Some Notes on Stakeholder Model

INTRODUCTION

The shareholder model versus the stakeholder model has been an on-going debate of corporate governance between supporters of both perspectives. Advocates of both sides have been arduously trying to justify the rationality and supposed supremacy of each model. While both models are purposeful and strong in their own special ways, the model in which to apply in a corporate setting depends very much on the type and structure of the corporation, which also takes into account the continuous changing practices of corporate governance and law.

A general description on the two models involves on the one hand, the shareholder model, which is a more traditional model, in which from its name itself, it views the corporation as a legal entity for the purpose of shareholders to maximise their profits and interest, with a maximum return of investment. On the other hand, there is the less traditional model, the stakeholder model, having emerged around the 21st century. The stakeholder model, contrary to its counterpart considers the corporation to be a locus which serves the wider external stakeholders' interests rather than the sole interest of shareholders' wealth.

Before dwelling into the differences between both models and its respective pros and cons, it is important to note that most literatures and analyses used to observe the differences were found to base their arguments and models on traditional theories and assumptions that were built upon old societal contexts far different from the current business trend and environment seen in this modern century.

Differences in Ideology

The underlining arguments between the models are two very contrasting and conflicting ideologies, from which stems the major differences of value judgments within capitalism. The shareholder model uses an ideology of individualism, private property, and individual liberty, which hence tries to justify maximisation of shareholders' value as the sole purpose of the firm. On the opposite side of the field, there is the stakeholder model with the idea of a justice for all, a communitarian thought of property and social conception of the firm, which ideas leads to the legitimization of accommodating the entire stakeholders' interests of the firm.

Observation of differences - pros and cons and limitations

Shareholding Pespective

Supporting theory : Inherent property rights theory

The shareholding perspective which emerged from the ideology of individualism stems off in the 15th to 16th century resulting from the period of Reformation and Renaissance. With the development of the capitalist economy in the following centuries, the ideology expanded following subsequent raise in capital and business expansions. It was then seen that the right to incorporate is inherent in the right to own property and right contracts. And hence the corporation was a legal extension of its owners, the shareholders.

Pros :

1) The idea of private ownership may be important to a desirable social order and also to the development of an efficient economy

2) There may be a more efficient outcome from the economic activities of the corporation as the individuals owning private property are likely to pursue self-interests (Hayek, 1969)

This is because a corporation owned by shareholders will aim at maximising the profits to increase shareholders value. A corporation that acts for a social purpose aside from shareholders' interests risk providing opportunities for managers to justify an abuse of power and also for government to intervene in corporate decisions. This would subsequently lead to allocation of corporate resources in a most inefficient way. A business under the shareholder model aims to make profit in a free market for shareholders, which if followed, reduces other social functions performed by the government, social institutions, and charities. The request for social responsibility in businesses will harm the foundations of a free society with a free-enterprise and private-property system. Hence this model will focus on its only social responsibility to make and increase its profits.

Cons : Uncertainty if shareholders' interest is effectively protected under the current institutional arrangements.

Since the shareholders have to delegate control to a few directors and managers to run the corporation on behalf of all the shareholders, there is a potential risk that directors and managers will serve their own interests at the expense of all the shareholders (Adam Smith, 1937). Generally speaking, the directors of a company cannot be expected to be as careful with the money that belongs to others as they are with their own money. Hence there is a potential management negligence. This is in line with the agency theory which claims that managers are pretty much untrustworthy and must always be monitored.

2) High agency costs required to ensure agents behaviour is aligned with the interests of the owners in shareholder models.

It is rather expensive and difficult for the principal to evaluate the performance of the agent, and to be sure that the agent has behaved accordingly. Aside from that, another issue involved is that the principal and agent may have contrasting ideas and prefer different actions as they view risk differently. For this reason, a solution to overcome the problem is to have a contract which governs the principal-agent relationship and an incentive scheme to align the interests of both parties. A complete contract which contains specifications of the agents duties, rewards and rights of the principal to monitor the