Shareholder and Stakeholder Theories of the Firm

Appropriate Objectives: Managers in Accounting and Finance
According to the classical theory of the ethical responsibilities of a firm, the sole obligation of the firm is to shareholders and the need to make a profit to sustain them economically. However, this classical theory has since been challenged by arguments that sustainability, obligations to employees and the community, and professional and social ethics must also influence firm decision-making. Particularly in the wake of a rash of corporate scandals, there have been calls to reevaluate the focus on profit-making alone, particularly profit-making with a single-minded focus on the short term.
According to Jensen (2010) “at the heart of the current global corporate governance debate is a remarkable division of opinion about the fundamental purpose of the corporation” (p.32). Managers, particularly in the realm of accounting and finance, may find themselves in the thick of such debate as the formerly single-minded focus upon the balance sheet has since shifted. One solution which has been advocated is that of stakeholder theory which suggests that rather than solely focusing on the needs of shareholders, managers must instead take into account all individuals that have a stake in the firm’s success or failure, not simply shareholders who are the technical owners of the firms but employees, customers, the community as a whole, and even the larger political climate.
Jensen (2010) counters that stakeholder theory is fundamentally flawed because it fails to take into consideration the reality of day-to-day objective-setting within organizations which require a clear and coherent objective. “To put the matter more concretely, whereas value maximization provides corporate managers with a single objective, stakeholder theory directs corporate managers to serve ‘many masters’” without a clear sense of how to prioritize these different interests, many if not all of which conflict (Jensen, 2010, p. 32). A good example of this is the question of modifying certain products to be more environmentally-friendly. From the perspective of the community, this may be beneficial in the long run because of the desire for products which have a minimal environmental impact. But from a consumer’s perspective, environmental reforms may generate products which are more costly. Some employees may benefit from expanded research and development in environmentally-friendly products while others may not if demand decreases.
Jensen (2010) argues that firms must have a single objective; he similarly argues against ways of achieving value for a firm using multiple perspectives which are alternatively used to stakeholder theory such as the Balanced Scorecard perspective. Even the Balanced Scorecard suggests that the financial value of the firm is only one way among many of determining firm value. But Jensen (2010) states that having multiple objectives for a firm is really like having no true objectives at all. Ultimately, for all of its naysayers, the classical theory of firm profitability remains the most useful one. “Even though the single objective will always be a complicated function…that 200 years’ worth of work in economics and finance indicate that social welfare is maximized when all firms in an economy attempt to maximize their own total firm value” (Jensen, 2010, p.34).
Contrary to some have interpreted the classical view of the firm, this does not mean that firms must engage in completely rapacious behavior and ignore the needs of others. After all, consumers are increasingly demanding that firms behave in an ethical way and adhering to ethical standards can build consumer trust. When firms have attempted to cut corners and risked the safety of consumers, they have witnessed a sharp downturn in demand. Moreover, ignoring legal requirements put into place to protect consumer safety simply results in more costly litigation and regulatory oversight.
Finally, Jensen (2010) argues that it is critical from a managerial perspective to inspire employees with a visionary perspective. Most employees (and most customers, it might be added) are not solely inspired by the idea of value maximization alone. Employees are human beings and demand some deeper purpose to their work. Thus while the firm’s objective must be singular, ethical ideals can be used to serve this profit-maximizing capability. Of course, one obvious objection to Jensen’s thesis is that employees and customers alike will be able to see through such blatant self-interested moralizing. Additionally, the question arises as to what the firm should do when there is a conflict between profits and the articulated values that uphold the firm’s larger purpose as articulated to employees.
This is why Letza, Sun, & Kirkbride (2004) ultimately argue that managers must conceive of the firm in terms of its relationships. “In order to learn business relationships must think about corporate interrelationships and social interactions” (Letza, Sun, & Kirkbride, 2004, p.258). Rather than viewing shareholder and stakeholder theory as polar opposites, the authors suggest both are inadequate and the firm must realize that it is dependent upon contingent support from customers, employees, political actors, and the community. Managers must thus seek to identify shared interests rather than take a zero-sum view of profitability of the firm. Rather than using other ideologies in a self-serving way, managers must instead identify a higher vision that supports both the firm’s profitability and the interests of those on whom it depends. Just as no individual is an island, no firm is an island and even to maximize profits, profits are ultimately generated by building relationships.




References
Jensen, M.C. (2010). Value maximization, stakeholder theory, and the corporate objective
function. Journal of Applied Corporate Finance, 22 (1), pp. 32-42.
Letza, S., Sun, X. & Kirkbride, J. (2004). Shareholding versus stakeholding: a critical review of
corporate governance. Corporate Governance, 12 (3), pp. 242-262.