Do Stakeholders Count?

Table of Content

1. Introduction

2. Shareholder-value and stakeholder-approach - the broad concepts

3. Who is a stakeholder?
3.1 The Broad and the Narrow View
3.2 Power, Legitimacy and Urgency of Stakeholders

4. Different Approaches of Justification
4.1 Descriptive Justification
4.2 Instrumental Justification
4.3 Normative Justification

5. Evaluation of the Stakeholder Theory
5.1 Stakeholder Theory as an Approach to Management
5.2 Stakeholder Theory as a Societal Theory

6. Conclusion

1. Introduction

According to Milton Friedman (1970), “in a capitalist economy 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”. With respect to corporations, this view is known as the shareholder-value approach, which defines a corporation’s main objective as maximising the shareholders’ wealth and management’s main responsibility as acting in the shareholders’ interest.

In contrast to this strictly economical goal approach, various scholars have since long questioned the shareholder value approach, emphasising that management is not only responsible to shareholders, but also to other entities inside and outside the corporation, called stakeholders, which might be employees, customers, suppliers, government or the environment. However, stakeholder theory has many advocates and the views what stakeholder theory really means are multifaceted. Especially the question as to how far management is responsible to various stakeholders, and if this even means that profit should be foregone in order to act morally or ethically correct, is not answered unanimously by stakeholder theorists.

Therefore, the question this paper will seek to answer is:

“ Is the stakeholder-theory a viable approach to management and does it contradict the shareholder-value theory? ”

The first part of the paper will give a general overview about what is meant by shareholder- value and stakeholder approach. However, as the views on what stakeholder-theory actually is and constitutes vary to a large degree between scholars promoting this view, the next section will try to elucidate the question who actually is a stakeholder to a company and how they could be classified. Following, different ways of how stakeholder theory is justified are presented and evaluated.

2. Shareholder-value and stakeholder-approach - the broad concepts

The difference between the shareholder-value and the stakeholder approach is the way they define corporate responsibility, the question to whom the directors and managers of a profit- seeking corporation owe their duty and in whose interests they are working. Shareholder- value theory follows the strictly economical approach that managers act as fiduciaries for the owners of the corporation, namely the shareholders. Agency theory sees the owners of the company as principals and the managers as agents acting on their behalf. This implies that every decision by management should be made with the intent to maximise the shareholder’s wealth, as long as these decisions and the resulting actions are within the bounds of law. To ensure that management acts in the owners’ interest, they should be either monitored or given financial incentives. Economic theory suggests that through profit-maximisation also social welfare will be maximised.

Proponents of the stakeholder approach generally disagree with the single focus on shareholder-value maximisation. Shareholders are seen as just one group of stakeholders to the organisation and management’s task therefore is to find a balance between the different stakeholders’ claims. However, whereas the economical theory of shareholder-value is pretty much clear in its objectives, stakeholder theory over the last decades has evolved into a diversity that makes it difficult to identify clear guidelines on who actually is a stakeholder or how their claims can be justified. The next two sections will try to elucidate the different viewpoints, first with respect to the question who actually is a stakeholder and then by describing the different approaches to justify and legitimise their claims.

3. Who is a stakeholder?

3.1 The Broad and the Narrow View

By rejecting the shareholder-value approach, stakeholder theorists urge the management of corporations to identify its stakeholders and consider them in their decisions and actions. Before trying to identify the reasons why and to what extent stakeholders should be considered, it is necessary to define who qualifies as a stakeholder and to categorise them with respect to certain attributes.

In the scholars’ various definitions of stakeholders, one can identify a range from very narrow to very broad views. In general, narrow views of stakeholders attempt to define relevant groups in terms of their direct relevance to the firm’s core economic interests (Mitchell, Agle & Wood, 1997). This definition certainly implies a corporation’s employees, its customers, its suppliers as well as its shareholders. This narrow definition of stakeholders still emphasises the importance of economical considerations and therefore might not be too far away from proponents of the shareholder-value view. After all, it should be obvious that stakeholders that are of vital importance for the corporations’ survival ought to be considered by management (to what extent, however, will be the topic of following sections).

For proponents of the broad view of stakeholders, however, “a stakeholder in an organisation is (by definition) any group or individual who can affect or is affected by the achievement of the organisation’s objectives” (Freeman, 1984). This certainly means that virtually anyone can be a stakeholder, which makes the task for management to identify who its stakeholders are very difficult.

In-between these two extreme views are numerous other criteria for identifying stakeholders; for example the question whether a relationship or a contract exists between the corporation and the other party; whether transactions take place; whether the other party bears risk resulting from the corporation’s actions, be it voluntary or involuntary; whether there is dependence of any kind, be it unidirectional or bi-directional, between the corporation and the other party. This wide array of proposals to identify stakeholders is rather confusing and not very helpful to managers who might try to determine who really is a stakeholder and who is not. Therefore, the following section will provide a framework that might help to acquire some general guidelines on how to define stakeholders.

3.2 Power, Legitimacy and Urgency of Stakeholders

Mitchell et al. (1997) provide a framework that helps to identify stakeholders and classify them in order of their importance (or “salience”) according to the attributes of power, legitimacy and urgency. A stakeholder has power if he has the means to impose his will on the corporation, be it through the use of physical resources of force, violence or restraint, through material or financial resources, or symbolic resources. A stakeholder has legitimacy when his actions are deemed desirable and appropriate within a social system. The attribute of urgency is given when the stakeholders claim is critical to him and calling for immediate attention.

Depending on the possession of one, two or three of the above mentioned attributes can a stakeholder be classified as either latent, expectant or definitive. Entities not possessing any of the attributes are considered as non-stakeholders. This classification scheme makes it possible for managers to assess the importance of and attention required for different stakeholders, even though in a subjective way, based on the manager’s perception. The question why, however, management should turn its attention to certain stakeholder groups more than to others, so, the question where the legitimacy of the stakeholders claims comes from and how they are justified, has not yet been answered. This will be the topic of the next section.

4. Different Approaches of Justification

The previous section described a scheme that makes it possible to classify different stakeholders according to their importance. However, the question remains how the stakeholder approach in general is justified and what its purpose is.

According to Donaldson & Preston (1995), the stakeholder theory has been advanced and justified in the management literature on the basis of its descriptive accuracy, instrumental power, and normative validity. The next three sections will examine these three bases of justification.

4.1 Descriptive Justification

By trying to justify stakeholder theory descriptively, scholars are collecting evidence that the stakeholder approach is indeed used by managers of corporations and imbedded in law. Different researches, for example surveys among managers have shown, that managers do not solely focus on shareholders but also on other constituencies such as employees and customers (Donaldson & Preston, 1995). Also, legal developments in the US seem to move away from a single-minded shareholder perspective and new laws give more power to other constituencies like consumers and employees. In other countries, such as Germany and Japan, certain aspects of stakeholder theory have since long been incorporated not only in law, but also in the general customs of business and society, for example the German law of co- determination, which requires the upper-tier board of management to consist of 50% employee representatives, or in the Japanese business practice of building “keiretsus”, where several firms that are “friendly” to each other agree on co-operating.

However, the mere fact that different aspects of stakeholder theory are applied in reality does not justify the theory. Undoubtedly, there is evidence of extreme incompetence and mismanagement in numerous companies, however this does not mean that it is desirable. If solely descriptive justification was used, the theory would be invalidated as soon as managers and legal authorities abandoned it.

4.2 Instrumental Justification

The approach of instrumental justification of stakeholder theory follows the hypothesis that corporations whose managers follow the stakeholder approach will perform better financially than those that do not. However, this hypothesis has never been tested directly, one reason being that the definition of the independent variables is extremely difficult. There is no such thing as an optimal approach of stakeholder management that could be tested statistically, so empirical verification does not exist.

In order to justify stakeholder theory on an instrumental basis, analytical argument is necessary. This has been done by linking the stakeholder approach to established concepts of principal-agent relations. Agency theory sees managers as agents acting on behalf of the owners, who are the principals. Hill & Jones (1992) have broadened this standard economical concept to a “stakeholder-agency theory”, which sees managers not only acting on behalf of the shareholders, but on the behalf of all stakeholders to the company. The key point of their theory is that “stakeholders are drawn into relationships with the managers to accomplish organisational tasks as efficiently as possible; hence, the stakeholder model is linked instrumentally to organisational performance” (Hill & Jones, 1992). But this is not necessarily in conflict with a shareholder-value approach. If the managers of a corporation take a long- term view of economical profit and if it was really true that the stakeholder approach is instrumental to organisational performance, these two views need not be contradicting. Proponents of the shareholder-value theory, if they take a long-term view of economical profit and do not favour every short-term profit that is achievable, should not have a problem with this instrumental justification of the stakeholder approach.

The problem is that other scholars do not only see stakeholder theory as an instrument to increase economical performance. According to Freeman & Evan (1990), “the very purpose of the firm is, in our view, to serve as a vehicle for co-ordinating stakeholder interests”. The arrangements between the different stakeholders which are administered by the managers should be governed by “fairness” as the ultimate criterion. However, what is fair and what is not fair can not be based on purely economical considerations; to answer this question, normative criteria is needed. This will be the subject of the next section.

4.3 Normative Justification

As soon as the stakeholder approach is justified not only instrumentally, but through moral or ethical arguments, the justification becomes normative. Referring back to Mitchell et al’s framework, a definitive stakeholder possesses the attributes of power, urgency and legitimacy. Normative justification tries to establish where the stakeholder’s legitimacy comes from. A stakeholder’s claim can be legitimate based on legal, moral or property-based grounds.

If the stakeholder’s claim is based on legal grounds, it will not be incompatible with the shareholder-value approach, which states that managers should maximise shareholder wealth within the bounds of law. As long as the stakeholder’s claim is legally binding, the manager will not be in conflict with his principal, the owner, if he fulfils the claim.

However, if the claim is based only on moral grounds, there is a clear conflict between the stakeholder approach and the shareholder-value approach. Stakeholder theorists might argue that the claimant has a moral right and that management might act immorally or unethically if it does not react to the claim. To answer the question what is morally or ethically correct in an objective way is impossible, it is dependent on general societal values that might differ from country to country.

In trying to justify stakeholder theory on a normative base that is more general, Donaldson & Preston (1997) use the theory of property. According to them, “the contemporary theoretical concept of private property clearly does not ascribe unlimited rights to the owners and hence does not support the popular claim that the responsibility of managers is to act solely as agents for the shareowners” (1997). The basis of the contemporary theory of property rights is the concept of distributive justice, which tries to determine fair distributions of objects with any value. Within the theoretical field of distributive justice, there are several competing theories, however most contemporary analysts seem to agree that there is no single valid theory of distributive justice, but that nowadays a more pluralistic approach is appropriate. From this fact, Donaldson and Preston (1997) derive that “the normative principles that underlie the contemporary pluralistic theory of property rights also provide the foundation for the stakeholder theory as well.” This paper will not try to assess if the theory of property rights really justifies stakeholder theory normatively. What the author of this paper deems important though is that even though Donaldson and Preston see their approach as a normative justification for stakeholder’ claims, they do not agree with more radical scholars who say that “such stakes constitute formal or legal property rights” (Donaldson & Preston, 1997). Therefore, the question remains how such stakeholders who have a claim against a corporation that is normatively justified on a moral or property-based, but not on a legal basis, are supposed to enforce their claims. And, in a case where such a claim would hurt shareholders’ interests, the question remains how managers themselves would justify answering such a claim before the shareholders.

5. Evaluation of the Stakeholder Theory

5.1 Stakeholder Theory as a Management Theory

If the stakeholder approach is not based on a normative justification, but rather seen as an instrument to achieve the goals of the organisation, then it can be seen as just another management theory which must in no way be incompatible with the shareholder-value view. However, in order to be compatible, the shareholder-value approach must be long-term, which implies that it is accepted to forego short-term economic profit for the long-term economic good of the corporation. If the stakeholder approach is used without loosing the economic objective of the corporation out of sight, it can be a powerful tool to gain a competitive advantage. It is since long accepted in management theory that companies have to analyse their environment in order to stay competitive. Consumers become more flexible and demanding, and more and more companies are moving from a marketing to a market orientation. This implies that companies not only try to persuade consumers to buy their products through marketing means, but that they actively listen to consumers and try to incorporate their claims. This “market-driven marketing” is perfectly compatible with the instrumental stakeholder approach. Due to increased global competition nowadays hardly any company can afford to neglect its customers and it almost generally accepted that “a market- oriented firm is in a better position to identify a sustainable competitive advantage and to increase or defend its market share” (Porter, 1985).

Also on the supply side, firms are more and more starting not to “squeeze” their suppliers in order to generate short-term profit, but are rather engaging in long-term relationships that involve a dialogue between the corporation and its suppliers for the benefit of both parties. Many companies feel that by engaging in relationship marketing they can increase the longterm economic well-being of their organisations.

With respect to employees, it has become apparent that it might me beneficial to the long- term economic success of the organisation to give strong consideration to the demands of the workforce in order to keep up productivity and morale. A recent example of how important the instrumental stakeholder approach is also for the economical well-being of the corporation is that of Daimler-Benz and its then newly appointed chairman Jürgen Schrempp in the middle of the 1990’s. Schrempp, who had declared himself a furious proponent of the shareholder-value approach, decided not to continue to pay workers in case of sickness, something that had been demanded by law for decades. The law had been changed recently and companies were not obliged anymore to continue pay for the first two days of sickness. He considered his decision as being necessary considering the shareholder-value approach. What he had not anticipated was the devastating effect the new rule would have on the morale of the workers. Daimler-Benz demanded supreme quality work from its workers in order to uphold the standards of the company, and it was part of the company culture that this was honoured by company management towards the workers. Schrempp had not anticipated the devastating impact of his decision and ultimately had to take it back. In applying a short-term shareholder-value view, Schrempp had neglected some of his most important stakeholders and thereby also endangered the long-term economical well-being of the company. With a long-term shareholder-value view in mind he would first have considered the potential impact of his decision in the long-run instead of trying to achieve some short-term cost reductions.

The stakeholders mentioned so far are all, customers, suppliers and employees are all encompassed by the above mentioned “narrow view” of stakeholders, because they are certainly relevant to the company’s core economic interests. But even stakeholders that are merely encompassed by the “broad view” of stakeholders might be considered by management without being in conflict with a long-term shareholder-value approach.

It is a common phenomenon that corporations are engaged in charity activities and make donations to charitable organisations. What might seem to be an altruistic move on the side of corporations and in direct conflict to the shareholder-value approach might well be in the long-term economical interest of the corporation and its owners if the goodwill that is created by these actions has a positive net present value. This might be the case if sales can be increased due to a more positive image of the company or negative reactions, such as boycotts, can be mitigated. This seems to be the case with many oil companies, such as Shell Corporation, who after a series of incidents that led to bad publicity and even boycotts of its outlets have started to become heavily engaged in social activities. However, the motives seem to be clearly economical, aimed at a long-term benefit for the corporation and therefore are not in conflict with the shareholder-value approach.

It can be said that the stakeholder approach as a management tool, if it is aimed at the long- term economical well-being of the corporation, is of major importance to most corporations in toady’s globalised and complex economy. Companies should constantly engage in screening their internal and external environment in order to identify stakeholders that are of relevance to their economic interest. This instrumental view of the stakeholder theory is not in conflict with a long-term oriented shareholder-value approach. As soon, however, as stakeholders are served by management that are of no short-term or long-term economical interest to the corporation and its owners, these actions by management are in conflict even with a long-term approach to shareholder-value. Such actions can not be justified on an instrumental basis but only on a normative basis. The implications will be dealt with in the following section.

5.2 Stakeholder Theory as a Societal Theory

Economic theory generally sees the only social responsibility of a corporation as maximising its profits to ensure its survival. Managers act as agents of the owners and are supposed to act in their interest. If stakeholder theory is justified on an instrumental basis and seen as a means to achieve long-term economic objectives of the company, this is still in accord with economic theory. However, many scholars in the field of stakeholder theory go further and demand management to react to claims of stakeholders that are supposed to have moral legitimacy, even if this goes against the economic interest of the corporation and their owners. By denying the economic principle of profit maximisation, stakeholder theory based on a normative justification is no longer just a management theory, but a societal theory.

By demanding managers to act on behalf of stakeholders that are of no economical interest to the corporation, proponents of the normative stakeholder theory want managers to act against the interest of the owners of the company, the shareholders. Examples would be the paying of wages that are higher than justified by any economic consideration, so even higher than would be necessary to keep up a needed level of morale. Another example would be to engage in charitable activities that create no goodwill at all and serve no other economic purpose. There are numerous other examples of stakeholders, whose claim might be justifiable on some moral or ethical grounds. The major problem is, that it is very difficult to find an objective answer to the question whose claims are morally justified and whose are not. Probably an objective answer to this question does not even exist, as questions of morality and ethics are dependent on a person’s system of norms, values and beliefs. There are no objective guidelines that can be given to managers, helping them to identify stakeholders whose claims are morally or ethically legitimate. This disqualifies normatively justified stakeholder theory as a coherent management theory, but not as a societal theory. It is certainly justified to question the shareholder-value approach and to demand that stakeholders whose claims are only legitimised morally or ethically be considered by management of corporations. But it is not the management’s task to decide what is morally or ethically legitimate and it is not management’s task to determine what is best for society. In a democracy, this is the task of the elected representatives who represent the whole society. If society decides through its elected representatives that corporations bear some kind of responsibilities towards whatever stakeholder, then this responsibility should be incorporated in the law and it is the duty of the managers, even under the shareholder-value approach, to obey the law.

It is the authors opinion that to decide what is in the public interest and what is best for social welfare is not to be decided by some people who happen at the moment to be in charge of particular corporations, chosen for those posts by strictly private groups. The normative stakeholder model, if fully implemented, would turn managers into politicians that would be given a responsibility that, in a democracy, ought to be carried out by people who have been democratically elected by the whole society. Managers are not in the position to decide what burden to place themselves and their shareholders in order to fulfil some vague social responsibility. If at all, only the shareholders are in the position to decide if they are willing to forego a certain profit in order to please other stakeholder groups, because it is the shareholders who ultimately decide if they agree with the management’s actions. If the shareholders disagree with management’s actions, they can choose either to sell their shares or not to re-elect management.

In a case like the Body Shop Corporation, the management of the company is determined to act in a socially responsible way. What is socially responsible or not is determined by management, also through continuous communication with stakeholders of all kinds. The important point is that management acts in accord with its shareholders, who have known the companies ethical principals when they invested in it and who are willing to forego profit if it is necessary to uphold these principles. There is nothing wrong with this, however, shareholders of other companies might not be willing to accept if management decides that it is necessary to forego economic profit, and then there is nothing management can do about it. It is not the intent of this paper to try to determine which social responsibilities corporations should or should not have. It merely states that, as soon as the principle of profit maximisation is abandoned, stakeholder theory becomes more than a management theory and evolves into a societal theory that ought to be discussed and dealt with by the whole society. The ultimate decision about what a corporation’s responsibilities are has to be made by society through its elected representatives by incorporating certain standards in law. It is important to note, that as soon as certain stakeholder’s rights are incorporated in law, their claim is not anymore just morally legitimate, but also legally legitimate. The co-determination law in Germany is such an example. Workers demand to be included in the decision making process of the corporation was deemed morally legitimate by a majority of Germans, who elected representatives who incorporated this right in German law. It was not the managers who made this decision, it was politicians.

6. Conclusion

This paper tried to give an answer to the question if stakeholder theory can be seen as a viable approach to management and if it contradicts the shareholder-value theory. The answer to this question is twofold. If the stakeholder-approach is justified on an instrumental basis, it definitely presents a viable approach to management of corporations. Even though there is no clear empirical evidence, that an instrumental stakeholder approach leads to a better economical performance, recent trends like the adoption of a market orientation by many firms or engagement in relationship marketing, as well as empowerment of employees seem to suggest that many firms see stakeholder management as a means to competitive advantage. The question if this approach is in conflict with shareholder-value theory depends on the view one has of what is meant by shareholder-value. If one regards shareholder-value as the long- term economic well-being of a corporation, then an instrumentally justified stakeholder approach is not only compatible with it, but nowadays even deemed essential to reach this goal.

Stakeholder theory on a normative basis, however, which also denies corporations primary goal of long-term profit maximisation, is not merely another approach to management theory, but a societal theory. It was not the intent of this paper to determine if the normative stakeholder theory is superior to the general economic theory of shareholder-value and profit maximisation, as it would be beyond the scope of this text. However, as an approach to management, normative stakeholder theory is not viable, because the question what social responsibilities corporations have or not have is a societal question, that cannot be left to management alone to decide. If shareholders disapprove with management’s actions, they have the legal authority to prevent these actions and even sack the managers themselves. Therefore, calling on corporate managers to act according to whatever moral or ethical standards might be useless in many cases, as long as these standards are not incorporated in the law.

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