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Stakeholders

Stakeholders

A firm's stakeholders are the individuals, groups, or other organizations that are affected by and also affect the firm's decisions and actions. Depending on the specific firm, stakeholders may include: governmental agencies, such as the Securities and Exchange Commission; social activist groups, such as Greenpeace; self-regulatory organizations, such as the National Association of Securities Dealers; employees; shareholders; suppliers; distributors; the media; and even the community in which the firm is located, among many others. The following discussion divides the stakeholder perspective into three categorizations, but it is important to realize that firms do not always initially set out to establish one perspective over another. Instead, firms tend to develop their views of stakeholders and stakeholder management over time in reaction to events that unfold throughout the firm's history.

STAKEHOLDER PERSPECTIVE

Although numerous ways of viewing stakeholders exist, categorizing stakeholder perspectives into three broad categories helps elicit the basic underlying themes among these numerous views. These broad categorizations include the separation perspective, the ethical perspective, and the integrated perspective.

The Separation Perspective. The separation perspective suggests that, because managers are agents of the firm's owners (the shareholders), managers should always strive to act in the best interest of the firm's owners. This view does not cause managers to ignore non-owner stakeholders; indeed, taking actions that benefit stakeholders also benefit owners, and the separation perspective would advise managers to do so. One facet that differentiates this perspective from the others, however, is the rationale behind such decisionsthe reason managers make decisions and take actions benefiting non-owner stakeholders is ultimately to reward owners. Clearly, problems arise when a given decision would maximize the benefit to non-owners at the expense of owners but would serve the greater good of society in general.

For example, suppose a new but relatively expensive technology was created that lowered pollution from steel mini-mills to well below the level required by the Environmental Protection Agency (EPA). As long as the mini-mills are already in compliance with EPA regulations, there is no legal mandate for the steel mini-mills to purchase and implement the new technology even though doing so would benefit stakeholders such as the community in which the mini-mill had factories. Yet, due to the cost of the new technology, owners' profits would suffer. The separation perspective would direct managers in this situation to dismiss the benefit of lower pollution levels for the community in favor of maximizing owners' profits by meeting EPA requirements, but not by spending funds in excess of what the EPA requires.

The Ethical Perspective. The ethical perspective is that businesses have an obligation to conduct themselves in a way that treats each stakeholder group fairly. This view does not disregard the preferences and claims of shareholders, but takes shareholder interests into consideration only to the extent that their interests coincide with the greater good. Budweiser, for example, has modified its advertising over the years to discourage underage drinking and driving while intoxicated. Social activist groups such as Mothers against Drunk Drivers have pressured Budweiser through their own advertising as well as media attention to maximize responsible alcohol consumption even though this may decrease overall sales for Budweiser. This approach focuses on ethics and suggests that managers have responsibilities apart from profit-oriented activities.

While recognizing the claims shareholders have to profit in exchange for putting their capital at risk, the ethical perspective holds ethics as the preeminent decision rule. Taken to an extreme, this perspective can minimize the right of owners to participate in financial gain in proportion to the risks they bear when doing what is ethically best for non-owner stakeholders runs counter to what is financially best for owners. A possible outcome

in a capitalist society could be that fewer and fewer owners place their capital at risk through firm ownership, a condition that may ultimately decrease the economic good of society in general and thus harm the very groups the ethical perspective intended to protect.

The Integrated Perspective. The third approach, the integrated perspective, suggests that firms cannot function independent of the stakeholder environment in which they operate, making the effects of managerial decisions and actions on non-owner stakeholders part and parcel of decisions and actions made in the interests of owners. This view holds that managerial decisions and actions are intertwined with multiple stakeholder interests in such a way that breaking shareholders apart from non-owner stakeholders is not possible. Managers who, according to this approach, make decisions in isolation of the multitude of stakeholders and focus singly on shareholders overlook important threats to their own well-being as well as opportunities on which they might capitalize.

For example, the National Association of Securities Dealers (NASD) is a self-regulatory organization that monitors and disciplines members such as insurance companies and brokerages. By incorporating NASD regulations into their management decisions and actions, insurance companies and brokerages, at least to some extent, preempt outside governmental action that may make compliance more restrictive or cumbersome. The NASD, in turn, answers to the governmental agency, the Securities and Exchange Commission (SEC). The SEC reports to the U.S. Department of Justice. Each of theseinsurance companies and brokerages, the NASD, SEC, and U.S. Department of Justiceare linked in such a way that insurance companies and brokerages ignoring these stakeholders would quickly be unable to make a profit and thus fail to serve the interests of owners.

EMERGENCE OF THE STAKEHOLDER PERSPECTIVE

The conventional thinking dominating the early management literature with the rise of management as a profession separate from the firm's owners was that, as agents representing owners, top managers' responsibility was primarily and ultimately to these owners or shareholders. Increasingly, though, managers have come to view non-owner stakeholders as essential to firms' success, not only in financial terms, but also in societal terms. However, this has not eliminated managerial decisions that are overly concerned with financial performance at the expense of other stakeholder interests. The spate of corporate scandals and financial disasters in the early twenty-first century demonstrates that despite the apparent logic of an integrated perspective of stakeholder management, some managers still hold to the separation perspective. The collapse of Enron and WorldComand charges of fraud against firms such as Tyco, Duke Energy, AIG, and Freddie Mac, among many othersillustrates this point quite well.

As shareholders of these and other firms have seen, a sole regard to financial results is not always in the best interests of these shareholders. Those holding Enron and WorldCom stock, even those who knew nothing about illegal activities by the firm's top management, quickly came to realize that excluding non-owner stakeholders is not necessarily consistent with maximizing shareholder wealth. In fact, excluding non-owner stakeholders can inadvertently bring more pressure on managers when non-owner stakeholder interests are not respected. Consider, for instance, additional regulations to which firms must now comply in the wake of many of the corporate scandals of the early 2000s. The Sarbanes-Oxley Act, passed in 2002, created additional reporting requirements in an attempt to prevent accounting abuses in the future. Estimates at the time of passage suggested that compliance would cost an average of $35 million per year for large firms with revenues in excess of $4 billion. According to one economist writing in 2007, firms affected by the Sarbanes-Oxley Act did in fact pay more in auditing fees, reduced their earnings through more conservative discretionary accruals, and experienced significantly lowered risk-adjusted stock returns over a three-year period. Obviously, then, neglecting non-owner stakeholders is not always in the best interest of shareholders even if managers take the separation perspective to stakeholder management. The significant reduction in corporate scandals in the mid and late 2000s, the mortgage crisis notwithstanding, suggests that some combination of new regulatory oversight, along with a shift away from the separation perspective, are having a positive effect on corporate governance.

The separation perspective can be traced at least as far back as 1776 when Adam Smith wrote An Inquiry into the Nature and Causes of the Wealth of Nations. Among Smith's most quoted lines is the work's preface, which states: It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. This reference to what has come to be known as laissez faire capitalism positions self-interest as the most prominent feature of national industrial development. Yet, even though he did not specifically use the term, Smith also realized that stake-holders outside the firm have an important part to play in industrialization. By making provision for what he called the public good, Smith disseminated the idea of owners' self-interest as a critical variable promoting economic growth, while also realizing that unchecked self-interest must be balanced against the greater good. In this respect, then, the separation perspective and the

integrated perspective, while not fully formed, both have their roots in early industrialism.

The ethical perspective stems at least back to the eighteenth-century writings of philosopher Immanuel Kant. The focus of the ethical perspective is the firm's responsibility to stakeholders from a normative view; that is, the ethically correct action should supersede actions based solely on self-interest, thus making managerial decisions and actions that impact stakeholders based on universal standards of right and wrong the rule that managers should follow. This standpoint, though, suffers from a shortcoming stemming from different standards of right and wrong. When right and wrong are apparent, decisions are easy, but management challenges are rarely so clear. Simply suggesting that managers do the right thing ignores conflicts of interest inherent in capitalistic competition, and doing the right thing can result in compromises that are not in the best interests of any of the stakeholders, but rather a way to satisfy, or make decisions and take actions that are good enough, but not optimal. The ethical view of stakeholders can result in managers overemphasizing the greater good to the point that they ignore the reality of self-interest, particularly as it pertains to maximize shareholder wealth.

Integrating the broad categorizations of separation and ethics allows room for both self-interest of owners and corporate responsibility to non-owner stakeholders. An integrated perspective of stakeholders positions the self-interests of managers as a key driver of economic growth, but tempers this with social responsibility toward non-owner stakeholders. Maytag, for instance, found that by balancing a plant closure with adequate notice, the reputation of the firm was held intacta benefit to ownersat the same time that competing stakeholder interests were considered. In this situation, Maytag's Galesburg, Illinois refrigeration assembly plant announced it would be moving operations to a location with less expensive labor and other operational costs, but took the unusual move of giving the firm's one thousand employees, its local suppliers, and the small Galesburg community two years to prepare. Maytag allowed local employment agencies to set up job training within the Maytag plant to prepare its employees for employment after the plant closure. This illustrates how integration of multiple stake-holder interests can move beyond only self-interest or only ethics by integrating both of these.

It is overly simplistic to suggest that managers should just do the right thing in all situations, because the right thing to do is not always clear. On the other hand, acting solely in the financial interests of shareholders can result in unintended consequences that ultimately cause shareholders harm. Integrating multiple perspectives allows room for managers to balance the interests of multiple stakeholders. Such stakeholder perspectives allow for competing dimensions, thus providing a framework to help managers harmonize the interests of multiple parties.

SEE ALSO Corporate Governance; Ethics; Shareholders

BIBLIOGRAPHY

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Stakeholders

Stakeholders

BIBLIOGRAPHY

Stakeholders are constituencies who are affected, voluntarily or involuntarily, by the actions taken by an organization, such as a corporation. Commonly cited examples of corporate stakeholders are employees, financial intermediaries, shareholders, customers, and suppliers, all of whom are affected by, respectively, a firms compensation and hiring decisions, investment choices, dividend and share repurchase policies, product-related issues, and material purchases. The term, however, is often more broadly applied to include local, state, and federal governments because firms pay taxes and use public resources; it can also be extended to include the local community because firms interact with the natural environment and engage in philanthropic activities; and furthermore, because many firms operate on an international scale, it may even include the global community.

Stakeholders may raise issues of concern with corporations and suggest actions that corporations should take. For example, if shareholders are concerned that a corporation is holding too much money, they may argue for increased dividends. Constituents from a local community concerned with air quality may urge a corporation to invest in cleaner technologies. Even though they are not legally required to do so, corporations may consider and implement stakeholders ideas because they provide a host of resources to corporations. Lenders and shareholders make financial resources available, employees and suppliers provide physical inputs, governments supply regulatory oversight, and citizens contribute to the social environment in which operations occur. In short, a corporation cannot exist without the support of a diverse set of stakeholders.

A corporation must consider the principles of stakeholder theory or stakeholder management when it decides which stakeholders to acknowledge and how to best respond to their often incompatible requests. The notion of stakeholders originated in the mid-1960s, but it was in the 1980s that, as evidenced by Edward Freemans 1984 book Strategic Management, the idea of stakeholder management began to gain ground in the field of economics. Stakeholder theory represents a significant departure from the older principal-agent view of the firm, which effectively recognizes shareholders as the only legitimate constituency by nature of their ownership position. Stakeholder theory, in contrast, understands the corporation in law and in practice as more than an extension of shareholders with narrow, well-defined goals. Rather, the corporation is viewed as its own entity with its own rights and obligations. As the trustees of the firm, usually its board of directors, are responsible for the firm, they can and should serve other constituencies for the benefit of the corporation. Furthermore, in practice, the distinction between shareholders and other stakeholders concerns may not be so clearly defined: Shareholders themselves are often employees, consumers, and residents in the communities where corporations operate. Consequently, as James Hawley and Andrew Williams argue in their 2000 study The Rise of Fiduciary Capitalism, shareholders may not be best served by the maximization of the share price alone and may be more concerned with a firms employment opportunities, quality of goods, and impact on the environment.

It is not clear which stakeholders will most benefit and what changes in corporate activities are likely to result when corporations acknowledge them. The outcomes could range from managerial opportunism, as Michael Jensen notes in his 2000 article Value Maximization, Stakeholder Theory, and the Corporation Objective Function, to economic democracy, as Paul Hirst suggests in his 1997 essay From the Economic to the Political, and anything in between these extremes. In any case, the concept of stakeholders greatly broadens the theorization of the corporation in terms of its governance, objectives, and conditions of existence.

BIBLIOGRAPHY

Freeman, R. Edward. 1984. Strategic Management: A Stakeholder Approach. Boston: Pitman.

Hawley, James P., and Andrew T. Williams. 2000. The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic. Philadelphia: University of Pennsylvania Press.

Hirst, Paul. 1997. From the Economic to the Political. In Stakeholder Capitalism, eds. Gavin Kelly, Dominic Kelly, and Andrew Gamble, 6371. Houndmills, Basingstoke, U.K.: Macmillan, and New York: St. Martins.

Jensen, Michael C. 2002. Value Maximization, Stakeholder Theory, and the Corporate Objective Function. Business Ethics Quarterly 12 (2): 235256.

David M. Brennan

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