Shareholder and stakeholder theories of corporate responsibility

Stakeholder Theory

In business, there is a conflict of ideas between the competing ideas of shareholder theory and stakeholder theory. This paper will outline what each of these theories is, and underscore some of the issues in this debate.

Shareholder Theory

Shareholder theory is the idea that businesses work for the shareholders. The idea was perhaps most famously elaborated by Milton Friedman in 1970. Friedman, arguing at a time when the idea of corporate social responsibility was just becoming popular, made a case that the social responsibility of business is to increase its profits. He offered the constraint that it should do so within the legal and moral context of the land, but the crux of the argument is that businesses do not have other responsibilities beyond the profit motive. At the heart of this theory is the idea that businesses are nothing more than a vessel by which investors earn a return on their capital. As such, managers are the agents of these investors, and the concern of managers should be to increase the wealth of the investors.

Underlying this is the idea that if businesses pursue other objectives, that represents an opportunity cost for profits, and one that was not authorized by the shareholders, who are assumed to behave in a perfectly pure rational manner. This is the shareholder theory, that businesses should only be concerned with the needs of shareholders because business only exists as vehicle by which capital can be expanded.

Stakeholder Theory

Stakeholder theory rejects many of the underlying assumptions of shareholder theory. First, stakeholder theory challenges the assumption that business only exists as a vehicle for investment. Business exists, it is argued, as a means of producing the goods and services that society desires. We have businesses to provide incomes for business owners, but to provide goods and services for society, and income for business employees. The latter is what separates a modern business from a business founded on slavery. Being that many people rely on business for many things, there are therefore many different stakeholders in any given business. Investors/shareholders are definitely one of those stakeholders, but they are not the only one. Managers therefore need to make decisions based on balancing the needs of the different stakeholders, rather than focusing on the needs of only one stakeholder (Donaldson & Preston, 1985).

The other assumption that stakeholder theory rejects is that investors are purely rational. That is an idea created in economics as a matter of expediency, to simplify economic modelling. Yet it does not hold in the real world. Investors are not only known to be irrational (Poteshman & Serbin, 2001), but they do have other interests in their investments including how the companies in which they invest behave. Thus, a core underlying assumption that investors only care about money is false, and that assumption is critical to the logic of shareholder theory.