wongchoti 2016). This will bring about consistency and comparability in the CSR reports of different companies so that decisions can be taken according to this metrics as well. GRI standards cover key non-financial areas where a company can make contributions and these standards also promote sustainability as a business practice.

The GRI reporting can be done on a monthly or quarterly basis so that regular track of the activities and its impact can be assessed. Further, it is suggested that CSR ratings should be introduced by a regulated body so that companies can be rated in terms of their CSR contributions and accordingly this report can be published. These practices would only enhance accountability and ensure that proper practices are followed which can lead to sustainable operations in the business (Graafland and Smid 2019). It is to be noted that compliance with the GRI standards would also help the business gain recognition in the global markets and also earn a goodwill in the home country. Therefore, it can be said that proper adherence to CSR policies and measurement of its impact can help businesses to improve its operations and be transparent. The discussion above shows some of the tools which can be used by businesses to improve its measurement criteria for CSR activities and further help the management to demonstrate the contributions which the company makes to the community at large.

Reference

3 Ways Your Organization Can Measure Corporate Social Responsibility Performance - EVERFI (2021). Available at: https://everfi.com/blog/community-engagement/3-ways-to-measure-corporate-social-responisbility-performance/ (Accessed: 14 January 2022).

Barnett, M.L., Henriques, I. and Husted, B.W., 2020. Beyond good intentions: Designing CSR initiatives for greater social impact. Journal of Management, 46(6), pp.937-964.

Ding, D.K., Ferreira, C. and Wongchoti, U., 2016. Does it pay to be different? Relative CSR and its impact on firm value. International Review of Financial Analysis, 47, pp.86-98.

Graafland, J. and Smid, H., 2019. Decoupling among CSR policies, programs, and impacts: An empirical study. Business & Society, 58(2), pp.231-267.

Rawhouser, H., Cummings, M. and Newbert, S.L., 2019. Social impact measurement: Current approaches and future directions for social entrepreneurship research. Entrepreneurship Theory and Practice, 43(1), pp.82-115.

Rim, H. and Kim, S., 2016. Dimensions of corporate social responsibility (CSR) skepticism and their impacts on public evaluations toward CSR. Journal of Public Relations Research, 28(5-6), pp.248-267.