Discuss the Nature and the Pros and Cons of Agency and Stakeholder Theory

The need to provide a more ethical and social commitment to society has escalated in the past few decades as a result of the many corporate scandals that have been brought to the fore. A primary example of these corporate scandals include the likes of the Enron debacle where its executives were able to hide billions in debt from failed deals and projects which its shareholders had no previous knowledge about. In the end, Enron claimed bankruptcy which left a large number of shareholders losing millions in investment, and employees out of work with salary and pensions owed to employees and so forth. Continued stories about corporate scandals and unethical behavior still show up in the news and make headlines which encourages businesses and the public at large to re-examine their role within the company and whether their values are in line with that deemed satisfactory and acceptable by society. As a result constant pressure is put on corporations to communicate information and adopt practices that relate to corporate social responsibility (CSR).

Corporate social responsibility (CSR) can be communicated or adopted by two very popular approaches. This essay will work to fully clarify in depth the two approaches of corporate social responsibility which includes the agency theory and stakeholder theory. The advantages and disadvantages of both approaches will be looked at and any limitations identified. I also hope to identify any relationship, linkage or connection the two approaches may have towards each other, and how best to satisfy stakeholders both direct and indirect to the corporation.

The definition of what pertains to be a stakeholder has had its fair share of criticism and has developed since the 1980s. Mercier (1999) defined stakeholders as "all of the agents for whom the firm's development and good health are of prime concern". Another definition of stakeholders which is widely popular and used frequently by scholars and academic writers and which is the basis of my essay was written by Edward Freeman in the book Strategic Management: A Stakeholder Approach 1984. Freeman (1984) defined stakeholder as "any group or individual that can affect or be affected by the realization of a company's objectives". Simply specifying that, any person or group can be a stakeholder of an organization or corporation if the person or group is affected or will be affected by the decision making, objectives, goals and actions of the particular organization either today or in the future. People or groups can either be directly affected or indirectly affected which categorizes the stakeholders into two groups.

The traditional stakeholders include the group of people who have direct interest in an organization. This group included shareholders, managers, suppliers, customers, employees and creditors. Traditional stakeholders are also acknowledged as the primary or direct stakeholders, they have either first hand or obvious interest in the organization. On the other hand a wider stakeholder group exists inclusive of government agencies, lobby groups, communities, competitors, and the public at large and in a strange sense future people who are yet to be identified. The latter group are also known as the secondary stakeholders, this group have no direct contract or relationship with the corporation but can still be affected by the corporations actions and decisions. For example a person who is not a customer of say NIKE sports shop in China, but lives not far from the factory may still be affected by the contaminant fumes produced by its factory, hence falling into the indirect stakeholder group. The direct stakeholders will be the employees of the China Nike Factory, this stakeholder group are the main participants mentioned in the agency theory.

The agency theory focuses on the traditional stakeholder group. Its main focus is to maximise shareholder wealth and does not take its corporate responsibility into consideration. The views, goals and actions of the shareholder (principal) are paramount and of high importance. A popular argument here is that because the principal provides the capital to run an organization their views should be the only perspective to consider as they are the key to the success of the organization. The agency theory is defined in detail.

According to Jensen and Meckling (1976, p. 308), agency theory can be defined as "a contract under which one or more persons (principals) appoints another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent". An example of an agent is the managers of an organization or the board of directors who are hired to perform to reach the goals and purpose set out by the principal/s. The principal in many cases are the investors, owners or shareholders of an organization. The principal provides the capital for the organization and it is up to the agents to perform to maximise profits for the shareholders, thus adding value to the shareholders.

With reference to the review articles by Kiser (1999) and Petersen (1993) both authors discuss in detail the tasks involved in the principal-agent relationship. As mentioned before the agents are selected by the principal, therefore the principal must select people who are reliable and trustworthy. As a result the principal has a tendency to appoint agents who see the world the same way the shareholders do, who share similar values to the principals and who have a common purpose and goal.

Appointing the right agent is a problem in itself. Agents tend to lose focus on what their main objective is, which profit maximisation according to the agency theory is. The view adopted in the agency theory is that agents are rational and possess the utility maximisation notion. Simply meaning agents tend to maximise their own personal welfare, ahead of the welfare of its investors or shareholders (principal). An example of agents maximising their own wealth in some instances is when managers would alter figures in its financial reports to make it seem better just to get the extra bonus promised to the agent by the principal. For this reason the principal and agent do not share the same levels of information. Since both parties do not share the same levels of information it is that easy for agents to take advantage of the situation for their own betterment which in return can be detrimental to the principal. This is a classic example of asymmetric information and it is morally wrong.

The lack of symmetric information between the agent and principal further adds to the problems between agents and principals. The principal can only see the end product which derives from the decisions, skills and strategy set out by the agent. The fact that the principal cannot see the initial process which leads