The shareholder versus the stakeholder approach

Table of contents

1 Introduction

2 Shareholder theory

3 Stakeholder theory

4 Important stakeholders
4.1 Employees
4.2 Customers
4.3 Creditors and suppliers
4.4 Societal stakeholders

5 Trust

6 Conclusion

Appendix

List of references

1 Introduction

It is often assumed that shareholders are the most important stakeholder group in any business. However, there are two main competing theories that argue how a company should be run: the shareholder approach and the stakeholder approach. On the one hand, the shareholder approach claims for profit maximisation of the shareholder as the only objective of business. On the other hand, the stakeholder approach suggests satisfying the interest of various stakeholders.

In practice, shareholder models have dominated in the past. However, corporate scandals and the financial crisis have raised doubts about that model and led to a loss of trust (Bottenberg et al., 2016).

This essay deals with the importance and interests of different stakeholders and tries to identify how they affect the success of a business.

Firstly, the essay will compare the shareholder and stakeholder theory and after- wards, the importance of employees, customers, creditors, suppliers and social stakeholders will be discussed. Further, this essay illustrates the drivers and changes of trust in a company.

2 Shareholder theory

Shareholder-oriented models are based on the idea that the primary target of a busi- ness is to increase profit, which leads to an increase in shareholder wealth and by arguing that shareholders are the owners of the company and the company's direc- tors act on their behalf. Consequently, the managers have a fiduciary responsibility to act in the best interest of the shareholders (Stern, 2017).

Friedman (1970:126) states that in a free market “there is one and only one respon- sibility of business—to use its resources and engage in activities designed to in- crease 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”.

Moreover, Friedman (1962) says that managers are bound to a legal framework, which should be created by the society or the state to make sure that social problems get solved and no stakeholders are disadvantaged.

However, if the manager makes decisions because of his “social responsibility”, he will spend someone else’s money – the money from the shareholders, as well as the money from customers and employees.

Further, the shareholder value maximisation model says that the most efficient way to increase the value of a firm is to concentrate mainly on the interests of sharehold- ers. If a company tries to focus on numerous stakeholders at the same time, it will end up in unsolvable conflicts, with the result that the manager possibly makes wrong decisions and thereby decreasing the value for all interest groups (Bottenberg et al., 2016).

Apart from the profit participation, shareholders bear a risk too. Hence, they have an immediate interest in management decisions. They provide long-term capital on a large scale - and depending on the company's legal form, shareholders are liable for payment of the debts. By taking the risk of shareholders into account and avoid- ing the withdrawal of the invested money, any relevant business should see the shareholders as the most important stakeholder group (Schmidt & Weiß, 2003).

On the other hand, some shareholders are only short-term interested and demand growth and profit at any cost (Busch et al., 2018).

Jack Welch, the former CEO of General Electric, was one of the strongest support- ers of the shareholder theory and regarded as an icon of modern management be- cause during his tenure, he managed to raise the company's value by 4,000 per cent. Nevertheless, he changed his mind and said: "On the face of it, shareholder value is the dumbest idea in the world […] Shareholder value is a result, not a strat- egy…your main constituencies are your employees, your customers and your prod- uct" (Guerrera, 2009:1).

3 Stakeholder theory

Freeman points out that any successful business has to create value for all stake- holder groups and the manager needs to figure out how the interests of these stake- holders go in the same direction (DardenMBA, 2009).

According to Freeman (1984:46), stakeholders are defined as "any group or indi- vidual who can affect or is affected by the achievement of the organization's objectives", but one can see stakeholders also as anyone who is interested in an organisation.

There are many ways to classify stakeholders, some of the most popular ones are internal and external groups, primary and secondary groups as well as groups in order of power and interest (Matuleviciene & Stravinskiene, 2015).

Moreover, the stakeholder approach says that “taking the interests of all the firm’s stakeholders into account, the firm could do ‘better’ (achieve greater performance) than by simply focusing on shareholder interests” (Pfarrer, 2010:88).

That means if the firm creates value for stakeholders, it will create value for share- holders in the long-term too.

Jack Ma of China’s Alibaba said to his investors that he will put “customers first, employees second, and shareholder third” by arguing that “a company that does not have satisfied employees will not have satisfied customers, and without satisfied customers, we could not possibly have satisfied shareholders” (Financial Times, 2014:4).

Furthermore, competitive advantage is an essential issue of strategic management and some research links stakeholder management to competitive advantages.

The well-known Porters five-forces model argues that companies need to assess the bargaining power and influences of the crucial stakeholder like suppliers, buyers, competitors, potential entrants and substitutes. Companies who pursue the stake- holder approach enhance their intangible resources like reputation, trust, innova- tion, legitimacy and knowledge creation which are hard to imitate and thus are cre- ating a competitive advantage and sustainable value in the long-run. (Wu, 2013; Bottenberg et al., 2016).

The following chapter will demonstrate why employees, customers, creditors, sup- pliers and social stakeholders can also be assumed as one of the most important stakeholder group.

4 Important stakeholders

4.1 Employees

Highly motivated and qualified employees are the company’s most important re- source. Paying attention to the employees’ needs (e.g. above-average compensa- tion, security of employment, job satisfaction or good working conditions) makes companies more attractive to highly experienced and skilled employees, which can lead to competitive advantage (Bottenberg et al., 2016).

George (2003:37), former chairman and CEO of Medtronic, points out that “The best path to long-term growth in shareholder value comes from having a well-artic- ulated mission that inspires employee commitment […] Real value can only be cre- ated by the hard work of dedicated, motivated employees that develop innovative products and services, establish intimate customer relationships, and build organi- zations over an extend period of time […] Competitors will eventually copy any innovative idea for product or service, but an organization of highly motivated peo- ple is very hard to duplicate”.

Besides financial incentives, co-determination, for instance through works councils or board seats, plays an important role too. Even though some associate it with re- duced decision-making quality, co-determination often leads to the enhanced use of existing internal know-how, due to greater proximity of employees to processes, products and customers. Also, good employee relations can also help a company to survive in bad times if both sides work together and are willing to lower one's sight. Opel, for example, was on the brink of insolvency in 2008, but they managed to survive because all parties (employee representatives, management and the local government) pulled together and the employees agreed to salary cuts in exchange of employment security (Bottenberg et al., 2016).

[...]