The Conflict Between Maximizing Profits and Considering Other Stakeholders

As the economy of Australia moves away from resource boom, it becomes significant for the directors of corporations to achieve complete understanding of the scope and nature of the duties imposed on them. As a result of this, the directors become completely operating in Australian law and at the same time they do not expose themselves and the company to unnecessary legal. One particular area where a lot of confusion is present for the directors in Australia is to achieve a ‘balance’ between the objective of maximizing the profit for the shareholders and to create benefits for the other stakeholders of the corporation like customers, suppliers, employees and the wider community (Denning, 2015).

The conflict that is present between maximizing the value for shareholders and the objectives of the shareholders is such a conflict that goes to the heart of the role played by the directors of corporations in modern marketplace. Therefore, while on one hand, as the corporation is ‘owned’ by the shareholders, it appears to be natural that the interests of the shareholders should be given primacy by the directors of the corporation. On the other hand, as the corporations have a significant impact on other people, apart from the shareholders (like the customers, suppliers, employees and wider community) there is a view according to which, it is important for the directors to consider all these interests whenever they’re making a decision related with the course of action that is going to be adopted by the corporation (Greenwood, 2008).

It is also worth mentioning that significant guidance is not provided by the Australian corporations’ law regarding the level of balance that needs to be maintained by the directors in this regard. Widely speaking, it has been provided by section 181(1), Corporations Act, 2001 that the directors are under an obligation to discharge their duties and exercise the powers in “good faith and in the best interests of the corporation”. In this way, the interests of non-shareholders stakeholders have not been expressly acknowledged. As a result of this vagueness regarding the “best interests of the corporation”, there are certain experts, who argued that it is already contemplative by the law that the directors should consider other stakeholders also whenever they are making decisions regarding the corporation. One such particular field is related with cases of insolvency. It has been recognized by the courts that when a corporation has become insolvent or, it is going to become insolvent or, if due to a particular transaction being contemplated by the corporation, it may become insolvent, it is possible for the directors consider the interests of the creditors (Laplume, Sonpar and Litz, 2008). Hence, this is the only situation where the directors can give priority to the interests of the stakeholders as compared to the interests of the shareholders. Even if it provides an example regarding the balance that needs to be maintained between shareholders and stakeholder priorities, insolvency does not act as a useful guide in the ordinary exercise of duties by the directors.

Guidance Provided by Australian Corporations Law

The uncertainty present in the law regarding this issue is matched by the perception of the directors regarding their role and duties. It is believed by the directors of corporations that they should be concerned with the interests of all the stakeholders of the company instead of only being concerned with the interests of the shareholders. According to a large number of directors, in order to act in the best interests of the corporation, the directors believe that they should balance the interests of all the stakeholders (Millon, 2010). This reveals that the directors in Australia focus on the interests of the stakeholders even been the law is not clear if they have to do so or even if they can do so. Currently there is a particular field where the balance between shareholders and stakeholders is being affected by the duties of the directors, is the corporate social responsibility.

Shareholder value theory: According to the shareholder value theory, it has been proposed that the main duty of the directors is to maximize the wealth of the shareholders. The basis for this view can be found in the book written by Adam Smith, The Wealth of Nations (Pfarrer, 2010). In its present form, this theory was provided by Milton Friedman. According to him, the only social responsibility that has been imposed on the corporations is to increase their profit. In a paper written by Michael Jensen and William Meckling (1976), this view was further reinforced. They described the firm as a legal fiction and the shareholders were the principal and the directors and managers were the agents. They also stated that the directors and managers who were following goals apart from the objective of maximizing the shareholder wealth for reducing social good as they imposed agency costs. As a result of this academic backing, the shareholder theory achieved significance by the end of the century.

However, as a result of the global standards and crises, questions have been raised regarding the shareholder oriented perspective. An example of this regard can be given of the global giant Enron, which was known for its corporate governance in order to increase shareholder value by the inadvertently collapsed as a result of accounting fraud and bad business decisions (Pfarrer, 2010).

Stakeholder theory: as against the shareholder value theory, the history of stakeholder theory is much shorter. First of all the terms of stakeholder was used in an internal memorandum issued in 1963 in Stanford Research Institute. Initially the use of the term received flak from Igor Ansoff. The reason was that according to him, stakeholders were a secondary constraint, placed on the initiative of the corporation. However, the concept of stakeholders appeared prominently in 1970s in a number of cases dealing with strategic planning literature (Freeman, Harrison, Wicks, Parmar, & Colle, 2010). The main contribution is considered to be made by Richard Edward Freeman in 1984 in the popularization of this concept. Since then, the stakeholder theory achieved significant prominence up to 1995 (Laplume, Sonpar, & Litz, 2008). At present, the stakeholder theory represents the present of a shift in perspective related with the current debate concerning corporate purpose.

The Perception of Directors Regarding Their Role and Duties

In this context, the stakeholders of the corporation can be described as a group or the individuals who are going to be affected by the achievement of the objectives of a particular organization. In this way, it is suggested by the stakeholder theory that the purpose of the corporation requires it to consider all those who have any interest in the activities of the organization, including the shareholders, customers, suppliers, employees and even the general public. Therefore, it is required that the management of the corporation should try to follow the objective of achieving a balance between the competing interests of various stakeholders. Due to this reason, the stakeholder theory is considered as a holistic approach adopted towards corporate purpose (Pfeffer, 2009). It also provides strategic depth to the interests of the management according to the different approaches. These are descriptive (which explains corporate behavior); instrumental (concerning the links between performance and strategies concerning the stakeholders); and normative (which interprets the functions of the organization from moral viewpoint). Although at one point of time, the shareholder value theory enjoyed the place of prominence, but now this theory is contested by the premises of stakeholder approach. In this view, both these can be compared, keeping in view the relevant factors for change.

The proponents of stakeholder theory have provided several arguments to deal with the implications of shareholder value theory. It has been revealed by a competitive analysis that the corporations that focus on the stakeholders are able to outperform the others even in times when they focus on shareholder wealth. This points out towards the practical effectiveness of stakeholder theory. Moreover, with the increase in the range of performance measurement tools, the need reduces to only rely on financial measures also. While evaluating the arguments given in favor of shareholder theory, it has been pointed out by several experts that even if the shareholder value ideology has pervasive extent, but it is still a managerial choice instead of being a practical necessity or a legal obligation. Therefore, the one exception being self-enrichment, significant discretion has been provided by the law regarding the other corporate goals like serving the community of protecting the employee (Pichet, 2008). These goals are also required to be pursued by the management. Indeed, the stakeholder theory provides holistic approach that includes several parties as compared to the shareholder theory still it has many detractors also. For example, Michael Jensen had stated that he stakeholder theory should not be considered as a valid competing theory due to the reason that it fails to provide complete specification of the corporate objective function (Jensen, 2001). As against the clarity that is offered by a single objective in case of the shareholder value theory, the emphasis in stakeholder theory is towards several objectives, which may result in conflict, confusion and inefficiency for the organization. This view has been supported by some other authors also according to whom, being accountable to all the stakeholders of the firm is not only unworkable, but also so diffuses that the accountability becomes extinct.

The Shareholder Value Theory and Its Criticism

Another argument that is also generally given against the stakeholder theory is that this theory undermines the basic features of society. For example, the theory denies the right enjoyed by the owners to dictate the use of their assets as it requires that the assets need to be used for the benefit of all stakeholders. As a result of this feature and the additional entrustment of assets by owners to managers, it results in compromising the agent principal relationship also.

Therefore, in the end, it can be stated that although strong arguments have been given in favor of both the theories, the issue is if the debate has any significant implications. In a survey conducted by the University of Melbourne in 2005, it was revealed that ideological acceptance may not be transformed into practical managerial behavior. The findings of this study also revealed that although the primacy of shareholders enjoys significance among the managers but a proposition cannot be made that the directors are going to follow the interests of the shareholders at the expense of other stakeholders (Jensen and Meckling, 1976). Therefore even if the shareholders are still considered as the most important among various stakeholders, the directors prioritize the interests of other stakeholders like the employees.

Despite this phenomenon, it appears that the global business community is in favor of a new ideological consensus. Both these theories are considered as the theories of value creation, but they have different prescriptions for this objective. The most significant argument given in favor of stakeholder theory is that considering the interests of additional stakeholders to some extent can prove to be financially beneficial for the corporation in present-day economic landscape, probably more than in case of shareholder theory. Even if the contention is present tha stakeholder theory gives preference to non-financial market stakeholders, ignoring the corporation, it has been proved by empirical observations that this view has been misconstrued. Therefore, it appears that there is a shift in ideology as well as in successful managerial business practices drifting away from shareholder value maximization.

Therefore in the end, it can be stated that although the shareholder value theory has long historical roots but it is also worth mentioning that the stakeholder theory is gradually but fundamentally changing the perspective of the directors, managers and the society. Therefore, even if it is still incomplete in its present form, the stakeholder theory is instrumental in steering the path for businesses to achieve their objective of value creation both for shareholders and the society. 

References

Denning, S. 2015, Salesforce CEO Slams ‘The World’s Dumbest Idea’: Maximising Shareholder Value. Forbes

Freeman, R. E., Harrison, J. S., Wicks, A. C., Parmar, B. L., & Colle, S. d. 2010, Stakeholder Theory: The State of the Art. Cambridge: Cambridge University Press

Greenwood, M. 2008, Stakeholder Theory, In R. Thorpe, & R. Holt, The SAGE Dictionary of Qualitative Management Research. London: SAGE Publications Ltd.

Jensen, M. C. and Meckling, W. H. 1976, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure Journal of Financial Economics, 3(4), 305-360.

Laplume, A. O., Sonpar, K., & Litz, R. A. 2008, Stakeholder Theory: Reviewing a Theory That Moves Us Journal of Management, 34(6), 1152-1189

Millon, D. 2010, Enlightened Shareholder Value, Social Responsibility, and the Redefinition of Corporate Purpose Without Law Washington & Lee Legal Studies Paper 2010-11.

Pfarrer, M. D. 2010, What is the purpose of the firm?: shareholder and stakeholder theories . In J. O’Toole, & D. Mayer, Good Business: Exercising Effective and Ethical Leadership (pp. 86-93). The Institute for Enterprise Ethics

Pfeffer, J. 2009, Shareholders First? Not So Fast… Harvard Business Review: Corporate Governance 

Pichet, E. 2008, Enlightened Shareholder Theory: Whose Interests should be Served by the Supporters of Corporate Governance? Corporate Ownership and Control, 8(2-3), 353-362.