Stakeholder Theory and Corporate Governance

In contemporary society, business organizations are taking on an increasingly complex and significant role. Some corporate giants control vast resources and possess enormous influence in human daily life. Especially when they enter areas such as health care and education, they can have a more deep relationship and powerful impact on society. However, the nature of business activities is to pursue the best interests and it could lead to some conflicts between different stakeholders. Thus, proper corporate governance needs to be used to ensure corporates continue operating on a normal track. In theory, corporate governance is a kind of system that could direct and control companies. The object of corporate governance is to make maximum profit for shareholders in the past. Unfortunately, it has been considered one of the most root causes of the governance crisis in recent times.

Stakeholder Theory and Corporate Governance

On the one hand, excessive pursuit of share price performance has neglected the interests of other groups, which causes the best interests between different stakeholders to unachievable. On the other hand, shareholder theory plays a passive role rather than an active role in the firm, in other words, managers’ just passive making decision that only adapts to the market instead of actively participating in the market. This is not only provoked the conflict between the various stakeholders and hinder the long-term development of the enterprise. Therefore, stakeholder theory gradually gained more attention.

Stakeholder Theory

Stakeholders could be any groups or individuals in an organization and enable effect or affected by a company’s operating. The aim of stakeholder theory is to find what are the best interests based on different stakeholder groups. Stakeholder theory promotes a practical, efficient, effective, and ethical way to manage organizations in a highly complex and turbulent environment. It means Stakeholder theory plays an important role in corporate governance and can serve the company to balance various groups’ benefits. There are three key features of stakeholder theory. Firstly, managers are supposed to recognize and monitor all legitimate stakeholders, when making a decision and operating they should fair consider the interests of all stakeholders. Secondly, managers should avoid potential conflicts between different groups and address problems through open communication and dialogue. Thirdly, managers need to maintain Friendly Corporation with other entities, both public and private, to avoid risks from an unstable environment. These principles illustrate the role of stakeholders play in a company and how to apply stakeholder theory in practice. Stakeholder theory usually including internal and external stakeholders. Managers, employees, and owners are included in internal stakeholders, and customers, suppliers; competitors are included in external stakeholders. Additionally, governments and local communities are considered as a legal or rule responsibility.  Specifically, these stakeholders have the following characteristics in the theory.

  • Shareholder: According to the act and the constitution of corporations, shareholders could exercise a serious of power such as voting and transfer ownership. When shareholders received better dividends from a company, they will buy more shares and help the company maintain stability through their rights. In general, shareholders only passively react company’s operation rather than actively participate in corporate governance.
  • Employees: Company gives employees more attention such as good training and generous welfare, they will work more effectively to bring better profit to the company. Moreover, employees could own a part of the shares in the company. As long as the company’s stock price rises, employees can benefit from it.
  • Bank and financial institution: When a company provided a confident financial report with them, these financial institutions will not recall funds and would lend the company more money in the future. In addition, the company is able to borrow funds at a low rate.
  • Government: The government collects a large amount of fiscal revenue through tax collection, while at the same time providing a convenient trading environment for enterprises. Even the government will give allowance to support company improvement.
  • Community: Local residents will provide the company with a large number of labor resources, and the company can rely on them for efficient production. Local residences will also prefer to purchase the company’s products or services when the company supports community building through charity activities such as help the community develops local traditional culture.
  • Environment: A number of environmental lobby groups considered as one part of the stakeholders and these lobby groups requested all companies to meet environmental standards during production. If the company is outstanding in the field of environmental protection, the environmental protection organization actually has a propaganda role for the company. These stakeholders can affect the company in many ways and become a significant role in corporate governance. Companies have the responsibility to treat these stakeholders equally and consider their interests. Because these companies need stakeholders to support their operations so that profit from it. Thus, stakeholder theory is significant in the practical application of corporate governance.

Significance of Stakeholder Theory in Modern Corporate Governance

Stakeholder theory can help companies maintain stability in a turbulent environment, conducive to the company’s long-term sustainable development, and reduce conflicts between various groups in the decision-making process.

  1. When stakeholders are treated well by an organization or company, they are more likely to return positive attitudes and behaviors. For example, customers will be buying more products due to better services and shareholders will buying more stock because share prices increase. In addition, it is more useful and effective in a complex and turbulent environment. Because stakeholders prefer to provide better information to companies that give priority to stakeholders. These companies could have a more flexible decision to responding uncertainly market and this advantage is not available for other competitions that not manage stakeholders. This is significant for corporate governance in the modern company due to the globalization process and uncertainty increased. Therefore, a company that applies stakeholder theory well could obtain better information in a complex business environment.
  2. The company actively participates in social activities, taking social responsibility can help to enhance its image and reputation. The public will be more inclined to buy products or services from companies with a positive social image. In addition, Companies with a sense of social responsibility tend to have a high profile, which will leave a deep impression on the public and make it easier to recruit and retain talented people. The benefits to the company are savings in recruitment, training, and management costs, and lower operating costs. This shows that the positive interaction of the company with stakeholders can promote their long-term sustainable development.
  3. Stakeholders participate in a company’s decision-making process could reduce conflicts between different stakeholder groups and improve decision quality to ensure competitive advantage. The company will consider all stakeholders’ interests during making decisions, which could balance the demands of individual groups to reduce economic losses. For example, when a company only give priority to profitability and neglect environment factor, the company could face a series of punishment from governments. This will not only affect the company’s income but also affect the company’s normal operations. Thus, stakeholders participate in the decision-making process could help the company reduce management costs and risks. These are three key features of stakeholder theory in corporate governance, which proves that stakeholder theory has unique advantages in maintaining a company’s long-term sustainable development.

Should Managers Consider all the Stakeholders?

Although stakeholder theory has several advantages, in practice, it does not always satisfy the best interests of all stakeholders. It is unnecessary for managers to consider all the stakeholders in corporate governance. For example, an organization provided employees with high benefits and training, which means the organization, needs many funds to support it. However, for that organization’s shareholders, the only goal is to pursue higher profits. This interest dispute could lead to the company’s decision-making inefficient and objective confusion. Thus, when the company’s directors consider both the interests of shareholders and other stakeholders, the corporate objectives are difficult to clarify, which can easily lead the company into trouble. There are some people who argue that all stakeholders supposed to be treated equally when stakeholder theory is applied in corporate governance.

They claim companies that treat each stakeholder unequally in corporate governance will difficulty obtaining support from outside. These views cannot be generalized. How to treat and distinguish stakeholders depends on the needs of the company. On the one hand, company managers cannot just advocate equal treatment of all stakeholders and ignore that some groups actually contribute more than others in the organization. For some securities companies, financing is certainly significant, and these capital providers deserve more attention in the company’s decision-making process. When these capital providers received adequate return and attention, they are willing to provide more funds to support the development of the company. Thus, a company that gives priority to one or two stakeholders still can obtain external supports. On the other hand, stakeholder theory confounds to government and business when a company maintains the equal status of all stakeholders and believes they are equally important to the business.

Stakeholders should be separated into direct stakeholders and indirect stakeholders. Direct stakeholders are those that need to be valued by the company in terms of ethics and obligations. These direct stakeholders can directly affect a company’s business and be affected by the company. Firm management should primarily serve the interests of these people. Indirect stakeholders are a group or individuals who will harm or benefit the company. They do not have a direct impact on the company but may affect other direct stakeholders, thus in some cases, the company needs to account for them during decision-making. In the current complex business situation, equity rather than equality should be the main principle of benefit distribution in the stakeholder theory.

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