In this report, purposes of corporations are investigated under two different approaches on corporate value maximization: Shareholder Approach and Stakeholder Approach. So, firstly both approaches are defined briefly. Secondly, compare and contrast of shareholder and stakeholder approaches is made. Keywords: Purpose, Corporation, Value Maximization, Shareholder Approach, Stakeholder Approach.
Shareholder Approach on Value Maximization:
Shareholder approach on value maximization focuses the corporation’s purpose on maximizing the wealth of owners by maximizing the profit while minimizing the importance of the other roles of corporation in the society. The origins of the ideas shaping shareholder theory are more than 200 years old, with roots in Adam Smith’s (1776) The Wealth of Nations. Smith’s three ideas are followed by modern supporters of shareholder approach, 1.
The importance of ‘free’ markets;
The ‘invisible hand of self-regulation’ and
The importance of ‘enlightened self-interest’
Shareholder approach supporters defend the idea that excessive oversight and regulation of industry is unnecessary. Members of the ‘Austrian School’ of economics were early supporters of the shareholder approach. They advocated the idea of ‘leave alone’ capitalism, which focuses on the importance of self-regulation among firms, with limited government intervention. Shareholder theory in its current form is linked most directly to the ‘Chicago School’ of economics, most notably to Milton Friedman and his colleagues, who have argued for nearly four decades that the overriding purpose of the firm is to maximize shareholder wealth. They believe solving social problems is the responsibility of the state. Friedman believed, in short, that the business of business is business. When firms become involved in social or public policy issues, wealth is diverted to issues outside the core expertise of their managers. This inefficient use of wealth will affect society in the long run. Friedman never argued that firms can act unethically, immorally, or illegally. Today, two influential schools of thought of shareholder approach are ‘transaction cost economics’ (TCE) and ‘agency theory’. TCE focuses on the importance of corporate hierarchies and monitoring employee behavior to minimize self-interested behavior. TCE focuses primarily on the principal vs. Agent (shareowner vs. Manager) relationship in publicly traded firms, and how to best align the competing interests of two parties to maximize firm value. Both TCE and agency theory assume that human beings are opportunistic, and, thus, will put their own interests before the firm’s.
Stakeholder Approach on Value Maximization:
The idea that a company should have an expanded role and responsibilities to other stakeholders besides its owners is much newer than shareholders theory. Both shareholder and stakeholder approaches are concerned with the purpose of the firm and strategies to improve its competitive position. Stakeholder approach does not view maximization of shareholder wealth as the most efficient way to generate competitive advantage for the firm. Approach holds that firms can best generate competitive advantage and wealth by taking more than just shareholders into account.
In the late 1970s and early 1980s, researchers with backgrounds in philosophy, psychology, sociology, and management began putting foth a new theory of the firm that challenged some of the basic assumptions of classic economics and shareholder approach. In particular, Archie Carroll and Ed Freeman theorized that by taking the interests of all the firm’s stakeholders into account, the firm could do ‘better’ than by simply focusing on shareholder interests.
Carroll noted that corporations have four major responsibilities: economic (to generate shareholder wealth), legal (to obey laws and regulations), ethical (to recognize that the firm is...
References: 1. MITSloan Management Review - The Shareholders vs. Stakeholders Debate http://sloanreview.mit.edu/article/the-shareholders-vs-stakeholders-debate/
2. Michael D. Pfarrer. ‘What is the Purpose of the Firm?: Shareholder and Stakeholder Theories’, Good Business: exercising effective and ethical leadership, 2010, p.86- 92
3. Latha Chari and R. P. Mohanty, Understanding value Creation - The Shareholder Value Perspective
Please join StudyMode to read the full document