Stakeholder theory

The stakeholder theory is a popular view on how to run organizations. It purports to be more moral than other views. I believe the beneficiary doctrine is a more useful framework.

R. Edward Freeman is a pioneer of stakeholder theory. He sets out the view in the book Strategic Management: a Stakeholder Approach, and other works. Freeman identifies groups, which are 'stakeholders' of a firm. He describes and recommends methods by which management can meet the interests of those groups.

As stakeholders, he includes -

  • Suppliers
  • Customers
  • Employees
  • Owners or shareholders
  • Local community
  • Management in its role as agent for these groups.

Freeman argues for a rethink of the concept of the firm around the question: For whose benefit and at whose expense should managers operate the firm. His own answer to the question is in the form of a stakeholder theory of the firm.

Stakeholder theory asks who should influence strategic planning

Freeman's answer is to replace the idea of managers having a duty to shareholders, with the idea that they are accountable to 'stakeholders'.

He and others challenge the current theory of the firm. This sees the objective as shareholder value maximization. They believe this leads to treating the groups other shareholders as means to shareholder ends.

Therefore, the stakeholders, not just shareholders should decide the future of the firm. This goes right to the heart of strategic planning. The first decision is about whom to involve in this major decision-making process. In effect, this raises questions about who can control the corporation.

Who controls the enterprise?

The stakeholder view of the corporation is really a debate over the governing corporate objective. It is not usually sated this way. The key question is - who are the intended beneficiaries?

This question has been with us for a long time. In 1932, Adolf Berle and Gardiner Means, in The Modern Corporation and Private Property showed a separation of the legal company owners from the control of their own property.

The firm is a kind of person in its own right. This idea, whether embodied in law or not, shapes governance and management in many countries.

Managers have scope to manage companies for their own ends, free of owner control.

In effect, investors give their wealth to those who control the corporation. They exchange the position of independent owner to become merely receivers of a payment for the use of their capital. They are just like other suppliers to the company. In doing so, they give away the right that the managers operate the firm mainly for the owners.

It seems that the target of the stakeholder theorist's attack is something of a fiction. The idea that the business is operating only in the interests of the shareholders does not fit reality. This is despite the rhetoric in many annual reports.

Berle and Means advocated improved, transparency, and accountability. More than eighty years later, we still hear such calls.

Regulation has gained more recognition of stakeholder groups. For example, the UK Companies Act of 2006 provides for what it calls 'enlightened shareholder value'. This does not take away shareholder value as the primary objective of the company. It does legitimize address the interests of other 'stakeholder' groups while doing so. It is a compromise between extremes of shareholder value only, versus full stakeholder control.

Documents related to this work on UK company law are available at this National Archives link.

Proposed more recent changes appear here.

Two views on the beneficiaries of the corporation

Since the 1930s, we have had a debate between by two views. On one hand, we have the shareholder primacy principle. On the other side, we have the stakeholder theory.

I believe that neither of these extreme views is adequate.

Neither one is ethically sound or logical. There are two sets of difficulties.
When the shareholder primacy rules without regard for the interests of other groups, there may be short-term financial success. If this is as the expense of one of more of the non-shareholder interest groups, there will be trouble.

In organizations ruled by stakeholder theory, one may get sensitive behaviour towards interest groups. This may be at the expense of delivering results for the intended beneficiaries. Look at this figure -

A compromise between the two views may be more workable than taking either view to its extreme. An example is the UK enlightened shareholder value view idea. I think we can do better using principles that apply across various jurisdictions.

A third way sees the shareholders as 'intended beneficiaries', and insists on proper conduct towards other interest groups.

Problems with shareholder primacy

Many companies set such corporate objectives as these -

  • 'We aim to maximise long-term profits'
  • 'Our company will maximise its market capitalisation'
  • ‘We will maximize shareholder value', and so on.

As early as 1969, George Steiner, and Igor Ansoff questioned the value of such objectives. Nevertheless, we still see these statements offered as the best way to set direction for firms.

Resources by George Steiner Books by Igor Ansoff

Despite their popularity, I see them as misleading guides for management action. They have the following defects -

  • It is doubtful that many companies attempt to 'maximize profits'. Do companies really stretch every piece of equipment, every square metre of space, and every employee to breaking point to earn more profits? When they know that their performance is already beyond excellent, do they keep pushing and pushing for just one more unit of profit? Do they ignore all risks, cast aside all humanity, and deny all morality to extract that very last penny? While there may be examples approaching this situation, we would doubt it is the norm.
  • How can a company tell if it has achieved this objective? How, in five years' time, will a firm know it has ‘maximized’ its profits over the previous five years? Will the firm's accountants sign certificates in which they declare that they certify that this company maximised its profits last year? If it is not possible to verify achievement of the objective, is there much point in setting it in the first place? Sadly, unverifiable, or even immeasurable objectives are set in many organizations.
  • The word 'maximize' is, in this context, literally meaningless. In the short term, there may well be a profit figure that it is impossible to exceed because of the given physical and non-physical resources that are available to the company at a given time. However, in the context of corporate strategic planning we are not talking about the short term. The whole purpose of the exercise is to ask what sort of resources the company should seek to employ in five, ten, or twenty years' time. We can simply have no idea what the word means in an open-ended context like this.

Problems with the Stakeholder Theory

The stakeholder theory says how organizations should behave in society. Its rules are generally vague and impractical. It often fails to clarify who the stakeholders are for any specific case. It is unclear what rewards an organization should bring them. It is difficult to see who should determine the allocation of benefits to each stakeholder. It does not provide any test by which any of their claims may be accepted or rejected.

Worse still, the theory provides a seeming justification for managers to highjack the organization to their own interest. This they do to an extent not generally appreciated. This sometimes renders their organization useless to its beneficiaries. Anyone for a repeat of Enron?

Pronouncing the rule that organizations must have more than one beneficiary blurs the focus of management and employees alike as to the true aims of their organizations. It confuses them; in attempting to be all things to all people it satisfies none.

Enron: let that be a lesson to you

The stakeholder theory also precludes the measurement of corporate performance, with appalling effects on decision-making.

This theory is probably responsible for much of the poor performance of many of our NPOs. It is a burdensome distraction. Moreover, because of its popularity, it delays the search for a more productive approach. We believe a far more productive approach is the Argenti 'principle of engagement' described in the next section. Mercifully, most organizations have more sense than to diligently follow the precepts of the stakeholder theory.

The Principle of Engagement

The Argenti Beneficiary Doctrine does not use the term 'stakeholder' at all. Instead, it defines two groups of people -

  • Intended beneficiaries and
  • Interest groups

The no harm principle states that, in pursuing the interests of the intended beneficiaries, no organization may cause significant harm to any of its interest groups. This rule will enhance the conduct of all organizations. However, this precept forms merely a floor for corporate behaviour. It often requires nothing more than care to avoid negative effects upon interest groups.

Something more positive is also required.

The principle of engagement is a more positive approach. It requires managers to identify every group of people willing and able to support the organizational purpose.

This will improve relations with the usual stakeholders. These include employees, suppliers, customers, and the local community. It may tap into new support. For example volunteers augmenting a traditional corps of employees. In some cases, the paid employees might become a minority. The extreme would be a trained, and paid central core, whose sole task is to engage external enthusiasts and supervise their work.

Importantly, the principle of engagement allows clear evaluation of the performance of any organization, something not possible with the stakeholder theory.

Unlike stakeholder theory, the principle of engagement sees just one passenger in the coach: the intended beneficiary. Everyone else should be outside. The employees, suppliers, local community, will be oiling the wheels, grooming the horses, polishing the brasses in the interests of this very important passenger. By contrast, the stakeholder theory sees everyone in the coach. This even includes the horses, and the management is in there, tucking into the passenger's steak and kidney pie!

A school should not be asking itself, 'What should we be doing for the children, the teachers, the parents, the community?' but how should we be asking the teachers, the parents, the community, to help us do more for the children?' The police should not ask 'What additional services should we perform for the community?', but 'How should we behave towards the community so they help us cut crime more willingly?' Completely different, is it not?

It is the job of the governing body to commit their organization to the no harm principle and the principle of engagement. They should use these criteria to monitor the conduct of their organization in society.

Other considerations

Protest groups challenge many organizations today. Such activities as trading with oppressive regimes, disposing of radioactive wastes, road building, using farm chemicals, and others are under attack. In some cases, the threat is severe enough to qualify as a major strategic issue.

Not all protests need to be threats. Some food, clothing, and cosmetics firms have prospered by treating them as opportunities. The use of artificial ingredients and inhumane methods in these industries has triggered innovations that improve the situation.

I believe organizations should not aim to satisfy a variety of groups. On the contrary, I think that an organization should aim to benefit one quite specific set of people, the intended beneficiaries. In doing this, it should recognize the needs of others.

The Stakeholder Theory says that, on the contrary, organizations do, and should, benefit a wide range of people. Indeed, everyone associated with an organization may be a stakeholder, and have a stake in its future. In addition to the intended beneficiaries, who, in this theory, have no special relationship to it, an organization should benefit its employees, the local community, customers, competitors, suppliers, the state, interest groups, and pressure groups, indeed anyone affected by it.

Organizations behaving responsibly

In the Stakeholder Theory, the danger is that the management becomes a Father Christmas, offering gifts to all concerned under a set of rules that the recipients themselves have made.

Of course, no organization can aim to satisfy its beneficiaries at the expense of all the other groups. However, there is a big difference between that and granting their every wish.

I believe the baseline for corporate conduct is the No Harm Principle. In pursuing its aims, no organization should cause significant harm to any third party. If it does, full compensation is due to anyone harmed by the organization.

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Find out more on the views of R Edward Freeman from his own writings-