The Effect Stakeholder and Shareholder Theories have on Director's Duties - Literature review Example

Discuss the effect stakeholder and shareholder theory's have on director's duties Name of the Student: Name of the Instructor: Name of the course: Code of the course: Submission date Discuss the effect stakeholder and shareholder theory's have on director's duties Introduction It is an apparent fact that the concepts of stakeholders and shareholders have evolved to become extensively used in the realms of strategic management. This is whereby the effectiveness of a manager or a director primarily depends upon how well he/she takes the stakeholders and the shareholders into account. This has culminated in the development of the stakeholder as well as the shareholder theory. Phillips, Freeman and Wicks (2003, p. 479) inferred that the expansive power in the stakeholder theory is a direct outcome of the fact that when limited reflection is engaged in its utility, its implications and prescriptions in management are infinitive. On the other hand, when debated in its ‘instrumental’ variations, - that the managers ought to attend to the stakeholders as a means towards achieving other goals at the organizational level, for instance, shareholder wealth maximization or profit-the stakeholder theory remains nearly unopposed. Against this backdrop, this paper is a profound effort to explore the effect stakeholder and shareholder theory's have on director's duties against the latter approach outlined in the above discourse. For the purposes of this analysis, it is imperative to first expound on the real meaning of the stakeholder and the shareholder theories and their inherent divergence aimed at generating a profound understanding of their effect on the duties of the director in any given firm. What arethe stakeholder and the shareholder theory? Pfarrer (2010, p. 86) noted that there are two antagonistic theories in regard to the purpose of business firms in the contemporary world. Each of these theories provides a robust structure for evaluation the corporate governance procedures, the executive compensation policies as well as the socio-economic performance of the business. The shareholder theory has been viewed to emanate from an economic point of view basically focuses on the purpose of the firm in the processes of wealth creation for the owners in a given firm while concurrently reducing the central importance of interactions of the firm with its other constituencies, for instance, the suppliers and its extensive role in the wider society (Pfarrer, 2010, p. 86). On the contrary, the stakeholder perspective takes the above perspective to an elevated level through broadening it to recognize the importance of wealth creation as well as the relationships of the firm with its multiple constituent groups- employees, shareholders, creditors, regulators, local community and suppliers- and the effects on the wider society (Pfarrer, 2010, p. 86) The effect stakeholder and shareholder theory's have on director's duties Freeman, Wicks and Parmer (2004, p. 364) determined that the stakeholder theory instigates with the assumption that values are explicitly and necessarily an element of doing business and thus rejects the separation thesis. It is fundamental to be cognizant of the fact that the separation thesis is primarily founded on the assumption that the economics and ethics in a firm can be sharply and cleverly divorced whereby in this particular context, the impediments of conducting business ethics or enhancing the moral performance of the business becomes futile, endless and ineffective. Therefore, based on the fact that the stakeholder theory rejects the separation thesis, this has extensive effects on the director’s duties in a firm. This is mostly more profound when modern terms like corporate social responsibility among others have become more and more embraced by diverse corporations in the contemporary world. Against this backdrop, the stakeholder theory insinuates that the director of the firm is under an obligation to ensure that the firm complies with the social demands in the market, for instance, consumer health in the production, advertisement and marketing undertakings of the firm. This is aimed at creating a positive consumer psychology and positive purchasing trends for the goods or services produced by the firm. This is based on the fact that a variety of buyer behavior processes as well as consumer psychology have been perceived as being the foundation of the success of the companies which have been efficient and effective in adapting ethical issues into their marketing processes as well as the snag of those that fail to do so. This is best epitomized by a situation whereby when a firm is confronted by negative media criticism as a result to non-sensitivity to the effects of its products on the consumers, the theory of reasoned action infers that as a response, several consumers in different groups will take this criticism that the manufacturing company for this product is not conforming to ethical marketing and thus, they feel that it is their moral duty not to purchase its products. As a result, other members in these reference groups will feel obligated to follow this trend based on the fact that they want to fit and feel part of these groups with shared ideologies. This will culminate in mass boycott for products from this manufacturer and thus extensively face non-consumption of its products. Against this background, the stakeholder theory adds an extra obligation on the director of any given firm, mostly those involved in goods production targeting mass consumption, to ensure that the firm is compliant and sensitive to the social effects of its products in the market. The effectiveness of the director in fulfilling this obligation will determine not only the consumption of these goods in the market but also the overall reputation of this firm in the eyes of prospective investors. On the contrary, the proponents of the shareholder theory have argued in the past decades that the primary purpose of the firm is to maximize the wealth of the shareholders. In this regard, these proponents believe that the responsibility of solving the problems at the societal level is to be undertaken by the state. On the other hand, they argue that the activity of corporate philanthropy among other activities which do not heighten the elevation of wealth for the shareholders are not only a waste of the shareholder’s money but also immoral based on the presumption that they amount to stealing from the owners of the business, who in this case are the shareholders (Pfarrer, 2010, p. 87). Against this backdrop, the shareholder theory limits the duties of the directors to the narrow confines of ensuring optimum value creation in the firm to ensure that the shareholders achieve maximum returns for their investment. This ought to be done in disregard of effects of the firms’ activities at the societal level, the employees and other constituent groups. Thus, the duties of the director primarily revolve around ensuring that the shareholders get maximum value from the firm. Secondly, the stakeholder theory is founded on the presumption that the firm ought to have robust mechanisms of ensuring that there is a harmonious coexistence between the firm and other external stakeholders, for instance, the pressure groups. In this case, the role of public relations directors in the firm is elevated aimed at creating a channel of communication with these stakeholders and adhering to their suggestions in the ethical conduct of business. This fact is best exemplified whereby in the wake of the sweatshop and child labor allegations against the Nike factories in Asia, the firm engaged significant consideration of the claims from the regulatory and activist stakeholders as well as the NGOs in its eventual decision making process on how to solve this challenge which was bound to pose detrimental impacts on its reputation in the region (Pfarrer, 2010, p. 87). Therefore, this consultative interrelation between the firm and the activist stakeholders impacts on the duties of the director because it serves in expanding the scope and jurisdiction of the director’s role in regard to considering and acting upon the recommendations of these external agencies. On the contrary, the shareholder theory holds that the director of a firm ought to be preoccupied primarily in the formulation and implementation of organizational policies which will assist in the profit maximization of the firm, in disregard of whether they prompt the outcry of the pressure groups or considered ethical or not. In this case, the duties of the director does not encompass consultation with these agencies in regard to the ethical standards of the firm and not even engaging their propositions in the decision making process. Thirdly, it is imperative to be cognizant of the fact that in the shareholder theory, the management endlessly strives towards heightening the shareholder’s value, mostly through reorganization and restructuring the firm through takeovers, mergers, privatization of enterprises which are publicly owned and vertical integration techniques. In this case, the employees are the ones who suffer as a result of job losses, and in majority of cases, poorer working conditions (Anderson et. al, 2006, p. 2). It follows from this deduction that the sole responsibility and duty of work reorganization and restructuring is basically under the firm’s director who is mandated with the task of setting strategic direction of the firm for profit and growth. This ‘shareholder primacy’ perspective appears to have emanated from the idea that the director as well as professional managers who effect the corporate strategies are merely ‘agents’ of the shareholders, and thus are under rudimentary obligation of managing the firm in the interest of the shareholders even if these strategies negatively harms the employees (Anderson et. al, 2006, p. 2). Nonetheless, the stakeholder theory holds that the director of a given firm is under particular obligation of taking into account the rights and welfare of the employees, in most cases above that of the shareholders. This is founded on the fact that the employees are the ones who voluntarily contribute to the wealth creating activities and capacity of the firm and thus its primary risk bearers. In this regard, the obligation to take care of the welfare of the employees through proper remuneration, rewards and recognition, risk compensation among other undertakings fall under the docket of the director of a given firm, thus expanding his/her duties in the daily operations of the business. There is also an extensive diversity in these theories in regard to legal obligation and the eventual duty of director to this effect. This is whereby in the ‘shareholder primacy’ perspective, it was clear that the directors owed no much legal obligation to the shareholders in a direct sense under the corporate law. In this regard, such legal obligations inferring to the overall influence on the entire strategic decision making processes of the board of directors, are owed to the company as opposed to the shareholders as much (Anderson et. al, 2006, p. 3). In actual sense, the directors are under legal obligation to act according to the best interests of the company whereby in majority of the courts, the interests of the company are regarded as the interests of the shareholders in the company. Thus, it is the duty of the director to comply with legal prerequisites in diverse company’s undertakings. Nonetheless, recent developments have broadened the scope of legal obligation of the director, for instance, recent inquiries by the Australian government have reinforced the legal competence of the director to adopt to a wider alley of interests while in pursuit of the corporate strategy. In this regard, the Corporation Act and the Common Law in Australia underpin that the directors in diverse corporations to exhibit some sought of accountability to the shareholders in some respect but this does not insinuate that the interests of the latter group should always be held paramount above the interests of other stakeholders (Anderson et. al, 2006, p. 3). This development is primarily embedded in the stakeholder theory. This latter development in Australia portray the increment of the duties of the director to encompass more legal obligations as entrenched in the stakeholder theory as opposed to the limited duties of the director in regard to legal obligation as underpinned in the shareholder theory previously analyzed. Lastly, it is worth noting that apart from the corporate responsibility towards the human characters like employees and consumers as explored in the preceding discourse, the stakeholder theory holds that a firm is bound to exhibit a greater sense of responsibility and paying more attention to the natural environment (Freeman, Wicks and Parmer, 2004, p. 365). This can mostly be perceived in the light of increased popularity of the concept of ‘greening’ environment responsibility. In this regard, there is increased duty on the side of directors in diverse firms to ensure that the firms which they are mandated to overlook are compliant with the different environmental agreements and regulations. This is founded on the fact that the sensitivity of the firm towards environmental sustainability is bound to influence consumer behavior. Laroche et al. (2001, 506) revealed in their US survey that the presumed severity of environmental problems has been significantly and positively related to paying more for the products which are considered as being environmentally friendly and whose production processes does not contribute to heightened environmental degradation and pollution, both at the national and international level. Thus, it is the duty of the director, as stipulated by the stakeholder theorists, to ensure that the firm has robust programs to ensure both short and long-term environmental conservation. On the contrary, the shareholder theory, as expounded in the preceding discussion, only underpins the maximization value for the shareholders and divorces the duties of the director from aspects like environmental responsibility. Towards this end, this theory postulates that the role of environmental conservation is not under the mandate of the firm but rather on different governmental agencies like United Nations Environmental Program (UNEP) among other bodies at the national and international levels. Conclusion From the above discourse, it is evident that there are extensive effects of both the shareholder and the stakeholder theory on the duties of the director in any given firm. Whereas the stakeholder theory tends to expand the scope of the director duty to include responsibility towards multiple constituent groups like employees, regulators and suppliers and the effects on the wider society, the shareholder theory tends to limit the director’s duty to value creation in the firm in the benefit if the shareholders who are the actual owners of the firm. References Anderson, M. et. al, 2006, Evaluating the Shareholder Primacy Theory: Evidence from a Survey of Australian Directors, University of Melbourne, Parkville, Victoria. Freeman,E., Wicks, A., & Parmer, B., 2004, ‘Stakeholder Theory and“The Corporate Objective Revisited”, Organization Science, Vol. 15, No. 3, pp. 364-369. Laroche, M., Bergeron, J. & Barbaro- Forleo., 2001, ‘Targeting Consumers who are willing to Pay More for Environmentally Friendly Products’, Journal of Marketing, vol. 18, no. 6, pp. 503-520. Pfarrer, M., 2010, ‘What is the Purpose of the Firm?: Shareholder and Stakeholder Theory’, Retrieved 16th August 2012, < http://www.enterpriseethics.org.dnnmax.com/Portals/0/PDFs/good_business_chapter_07.pdf>. Phillips, R., Freeman, R., & Wicks, A., 2003, ‘What Stakeholder Theory is not’, Business Ethics Quarterly, Vol. 13, No. 4, pp. 479-502. Read More