Shareholder vs. Stakeholder Value in a Nutshell

Most firms consider their role and sphere of influence more widely than solely focusing on generating revenue and profit alone. A survery of forward-looking purpose and mission statements by UK and US firms discuss the role of the firm in terms of adding value or solving problems at a societal level. This begs an answer to the question: Whose interests does the firm serve?

The answer to this fundamental question is far from straight forward. Throughout the history of debate whether firms should have a wider social responsibility, beyond the organizations’ business activities, has been surrounded by controversy. Professor Milton Friedman, a Nobel Laureate in Economics, famously stated that the only social responsibility of business is to use its resources and engage in activities designed to increase its profits (1970). Friedman’s position has become known as the shareholder model of business. Friedman argued that having a wider social responsibility beyond maximizing returns to the shareholders, the owners of a business, was an immoral idea that violated the rights of the shareholders (Friedman,1970). Freidman and his University of Chicago colleagues argued that, shareholders who had invested in the firm were expecting the business through its agents, corporate managers, to engage activities that would maximise returns for their investment. To use corporate resource to solve non-business social problems, would effectively amount to theft from shareholders. Should shareholders wish to solve wider social problems, then they should do it privately, not through a business. In addition, successful firms provided employment for people and through taxes on their profits, they made a contribution to the wider society.

The critics of shareholder value maximisation are many. For example, Stout (2012) states that shareholder value thinking leads corporate managers to focus on short-term performance at the expense of long-term value creation. Jensen (2002) argues that in order to maximise value, corporate managers must both satisfy and enlist the support of all corporate stakeholders — customers, employees, managers, suppliers, financiers, and local communities. This wider concern for other stakeholders beyond the narrow focus on shareholders has become knowns as stakeholder value view according to which, instead of striving to maximise shareholder wealth, managers should strive to balance all stakeholder interests (Freeman, 1984). In contrast to the shareholder view, the stakeholder view posits that the essence of the firm is to create value for all stakeholders, not just the firm’s shareholders alone.

So, are shareholder and stakeholder perspectives incompatible? Friedman never thought that corporate managers should ignore other stakeholder interests, although Friedman’s concern for stakeholder interests was limited to the extent that they were instrumental to the interest of shareholders. However, Friedman’s thinking was not opposed to the stakeholder view if one were to accept that the primary responsibility of corporate managers is to create as much value as possible for stakeholders because this is how one creates as much value as possible for the shareholders. In other words, what’s good for all stakeholders is good for the firm’s ultimate owners, the shareholders. In addition, we should note that it’s hard to create value for all stakeholders without making a profit, unless the organization is a charity or an aid organization that relies on donations and benefactors to sustain their activity (Birkinshaw, et al., 2014). Hence, the profit motive that is the cornerstone of any firm’s raison d’etre is good for the wider society.

Sources:

Birkinshaw, J., Foss, N. J. and Lindenberg, S. (2014) Combining purpose with profits. MIT Sloan Management Review, Spring 2014.

Friedman, M. (1970) The social responsibility of business is to increase profits. The New York Times Magazine. September 13, 1970.

Freeman, R. E. (1984) Strategic Management: A Stakeholder Approach. Pitman, Boston, MA

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