Skip to main content
Business LibreTexts

2.7: Stakeholder Theory - A Viable Alternative?

  • Page ID
    29514
  • \( \newcommand{\vecs}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } \) \( \newcommand{\vecd}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash {#1}}} \)\(\newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\) \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\) \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\) \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\) \( \newcommand{\Span}{\mathrm{span}}\) \(\newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\) \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\) \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\) \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\) \( \newcommand{\Span}{\mathrm{span}}\)\(\newcommand{\AA}{\unicode[.8,0]{x212B}}\)

    Although the recognition of stakeholder obligations has been with us since the birth of the modern corporate form, the development of a coherent stakeholder theory awaited a shift in legal thinking from a perspective on shareholders as “owners” to one of “investors,” more on a par with providers of other inputs that a company needs to produce goods or services.See Jensen and Meckling (1976); Fama (1980), pp. 291–293; and Fama and Jensen (1983b). For a somewhat different view, see Klein (1982). Whereas the ownership perspective, rooted in property law, provides a natural basis for the primacy of shareholder rights, the view of the corporation as a bundle of contracts permits a different view of the fiduciary obligations of corporate managers. Freeman and McVea (2001) describe stakeholder management as follows:

    The stakeholder framework does not rely on a single overriding management objective for all decisions. As such it provides no rival to the traditional aim of “maximizing shareholder wealth.” To the contrary, a stakeholder approach rejects the very idea of maximizing a single-objective function as a useful way of thinking about management strategy. Rather, stakeholder management is a never ending task of balancing and integrating multiple relationships and multiple objectives.Freeman and McVea (2001), p. 194.

    To pragmatists, the rejection of a single criterion for making corporate decisions is problematic. Directors occasionally face situations in which it is impossible to advance the interests of one set of stakeholders and simultaneously protect those of others. Whose interests should they pursue when there is an irreconcilable conflict? Consider the decision whether or not to close down an obsolete plant. The closing will harm the plant’s workers and the local community but will benefit shareholders, creditors, employees working at a more modern plant to which the work previously performed at the old plant is transferred, and communities around the modern plant. Without a single guiding decision criterion, how should the board decide?

    The problem is not just one of uncertainty or unpredictability. Ultimately, the stakeholder model is flawed because of its failure to account adequately for what Bainbridge (1994) calls “managerial sin.”Bainbridge (1994). The absence of a single decision-making criterion allows management to freely pursue its own self-interest by playing shareholders off against nonshareholders. When management’s interests coincide with those of shareholders, management can justify its decision by saying that shareholder interests prevailed in this instance, and vice versa. The plant closing decision described above provides a useful example: Shareholders and some nonshareholder constituents benefit if the plant is closed, but other nonshareholder constituents lose. If management’s compensation is tied to firm size, we can expect it to resist any downsizing of the firm. The plant likely will stay open, with the decision being justified by the impact of a closing on the plant’s workers and the local community. In contrast, if management’s compensation is linked to firm profitability, the plant will likely close, with the decision being justified by management’s concern for the firm’s shareholders, creditors, and other constituencies that benefit from the closure decision.

    It has been argued that shareholders, in fact, are more vulnerable to management misconduct than nonshareholder constituencies. Legally, shareholders have essentially no power to initiate corporate action and, moreover, are entitled to vote on only very few corporate actions.Under the Delaware code, shareholder voting rights are essentially limited to the election of directors and the approval of charter or bylaw amendments, mergers, sales of substantially all of the corporation’s assets, and voluntary dissolutions. As a formal matter, only the election of directors and the amendment of the bylaws do not require board approval before shareholder action is possible. See Delaware Code Ann. tit. 8, § § 109, 211 (1991). In practice, of course, even the election of directors, absent a proxy contest, is predetermined by the existing board nominating the following year’s board. Rather, formal decision-making power resides mainly with the board of directors.As a practical matter, of course, the sheer mechanics of undertaking collective action by thousands of shareholders preclude them from meaningfully affecting management decisions. In effect, shareholders, just like nonshareholder constituencies, have but a single mechanism by which they can “negotiate” with management: withholding their inputs (capital). But withholding inputs may be a more effective tool for nonshareholders than it is for shareholders. Some firms go for years without seeking equity investments. If the management groups in these firms disregard shareholder interests, the shareholders have no option other than to sell out at prices that will reflect management’s lack of concern for shareholder wealth. In contrast, few firms can survive for long without regular infusions of new employees and new debt financing. As a result, few management groups can prosper while ignoring nonshareholder interests. Nonshareholder constituencies often also are more effective in protecting themselves through the political process. Shareholders—especially individuals—typically have no meaningful political voice. In contrast, many nonshareholder constituencies are represented by cohesive, politically powerful interest groups. Unions, for example, played a major role in passing state antitakeover laws. Environmental concerns are increasingly a factor in regulatory actions. From this point of view, it can be argued that an explicit focus on balancing stakeholder interests is not only impractical but also unnecessary because nonshareholder constituencies already have adequate mechanisms to protect themselves from management misconduct.


    2.7: Stakeholder Theory - A Viable Alternative? is shared under a not declared license and was authored, remixed, and/or curated by LibreTexts.