Does the "Stakeholder Model" further or endanger the business ends of companies?

The issue of corporate governance is becoming of ever increasing social significance. The government have made this clear with their ‘long-term fundamental review of core company law’ , which has culminated in the introduction of the Company Law Reform Bill into parliament on the 3rd November 2005. The selection of the appropriate model for corporate governance has been a contentious subject since the famous debates between Adolf Berle and Edwin Merrick Dodd JR in the early nineteen-thirties . The distinctive approaches of Berle and Dodd have polarised into two groups which can loosely be understood as those which advocate stakeholder primacy and those that advocate shareholder primacy. This debate continues unresolved and across many jurisdictions there is, as may be expected, a variety of regimes which are placed along a continuum between the two extremes. The aim of this work is to asses to what degree the Stakeholder model is compatible and also preferable with the aims of corporate business. In doing so we will briefly set out the debate between scholars of the stakeholder and shareholder models. We will then move onto the potential advantages and disadvantages of the Stakeholder Model and hopefully be able to come to a conclusion on these issues.

Stakeholder / Shareholder

The traditional role of a corporation has been considered to be shareholder wealth maximisation:

‘The modern theory of the firm, which is central to finance and corporate law, views the corporation as a nexus of contracts between the various corporate constituencies. Upon this foundation finance theory and corporate law postulate shareholder wealth as the objective of the firm’

However, it has long been recognised by both scholars and great industry leaders alike that their role, speaking realistically and aspirationally, is not that simple. Dodd JR cited Mr Owen D Young and the way he perceived his role:

‘I think what is right in business is influenced very largely by the growing sense of trusteeship…One no longer feels the obligation to take from the labor for the benefit of capital, nor to take from the public for the benefit of both, but rather to administer wisely and fairly in the interest of all’

Young identified groups such as shareholders, employees, customers and the public at large as those groups of which he saw himself being a trustee thereof. This was the embryonic viewpoint which has come to argue that corporate governance should include all stakeholders defined as ‘those whose continued support is necessary if the firm is not to be seriously damaged’ . It has been argued by pro-stakeholder scholars that the shareholder primacy approach, which has certainly dominated the UK jurisprudence and case-law on the issue, ‘limits the goal of corporate governance to profit maximisation’ . The dichotomy is quite clear and falls between ‘all the interest which the corporation affects’ or ‘its absentee owners’

The academic debate has generally tended to favour the stakeholder model and yet for some reason shareholder primacy remains the ideological touchstone for the judiciary in this country and the predominant explanation, recently given the legislative stamp of approval , from Berle to modern day has been the lack of a practical way of instituting the legal framework for such a duty. It is as Sir Samuel Britton stated a fact that ‘If directors are accountable to everybody for everything, they will end up being accountable to nobody for anything.’

However, an important factor to remember is that the tendency to exaggerate the dichotomy between the stakeholder and shareholder models leads to a view that the interests of shareholders must be sacrificed at the expense of including other stakeholders ; however this isn’t strictly the correct approach. The stakeholder model advocates a more pluralist approach to business which merely admits that the profit-oriented interests of shareholders aren’t the only interests which are relevant to the running of a company. This must be borne in mind when we consider the arguments in the next section surrounding what is the correct business ends of a corporation and to what degree the stakeholder model is compatible with those ends.

Business Ends and Compatibility with Stakeholder Model

One of the favourite paradigms for pro-stakeholder arguments is the large multi-national corporations. These large businesses by virtue of their size cause commentators to question whether the ‘business ends’ of that corporation can be fully understood in a profit-maximising notion. It is a fact that only 500 companies control 25% of the world’s economic output which means that some of the directors and executives within such companies ‘have more power than most sovereign governments to determine where people will live; what work they will do, if any; what they will eat, drink, and wear; what sorts of knowledge they will encourage; and what kinds of society their children will inherit’ .

This means that inevitably commentators have argued they cannot be considered purely private entities and that to a degree they are public organisations. It has long been argued, in fact it was the mainstay of Dodd’s criticisms of Berle, that shareholder’s have become alienated from companies. They argue that shareholders are passive owners of the company and ‘simply a supplier of capital on terms less definite than those customarily given or demanded by bondholders’ . This has lead to a separation of ownership and control in a lot of companies and means that in reality director’s are at liberty to follow ends other than those of the shareholders. The rhetoric of shareholder ownership still finds its place in modern judicial and academic pronouncements but the soundness of these has to be questioned . The lack of control over assets or right to a share of the profits makes the ownership reality and theory fallacious at the least. This discretion of directors to act as they please has been the focus of the debate surrounding corporate governance and the stakeholder / shareholder debate.

This position means that we have to completely reassess what we understand to be the business ends of corporations. If shareholders aren’t understood as owners then the traditional business end of a corporation has to be reassessed. The Stakeholder model as such makes a statement about what corporate objectives ought to be rather than furthering or endangering any particular objective. The aim from this point onwards is to discover whether, if the objectives of a corporation cannot be wholly encapsulated in some abstract ideal of an agency relationship between shareholders and directors, the adoption of the stakeholder theory is necessary or desirable. I will start by looking at a few critiques of the stakeholder theory so that we can begin to come to a conclusion.

Sternberg has categorically stated that the stakeholder doctrine that we have been concerned with depicting above is ‘intrinsically incompatible with business and all other substantive objectives’. She offers a number of reasons primarily aimed at showing how the intromission of the stakeholder theory on traditional corporate objectives would wreak havoc. She points to the fact that the stakeholder creates no sensible way of dealing with accountability because those responsible for the administration of the business are accountable to the stakeholders. However, many of those in charge of the corporation will be themselves stakeholders and in that respect are accountable to them.

A fundamental criticism of the stakeholder theory is that it endangers any type of substantive business end, in other words the only end of a business is to balance the interests of stakeholders however this objective is highly impractical. In abstract the stakeholder theory mandates appreciation of ‘those whose continued support is necessary if the firm is not to be seriously damaged’ but this would make the number of people in reality astronomical. There would for practical reasons need to be some kind of way of delineating certain clear stakeholders, a delineation which has no foundation in the theory itself. Sternberg makes a particularistic attack on the whole of the stakeholder theory in general; in essence what she is arguing is that terms such as ‘interests’ have such subjective meanings to each individual of a stakeholder group that the concept of stakeholder interest is meaningless . Perhaps more devastating is that even if there were some coherent concept of stakeholder interest which could be identifiable to the executives of a corporation then the accountability of such executives to stakeholders could only be manageable ‘if everyone involved accepts a common purpose that can be used for ordering priorities’ . The mechanics of such accountability are difficult to grasp for example how an employee of a corporation could be committed to the employer’s objective when that employer is in part subject to the interests of that employee.

The bottom line criticism of stakeholder doctrine can be best understood if we ask ourselves questions such as ‘How do we want the firms in our economy to measure their own performance? How do we want them to determine what is better versus worse?’ Jensen argues that the economists answer to the question would be maximisation of the long-term value of the corporation, and we could hypothesise that the stereotypical legal scholars would state the maximisation of the interests of shareholders. The main issue that arises out of both the work of Jensen and Sternberg is that as a normative structure of corporations the stakeholder model is not feasible:

‘Without the clarity of mission provided by a single-valued objective function, companies embracing stakeholder theory will experience managerial confusion, conflict, inefficiency, and perhaps even competitive failure’

What becomes clear from the analysis is that perhaps the stakeholder model would endanger business ends. The problem is that stakeholder theory provides no criterion to establish whether directors are behaving well or performing poorly . However, interestingly there is a tacit rejection in critics of the stakeholder theory of any kind of shareholder primacy. There is a seeming need for a third alternative corporate governance model. However, we should not immediately abandon the stakeholder theory as it has had some defences.

In responding to some of the criticisms outlined above Freeman & Phillips have argued that ‘Business is that human institution that is about value creation and trade’ . They argue that this aim of business can be satisfied by a stakeholder model by use of libertarian principles which would give normative force to the stakeholder model. Primarily value creation is caused by stakeholder co-operation, capitalism only works because different stakeholder groups come together in order to create value. The complexity and particularistic nature of the groups don’t work in opposition to stakeholder theories but rather are an integral part which acknowledges value creation wouldn’t be possible otherwise, it is accepted that economic maximisation isn’t always the motivating factor of people coming together. In fact any libertarian theory recognises that humans are complex. The main aim for a corporation in this schema is:
‘Stakeholder Capitalism requires that freedom loving human beings be at the
centre of any process of value creation and trade. It underscores the responsibility thesis that common decency and fairness are not to be set aside in the name of playing the game of business’
However, as we see from this exposition the only way to make such a humanistic stakeholder model further business ends is to accept that the predominant reason for business is value creation and trade. The end of business is not to balance the interests of stakeholders.

Conclusions

There are a number of interesting conclusions that flow from the foregoing discussion. Primarily, we have to realise that the Stakeholder model is a managerial model. It is a way of dictating how a company ought to run, however there has been a mutation by certain critics to create a misunderstanding that it provides a rationale for why a company ought to be run. This confusion is part of why Goldenberg called the word stakeholder ‘wretched’ , it has meant so many things to so many people.

The shareholder primacy rhetoric is patently incorrect and probably incompatible with a good economic model of corporate governance but that doesn’t mean that the stakeholder model is a direct replacement for that concept. In fact the two could exist perfectly well in the same corporation. The directors will balance all the interests of all the stakeholders in coming to decisions about that which will most benefit shareholders, such as the UK government have proposed in their review of company law . It would perhaps be apt to conclude this work that the stakeholder model neither furthers nor endangers individual business ends per se. The Latin phrase Post Hoc Ergo Propter Hoc comes to mind in that business ends are useless without a stakeholder approach, any modern corporation would fail if it did not in some degree pay heed to the interests of its stakeholders and perhaps the words of Mr Owen D Young, cited above, show that it was ever thus. The stakeholder approach is necessary for business ends, if we understand it in the less radical and sustainable manner that was outlined by Freeman & Phillips.

Please note: The above essays and dissertations were written by students and then submitted to us to display and help others. Thanks to all the students who have submitted their work to us.

Back to Free Law Essays