To what extend does a company exist only for the benefit of its shareholders? Discuss the place of agency theory and its alternatives, including the problems of putting these theories into practices.
It is widely known that stock market is the place where corporations able to raise large amount of fund from the many investors available in the society. As a return or reward for the investors, they are given a certain amount of share according to the amount of the money contributed. In other words, investors are the owner of the public listed corporations or company. They are the shareholders. Thus, it is reasonable to expect that a company existed to reward the shareholders, because without the pool of funds provided by the many investors, a corporation or company will never existed before (Dobos et. al., 2011). However, such a view is gradually changing in the modern corporate world. There are arguments that company existed not only to serve shareholders, but also the other stakeholders as well (Cragg, 2004). This article will discuss the several issues related to shareholder theories, and the new stakeholder theories, if they are relevant to the corporate world today.
As discussed above, shareholders are essentially the legal owner of corporations, as they provided the fund to start up the company in the very first place. Thus, their rights should be protected. The company is effectively an asset of the shareholders, and thus, the company is logically to be managed to serve the interests of the shareholders (Danielson et. al., 2008). For this, conventional shareholder theory often argued that the management of a corporation is to maximize the shareholder wealth, as the shareholders are essentially the owner of the corporations. Such a view assumes those corporations exist only for the benefits of the shareholders. However, that is more easily said than done, because managers may not necessary work hard to fulfill the shareholders needs or rights. This led us to introduction of Agency Theory as to be discussed in the following section.
Agency theory arises due to the nature of the limited liability of the corporate ownership of public listed company. Particularly in those public listed companies, the ownership as well as the control of the corporations is separated. The ownerships belong to the shareholders, while the control is handed to the management. Effectively, the job to run the daily operations are handed or delegated to the manager. In such a case, managers become the agents, while the owners become the principles.
Very often, managers have personal goals that compete with the mission of shareholder wealth maximization. This leaded to agency problem. Technically speaking, a potential agency problem will arise whenever the manager of a firm is not the owner, or own less than 100% of the shares of the firm. There are several cases or situation that agency problem can arises. These will be discussed as follow.
Manager may not work as hard as possible for shareholder wealth maximization purposes – they may pursue a relaxing working style. As the manager never own the entire company, he may not work as hard as if the company is belong to him entirely. A manager may just want to receive a certain amount of salary, leading a relaxing lifestyle, while not putting good efforts to ensure the success of the company (Brigham et. al., 2004). In the case where manager never own any single share on the company, his risk is minimal, and thus, not face higher risk if the company fail and collapse, as the shareholders are the one to suffer most.
Managers may decide to reward him with excessive perquisites. Instead of maximizing shareholder wealth, manager may engage in works or efforts to maximize his compensation, ranging from salary, stock options, bonuses, travelling claims or allowances and any others (Brigham et. al., 2004). He may also prefer to support his pet projects, or to buy his preferred toys using corporate money. After all, that money is funded fully by the shareholders, and he got nothing to lose. Such acts are truly unethical and are harming shareholders wealth, and indeed a great challenge to good practices of corporate governance.
Managers may decide to maximize the size of the company, not for wealth maximization purposes, but to entrench his position in the firm/ industry. There are also managers that engage heavily on empire building actions, instead of focusing to deliver true value to the shareholders (Fontrodona et. al., 2006). These managers may engage heavily in acquiring smaller competitors or other businesses to enlarge his power in the corporation. Besides, they may use the size of corporations to justify the need to increase his compensation. Furthermore, as the size of the company becomes bigger, their position is more secure, as it become harder for the company to be acquired by the other bigger corporations. However, such an act is detrimental to the financial health of the shareholders.
Managers may engage in actions that can enhance their reputation, at the costs of shareholders wealth. As managers are effectively using the shareholders’ money to manage the corporations, they tend to use the money for personal benefits. For example, they may donate a large sum of money to charity, in order to enhance their personal reputation. Although donation to charity is ethical conduct, but to do that using others’ money for personal benefits is highly unethical. Besides, managers may also engage in excessive risk taking attitudes, by continuously pursuing the high risk high reward projects, as they share the upside, but not the downside of the projects. All these are not really beneficial to shareholders.
As the principal-agents issues outlined above can be detrimental to shareholders (i.e., the rightful owner), good corporate governance practices are suggested to mitigate the issues arise from agency problems. However, that is not something easy to deal with, as agency costs do exist. The several agency costs include: the time and efforts spent to monitor the managers conducts, the resources spent on shareholder engagement, audit as well as risk management programs to be implemented in corporations to control the principle-agents risks. Besides, the measures implemented to control the issues can be costly to the agent side as well. For example, instead of focusing to conduct the business, agents now have to spent time to prove that they are accountable. They, they need to spent time explaining and meeting shareholders (Fontrodona et. al., 2006). The additional paper work for audit, risk management and reporting purposes will also cost a lot to financial, human resources, not to mention the opportunities cost lost in fulfilling the many requirements.
However, there is another viewpoints emerging in the recent years. People started to realize that the existence of corporations should not only serve the shareholders, but also the stakeholders, because the impacts of corporate actions to the society can be huge (Cragg, 2004). Today, corporations are expected to carry out relevant Corporate Social Responsibilities (CSR), mainly for ethical reasons, and partly for financial reasons. This means that the corporations will be held accountable for a wider range of stakeholders. Now, the focus is not merely the relationships between the managers to the shareholders, but also between the corporations to the suppliers, customers, competitors, local community, governments, future generations and the environment (Smith et. al., 2003). All these led to the rise and increasingly popular Stakeholder Theory, which serve as a viable and relevant theory to Shareholder Theory in the past.
According to the Stakeholder Theory, shareholder wealth maximization is no longer the single priority in managing a company, but a more holistic approach to managing the corporations is required (Danielson et. al., 2008). Managers are now burdened with the needs to act morally, responsibly and ethically towards the other stakeholders as well as the society. It is no longer good to act in accordance to the legal framework, but a proactive approach to manage the corporations should be followed. Today, the concepts of green and lean operations are to be emphasized (Cronin et. al., 2011). It is also important for the managers to consider the issues of sustainability (Crittenden et. al., 2011). All of these are important today, as global warming, corporate scandals as well as the need to act in a sustainable manner is becoming more critical to modern society today. All these are becoming more important, as people witnessed how the many irresponsible corporate actions had led the world into very serious financial crises in the year of 2008/ 2009. The reputation of business entities are hurt badly and people seem to trust the business entities less.
Although the Stakeholder Theory sounds compelling, the implementation of such theory in the corporate framework is never an easy task. In the following paragraphs, the various problems of putting Stakeholder Theory into practices will be discussed.
It is hard to balance the needs and aspirations of the various stakeholders. As there are many stakeholders involve, it is very hard for a manager to take care of all of the stakeholders, including customers, employees, suppliers, competitors, governments, society and other at a fair manner. For example, in many instances, to meet the aspiration of a category of stakeholders, for example, the shareholders may not be beneficial for the other stakeholders. Shareholders largely want higher return from their investment, but employees may want higher salary, to the extent that shareholders may be left with little return from their risky investment. There are no fix guidelines on how the balance the efforts to meet each of the categories of stakeholders, and thus, management must exercise their judgment subjectively (Ditlev-Simonsen et. al., 2008). Besides, it is also unsure and debatable that which stakeholders should be placed greater priorities or importance in the Stakeholder Theory. The debate about which stakeholders should be catered for is largely philosophical, and the appropriate judgment may differ from cases to cases. If the management is again burdened with such tasks, they may not have the time to properly run a business, which is their main duty and responsibilities being hired in the firm (Mainardes et. al., 2011).
It is a voluntarily measures, not compulsory. The argument of Stakeholder Theory is about a corporation going the extra mile to meet the several Corporate Social Responsibilities. Thus, some of the corporations may not want to pursue CSR activities. In some instances, such a situation can be detrimental to those corporation actively pursuing CSR activities. For example, in competitive industry, firms that pursue CSR activities may no longer have the privilege to drop the price to compete for greater market shares. These firms are then susceptible to those firms that concentrate fully on price war, regardless of what is argued by Stakeholder Theory. Obviously, there are not benefits to be reaped by those that proactively acted responsibly and ethically. Furthermore, there are no clear evidences that CSR can bring any real benefits to the corporation (as to be argued in section below).
The money invested or spent on Corporate Social Responsibilities may not bring any benefits to the shareholders/ managers. Stakeholder Theory is still largely philosophical in practices, as the question if proactively taking care of all of the stakeholders through a responsible manner will benefit the firm is unclear (Mainardes et. al., 2011). The evidences that ethical firms practicing the Stakeholder Theory can reap better return are mixed. The efforts spent on such activities might not be justified, given that time will be wasted, while company may even gain greater benefits by investing the time and financial resources in other events/ places.
There are trade-offs or sacrifices to be made. Very often, to take care of the many stakeholders’ means the managers have to sacrifice something else. For example, a very kind company may be spending a lot of resources to take care of the employees’ welfare, but at the expense of the customers and shareholders. To make everyone happy is largely impossible (Van Buren et. al., 2003), and this definitely causes the practicing of Stakeholder Theory harder to be implemented. The managers have to decide which items to be sacrifice, and to judge if the trade-off is relevant. Managers will definitely face with several ethical dilemmas in attending to the expectations of so many stakeholders of a firm.
Not all stakeholders’ needs can be met financially. Furthermore, it is not necessary that to spend money can solve all the issues faced by the various stakeholders. As different stakeholders have different expectations, not all of these expectations can be solved by financial terms. After all, not a single company will have the sufficient financial resources to make all stakeholders’ happy.
Overall, this article has shown the rationale for pursuing the Shareholder Theory in the past. Such a theory is relevant as the shareholders are the legitimate owner of the company. It is also discussed how the Agency Theory come into place, as the owner as well as the managers of the companies are largely separated. The concepts of Agency Theory are relevant to understand the rationale for implementing a strong and proper corporate governance practices in the corporations. It is shown that due to the agency problems, a lot of costs may be incurred. Apart from that, this article also proceeds further to discuss the alternative to Shareholder Theory – namely the Stakeholder Theory. In today business landscape, it is argued that to purely manage a firm to maximize shareholders wealth is not sufficient, but corporations should take proactive and extra efforts to exercise Corporate Social Responsibilities. However, it is also discussed that the implementation of Stakeholder Theory is never easy. There are yet many problems to be solved before the Stakeholder Theory can be readily implemented in the corporate world in the future.
References & Bibliography
Brigham, E. F., & Houston, J. F. (2004). Fundamentals of financial management, 10th edition. International Thomson Publishing.
Cragg, W. (2002). Business ethics and stakeholder theory. Business Ethics Quarterly, 12(2), 113.
Crittenden, V., Crittenden, W., Ferrell, L., Ferrell, O., & Pinney, C. (2011). Market-oriented sustainability: a conceptual framework and propositions. Academy of Marketing Science. Journal, 39(1), 71.
Cronin, J., Smith, J., Gleim, M., Ramirez, E., & Martinez, J. (2011). Green marketing strategies: an examination of stakeholders and the opportunities they present. Academy of Marketing Science. Journal, 39(1), 158.
Danielson, M., Heck, J., & Shaffer, D. (2008). Shareholder Theory – How Opponents and Proponents Both Get It Wrong. Journal of Applied Finance, 18(2), 62-66.
Dickinson-Delaporte, S., Beverland, M., & Lindgreen, A. (2010). Building corporate reputation with stakeholders: Exploring the role of message ambiguity for social marketers. European Journal of Marketing, 44(11/12), 1856-1874.
Ditlev-Simonsen, C., & Midttun, A. (2011). What motivates managers to pursue corporate responsibility? a survey among key stakeholders. Corporate Social – Responsibility and Environmental Management, 18(1), 25.
Dobos, N. (2011). Non-Libertarianism and Shareholder Theory: A Reply to Schaefer. Journal of Business Ethics, 98(2), 273-279.
Fontrodona, J., & Sison, A. J. G. (2006). The Nature of the Firm, Agency Theory and Shareholder Theory: A Critique from Philosophical Anthropology. Journal of Business Ethics, 66(1), 33-42.
Frow, P., & Payne, A. (2011). A stakeholder perspective of the value proposition concept. European Journal of Marketing, 45(1/2), 223-240.
Fuller, M. (2010). A Social Responsiveness Approach to Stakeholder Management: Lessons from the Canadian Banking Sector. Journal of Leadership, Accountability and Ethics, 8(2), 51-69.
Huang, C. (2010). Corporate governance, corporate social responsibility and corporate performance. Journal of Management and Organization, 16(5), 641-655.
Mainardes, E. W., Alves, H., & Raposo, M. (2011). Stakeholder theory: issues to resolve. Management Decision, 49(2), 226-252.
Smith, H. J. (2003). The shareholders vs. stakeholders debate. MIT Sloan Management Review, 44(4), 85.
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“The system by which companies are directed and controlled” (Cadbury Committee, 1992), is the corporate governance usually defined as. The relationship within a business structure is complicated, its board, its shareholders and its stakeholder. The business direction are given by corporate governance through the business objective set, meanwhile, it is determined to reach the goal and monitor the process (OECD, 2004). The various of stakeholder interests are balanced according to this system.
In recent year, the ‘Enterprise and Regulatory Reform Act 2013′, a vote about directors’ pay is given to the shareholders of UK quoted companies, which is a kind of decision power of the executive compensation.
Since the directors’ pay is an important part in corporate governance, motivate them working and attain company objective. Whether the good or bad condition on executive compensation will affect workers loyalty of company, it is included the salary or welfare of the worker which is the main motivation push them to work. This essay is going to discuss about whether the shareholders should have a right to say on Executive Compensation critically. Real life cases will be included for supporting the point mentioned.
In the circumstance of shareholders have to a say on business executive compensation, to a certain extent it is affecting the office atmosphere. Corporate governance is used to facilitate effective, entrepreneurial and prudent management that can deliver success of the business in long term (The UK Corporate Governance Code, 2004). After the reform of legislation, the directors’ pay are depends on shareholders hand. The confident and loyalty of director will be influenced, not to mention the grassroots worker. It can be said as a better condition of workers received, the better performances they will provide. In order to attain the purpose of corporate governance, the right for shareholder to adjust on executive compensation is needed. In the following parts, the real life cases will be provided to prove it is beneficial to business on allowing decision power to them.
Oracle, is a multinational computer technology corporation. Specialize in designing and developing enterprise software product, its own database system which is the particular technology it focused on. The well revenue brought by its software has lead Oracle be the second-largest software maker after Microsoft. Even in such kind of large enterprise like Oracle, the shareholder arise a doubt on the business performance. It will turns up a pressure on the business director. Since there are some criticism say ‘the company’s ‘lack of communication’ has heightened their concern over pay, boardroom accountability and the independence of non-executive directors.'(David Oakley, 2015) Over the past four year, the union of shareholders request of meeting with director has been neglected, this can be regards as disrespectful to investor. Hence, the shareholders have rejected the executive compensation scheme over the past three years. And they complained that the reduction of director’s remuneration is not enough. The more penalty should be given to director in order to push them tackle the existing obstacles. Normally, the management not willing to negotiate to the union is because of the amended policy may threat to their previous interest. For example like the commission they could receive decreased. As a result, we can concluded shareholders have a say on executive compensation can be a tool to encourage management monitor and control the stakeholders interest balanced, avoided communication problem appear, though it might go to another way. In term of corporate governance, business objective can be attained which could lead to a long-term success of the company. (The UK Corporate Governance Code, 2014)
Another cases is from GlaxoSmithKline, it is a science-led global healthcare company that researches and develop various innovative medical product which headquarter in London. The sixth-biggest scale pharmaceutical company in the world. In 2003, Mr. Garnier, the chief executive officer has been rejected on a proposal would boost the compensation package by the shareholder. It is because of the shareholder started to be alerting their consideration about the business performance under Mr. Garnier (GAUTAM NAIK, 2003). Since the company obtains of strong sales and profit, but its stock price was facing a dilemma because some of the best-selling medicines have face the unexpected cut-price competition. And Mr. Garnier did not have an appropriate solution against it. And so aroused the shareholders’ dissatisfaction to vote in negative. After the ‘golden parachute’ payment to Mr. Garnier being banned, there will be a re-election that purpose for the post of Chief Executive and Chief Financial Officer (BBC, 2003). Hence, the decision power on shareholders can ensure the business operation would not harm to their own interest. When problem arises, reduction on compensation will be given or re-election on the person in charge to solve it. To conclude, in term of shareholders which is beneficial to them if they could have a say on executive compensation as to prevent own interest damaged.