Shareholder versus Stakeholder Theory

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Introduction

The unethical business practices of Enron and Worldcom have sparked off debates as to which of the two theories – shareholder or stakeholder theory – should prevail. These are two competing corporate governance theories on what the objective of organisations should be. Shareholder theory asserts that the overriding duty of an organisation is to maximise shareholder returns (Friedman, 1962). Stakeholder theory broadens the first perspective, recognising that managers have a duty to not only its shareholders, but also its customers, employees, suppliers and the community (Freeman, 1994). This blogpost aims to review existing literature and argue on why stakeholder theory is preferred to shareholder theory in promoting business ethics.

Misguided Use of the Shareholder Theory Results in Unethical Behaviour

Business ethicists have argued that the shareholder theory promotes unethical behaviour as it focuses on the myopic pursuit towards earnings. The temptation to maximise short-term returns and distortion of the truth, results in unethical means. As cited in the Financial Times (2009), Jack Welch labelled shareholder theory as the “dumbest idea in the world.” However, I believe that the shareholder theory is in itself a sound theory, but the problem lies with the misguided use of the theory.

Investors do not always act rationally. Their expectations may drive short-term share prices to deviate from a firm’s intrinsic value, serving as a poor measurement for long-term shareholder value. As managers are typically paid according to short-term movements in share prices, they will pursue short-term activities that will push share prices up quickly. The 2008 financial crisis epitomises the problem. Lehman Brothers engaged in risky ventures like mortgage securities, resulting in a high debt-to-equity ratio of 60 to 1, in 2008 (Lehman Brothers Annual Report, 2008). As Milton Friedman (1962) wrote, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it … engages in open and free competition, without deception or fraud.” Thus, the theory dictates that the pursuit of profits should be conducted legally and ethically. The financial crisis is evidence of the misuse of the shareholder framework, whereby managers abused the model and behaved unethically through the excessive use of leverage to maximise short-term profits.

Stakeholder Theory Promotes Ethical Behaviour and Creates Shared Value

According to stakeholder theory, managers need to ensure that the ethical rights of the stakeholders are not infringed upon, as well as balance stakeholders’ interests during the decision-making process. Given the negative social repercussions of the financial meltdown, policymakers and business leaders need to promote ethical behaviour through the use of stakeholder theory. In shareholder theory, managers were compensated for generating stellar returns, but when the firm performed poorly, managers did not have to compensate for the losses. These compensation schemes rewarded risk taking for high returns, but did not punish for losses. Hence, by taking into consideration the interest of various stakeholders like depositors and bondholders, it will promote ethical behaviour and mitigate excessive risk-taking. Thus, possibly preventing the next financial crisis.

Critics of the stakeholder theory argue that the pursuit of business ethics by managing multiple stakeholders’ interests reduces profitability, which is in turn detrimental to shareholders (Laffer, 2005). This has been true for corporate social responsibility (CSR) programs, which have often remained on the periphery of business strategy and functioned as a cost center for organisations (Ethical Corporation, 2005). However, I believe that Porter and Kramer’s (2011) concept of creating shared value (CSV) will enable companies to balance multiple stakeholders’ interests while achieving profitability. In contrast to CSR, CSV involves creating economic value in a way that also creates social value by addressing social needs.

Unilever’s Project Shakti is a CSV initiative that allows low-income women in rural India to sell Unilever’s products. With more than 50,000 Shakti entrepreneurs covering over 100,000 villages in rural India, Unilever has redesigned its distribution strategy to reach previously inaccessible areas. The model has increased the household incomes of these entrepreneurs and enhanced living standards through Unilever’s hygiene products. Sales from Project Shakti contributes to 5% of the company’s total revenue in India, and it also serves as replicable distribution model to penetrate other emerging markets (Unilever, 2015). In addition, Paul Polman, CEO of Unilever, commented “I don’t drive this business model by shareholder value … I work for the customers” (Financial Times, 2010). Nonetheless, Unilever’s share price has appreciated significantly under Polman’s leadership since 2009, achieving an annualised return of 8.23% (Yahoo Finance, 2015). Evidently, embracing stakeholder theory allows companies to increase shareholder value as well.

Conclusion

Shareholder theory is in itself a sound theory, but the problem lies in its execution. The model has been abused by focusing on the myopic pursuit of earnings, at the expense of business ethics. Hence, I believe that organisations should adopt the stakeholder model to promote business ethics and create shared value.


References

Friedman, M. (1962). Capitalism and Freedom, University of Chicago Press, Chicago, IL.

Freeman. (1994). Strategic Management: A Stakeholder Approach.

Financial Times. (2009) Welch condemns share price focus. Retrieved from http://www.ft.com/intl/cms/s/0/294ff1f2-0f27-11de-ba10-0000779fd2ac.html#axzz3WE1ntYSk

Lehman Brothers Annual Report. (2008).

Laffer, A. (2005). Corporate Social Responsibility Detrimental to Stockholders.

Ethical Corporation. (2005). Noted economist says corporate social responsibility is irresponsible. Retrieved from http://www.ethicalcorp.com/ content.asp?ContentID=3415

Unilever. (2015). Project Shakti. Retrieved from http://www.hul.co.in/sustainable-living-2014/casestudies/Casecategory/Project-Shakti.aspx

Financial Times. (2010). Unilever chief backs criticism of shareholder primacy.

Yahoo Finance. (2015). Retrieved from http://finance.yahoo.com/

 

The missing puzzle piece to boost Singapore’s languishing productivity growth

Despite the government’s strong push for improving workplace productivity through schemes like the Productivity and Innovation Credit (PIC), Singapore’s productivity growth has been undeniably dismal. Productivity growth has averaged -0.05% per year from 2011-2014, far below the government’s target of 2-3% growth per annum. I believe that the pervasive problem for knowledge workers is the misalignment in the work environment between motivation and work productivity.

Randstad’s 2014 survey found out that nearly half of Singapore employees dislike their jobs, with 80% not hesitating to change jobs if they could earn a higher salary. From these findings, it may seem that money is a strong motivator in Singapore. Is this a contradiction of the motivation theories? Thus, in order to motivate employees to improve productivity, is money the solution?

Rising Cost of Living

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Singapore is the world’s most expensive city for the second year running, according to the Economist Intelligence Unit. Rising housing prices and cost of car ownership have fueled a continuous rise in living costs over the past decade. A 2013 study by HSBC found that more than 4 in 10 Singaporeans have set aside money for retirement, mainly because of the high cost of living. While Herzberg’s Two-Factor Theory says that it is true that pay is not a strong satisfier, employees’ perceived lack of pay is a serious dissatisfier. Hence, due to the rising cost of living, many perceive their pay as inadequate, resulting in job dissatisfaction.

Culture of Chasing Money

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Many money-as-a-reward policies have wired Singaporeans to think that money will motivate us to excel. From a fresh age, children are rewarded with prize money for achieving stellar grades in schools. In addition, under the Multi-Million Dollar Awards Programme, Singapore athletes are rewarded with S$1 million for an Olympic gold medal. Hence, Singaporeans have been accustomed to a culture of chasing after money and it has forged a misconception that money is a motivator. According to Dan Pink, extrinsic motivators like money, do not motivate employees, instead they hinder creativity and productivity. Hence, enticing employees with monetary rewards is distractive and counterproductive to the training and innovation development undertaken.

Limitations of Pink and Ariely’s Rewards System

Therefore, is the solution to work productivity, the implementation of reward systems that are advocated by Dan Pink and Dan Ariely? This would be ideal, but it is close to impossible. Given the tight labour market, in order to retain talents, companies need to reward competitively. Failure to do so would place companies at a risk of losing their greatest assets. The loss of tacit know-how, customer relationships, and high performance results in lowered productivity. The bottomline is that companies not only have to reward handsome pays in order to eliminate job dissatisfaction, but also to retain talents. Hence, I believe that reward systems that are entirely based on Pink’s and Ariely’s research, are impossible. However, there some useful pointers that companies can adopt to motivate workers to increase productivity.

Recommendations to Spur Workplace Productivity

With the PIC scheme, companies are employing a top-down approach to improving employees’ productivity. However, once companies confide knowledge workers in an environment that is highly structured and involves micromanagement, it can compromise motivation and thus productivity. Employees feel obliged to attend training workshops and embrace new technology because they ‘were told to do so by their managers.’ There is an evident lack of mastery, autonomy and purpose, which is the key to enhancing productivity.

In Budget 2015, the government introduced the SkillsFuture Credits initiative, involving cash grants from the government for individuals to pursue professional development courses. This motivates Singaporeans to pursue courses that they are genuinely interested in, instead of the compulsory courses that are imposed on by their managers.

Both the organisation and employee are crucial in ensuring that the scheme is successful in improving productivity. Firstly, organisations should create an environment where that are other motivators besides monetary rewards. Leaders should nurture and leverage on the intellectual capital by building a culture that encourages risk taking and empowers work autonomy. This would allow organisations to increase productivity by tapping on the new skillsets that employees have acquired through the SkillsFuture Credit initiative. Google empowers its employees with the autonomy to spend 20% of their time pursing their own ideas that they are passionate about. This initiative has sparked off many innovation ideas such as Gmail and Google Earth.

Secondly, despite Singapore’s culture of chasing money, employees need to learn how to look beyond monetary rewards. Workers should adopt a mindset shift and learn to respond to intrinsic motivators. Quoting Steve Jobs, “Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do.”


 

References:

Pinder, C. C. (2008). Work motivation in organizational behavior .

Havard Business Review. (2008). Employee Motivation: A Powerful New Model. Retrieved from Work motivation in organizational behavior

Business Times. (2015). Productivity drive should focus on topline growth now. Retrieved from http://www.businesstimes.com.sg/government-economy/singapore-budget-2015/productivity-drive-should-focus-on-topline-growth-now

AsiaOne. (2014). Singapore employees unhappiest in Asia Pacific: Randstad report. Retrieved from http://business.asiaone.com/news/singapore-employees-unhappiest-asia-pacific-randstad-report

Straits Times. (2015). Singapore still world’s most expensive city, says EIU. Retrieved from http://www.straitstimes.com/news/business/economy/story/singapore-still-worlds-most-expensive-city-says-eiu-20150303

HSBC. (2013). The Future of Retirement. Retrieved from http://www.hsbc.com.sg/1/PA_ES_Content_Mgmt/content/singapore/personal/wealth-management/pillars/retirement/the-future-of-retirement.pdf

Straits Times. (2015). SkillsFuture scheme: How it can help you. Retrieved from http://www.straitstimes.com/news/singapore/more-singapore-stories/story/skillsfuture-scheme-how-it-can-help-you-20150227