1.2Shareholder and Stakeholder Paradigms
The story about the bookstore highlights the two main theories on why firms exist: the shareholder and stakeholder paradigms. The term shareholder refers to the financial owner(s), or stockholders, of the organization. By contrast, the term stakeholder is used to refer to any person or institution that has interest in the well-being of an organization and is impacted by the organization's actions. For example, in addition to the owners, stakeholders include the community and government where the organization resides, as well as the organization's workers, suppliers, and customers (see Figure 1-1).
Let's take a deeper look into the shareholder and stakeholder paradigms.
The Shareholder Paradigm
If you ever take a corporate finance class, you will probably memorize the following: "The goal of the firm is to maximize shareholder (or owner) wealth." Where did this idea come from? Answer: In 1931, in a Harvard Law Review article, A. A. Berle suggested that corporations should create benefits for shareholders. In other words, managers are the "guardians" or "trustees" of the shareholders. Under Berle's perspective, managers do not need to consider the interest of all stakeholders, just the shareholder.
More recently, Nobel laureate Milton Friedman, one of the most influential economists of the 20th century, reiterated Berle's perspective that organizations have the sole responsibility to provide financial gain for the organization's shareholders, noting, "The social responsibility of business is to increase its (the organization's) profits." Under Friedman's assumption, the executives of an organization are the employees of the shareholders. As such, employees have the responsibility to make as much money as possible. An underlying assumption of Friedman's argument is that while businesses should maximize their profits, they must still obey the legal rules and ethical customs of society.
"There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud." - Milton Friedman, New York Times Magazine, 9/13/70.
Friedman goes on to argue that anything other than maximizing owner wealth is basically a tax on those who lose out from non-wealth maximizing corporate social responsibility (CSR) activities. He argues that not only the owners lose out, but employees don’t have salaries as high as they could have and customers pay more than they should have to if firms engage in modern CSR. Friedman goes on to argue that this taxation is unethical because the managers typically practice modern-day CSR without a democratic vote of everyone who is giving up something (or being taxed) to fund the CSR initiatives (like the employees and customers). In essence, Friedman argues that unless business wants to enter the world of politics and democratic voting, modern-day CSR is an unethical business practice because it represents taxation without representation.
Today, the shareholder focus is widely held and almost always serves as the framing for financial management. Under the shareholder theory, firms exist and managers manage to maximize the wealth of the firm owners. If the firm is publicly held or has shareholders, then this equates to maximizing shareholder wealth. If the firm does not have shares, then it is simply to maximize owner wealth.
The Stakeholder Paradigm
Not surprisingly, not everyone agrees with Berle and Friedman. In fact, only one year after Berle proposed the shareholder paradigm, E. Merrick Dodd challenged this shareholder-centric perspective, arguing that corporations should also consider the interests of the organization's workers, consumers, suppliers, and society as a whole in the decision-making process. Dodd believed that organizations have a responsibility to all stakeholders—not just shareholders. A number of prominent business leaders supported the idea that companies must take a more holistic approach. For example, Henry Ford, the famous American industrialist once stated, "For a long time people believed that the only purpose of industry was to make a profit. They are wrong. Its purpose is to serve the general welfare."
Since the 1990s, many thought leaders have turned to the stakeholder paradigm to argue for a more balanced approach to corporate goal setting and decision-making. Specifically, they argue that although limited by rules and regulations, a free market system often pressures individuals to engage in greed, excess, and abuse. Adopting a stakeholder perspective means that managers should not simply focus on economic performance. Rather, managers should also consider their organizations' social and environmental performance. Simply put, a stakeholder perspective requires companies to act as good corporate citizens—the essence of corporate social responsibility (CSR). Importantly, since diverse stakeholders often have conflicting goals, managers must often evaluate tradeoffs across stakeholders to decide which course of action to take. Thus, pursuing a stakeholder approach is seldom easy.
Firms across the globe are being pressured to step up to their corporate social responsibilities. Whether it is a coal burning super plant in China or a manufacturing sweatshop in Vietnam, firms are being encouraged to be environmentally conscious as well as to respect human rights.
With the globalization of business, even domestic firms should be mindful of their entire supply chain. To be a responsible corporate citizen, firms should make sure that all of the firms in their supply chain are treating employees appropriately, being careful about the environment, and obeying the rule of law.
If you're interested in learning more about CSR around the globe, check out the Corporate Knights website at http://www.corporateknights.com/. This site has over a dozen channels covering topics such as clean tech, climate, carbon, education, food, health, leadership, mining, supply chain and other CSR-related topics.
An example of a country that prides itself on its commitment to CSR is Sweden. If you go to this webpage dedicated to the topic, https://sweden.se/business/csr-in-sweden/, you will see that the nation's businesses put in much effort to support CSR initiatives. The opening two paragraphs of the site state: "Sweden leads by example in corporate social responsibility. The term corporate social responsibility (CSR), also known as sustainable business practice, is used to describe the work companies do that has a positive impact on society, the environment or the economy. In 2011, the EU Commission defined CSR as the ‘responsibility of enterprises for their impacts on society’. Efforts to reduce emissions of carbon dioxide, promotion of equal career opportunities, and involvement with local communities are examples of CSR initiatives. Swedish companies have a long history of active CSR work and Sweden is viewed as a pioneer within the field. In 2013, Sweden topped the RobecoSAM Country Sustainability Ranking, which ranks 59 countries based on 17 environmental, social and governance indicators. The scope of the term CSR has expanded dramatically over the years and now covers aspects of business operations as diverse as corruption in supply chains and local environmental efforts. Yet even though Sweden has made great progress, there are many challenges remaining."
Now, let's return to our bookstore example. Suppose the bookstore used a balanced approach to add the most value possible to all of the stakeholders—the owners of the firm for sure, but also the students, the professor, the book publisher, the book authors, and everyone else impacted by the sale/purchase of the text. Which paradigm would the book store be using? You got it—the stakeholder theory.
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