Corporate Social Responsibility and Shareholder Value Maximization - Essay Example

? Corporate Social Responsibility and Shareholder Value Maximization 6th, September, Table of Contents Table of Contents 2 Introduction 3 Shareholders Value 3 Maximization of Shareholders Wealth 4 Factors that Affect the Shareholders and Owners Wealth 5 Importance of a Company 6 Shareholders Theory 6 Stakeholders Theory 6 Ways of Measuring Shareholders Value 7 Importance of Maximizing the Shareholders Value 8 Corporate Social Responsibility 8 Conclusion 9 Corporate Social Responsibility and Shareholder Value Maximization Introduction In the recent past, particularly over the last two decades, the ideology of maximization of shareholders value as a norm of corporate management has been under great scrutiny. The issue of whether companies should engage in social matters affecting the society has been a source of controversy with some people supporting corporate social responsibility while others are opposed to it. Effective management of a company entails making realistic financial decisions, which are in line with the firm, or company’s goals. The choice to maximize company shareholders stocks remain an important role of firm managers and acts as an indicator of the level of advancement. The wealth possessed by the shareholders can be determined by analyzing the market price or value of the company’s common stock. Maximizing of shareholders wealth should be a long-term goal of the firm, which can be achieved by maximizing short-term earnings and reducing the expenditures. However, the management should be careful not to cut down too much on the expenditure since research and development are crucial in enabling firms develop novel products which contribute to increased wealth. This paper focuses on why the primary objective of management should be to increase the wealth of shareholders and owners. Increment of shareholders wealth portrays improved or good management in different areas, which include risk management, income management, developments, tax rates as well as in research. The move to increase shareholders wealth helps create a favorable working environment since it helps motivate the shareholders. However, firms that may choose to focus solely on increasing the shareholders wealth and disregard corporate social responsibility risk been scrutinized negatively especially by neighboring communities. Shareholders Value Shareholders are the persons who own or have bought shares in a corporation or firm. Shareholders have certain right in a firm since they are considered the owners of the firm. Being the owners of the firm, shareholders are concerned with the performance of the firm. Additionally they are involved in the firm’s decision-making process through voting process especially when important decisions are being made. Since the shareholders have invested financially in a firm, they require the employees to work towards increasing the wealth of the firm (Bejou, 2011, 1-6; Van Beurden & Gossling, 2008, 407-414). One of the major roles of financial managers in a firm is to acquire funds for the firm and make use of the money to fund projects that will increase or maximize the value of the shareholders as well as firm owner’s wealth. Shareholders value can be defined as the value or wealth due to the management’s capability to maximize on earnings, share prices, as well as the dividends. It is calculated by considering the number of outstanding shares and their market price. The shareholders’ value can be decreased by factors such as issuing shares (Fontaine, Haarman and Schmid, 2006, Web). On the other hands, dividend payments tend to augment the shareholders’ value. All the decision made by the management has the potential of affecting the firm’s ability to increase the wealth or the firm’s cash flow is regarded as shareholder value. Increasing shareholders value entails making responsible decision on the investments to make and the appropriate time to invest. One of the main factors that threaten the shareholders’ value is reckless decision aimed at chasing profits but end up causing decline in the value of shareholders wealth (Van Beurden & Gossling, 2008, 407-420; Acton, 2012, 112-119). Maximization of Shareholders Wealth Maximization of shareholders wealth entails making of decisions aimed at increasing the future profits of a firm. The decision made could decrease short-term profits for a while but end up increasing the future profits since maximization of shareholders and owners profits is a long-term goal. The concept of increasing the shareholders’ value advocates that a firm should concentrate on creating wealth or maximizing shareholders value and minimize efforts spent in improving the welfare of the society. Supporters of this concept argue that the sole purpose of managers in a firm is to work towards increasing the firm’s wealth. They argue that firms are not supposed to engage in other matters particularly those in the society but are supposed to focus on safeguarding and increase the shareholders wealth (Acton, 2012, 45-56). Milton Friedman, a popular American economist argued that the main obligation of a firm or any type of a business should be maximizing the shareholders wealth. He argued that increased shareholders wealth would be reflected in improved welfare of the society. The society would benefit through aspects such as increased employment, which is only possible if the financial standings of a firm are good. Friendman disregarded any other roles taken by firms and argued that it would only lead to reduced performance which would affect shareholders’ wealth (Wilcke, 2004, Web). Wealth maximization aims at making plans to enable shareholders to get maximum dividends arising from increased market prices of the shares. Wealth maximization is based on the supposition that the existing share prices are reflective of the activities of a company. This assumption is appropriate since share prices are indicators of the wealth or shareholders’ value at any particular moment (Moyer, McGuigan and Kretlow, 2008, 9-12; Wilcke, 2004, 200-209). To maximize the shareholders’ value, the managers should aim at increasing the market value of the firm’s shares. The market price or value of shares is determined by cash flows, timing as well as risk involved. Cash flow is defined as the tangible cash that is created by the firm. It the cash generated that is used to obtain additional assets for the firm. Cash flow is generated through increased profits in a firm, which are made available for further investments (Ahlstrom, 2010, 11-24; Wilcke, 2004, 187-204). Timing is another aspect that determines the value of shares owned by a firm. Timing of cash flow helps in determining the cash generated for investment. The other factor that determines the value of share is risks. The capital market keeps fluctuating such that the market prices are not stagnant but change from time to time. Additionally, the risk involved in investing varies depending on the vulnerability of the capital market. It is thus crucial that financial manager’s asses the market conditions before making investments (Cosans, 2009, 391-399; Husted & de Jesus, 2006, 80-91). Factors that Affect the Shareholders and Owners Wealth The claim that maximizing shareholders value is crucial in corporate governance arose in United State around 1980. In the 1980s, firm that had employed excessive employees who were maintained over long periods characterized the corporate sector. Management of a firm entails making of decision with the aim of maximizing the entire wealth of a firm hence the shareholders wealth. Some company executives tend to overemphasize on quarterly earnings since they consider them indicators of the stock market values. Actually, the quarterly earnings figures are important drivers of stock market values but are not true indicators of the shareholders’ value (Moyer, McGuigan and Kretlow, 2008, 11-22). The factors determining the value of a firm or the shareholders’ value can be grouped into environmental related and those factors that relate to company policies and decisions. Environmental related factors include the government laws as well as regulations that may affect the company (Moyer, McGuigan and Kretlow, 2008, 9-12). Another factor is the level of economic activity, which varies depending on the performance of the global economy. Company policies are crucial since they determine when and where a firm will invest (Husted, & de Jesus, 2006, 81-89). Importance of a Company Business firms play different, which benefit either the entire society or the shareholders who are also referred to as the stakeholder. There are theories that explain the roles of firms in improving the shareholder as well as the stakeholder’s welfare. The shareholders are the business owners while the stakeholders are people who are affected either directly or indirectly by the firm’s operations. However, this paper will discuss two of the major and competing theories commonly referred to as the shareholder and the stakeholder theories (Pfarrer, Web, 1-5; Shaw, 2009, 565-576). Shareholders Theory This theory argues that firms should aim at creating wealth to benefit it owners and should not concern itself with other constituencies such as the local communities. Adam Smith pioneered the shareholders theory. He argued that the sole purpose of a firm should be to generate profits hence increase the wealth or shareholders (Baker and Powell, 2005, 9-15). This theory argues that the government should have minimal or no intervention on matters pertaining to the operations of a firm. According to this theory, government regulation is irrelevant since any firm that may engagfe in illegal operations end up being weeded out by the market. They thus claim that any moves made by the government to intervene in matter regarding the ethics of a firm or any industry are unnecessary (Fontaine, Haarman and Schmid, 2006, Web). Some examples of individual who strongly supported this theory include Friedrich Von Hayek, Joseph Schumpeter ans Israel Kirzner. The above persons were capitalist whi claimed that firms should be left alone to self-regulate their operation with little or no intervention from the govement. Moreover, the shareholders theory argue that it is not the responsibility of firms to intervene in matters affecting the society. Friedman, a strong supporter of this theory argues that it is the role of state to handle social development issue affecting th society (Pfarrer, Web, 1-5; Fontaine, Haarman and Schmid, 2006, Web). Stakeholders Theory The stakeholders’ theory argues that financial managers should make decisions that aim at improving the welfare of all stakeholders of a firm. Although employees, customers, neighboring communities as well as the government are considered stakeholders, shareholders remain the most important component of a firm. The primary goal of a corporate firm should thus focus on the welfare of the shareholders by ensuring that the market value of the stocks remains high (Baker and Powell, 2005, 19-25; Pfarrer, Web, 1-5). There are different types of shareholders who include debt holders, desired stockholders in addition to the common stockholders. The most important of the three stockholders are the common stockholders. The financial managers should always lay more emphasis on the wellbeing of the common stockholders by setting goals and making decisions that aim at increasing the value of their stock (Pfarrer, Web, 2-6; Fontaine, Haarman and Schmid, 2006, Web). Common stakeholders are considered the company’s shareholders or owners. The actions or decision taken by the financial manager should entail identifying the activities or goods as well as services that will increase the value of the firm. Maximizing shareholders value is crucial in that it acts as a good measure of the value of a firm’s growth as well as financial standing. Additionally the price of stock acts as a measure of current and future financial standing of a firm hence an appropriate way of measuring the shareholders economic value. It is thus by adding value or the price of shares that the financial managers are able to maximize he shareholders or firm owners wealth (Pfarrer, Web, 1-5). The stakeholders’ theory assumes that managers act responsibly and in no way deceive the financial markets with the aim of increasing the stock prices. Additionally, the theory argues that managers should not engage in any unethical or illegal action while maximizing the shareholders wealth. It is by observing the above two conditions that the goal to maximize that shareholders wealth becomes consistent with the interest of the shareholders as well as the society (Pfarrer, Web, 11-15; Fontaine, Haarman and Schmid, 2006, Web). Ways of Measuring Shareholders Value Some people consider short-term increments or decline in the price of the price of the shares or stock to mean that the firm is growing or deteriorating. However, short alteration in the stock price is not always indicators of good or poor financial management. The stock prices or the shareholders’ value is determined by several factors. Additionally, the factors determining the stock prices are in most cases beyond the control of firm management. However, there are things that financial managers can do to facilitate or enhance the stock prices hence improve the shareholders wealth (Baker and Powell, 2005, 29-35). The shareholders’ value can only be created or maximized if the profits made exceed the expectation of the investors, which can be determined by the cost of capital. Profitability is mainly measured using Return On Capital Employed (ROCE). ROCE is the measure of operation profit or losses in addition to net income after all the tax deductions have been made (Wilcke, Web). Another way of measuring the shareholders’ value is by assessing the progress of a company in terms of it performance. This is done by examining how far a company has progressed towards attaining the goals that had been previously set. Assessing a company’s performance helps the management department to foster profitability and competitiveness, which result in increased the shareholders’ value (Acton, 2012, 79-82; Moyer, McGuigan and Kretlow, 2008, 19-26). Another way of measuring performance is referred to as benchmarking, which entails assessing business practices, procedures, as well as innovations that are important in stimulating progress. Benchmarking is crucial since it helps company make changes on the set goal to maximize performance. Performance measurements are based on the statistics obtained from financial statements such as income statements as well as balance sheets. By assessing the above financial statements in addition to the cash flow statements, a company can be able to tell how its fairing. Additionally, the company can identify areas to focus on to improve its performance (Acton, 2012, 79-80; Wilcke, Web). Importance of Maximizing the Shareholders Value As the global completion amongst companies increase, there is need for companies to maximize on the value of their stock, which results in ultimate increase in shareholders’ value. Measuring the value of the company shares is crucial since it helps companies monitor their level of growth. Additionally, knowing the worth of shares enables company management evaluate their past decision and make better future decisions (Moyer, McGuigan and Kretlow, 2008, 55-62; (Baker and Powell, 2005, 43-54). Corporate Social Responsibility The issue of social corporate responsibility has been under discussion for several years. Most discussed is the role of corporate social responsibility in determining the success of a firm. Those in support of corporate social responsibility argue that firms make use of resource in the society and are thus entitled to intervene in social matters affecting the society. However, critics who are also supporters of shareholders theory argue that firms have no responsibility on matters affecting the society and are only supposed to focus on increasing or maximizing shareholder value (Craig Smith, 2003, 52-60). The critics argue that corporate social responsibility only leads to loss of focus of the firms involved which leads to grave effects since the shareholders end up gaining less from their investments. Additionally, those opposed to corporate social responsibility argue that it lead to those firms practicing it being put at a competitive disadvantage as compared to firms not involved in societal social matters (Wilcke, Web).An additional argument against corporate social responsibility is that persons within the corporate sector are less informed or even equipped to deal with social matters. They thus advocate that social matters be left to the state as well as other organizations that are capable of dealing with them better and conclusively (Craig Smith, 2003, 52-76). Though making of profit is the main objective of most firms, it is important that firms contribute to the society. Supporters of stakeholder’s theory who are also advocators of corporate social responsibility argue that firm or companies have a social responsibility of supporting social matters in the society. The contribution could be in terms of creating employment, bringing in innovations, or improving the economy, which results in improved welfare of members of the society. Even minor growth in economy eventually results in increased income growth in the firm (Acton, 2012, 79-82; Moyer, McGuigan and Kretlow, 2008, 42- 53). Those in support of corporate social responsibility argue that firm or corporation generate numerous social problems in the society and are thus supposed to create way in which they can resolve these problems. Additionally, when corporations assume social responsibility in the society, they are more likely to gain government trust. This is important since it leads to reduced government regulation which enables the corporations to function more freely. Another argument put forward to encourage firms to take social responsibility is that large firms have large financial reserver and it is only fair that they devote part of their wealth to be used to resolve society issues. (Bichta, 2010, 5-10). Conclusion The issue of whether corporate organisation are supossed to take social responsbility on matter affecting the society has been under discussin for a long time. Some researchers like Milton Friedman argue that the sole purpose of business was to maximize profits based on the assumption that such action would benefit society through increased employment. In support of corporate social responsibility, argue that company activities have great negative impacts on the society and organizations should thus engage in activities aimed at improving the welfare of the society.  In respect to the issue of corporate social responsibility, two opposing theories referred to as Stakeholders theory and shareholders theory have emerged. Shareholders theory opposes corporate social responsibility and argues that firms should not engage in social matters since it is the role of state to resolve such issues. The shareholder theory posits that involvement in social activities can lead to loss of competitiveness hence underperformance of firms. Stakeholders theory supports corporate social responsibility and argues that it enables firms gain government confidence hence more freedom. Works Cited Acton, A 2012, Issues in Industrial Relations and Management: 2011 Edition. ScholarlyEditions, New York. Ahlstrom, D 2010, “Innovation and Growth: How Business Contributes to Society.” Academy of Management, pp. 11-24.  Baker, K & Gary P 2005, Understanding Financial Management: A Practical Guide. John Wiley & Sons, New York . Bejou, D 2011, ‘Compassion as the New Philosophy of Business’, Journal of Relationship Marketing, Vol 27, issue 10, pp. 1-6.  Bichta, C 2010, Corporate Social Responsibility a Role in Goverment Policy and Regulation? Reasearch Report 16. Centre for the Study of Regulated Industries (CRI), London. Cosans, C 2009, “Does Milton Friedman Support a Vigorous Business Ethics?” Journal of Business Ethics, issue 87, pp. 391-399.  Craig Smith, N 2003, “Corporate Social Responsibility: Whether or How?’ California Management Review, vol. 45, no. 4, summer, pp. 52-76.  Fontaine, C, Antoine, H & Stefan S 2006, The Stakeholder Theory.Viewed 6 Sep 2012 . Husted, BW & de Jesus Salazar, J 2006, “Taking Friedman Seriously: Maximizing Profits and Social Performance” Journal of Management Studies, Vol 43, Issue 1, pp. 76-91.  Shaw, W 2009, “Marxism, Business Ethics, and Corporate Social Responsibility,” Journal of Business Ethics, Vol 86, pp. 565-576.  Moyer, C, James, M & William K 2008, Contemporary Financial Management. Cengage Learning, New York. Pfarrer, M 2010, What is the Purpose of the Firm?:Shareholder and Stakeholder Theories.Viewed 6 Sep 2012 . Van Beurden, P & Gossling, T 2008, “The Worth of Values – A Literature Review on the Relation between Corporate Social and Financial Performance’, Journal of Business Ethics, Vol 82, pp. 407-424. Wilcke, R 2004, An Appropriate Ethical Model for Business and a Critique of Milton Friedman’s Thesis. A Journal of Political Economy, Vol 9, No 2. Viewed 6 Sep 2012 . Wilcke, RW 2004, “An Appropriate Ethical Model for Business and a Critique of Milton Friedman’s Thesis”, The Independent Review, volume IX, no. 2, Fall, pp. 187-209.  Read More