Introduction:

Why do firms exist? What is their purpose in society?

Topics 1 and 2 consider these questions by looking at the firm from a number of alternate perspectives, namely:

• The shareholder approach, which sees the firm as existing principally (or exclusively) for the benefit of its shareholders and the role of the Board and managers is to deliver (some would say, maximise) shareholder value.
• The stakeholder approach, which sees the firm as a social entity whose existence requires the inputs of a broader range of parties than merely that of shareholders, plus the firm impacts on, and is impacted on by, many parties. In this sense, managers have a role to deliver (or, again some would say, maximise) value to all of the firm’s stakeholders, not just shareholders.
• The triple-bottom-line view that sees a firm as having economic, social, and environmental responsibilities and proposes that these all need to be given consideration.
• The corporate social responsibility view, which sees a firm as having a number of social and environmental responsibilities and proposes that pursuit of profits is conditional on these responsibilities also being met.

In topics 1 and 2, we look at each of these four views, consider the implications for business conduct, and look at some practical situations where the issues we cover can be seen in a real-world setting.

Topic 1 covers the shareholder and stakeholder approaches. Topic 2 covers the triple-bottom-line and corporate social responsibility views.

Learning objectives:

1. Understand the features of, and differences between, the shareholder and stakeholder approaches to the nature of the firm.
2. Purposefully critique these two approaches and appreciate their implications in how firms go about their activities.
3. Identify a firm’s stakeholders and consider the implications of using common stakeholder analysis tools for this purpose.

Discussion:

For this topic, we look at two ways in which the nature of the firm is conceived: the shareholder approach, and the stakeholder approach.

The shareholder approach sees the firm as existing principally (or exclusively) for the benefit of its shareholders and the role of the Board and managers is to maximise shareholder value. This view has a strong grounding in the notion of private property rights with shareholders seen as the owners of a firm and in this sense, having rights attached to that ownership that see shareholders as the party for whose benefit the firm exists. In this sense, any other party (customers, the local community, the environment etc) are really only of instrumental value to the firm – the interests of parties other than shareholders matters, but do so to the extent to which these parties contribute to shareholder value.

The stakeholder approach is a challenging concept to pin down. Even basic questions as to who or what is a stakeholder, and what obligations an organisation has towards its stakeholders, remain contested (Mitchell, Agle & Wood 1997; Phillips, Freeman & Wicks 2003). At a conceptual level however, and in the corporate setting, the stakeholder approach sees the firm as a social entity whose existence requires the inputs of a broader range of parties than merely shareholders. In addition, the firm impacts on, and is impacted on by, many parties, not just shareholders (let’s call these parties the beneficiaries). For the stakeholder approach, the central role of managers is to ensure the survival of the corporation (Freeman & McVea 2001) but to do so in ways that maximise the overall value the corporation creates based on what the beneficiaries consider to be of value relevant to their interests, and to distribute this value fairly to all of the beneficiaries (Phillips, Freeman & Wicks 2003). In this sense, beneficiaries are seen as ends in themselves and not merely as instruments to increase the returns to shareholders. The stakeholder approach does not ignore the interests of shareholders, but sees the existence of the firm as requiring more than what shareholders may contribute. It requires government funded physical and regulatory infrastructure, bankers, environmental inputs, employees, customers…. a range of participants that all need to come together to see the firm exist and function.

The line between the shareholder and stakeholder approaches becomes somewhat ambiguous at times, particularly where the stakeholder approach is espoused but, in reality, is practiced in terms of ‘managing stakeholders’ to ensure shareholder value is maximised – as such, it is more of a shareholder approach in disguise. Banerjee (2008) discusses this point at length and takes a strong critical stance on how the stakeholder approach is practiced in the day to day business setting – here is a little of what he has to say:

 “ despite all the strident rhetoric about the ‘stakeholder corporation’ the reality is that stakeholders who do not toe the corporate line are either coopted or marginalized. The stakeholder theory of the firm represents a form of stakeholder colonialism that serves to regulate the behavior of stakeholders. That (perceived) integration of stakeholder needs might be an effective tool for a firm to enhance its image is probably true. However, for a critical understanding of stakeholder theory, this approach is unsatisfactory. Effective practices of ‘managing’ stakeholders and research aimed at generating ‘knowledge’ about stakeholders are less systems of truth than products of power applied by corporations, governments and business schools” (p. 72)

Banerjee gives an example of this problem he sees in how the stakeholder approach can be practiced as little more than a shareholder approach in disguise:

In my work with two indigenous communities in Australia I sought ‘stakeholder input’ about the presence of a mine on indigenous land. The response was unanimous: both communities wanted the mining company (a very, very, very large multinational company) to ‘clean up, pack up, leave and never come back’, to quote the words of one traditional owner. The company’s response was to hire an anthropologist to ‘consult’ with communities on how best to expand its operations. The fact that these ‘consultations’ take place under drastically unequal power relations remains unaddressed.  As Tatz (1982) points out, Aboriginal communities are the ‘receivers of consultation, that is, that Aboriginal people are from time to time talked to about the decisions arrived at’ (1982: 176, original emphasis). In every case involving ‘consultation’ with traditional owners in Australia, the focus was not whether or not mining should proceed but under what conditions should it be carried out. Royalties, promises of jobs, pitting one community against another are some strategies that have proved useful for mining companies.” (p. 64)

Both the shareholder approach and the stakeholder approach have their supporters and critics, and some of the arguments from both sides are included in the readings.

Importantly for this course is to consider the implications for managers from adopting either of these approaches in the way businesses are managed.

Who/what are stakeholders?

Who/what are a firm’s stakeholders? This question is the subject of significant debate in the stakeholder literature with two main themes evident: a narrow view and a broad view. The narrow view focuses on those human parties (people, groups of people, organisations, and institutions) that are of direct relevance to a corporation's economic interests and without whose continuing involvement and support the corporation could not survive (Clarkson 1995; Dunphy, Griffiths & Benn 2003). Tag-names for these stakeholders include 'primary stakeholders' (Clarkson 1995) and 'normative stakeholders' (Phillips, Freeman & Wicks 2003), although these terms are not necessarily used in ways that are directly comparable. Despite this, and although varying a little in who exactly might comprise this set of stakeholders, this core group usually includes shareholders, financiers, employees, customers, suppliers, local communities and, for some authors, government (Clarkson 1995; Kaler 2004). This then becomes the set of stakeholders who are seen to have a moral and legitimate claim on a corporation to have that corporation direct its efforts to addressing their interests, and are those parties for whose benefit the corporation should be managed (Phillips, Freeman & Wicks 2003; Kaler 2004; Walsh 2005) (i.e., they are the beneficiaries referred to above). Some authors stop at this point and hold that anyone or anything outside of this set of parties is not a stakeholder whereas others extend stakeholder status to 'secondary' or 'derivative' parties. The greater this extension, the more the broad stakeholder view is embraced. If secondary/derivative stakeholders are recognised, these tend to be seen as parties that in some way impact on a corporation's ability to meet its obligations to the beneficiaries for whom the corporation is being managed. Meeting the interests of this broader set of stakeholders is, in this context, considered as a legitimate management activity but becomes mostly a matter of using these stakeholders as a means of maximising corporate value for distribution to a corporation's beneficiaries.

The broad view of who or what is a stakeholder follows an approach more in keeping with the Freeman definition namely:

"[a stakeholder is] any group or individual who can affect or is affected by the organisation's objectives" (Freeman 1984, p. 5, cited in Freeman & McVea 2001).

Broad views are often limited to considering only humans or human institutions in the here and now, however some definitions (very broad) extend further to include the natural (non-human) world (species, ecosystems, the biosphere as a whole and so on), future generations, and even past generations by way of recognition and respect for ancestral values and beliefs (Starik 1994; Dunphy, Griffiths & Benn 2003). In addition, some broad views of who or what is a stakeholder prescribe certain qualities a party needs to possess in order to be granted stakeholder status (such as at least one of the attributes of power, urgency, or legitimacy (Mitchell, Agle & Wood 1997) – more on this later). Others simply see stakeholders as anyone or anything that impacts on a corporation and/or is impacted on by it.

Stakeholder analysis tools

A number of stakeholder analysis tools have been developed to help managers identify and assess stakeholders and consider what action should be taken towards them. Some of these tools are shown in the additional readings section for this topic.

Mitchell et al propose a 3 dimensional model where any party holding any of the attributes of power, urgency, or legitimacy in relation to a corporation is a member of that corporation's stakeholder field and should command management attention. According to this model, managers pay attention to stakeholders holding two or all three of the attributes, with stakeholder power being of particular importance. Mitchell et al make the point that this model is descriptive, not prescriptive (i.e., it describes what managers do rather than represents what the authors think managers should do), although this has not stopped the model from being presented as a how-to (prescriptive) tool for managers. Mitchell et al also see their model as being quite useful to managers from a practice perspective despite this descriptive base.

Mitchell et al stakeholder analysis and categorisation model (refer to the Mitchell et al reading for this topic for more detail on the model).

Another common model is presented by Johnson et al (Johnson, Scholes & Whittington 2005) who use a 2x2 matrix based on stakeholder power to exert influence on the firm, and stakeholder interest in what the firm is doing. Each of the four quadrants then has a strategy identified as to how managers might go about dealing with those stakeholders.

Johnson et al stakeholder mapping and management matrix.

These models are not without their critics. Clifton & Amran (2010) for example propose that stakeholder analysis and mapping tools that give preference to stakeholders with high power (as do the two models shown above) are inconsistent with sustainable world criteria as they violate concepts of justice by making power a morally relevant criteria on which to base decisions on how people should be treated (we look at this issue of justice in more detail in later topics). These authors also propose that the other three stakeholder attributes of interest, urgency and legitimacy incorporated in these models are also troublesome. This interest attribute for example is claimed to be highly vulnerable to reducing the stakeholder approach in the management setting to little more than managing stakeholders for the achievement of corporate interests by making the issue of stakeholder interests legitimate only if those interests align with corporate objectives. In short, Clifton & Amran propose that stakeholder identification and assessment models such as those of Mitchell et al and Johnson et al, although providing an assessment of the political landscape in which corporate decisions are to be made and the pressures to which managers may be exposed in addressing stakeholder interests, work against basic principles of what it means to act justly and also work against the key elements of justice that are fundamental to what it means for there to be a sustainable world.

An alternate approach to assessing stakeholder interests and considering what action might need to be taken is to simply list who the stakeholders are, consider what they provide to the organisation and what the organisation provides to them, how they impact on the organisation and how the organisation impacts on them, and what their interests are and how this should be addressed. This approach has the benefit of avoiding basing stakeholder assessment on the parameters that are seen to be troublesome in the models discussed above. How the actual actions the organisation takes are managed to ensure stakeholders are treated justly is of course, a matter for managers to confront and address in the face of what might be some significant pressures from more powerful stakeholders, and challenges to satisfy conflicting interests where questions of tradeoffs come in to play.

Private property and share ownership

The last point we will cover here has to do with the shareholder approach and the claim that share ownership has private property rights attached to it that trump the interests of other parties who might be classed as stakeholders in a firm. This is a complex issue but one alternate view on the how shareholders in publically listed corporations can be viewed is given by Ghoshal (2005). Here is what Ghoshal has to say:

“As an example of how this pretense of science affects management practice, consider the dictum of Milton Friedman that few managers today can publicly question, that their job is to maximize shareholder value. Where did the enormous certainty that this assertion seems to carry come from?

After all, we know that shareholders do not own the company—not in the sense that they own their homes or their cars. They merely own a right to the residual cash flows of the company, which is not at all the same thing as owning the company. They have no ownership rights on the actual assets or businesses of the company, which are owned by the company itself, as a “legal person.” Indeed, it is this fundamental separation between ownership of stocks and ownership of the assets, resources, and the associated liabilities of a company that distinguishes public corporations from proprietorships or partnerships. The notion of actual ownership of the company is simply not compatible with the responsibility avoidance of “limited liability.”

We also know that the value a company creates is produced through a combination of resources contributed by different constituencies: Employees, including managers, contribute their human capital, for example, while shareholders contribute financial capital. If the value creation is achieved by combining the resources of both employees and shareholders, why should the value distribution favor only the latter? Why must the mainstream of our theory be premised on maximizing the returns to just one of these various contributors?

The answer—the only answer that is really valid— is that this assumption helps in structuring and solving nice mathematical models. Casting shareholders in the role of “principals” who are equivalent to owners or proprietors, and managers as “agents” who are self-centered and are only interested in using company resources to their own advantage is justified simply because, with this assumption, the elegant mathematics of principal–agent models can be applied to the enormously complex economic, social, and moral issues related to the governance of giant public corporations that have such enormous influence on the lives of thousands—often millions—of people.

But then, to make the model yield a solution, some more assumptions have to be made. So, the theory assumes that labor markets are perfectly efficient—in other words, the wages of every employee fully represent the value of his or her contributions to the company and, if they didn’t, the employee could immediately and costlessly move to another job. With this assumption, the shareholders can be assumed as carrying the greater risk, thus making their contribution of capital more important than the contribution of human capital provided by managers and other employees and, therefore, it is their returns that must be maximized (Jensen & Meckling, 1976).

The truth is, of course, exactly the opposite. Most shareholders can sell their stocks far more easily than most employees can find another job. In every substantive sense, employees of a company carry more risks than do the shareholders. Also, their contributions of knowledge, skills, and entrepreneurship are typically more important than the contributions of capital by shareholders, a pure commodity that is perhaps in excess supply (Quinn, 1992). As Grossman and Hart (1986) showed, once we admit incomplete contracts, residual rights of control are optimally held by the party whose investments matter more in terms of creating value. If these truths are acknowledged, there can be no basis for asserting the principle of shareholder value maximization. There just aren’t any supporting arguments” (pp. 79-80).

References

 Banerjee, SB 2008, 'Corporate Social Responsibility: The Good, the Bad and the Ugly', Critical Sociology, vol. 34, no. 1, pp. 51-79.

 Clarkson, M 1995, 'A Stakeholder Framework for Analyising and Evaluating Corporate Social Performance', Academy of Management Review, vol. 20, no. 1, pp. 92-117.

 Clifton, D & Amran, A 2010, 'The Stakeholder Approach: A Sustainability Perspective', Journal of Business Ethics, vol. 98, no. 1, pp. 121-136.

 Dunphy, D, Griffiths, A & Benn, S 2003, Organizational Change for Corporate Sustainability, Rouledge, London.

 Freeman, RE & McVea, J 2001, 'A Stakeholder Approach to Strategic Management', Darden Business School Working Paper, vol. 01-02.

 Ghoshal, S 2005, 'Bad Management Theories Are Destroying Good Management Practices.', Academy of Management Learning & Education, vol. 4, no. 1, 2005/03, pp. 75-91.

 Johnson, G, Scholes, K & Whittington, R 2005, Exploring Corporate Strategy, Pearson Education Limited, Essex, England.

 Kaler, J 2004, 'Arriving at an acceptable formulation of stakeholder theory.', Business Ethics: A European Review, vol. 13, no. 1, 2004/01, pp. 73-79.

 Mitchell, RK, Agle, BR & Wood, DJ 1997, 'Toward a Theory of Stakeholder Identification and Salience: Defining the Principle of Who and What Really Counts', Academy of Management Review, vol. 22, no. 4, pp. 853-886.

 Phillips, R, Freeman, RE & Wicks, AC 2003, 'What Stakeholder Theory is Not.', Business Ethics Quarterly, vol. 13, no. 4, 2003/10, pp. 479-502.

 Starik, M 1994, 'The Toronto Conference: Reflections on Stakeholder Theory', Business & Society, vol. 33, no. 1, pp. 89-95.

 Walsh, JP 2005, 'Book Review Essay: Taking Stock of Stakeholder Management.', Academy of Management Review, vol. 30, no. 2, 2005/04, pp. 426-438.