In light of recent debates about the purpose and social responsibility of the modern corporation, the principle of shareholder and stakeholder theory is brought to comparison with each other, to determine which principle corporation should follow.
This commentary critiques the arguments that Anant K. Sundaram and Andrew C. Inkpen has raised which supports the principle of shareholder theory, as well as the refute via stakeholder theory by R. Edward Freeman, Andrew C. Wicks, Bidhan Parmar.
Value Maximisation & Entrepreneurial Risk Taking
Sundaram & Inkpen argues for the primacy of shareholder value maximisation via their first two points that it maximises the value of the whole firm and that appropriate risk to allow for the firm’s growth will be taken. The reason for their argument is that shareholders are ‘residual claimants’ with appropriate incentives to make any discretionary decisions - as such it makes sense that when the residual claimants’ value are maximised, naturally the stakeholders’ shares have been maximised as well1. This also relates to stakeholders being ‘fixed claimants’, would avoid high-growth investment opportunities for firms, as they would “prefer the prospect of permanence from cash flow stability” for their second point. However the assumptions that Sundaram & Inkpen made is that only shareholders will ultimately want to maximise value to the firm, and that stakeholders will deviate the firm’s objectives away from value maximisation.
Freeman et al points out that Sundaram & Inkpen separates shareholders from stakeholders, but the fact that shareholders are stakeholders too cannot be avoided. This reinforces stakeholder theory that via value maximisation for stakeholders, it ultimately leads to increase productivity as well as profit due to betterment of products. Moreover the idea of entrepreneurial risk in context of joint stake holder relationship, dispels the notion that stakeholders are risk averse. Instead, it shows that stakeholders are willing to take the risk if they are educated on the exponential benefit that such risk brings.
Overall Freeman has proposed a better argument for stakeholders for the first two arguments, but we cannot entirely rely on either principle for a firm. Firstly, there is asymmetric information between the shareholder and the stakeholders; owners versus managers and workers of the firm. This is because of the hands on experience that stakeholders have dealing with consumers, they possess information about the conditions of a successful implementation of the business strategy. Secondly if we just rely on stakeholder theory, there might be possibility that managers hide their actions from owners. This shows incompleteness in the principle-agent contract, and therefore performance-based contracts as well as reputation for the managers will be used as incentives for satisfying investors’ demands, or, in short: maximize the firm’s shareholder value2.
Single Objective versus...