Shareholder and Stakeholder Models of Corporate Governance - Essay Example

Compare the ‘shareholder’ and ‘stakeholder’ models of corporate governance. Which one strikes a better balance between the objectives of the employment relationship? Discuss with reference to two countries of your choice. 1. Introduction In order to secure their growth modern organizations often promote policies that are against the interests of their employees. This phenomenon usually leads to strong conflicts in the internal organizational environment especially in regions where unionization is highly developed. It should be noted though that this problem is not equally intense worldwide depending on the mode of corporate governance supported by the local legal system. Two major modes of corporate governance have been reported in the global market: the shareholder model, a system applied in the countries based on the Anglo-Saxon legal system, such as USA and UK, and the stakeholder model, a system used in countries out of the above legal framework, as for example Germany. In this study the above models of corporate governance are compared. At the same time, the level at which each of these models can secure a balance in regard to the objectives of the employment relationship is explained. In order for the above issues to be made clear reference is made, as examples, to two countries: USA and German. The first of the above countries is known for its support to the shareholder model while the second country promotes the second model of corporate governance, i.e. the stakeholder model. The literature published in this field is presented and evaluated. It is concluded that the stakeholder model is most supportive towards employees’ rights, meaning that the particular model can be valuable in achieving the objectives of employment relationship. Moreover, it has been proved that the changes made on the shareholder model for making this model friendlier for employees have not been quite satisfactory: the shareholder model, despite its alternations, remains a framework that focuses on profits rather than on human relations within each organization. 2. “Shareholder” and “stakeholder” models of corporate governance.  2.1 Comparison of the “Shareholder” and “Stakeholder” models of corporate governance Corporate governance, as used in modern market, can have two modes depending on the hierarchy of interests of third persons, as these interests are taken into consideration when controlling a business: the shareholder model and the stakeholder model (Brink, 2011, p.331). As a framework, corporate governance indicates the schemes and rules used by corporate investors ‘to control managers for ensuring returns on their investment’ (Xu and Wang, 1997, p.42). The first of the above models, the shareholder model, is based on the following view: businesses belong to shareholders; in this context, for businesses the interests of their shareholders should be set as a priority (Brink, 2011, p.331). It is implied that in businesses based on this model all decisions have to be aligned with the benefits of shareholders no matter of the potential effects of these decisions on other parties, such as employees (Brink, 2011, p.331). In the above businesses managers are not allowed to promote policies that do not support the interests of shareholders (Brink, 2011, p.331). In fact, there are regions where managers are obliged by the law to act setting the interests of shareholders as a priority (Monks and Minow, 2004, p.111, in Brink, 2011, p.331). On the other hand, the stakeholder system considers business as an entity based on a network of interests, such as the ‘interests of customers, employees and the government’ (Fernando, 2009, p.50). In fact, the term stakeholder, as used in the above system, refers to ‘individual and to groups’ (Du Plessis, Hargovan and Bagaric, 2010, p.23), the interests of whose are influenced by business decisions and activities. The practices of businesses that promote the stakeholder system are part of the stakeholder theory, which is highly criticized as of the difficulties in regard to its applicability in real terms, i.e. under common market conditions (Fernando, 2009, p.50). In the context of the stakeholder system, as described above, each stakeholder has the chance to contribute in business growth but also to receive specific benefits by the business; in other words, the stakeholder system reflects a strong relationship between the business and its stakeholders (Du Plessis, Hargovan and Bagaric, 2010, p.23); the bond between the business and its shareholders is usually less strong at the level that emphasis is given on the return of shareholder value without a prerequisite of support by the shareholders to the business to exist (Brink, 2011, p.330). Emphasis should be given to the following fact: the position and the role of stakeholders within organizations are evaluated differently in countries worldwide under the influence of local culture and local legal system (Du Plessis, Hargovan and Bagaric, 2010, p.24). The stakeholder model is often justified, as of its characteristics, by referring to the ‘contract theory of the firm’ (Zu, 2008, p.70); the above theory is based on the view that each business is constituted by a series of contracts (Zu, 2008, p.70). In addition, the particularistic theories promote the idea that countries cannot adopt similar rules in regard to management, meaning that differences in regard to corporate governance systems used worldwide cannot be avoided (Koen, 2005, p.4). It should be noted that the two models are highly differentiated as of the type of control employed especially in regard to key strategic decisions: in the context of the shareholder model ‘indirect control is mostly used’ (Xu and Wang, 1997, p.43); this type of control is developed using a series of schemes, such as ‘voting by feet and the respect of minority shareholder rights’ (Xu and Wang, 1997, p.43). In opposition, the stakeholder system is based on ‘direct control’ (Xu and Wang, 1997, p.43). The monitoring of the decisions of the board and the regular replacement of managers in key organizational positions are methods used for securing direct control in the stakeholder system (Xu and Wang, 1997, p.43). In general, the shareholder mode of corporate governance tends to focus on business growth, as this fact also enhances the market, at national or at international level (Borsch, 2007, p.1). The stakeholder system, which is quite popular in Europe, emphasizes on ‘coordination and negotiations within organizations’ (Borsch, 2007, p.1). In this context, the shareholder system hides a significant risk: it cannot secure employees’ rights, in opposition with the stakeholder system in which ‘employee exploitation can be effectively controlled’ (Aras and Crowther 2012, p.173). This result can be explained as follows: when multinationals based on the shareholder model enter a foreign market they tend to set profit as a priority (Aras and Crowther 2012, p.173). However, for such firms the development of the relationship with local consumers should be first in the hierarchy of organizational goals; profit should result if the position of the firm’s brand name in the foreign market is stabilized (Aras and Crowther 2012, p.173). As a result, these firms are expected to suffer major failures in the target market, even if their short-term profits are quite satisfactory (Aras and Crowther 2012, p.173). On the other hand, the shareholder system favours the development of financial institution and supports globalization in regard to financial products/ services (Borsch, 2007, p.2). As a result, the shareholder system is considered as related to high profitability while the stakeholder system does not seem to have such potential (Borsch, 2007, p.2). In addition, the shareholder system, despite its problems is more popular by global investors, a fact that leads many firms worldwide to prefer this system compared to the stakeholder system (Borsch, 2007, p.2). 2.2 Which one strikes a better balance between the objectives of the employment relationship? Corporate governance can highly affect employment relations. In USA, where the shareholder model of corporate governance is promoted, employment relations have the following characteristics: employees are considered as individuals who are compensated for their services towards their organization; the level and the type of this compensation/ rewarding is defined in the relevant employment contract (Budd, 2006, p.94). Thus, employees are not considered as being highly motivated to support organizational growth, at least not at the level of shareholders (Budd, 2006, p.94). The latter participate in the organization’s capital, through their shares; thus their willingness to support the increase of business profits is quite high (Budd, 2006, p.94). For this reason, in US corporations the position of employees within the organization is regarded as of lower importance than that of shareholders (Budd, 2006, p.94). In regard to this phenomenon it has been argued that in businesses based in countries where the shareholder system is promoted governments tend to accept the dominant position of shareholders, as this acceptance is made clear in the legislative framework regulating business activities in the specific countries (Barry and Wilkinson, 2011, p.46). It is implied that securing employee relations, against the interests of shareholders, can be quite difficult in the above countries since local legal system is supportive towards the shareholders, rather than to employees. The superiority of shareholders towards employees, as this superiority is promoted in the context of the shareholder model of governance, can be justified if referring to the economic theory, especially to the part of that theory that highlights the importance of ‘specialized investments for business growth’ (Blair and Roe, 2010, p.59). Because of their potential to increase business expansion these investments are often considered as a criterion for developing key strategic decisions; in such case, employees’ rights are underestimated or, even, ignored (Blair and Roe, 2010, p.59-60). Still, the key role of investment in organizational performance, as this role is enhanced in the context of the shareholder model, has been doubted through the decades. An example is the labor theory which emphasizes on ‘human capital’ (Blair and Roe, 2010, p.60). For the above theory the specific type of capital is decisive for the success of business operations (Blair and Roe, 2010, p.60). The theory of human capital was introduced ‘in 1964 by Gary Becker’ (Blair and Roe, 2010, p.60) and remains of critical value up today. In addition, the labor theory verifies the importance of employees, as stakeholders, for business growth, a view promoted in the context of the stakeholder model of corporate governance, as explained earlier. The value of employees, as members of each organization, is highly recognized in countries that promote the stakeholder system. In the context of this system, employees, as also the other stakeholders of the business, are given the chance to participate actively in the decision-making process of their organization (Barry and Wilkinson, 2011, p.47). The ‘model of codetermination’ (Barry and Wilkinson, 2011, p.47), as applied in Germany is an example of the above practice. Codetermination in Germany appeared, for the first time, in 1848, and was characterized by the potential of employees to state their view in regard to the ‘improvement of their working conditions’ (Page, 2011, p.7). At this point, the efficiency of the two system could be evaluated by using the model of Budd (2004). According to Budd, effective employment relationships would be depended on the existence of ‘a balance between ‘Voice, Efficiency and Equity’ (Budd, 2004, p.9, Figure 1). In the relevant graph each of the three corners, as referring to the model’s elements, represent specific requirements of the balance in regard to the objectives of the employment relationship. It is clear that for achieving this balance a business must promote a corporate governance framework that would include rules and practices promoting the three elements of the model at an average level. In regard to the graph (Figure 1), such balance would be located at the heart of the graph. Figure 1 – Balance in employment relationship (Budd, 2004, p.9) 2.3Discussion with reference to US and Germany The differences between the shareholder model and the stakeholder model of corporate governance, especially in regard to employment relations, is made clear if referring to the case of two countries influenced by these models. In Germany, a country that promotes the stakeholder model of corporate governance, business operations are regulated by strict and detailed laws while unionization is an important part of employment relation (Barry and Wilkinson, 2011, p.47). In such environment, the violation of employees’ rights by business owners is quite difficult. In addition, in the particular country business activities are supported by funds retrieved mostly by financial institutions and by the state; in this way, each business are not under the close control of shareholders but it rather depends by institutions, or the state (Barry and Wilkinson, 2011, p.47). In this context, managers can apply policies that promote the employees’ interests without causing strong oppositions, as such phenomenon could negatively affect business performance (Barry and Wilkinson, 2011, p.47). In addition, in Germany employees can participate in the ‘supervisory board’ (Mallin et al., 2010, p.51), a board through which employees can influence the corporate governance of their organization. In Germany, the promotion of the stakeholder model of corporate governance could be explained by the fact that the country is not a strong supporter of capitalism; it rather supports a less strong mode of capitalism, known also as ‘the other capitalism or the Rhine model’ (Albert, 1993, p.100). In fact, in Germany two have been the key factors that increased the power of employees to secure their rights: a) the funding of businesses is mostly based in banks and b) it is easier to employees to organize ‘collective actions against employers’ (Dore, Lazonick and O’Sullivan, 1999, p.105). Another important characteristic of German market is that it is structured in such way so that ‘public interests are addressed’ (Streek, 1996, p.7). In such environment, employment relationship can be highly developed so that employees’ rights are adequately protected. In US the participation of employees in the decision – making process is quite limited, often non-existent (Ferrell and Fraedrich, 2006, p.50). For controlling the ethical issues that can possibly appear because of the exclusion of employees from the decision-making process, corporations in USA have adopted the social responsibility concept (Ferrell and Fraedrich, 2006, p.50). The above concept denotes that a business is responsible towards its social environment, thus, also, to its employees (Ferrell and Fraedrich, 2006, p.50). The stakeholder model of corporate governance has been promoted in USA since the country highly values the importance of corporation, as a key entity in regard to market performance, a view based on a theory known as corporatism (Dore, 2000, p.223). In the above country, the specific model of corporate governance has been also promoted by ‘the theory of institutional investor’ (Lazonick and O’Sullivan, 2000, p.16); the above theory reflected the potential of shareholders ‘to exercise their rights more collectively’ (Lazonick and O’Sullivan, 2000, p.16). This practice was made feasible through the high involvement of banks and other financial institutions in the financial support of businesses (Lazonick and O’Sullivan, 2000, p.16). However, both the above theories ignored employees, as critical contributors in business success. Among the two countries the one which is more able to achieve a balance in regard to the objectives of the employment relationship is Germany. This view is based on the model of Budd (2004), as presented in Figure 1. Indeed, in Germany, as noted above, unions are developed while strict restrictions apply in regard to the employees’ rights. Also, regulatory standards are in place for protecting employees’ rights. The above conditions are not met by USA, where emphasis is given on laws increasing the chances of businesses for achieving high profits. 3. Conclusion According to the issues discussed above the shareholder model is highly differentiated from the stakeholder model, as the two models are related to corporate governance. Particular differences seem to exist in regard to the potential of the above models to promote the objectives of the employment relationship. In fact, through the literature review developed for this study it has been proved that the stakeholder model is more appropriate for achieving the objectives of the particular relationship. This finding can be considered as expected at the level that in countries that support this model employee rights are secured by the law. In addition, in the above countries the rules of business operations are such that it is quite difficult for business owners to exclude employees from the decision-making process. On the other hand, markets seem to be more supportive to the shareholder model of corporate governance as this model emphasizes on the interests of investors, i.e. on shareholders, and not on communication and cooperation, as vital requirements for the successful completion of daily business operations. In this context it could be noted that the stakeholder model should be characterized as of key importance for the development of an effective employment relationship. At the next level, such relationship can secure business success; the achievement of the above target cannot be guaranteed when profit is set as a priority, as the stakeholder model of corporate governance supports. Bibliography Albert, M. (1993) Capitalism vs. Capitalism, New York: Four Wall Eight Windows, p.100 Aras, G. and Crowther, D. (2012) Global Perspectives on Corporate Governance and CSR. London: Gower Publishing, Ltd., p.173 Barry, M. and Wilkinson, A. (2011) Research Handbook of Comparative Employment Relations. Cheltenham: Edward Elgar Publishing, p.46-47 Blair, M. and Roe, M. (2010) Employees and Corporate Governance. Washington: Brookings Institution Press, p.59-60 Borsch, A. (2007) Global Pressure, National System: How German Corporate Governance is Changing. New York: Cornell University Press, p.1-2 Brink, A. (2011) Corporate Governance and Business Ethics. New York: Springer Science & Business Media, p.330-331 Budd, J. (2006) Employment with a Human Face: Balancing Efficiency, Equity, and Voice. New York: Cornell University Press, p.94 Budd, J. W. (2004) Achieving Decent Work by Giving Employment a Human Face. Geneva: ILO, p.9 Dore, R., Lazonick, W. and O’Sullivan, M. (1999) Varieties of capitalism in the twentieth century. Oxford Review of Economic Policy, Vol.15, No.4, pp.102-120 Dore, R. (2000) Stock Market Capitalism: Welfare Capitalism. Oxford: Oxford University Press, p.223 Du Plessis, J., Hargovan, A. and Bagaric, M. (2010) Principles of Contemporary Corporate Governance. Cambridge: Cambridge University Press, p.23-24 Fernando, A. (2009) Corporate Governance: Principles, Policies and Practices. New Delhi: Pearson Education India, p.50 Ferrell, O. and Fraedrich, J. (2006) Business Ethics: Ethical Decision Making and Cases. Belmont: Cengage Learning, p.50 Koen, C. I. (2005) Comparative International Management, London: McGraw-Hill, p.4 Lazonick, W. and O’Sullivan, M. 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