Advantages, Disadvantages, and Future Perspectives of Enlightened Shareholder Value Approach - Coursework Example

Does the concept of Enlightened Shareholder Value succeed in bridging the gap between the Shareholder and Stakeholders Value theories? Critically discuss the advantages, disadvantages and future perspectives of this new approach. 1. Introduction In the Enlightened Shareholder Value approach, much focus is given to “corporate stakeholders, including the environment, employees, and local communities” which are considered important in establishing long-term shareholder benefits1. Much debate has been seen throughout the years on what the goals of corporations should be. In order to seek an answer to this query, the shareholder value principle and the stakeholder theory has been considered. The shareholder value principle requires for a corporation to be managed in ways which support the shareholders over and above other parties having claims on the company. This principle has been seen in the US, the UK, Canada, and Australia. The stakeholder theory on the other hand declares that the goal of the corporation must be to support all individuals who have been identified as stakeholders2. Under this set-up, the organization therefore seeks to manage the corporation for its shareholders, as well as all stakeholders who can be impacted by the organization. This theory is seen in Germany and in some European countries. In general, the shareholder value principle is being applied in most UK corporations. This paper now seeks to discuss whether or not the concept of Enlightened Shareholder Value succeeds in bridging the gap between the Shareholder and Stakeholders Value theories. It shall critically discuss the advantages, disadvantages and future perspectives of this new approach. 2. The Shareholder theory 2.1 Background The shareholder theory is rooted in Adam Smith’s ideas. It is a theory which includes the concept that the main purpose of businesses is to establish profits and increase the sharing of wealth. In general, the shareholder theory supports three ideas: the importance of free markets, the invisible impact of self-regulation, and the significance of enlightened self-interest3. Based on this theory limited government control is needed because the markets must best be managed through an invisible hand, with corporations working with each other and attempting to maximize profits. The current application of the shareholder theory is based on the Chicago School of Economics which highlighted the fact that the primary purpose of corporations is to maximize the wealth of shareholders; this theory also argues and that resolving social issues are state functions, not corporate functions4. Sharing wealth through philanthropy is therefore considered a useless enterprise for the corporation; in some instances, it may even be considered immoral because it is as good as stealing from the shareholders. The importance of the shareholder has been based on the principle of corporate law supported by the contractarian school in the US5. The contractarians declare that contractual relations among individuals within a company must be considered sacred6. These contractarians therefore uphold the right of the shareholders as the main basis for any corporation. This preference is based on the idea that for as long as the corporation is solvent, the company must be run in favour of residual claimants7. These claimants have an interest in the company’s profits and therefore, their stake in the outcome of the company is also high. If the company suffers a downturn however, these shareholders also suffer to a significant extent. It is therefore important for shareholders to have a right to control the corporation over and above the interests of stakeholders8. 2.2 Criticism The shareholder theory is however very much focused on earning profits for its shareholders, with little to no concern at all attributed to how, who, or what is affected negatively by the corporation in gaining said profits. This theory also does not consider the environmental, social, cultural, and even political impact of their profiteering practices9. If this shareholder theory is to be applied in all corporate practices, stakeholders are inconsequential to the corporations. There is no balance in this corporate practice – in relation to those who would benefit and those affected by corporate profit-seeking practices10. This theory cannot appropriately gain support in the current setting because of the greatest awareness that people now have against purely profit-oriented motives by corporations. 3. Stakeholders theory 3.1 Background The stakeholders theory is focused on the stakeholders and that the primary concern of corporations must be on the stakeholders, not their shareholders. This theory also does not believe that maximizing shareholder wealth is the best way for corporations to succeed11. This theory was first seen in the late 1970s and early 1980s when researchers involved in philosophy and sociology started suggesting a theory that challenged the shareholder theory. These theories suggested instead that by considering all the interests of the stakeholders, it is possible to perform better as a corporation12. Stakeholders are individuals or groups who impact or may be impacted by a corporation’s actions, including competitors, consumers, employees, investors, regulators, suppliers, and governments. In other words, stakeholders are those who under particular circumstances actually “count” in a corporation’s actions. This theory impacts on various scholars who seek the importance of firms interacting with their environment – interacting with the clients, suppliers, competitors, the media, including activists. This theory also seeks to encourage the two-way communication between the stakeholders and the corporation as a whole. In recent years, stakeholders have made a significant impact on how businesses are being carried out and various corporations have now made bigger considerations on how they can achieve and satisfy stakeholder needs13. Stakeholders hold a significant amount of pull on the corporation’s corporate image, especially in relation to the corporation’s fulfilment of his corporate social responsibilities. The fulfilment of the needs for each stakeholder seems to be the measure for CSR rating for any corporation and many corporations are often significantly pressured to make major strides in order to meet stakeholder needs14. 3.2 Criticism There are however criticisms to this theory. One criticism is based on the fact that corporations do not exists in the actual physical plane – only people do and only people can be burdened with responsibilities15. The only social responsibility which businesses can actually fulfil is on the use of resources and on engaging in activities which are meant to improve profits for as long as it fulfils various rules. In the practical sense however, the main responsibility of corporations is still to earn profits, not to be highly focused on stakeholders and their concerns. In this case, the stakeholder theory may not hold much water16. Managers also often have limited resources in order to fulfil its CSR and only a few stakeholders may actually capture their attention. This theory will also be very impractical for corporations to implement because corporations are established in order to earn profit. If corporations would prioritize stakeholders, profits would be reduced and the corporation would have trouble staying afloat17. Moreover, shareholders would be turned off into investing in these firms knowing that they would not actually be getting the most profit for their money. 4. Enlightened Shareholder Value Approach 4.1 Benefits of ESV Based on a review of UK corporate practices, the CLRSG advocated the Enlightened Shareholder Value approach in order to improve wealth generation and overall competitiveness, especially for shareholders18. This would still require directors to act in the best interests of the shareholders. However, it also diverted some attention from the financial bottom line and included a more inclusive approach to corporate practice, thereby focusing on building long-term relationships19. It also included the importance of establishing a balance of interests among competing stakeholders. Based on this approach, the shareholder would benefit in the end, encouraging the directors to take on a more balanced and long-term approach to corporate management. This approach rejected the pluralist theory which would have protected various interests for the corporation, all of which may be subordinate to shareholder interests20. Under the enlightened shareholder value approach, the directors are required to secure the success of the corporation for shareholders by “taking proper account of all relevant considerations for that purpose”21. The ESV approach also seeks to protect the relationship of the employees, customers, and suppliers; and it also seeks to protect the community and the environment. The concept of ESV is very much similar to enlightened value maximization which has been advocated in recent years. Enlightened value maximization acknowledges the fact that the long-term impact of any organization cannot be protected if the constituency is mistreated; in this case, inadequate value would be formed for customers, employees, suppliers, the environment, and communities22. The CLRSG recognized the value of enlightened value maximization in its reports. The CLRSG eventually gained the favour of the UK government and sought to make its recommendations fully protected through the Companies Act of 200623. This act basically stated that a director must act in a way which considers the success of the corporation and its members, and in effect, considers the long-term impact of their actions; the interests of employees; the importance of promoting the company’s relationships with its suppliers and customers; the impact of the corporate operations on the company and the environment; and the need to maintain fairness between the members of the corporation24. The CLRSG and the UK government, in passing the Company Act of 2006 and in recognizing the importance of Enlightened Shareholder Value sought to place a high degree of importance on the long-term impact and future of corporations. The emphasis placed on the ESV is on the word ‘enlightened’ which implied the importance of a more conscientious shareholder. The ESV therefore sought to fill in the gaps between the shareholder value principle and the stakeholder theory by trying to gain the best of both principles and apply them as one approach. In this case, directors have to consider other interests, not solely of the shareholders. Enlightened Shareholder value Approach establishes decisions rules which are different from the financial enrichment of shareholders; however it also offers various advantages for corporations25. Maximizing shareholder wealth generally increases the value of the corporation and therefore benefits the shareholders in general. With the corporate pursuit of profit, the society can also benefit in general. ESV decision rules review these arguments in such a way as to consider the limits of law and markets. One of these limits is related to negative externalities26. If it is more or less assumed that nonshareholders have a priority claim on corporate assets while shareholders only have residual claim, and maximizing shareholder wealth only produces benefits for nonshareholders in the absence of external elements27. However if the corporate considers risky actions, the risk in the increased return does not benefit shareholders. ESV helps resolve this dilemma. If the shareholders are not the sole claimants in the firm, then their economic value is not based on corporate value28. ESV supports the notion that taking advantage of corporate value also maximizes shareholder wealth, but not the other way around29. This decision rule may encourage corporations to recognize the risks to stakeholders. The focus of ESV on the importance of credit to wider stakeholder claims also mixes well with general findings that profits delivered to shareholders are often based on advantages gained by stakeholders. ESV also declares that even as shareholders and stakeholder interests meet, the amount which the corporation allocates to various stakeholders may limit the long-term shares of shareholders and also increase the risk being carried by the corporation30. Therefore, it may not be possible to ensure shareholder economic profits when these elements are not included in the analysis. ESV’s focus on wider definitions of shareholder value therefore provides important revisions on corporate standards. In relation to the argument that maximizing profit is best for society, ESV also emphasizes the other side of such argument – that corporations which do good for the general public will also perform well in the market31. Moreover, ESV emphasizes that the public outpouring of profits may be diminished by the risks placed on stakeholders which are not adequately protected under current provisions of the law. Specifically, the focus of ESV supporters on environmental, social, human, local, and community rights and welfare highlights the inefficiency of contractual protection for involuntary stakeholders and other international corporations32. Placing pressure on corporations may help resolve this dilemma and return the focus on environmental and employee concerns. Another argument which may favour shareholder maximization is that maximizing shareholder wealth is already implies from the contracts between the firm and the shareholders. Since shareholders do not have contractual responsibilities which are often available for stakeholders, these shareholders may not want to invest in the corporation if their interests as shareholders are not protected. 3.2 Drawback of ESV The ESV can make it difficult for directors to take the shareholders to another level, and instead, it has often taken their responsibility to a broader context33. The UK government supports the notion that a company director needs to have sufficient consideration for the interests of the general public as well as for the long-term interests of the company; this would mean that the company has a more enlightened approach in doing business34. Moreover, directors cannot pursue interests which would be harmful to the material interests of shareholders. Directors therefore cannot refuse the dismissal of employees, unless this dismissal would serve the shareholder interests. The issue of private and special interests seems to pose a difficult consideration for the ESV approach. In this case, the basic consideration is that the activist shareholders, union funds, and hedge funds might then flex their power in order to ensure private interests, thereby allocating value from shareholders to specific shareholders35. The shareholders may also side with the management against stakeholders. ESV cannot adequately resolve these challenges. It however is quick to advise corporations that shareholder activism which seeks to compromise stakeholder concerns is not permissible36. Public pensions and hedge funds may not also pose a significant long-term risk for stakeholders. Moreover, this practice may also cause shareholders to withdraw from the corporation. 4.3. Application of ESV approach to future ESV supports the revision of corporate contract arguments which fits the realities for public corporations. Maximizing shareholder wealth is already assumed and is supported on the basis of shareholders already having limited power protected by the law37. As legal protection may be enough for most stakeholders, this protection often does not apply to stakeholders for global corporations. With the increase of investors and decreased activism, the contention that shareholders need specific protection under corporate law has lost its force38. It is also no longer accurate to argue that shareholder wealth maximization which does not consider stakeholders is the proper standard which all shareholders would necessary establish with other corporate shareholders. Various investors may actually consider the terms of their investment based on the portfolio of corporations in order to ensure that corporations would deliver profits and also consider other issues39. Shareholder value maximization supports the idea that the goals of the corporations can be separated from the means to gain such a goal; this is a responsibility which shall be left to public officials. However, based on the risks on reputation which irresponsible practices can bring, shareholder financial interests are often associated to the economic as well as the future social concerns of stakeholders40. ESV acknowledges that it may no longer be possible to separate the public and the private functions of corporations. Opinions often emphasize the normative benefits of supporting the goals and the processes of corporations; however issues brought up through shareholder activism establishes that many shareholders are actually very much concerned about the methods of achieving shareholder values41. ESV therefore observes the reality that shareholders actually expect corporations to take account for how their money is being allocated. Various corporate experts have discussed the nature and the function of corporations, and these discussions have mostly veered away from stakeholder concerns and broader responsibilities42. Corporate social responsibility can actually be considered under the same unfortunate trend. In the past few years however, stakeholder and shareholder interests have started to blend and blur. ESV seeks to reduce remaining barriers, supporting a more integrated foundation for corporations and its related goals43. In forwarding considerations on enlightened shareholder values, various trends and concerns for future applications have emerged. Firstly, there seems to be limited attention being allocated to stakeholders44. Shareholder power may cause the managers to allocate little attention to stakeholders. However, this argument has been discounted under this article because enlightened shareholder value is actually gaining much support from investors and often motivates corporations to consider favourable stakeholder decisions. Secondly, increased shareholder influence is however a major issue for those concerned about corporate actions which may reduce stakeholder interests. The ESV responds to this situation by highlighting the fact that specifying stakeholders in investment and in corporate decisions can support long-term shareholder shares45. Therefore ESV is mostly based on efficiency rationales in the investors and has the prospect of making major gains in mainstream investment and communities46. It may however be important to argue that ESV decision, including the stakeholder decisions may limit efficiency because they place much focus on stakeholders. Lastly, strong support for the shareholder wealth maximization program is based on the fact that it helps managers remain accountable to their shareholders as they set a clear focus – that of gaining as much profit for the shareholders as they can47. In this case, the ESV is criticized because it can compromise the directors and the standards which they choose in managing competing stakeholder and shareholder interests48. These interests establish a cloak for management of selfish interests which is akin to the act of serving two masters at the same time. Managers under this dilemma may seek to negotiate with the parties concerned. ESV, as well as shareholder wealth maximization, manages this dilemma by establishing long-term shareholder value as the main standard. However ESV investors may want the management to justify the stakeholder concerns, either by preventing any risks for them or by establishing opportunities to generate wealth which can also benefit stakeholders49. This decision can pose difficulties, but these issues are common in the corporate practice with managers always being confronted with competing concerns. 5. Does the ESV bridge the gap? The ESV has made major strides in bridging the gap between the shareholder value principle and the stakeholder value theories. The ESV considers both the interests of the shareholders and the stakeholders and lays them out in relation to broader corporate considerations50. In actual practice in the UK however, seeking to implement the favourable goals of the ESV have not gained major strides and benefits. Although the ESV is forwarding a different approach to corporate practice, and directors are actually portraying different roles as compared to the past, the focus of UK corporations seems to remain on the shareholder value principle. Although the CLRSG also supports the goals of the ESV, it also seems to declare that corporations must be managed in a way which seeks to support their competitiveness; moreover, the methods which the corporation can use must be based on the realities of the market place51. Their actions and decisions must not be “done at the expense of turning company directors from business decision makers into moral, political or economic arbitrators”52. This provision limits the actions of directors in relation to applying fully the principles of the ESV. Some commentators are however quick to declare that the UK is establishing a long term application of the ESV approach and that various UK corporations are being encouraged to consider stakeholder interests53. These commentators are also suggesting that there is a convergence occurring in the market, one which is gearing towards an Anglo-American market based approach for corporations. They also declare that there are varied interests of the UK in other countries which are adopting the shareholder value principle and through mergers with other companies, the impact of other corporate practices are becoming more significant. Analysts also declare that ESV kills two birds with one stone with stakeholders getting more attention and shareholders able to maintain profits in the corporation54. It is however still important for corporations to serve their shareholders well through significant profits. This is still the primary purpose of corporations, and the primary reason why shareholders invest in these corporations55. The ESV nevertheless seeks to present a more tempered approach to corporate practices, one which seeks to consider other less profitable elements, including the concerns of stakeholders, suppliers, local communities, and the environment. In this regard, ESV provides a venue for both principles to co-exist, serving both interests well for the maximum welfare of all parties concerned and for the sake of long-term goals and objectives. 6. Conclusion In reviewing the issue being discussed, most especially the impact and application of the ESV, it is important to note that corporations primarily exist for profit and for the profit for their shareholders. The shareholder value principle has long been the dominant principle for most corporations with the stakeholder theory fighting hard to make its mark in the corporate practice. In recent years, with calls for corporate social responsibility and negative corporate practices impacting stakeholders, legislation and politics, as well as the society in general has vastly criticized the financial focus of corporations. In this regard, the Enlightened Stakeholder Value Approach has been considered as a possible approach to minimizing the negative impact of corporations. The principles which surround the ESV make it possible to protect both the shareholders and the stakeholders. It is a difficult process to implement, but in principle, is possible to achieve. In the current practice, no clear processes and success has been gained in fulfilling the principles being sought by the ESV, nevertheless, the initial actions of corporations have been laid out. In order to achieve a better future for the ESV approach, corporations need to make a serious accommodation for the principles being laid out by the ESV. 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