Comparison of Stakeholder Theory and Agency Theory - Coursework Example

 Does stakeholder theory provide a better basis for the development of Corporate Governance in the 21st century than agency theory? 1. Introduction Business around the world in recent times within the realms of ever increasing cut throat competition has become much more complex. For successful operation of the same, the stakeholders associated are continuously developing innovative and useful strategies and implementing them simultaneously. Now, one of the major criteria for business growth and expansion is that of endowment from the investors (Mallin, 2007, p.1). Investors are guided by the motive of optimizing their profit portfolios with their investment decisions mainly based on the basis of the financial health after analyzing the final or annual reports of the company done by external auditors. The final reports audited by the external auditors are assumed to be providing a true and fair value of the companies aligned with full compliance of accounting standards (international and national) and norms (Mallin,2007, p.1). But in reality, it has been found that despite healthy financial positions of the companies reflected through the annual reports of high profile corporate companies, a large number of them have crumbled down financially or went bankrupt. Through collapse of the companies it is imperative to assert that stakeholders of the companies like employees, customers, suppliers, bondholders and many others have been adversely affected financially (Mallin,2007, p.1). 2. Concept of corporate governance (CG) and aim of the paper The concept of corporate governance occupies a central position at this juncture. CG can be visualized as a unique theoretical dimension of organizational behavior which is developed for providing stout answers to the company collapses and generating optimal preventive measures against the bottlenecks and running them in a successful manner within a dynamic forefront. One of the fruitful definitions derived from Walker review in 2009 can be considered in this respect which is as follows: “The role of the corporate governance is to protect and advance the interests of shareholders through the setting the strategic direction of a company and appointing and monitoring capable management to achieve this” (Solomon, 2011). Now approaches of corporate governance varies and they are practiced separately in different countries and in this paper two theories of corporate governance i.e. the stakeholders theory and agency theory will be analyzed on a comparative ground along with suitable examples. The influence of each theory in the development of corporate governance and their practices in different countries along with the relevance of each theory will be elucidated. Discussions will be also made on whether these two approaches are exclusive to each other along with consideration of alternative approaches. The subsequent section will be elaborating the crux of stakeholder’s theory. 3. Stakeholder’s theory of CG The stakeholder theory of corporate governance find its roots in 1930s and the theory represent a coordination of economics, cognitive sciences , business ethics and that of the stakeholder’s concept. The theory is grounded on the notion that the firms acts as input output models through explicit addition of all the interest groups which include “employees , customers, dealers, government and the society at large” (Fernando, 2009, p. 50). In this theory of corporate governance the crux lies in the interactions of the stakeholders. It has been found that the directors and managers of the companies who oversee and are in the controlling position of the corporate purpose hold the key in voluntarily imposing various ethical constraints viewed as necessary conditions for attaining market efficiency. These ethical constraints if act as impediments in the business process then it is not fruitful (Berenbeim, 2012, p.60). The corporate objective is to maximize value and the role of manager will be directed completely towards making decisions that consider all the interests of stakeholders in a firm. The managers and the directors find different ways in choosing multiple constituencies with conflicting interests (Jensen, 2002, p.13). Some examples can be given in this case. The customers basically demand low prices along with high quality and optimal services. The employees demand escalated wages with good working conditions with fringe benefits like vacations, medical benefits, and pensions and so on. The suppliers of capital demands low risk along with high returns and the communities demand charitable contributions, welfare expenditures for benefiting the community as a whole. Decision criterion and objective function is at the core and it must also make specifications of ways in which tradeoff between the demands can be made (Jensen, 2002, p.13). 4. Agency theory of CG Agency theory is another theory of corporate governance and it find back its roots in the early 1960s and 1970s when the economists were basically exploring the notion of risk sharing among the individuals or groups. Agency theory broadened its horizon when cooperating parties possess different goals and vision of labor. The theory takes into account the ubiquitous agency relationship where one party delegates work to another agent who performs that work (Choi & Yocam, 2010, p.7). The theory is basically centered on the resolution of two main problems which can occur within the agency relationship. The foremost problem generates when the degrees of goals and desires of the principal and agent are in not in compliance. Secondly, problem arises when it become difficult or expensive for the principal in verifying the whereabouts of the agents. In this case, the constraint is that the principal is not able to verify the appropriateness of the agent’s behavior. Secondly, the risk sharing problem also emerges in cases where the principal and agent possess different attitude towards risk. In this case it may happen that there are different preferences in actions owing to different risk preferences. The focus of this theory is to attain the most efficient contract associated with the principal and the agent (Eisenhardt, 1989, p.58). The examples associated in this theory includes certain given assumptions circumscribing the people namely self interest, bounded rationality, risk aversion, information for both the buyers and sellers, goal conflict among the members. It targets at answering questions like whether a behavioral oriented contract as for example salaries, hierarchical governance are efficient than outcome oriented contract which include commissions, stock options, property rights transfer and market governance or not. The theory also directs towards strengthening the relationships and gaps between principal and agent partly differing in goals like that of compensation, regulation, leadership, whistle blowing, vertical integration, transfer pricing and so on (Eisenhardt, 1989, p.58). 5. Comparison between the two theories A brief insight on both the theories thus developed gives an idea that both the theories provide unique dimension towards corporate governance whose significance is immense. Now it will be interesting to make a comparative analysis between these two theories and also examining whether the two theories are in contradiction with each other or not. Milton Friedman stated that only moral obligations which the managers face is that of maximizing shareholder return which targets at best allocation of social resources. Shankman in 1999 pointed about the conflict between the stakeholder and agency theory. Shankman represented that the stakeholder theory and not the agency theory as normative in its orientation. Again Shankman states that the agency theory may be subsumed within a general stakeholder’s model of the companies as the stakeholder theory is a necessary outcome of the agency theory and it provides a more appropriate way in conceptualizing the theories of firms. The stakeholder theory acts as a necessary outcome of the agency theory and can be represented as a more appropriate way in conceptualizing theories of firms. Agency theory when defined in a proper manner can be defined as the narrow form of the stakeholder theory. The assumptions of the agency theory which holds the human behavior and motivation implicit are in general contradiction. Hill and Jones in 1992 stated that the principal agent concept of the agency theory can be well applied as a subset of the stakeholder theory. But it can be also stated that moral discourse for the management of the companies employing the theories are rigorously different. Quinn and Jones in 1995 stated that agency theory leads to a discourse which is guided by self interest principles while the other leads to the discourse of duty and responsibility. A combination of both can be regarded as a potential solution but for realistic assumption it can be stated that adapting the business case rather than the pure ethics case is judicious. The notion of the business case of stakeholders approach is that of choosing a corporate social responsibility approach for maximizing the wealth of the shareholders. Camelot plc in United Kingdom is a good example in which the company has entered strategies for demonstrating stakeholder’s dialogue and active management with a diverse group of stakeholders. However there is controversy between the agency theory and stakeholder approach, but in the long term inconsistencies diminish and both the theories target at maximizing the wealth maximization of the companies. It can be stated that the stakeholders approach is to be implemented with the attributes of agency theory within the internal mechanism of the organization (Solomon, 2011). 6. Countries and alternative CG models - relevance with the two theories From the studies of Rose and Maries in 2003 it is reflected that in Denmark traditional system of corporate governance prevailed originally with the target over protecting a broad group of stakeholders rather than just on the shareholder group. Later it adopted Anglo Saxon model which focused on the shareholder’s value. It can be stated that both a mixture of insider and outsider model was applied. In Iceland possessed small unitary board of directors along with a split role of the CEO and chairman and it reflected an insider model. Italian corporate governance aligns with the insider model with companies basically being family owned or owned through cross company shareholdings (Solomon, 2011). These are some examples of countries using alternative corporate governance model. There are other models like transaction cost theories but the scope of discussion is limited. As a recommendation it can be stated that stakeholder theory will have to be applied in the core as an outsider model with attributes of agency theory within the internal mechanics of the organizations. 7. Conclusion The discussion gives a brief idea about two theories of corporate governance which is highly important for application within the business for successful application of the same. The stakeholders approach target towards the achievement of value creation through optimally benefitting the interests of stakeholders associated with the companies. The agency theory targets at value creation through resolving the principal agent conflicts and risk mitigation. The stakeholder theory is synonymous to outsider’s models taking care of the overall impact of business and the agency theory is synonymous to that insider model. The two theories are not mutually exclusive however their moral discourses are different but in the long run their objectives remain the same. Through some country examples it can be also stated that stakeholders approach is more useful. As a recommendation it can be stated that stakeholders approach is a super set and agency theory is its subset and maximizing the stakeholders through stakeholder theory is judicious. References 1. Berenbeim, R, (2012), Corporate Governance in Emerging Markets…and Everywhere Else, Vital speeches of the day, Vol. 78 Issue 2, pp. 59-63 2. Choi, A & Yocam, E, (2010), Corporate Governance: A Board Director's Pocket Guide, iUniverse 3. Eisenhardt, K, M, (1989), Agency Theory: An Assessment and Review, Academy of Management Review, Vol. 14, Issue. 1, pp. 57-74 4. Fernando, A, C, (2009), Corporate Governance: Principles, Policies and Practices, Pearson Education India 5. Jensen, M, C, (2002), Value Maximization, Stakeholder theory, and the corporate objective function, Journal of Applied Corporate Finance, Vol. 13, Issue.3, pp. 8-21 6. Mallin, C, A, Corporate Governance. Oxford University Press 7. Fernando, A, C, (2009), Corporate Governance: Principles, Policies and Practices, Pearson Education India 8. Solomon, J, (2011). Corporate Governance and Accountability. John Wiley & Sons Read More