Does Stakeholder Theory Provide a Better Basis for Corporate Governance than Agency Theory - Essay Example

Does Stakeholder Theory Provide A Better Basis For The Development Of Corporate Governance In The 21st Century Than Agency Theory? Insert InsertGrade Course Insert Tutor’s Name Submission Date Stakeholder and Agency Theory Introduction and Background Organizations are increasingly looking for means of constantly improving their functions and operations to enable them achieve their set objectives in the current dynamic business environment. Corporate governance is therefore an essential component of public and private enterprises today (Mulili and Wong 2011). This paper focuses on the two theories of corporate governance that have been subject of debate by many analysts on how they approach the issue of governance. It is important to understand the meaning of corporate governance to be able to fully discuss its features. Even though there are different variables that come into play because of the different operating environments in different nations, corporate governance may refer to that process that leads to effective control, direction and accountability in organizations. As a result, corporate governance involves elements like control, co-ordination, direction and the checks and balances associated with management of organizations. In addition to the definition of the term corporate governance, it is equally important to point out that the practice has evolved over the years to become a more complex but essential feature for the success of contemporary organizations. The concept of corporate governance has been fast adopted in various parts of the world but with some major variations because of the different circumstantial variations of nations (Clarke 2004). Consequently, there have been different frameworks of corporate governance that have emerged as a result of this. However, there are two main approaches of corporate governance that can be identified. Other differences may arise because of the different legal systems that are implemented in different countries. As a result, countries that followed civil law like France, Germany, Italy and Netherlands developed corporate governance frameworks that focused on stakeholders such as employees, managers, creditors, suppliers, customers and the wider community. On the other hand, countries that had a tradition of common law like Australia, United Kingdom, USA, Canada and New Zealand developed corporate governance structures that focused on shareholders’ returns or interests. In their case, corporate governance was supposed to ensure that corporations achieved the objectives set by their owners. Consequently, the two main corporate governance approaches have been termed as insider and outsider approaches respectively. Having reviewed the background of corporate governance it is therefore important that the theories of corporate governance that have been put forth be discussed. Theories of Corporate Governance There are two theories of corporate governance that have been proposed by scholars and of which will form a basis for this discussion. They include the stakeholder theory and the agency theory as discussed below. The Stakeholder Theory Also referred to as the stewardship theory, the theory proposed by Freeman is based on the argument that organizations have a wider obligation of serving the general interests rather than just attaining the capitalistic goal of wealth maximization (Mulili and Wong 2011). The theory holds that firms are socially responsible to all parties that interact with it or those that are affected by the firms’ quest on achieving its set objectives (Freeman et al 2010). As a result, corporate are said to be socially responsible to their stakeholders, that is, the suppliers, employees, clients, shareholders, interest groups and the government among other industry actors they are directly or indirectly involved with. It has been noted that stakeholders are important to corporations because the manner in which they are handled determines their feedback (Gregg 2001). For instance, when they get more in terms of value or extra benefits, they are likely to return to the firm and hence giving back. This illustrates the main motivation for the proposal of this theory among many business scholars and analysts alike. Corporate organizations that embrace the propositions of this theory are therefore obliged to integrate the various stakeholders into the firm’s strategic framework. In general terms, the theory suggests that an organization’s top management such as directors and the chief executive are like stewards of the firm and are therefore expected to act on the best interests of the firm’s stakeholders rather than on their own interests. In effect, the management is expected to always look at the future of the organization rather than individual goals (Philips 2011). The Influence That Each Theory Has Had On the Development of Corporate Governance Practice around the World On the other hand, the agency theory proposes a different approach to the handling of organization’s interests as discussed below. The Agency Theory This theory is based on the concept of principal-agent relationship and in that case therefore, the managers of an organization do their work professionally on behalf of the owners of the business (Mulili and Wong 2011). Since conflicts are inevitable in cases where the principles feel that their agents are not fulfilling their wishes, the agency theory proposes a framework for the resolution of such problems. Generally, the theory is based on the assumption that organizations are in existence for the purposes of enhancing wealth accumulation for their owners or otherwise the shareholders. This is in stark contrast with the stakeholder theory that assumes that the organization must bring on board all parties it engages with including the larger society. Information availability is at the heart of this theory since it proposes that management are likely to perform better when they have more information and therefore make the firm more competitive. Another assumption, however, is that; managers will tend to work according to their personal ambitions rather than towards the general goals of the organization (Kate 2011). In this case, the theory therefore proposes that there be structures put in place by organizations to counter this effect. The agency theory holds that the sole aim of corporate organizations or corporate governance should be that of minimizing the likelihood of managers to act contrary to the expectation of the owners. It therefore proposes that management be part of ownership because they will have a sense of responsibility for attaining the goals of the organization. This is because management seem to have a lot of control when shares are held by a large number of people who are likely to leave decision making to the management. This theory therefore seem to major on the management of corporate organizations and therefore has been said to be applicable to the board of directors and the shareholders. It only focuses on the contract between the top management and the firm’s shareholders. The actions of the agents, in this case the managers, should be checked so that they do not go against the wishes of the principals who are the owners or shareholders. Country Applicability As mentioned earlier, corporate governance has differed among nations and taken the shape of either the agency or stakeholder theory. For instance, countries that followed civil law like France, Germany, Italy and Netherlands have tended to be aligned to the stakeholder approach of governance. They have given pre-eminence to stakeholders such as employees, managers, creditors, suppliers, customers and the wider community. The adoption of the theory in these countries has therefore been motivated by the legal environment and the socio-cultural environment motivated by ethics. For example, the management of corporate in such countries are required to put into place corporate social responsibility measures of ensuring that the organization is conscious to the needs of sustainable development. They must always be observant to look into the environment and the interests of the society. On the other hand, countries with a background of the implementation of common law like Australia, Canada and New Zealand have developed corporate governance structures that focus on shareholders’ returns or interests. In their case, corporate governance was supposed to ensure that corporations achieved the objectives set by their owners. This insider approach is likened to that of the agency or stewardship theory whereby the firm is only responsible to its owners or shareholders and the objective of management is to ensure that wealth creation is maximized for the benefit of the owners. It is however important to note that in the recent years, the corporate world has been fast changing and therefore affecting the style of governance. Compatibility of the Two Theories It is evident that the two theories of corporate governance differ in approach but are mainly constructed for the purposes of wealth maximization (Ahmad 2012). Whereas the agency theory assumes that the existence of business depends on the relationship between the owners and the managers, the stakeholder theory broadens this approach by adopting a more inclusive role. The issue of ethics and regulation are therefore the major concerns that create a divide between the two approaches. However, it is likely that organizations cannot exclusively run in the basis of either the agency or stakeholder approach. Alternative Approaches to Corporate Governance Alternative approaches to corporate governance have therefore been based on hybrid frameworks that have adopted both the components of agency as well as stakeholder theories (Stinj et al 2012). For instance, in communist markets, corporate governance has been aligned to stakeholder approach but included control of directors to ensure all benefit from wealth creation. On the other hand, in liberal or capitalist markets, corporate governance has taken the shape of a balanced stakeholder-agency approach to ensure that there are checks and balances to wealth creation. Conclusion In the contemporary society of management, it is important that all participants are adequately brought on board. However, the major challenge that faces organizations is how to effectively cater for the interest of all without being unfair or biased. This has necessitated the rise of hybrid forms of corporate governance approaches that incorporate the controls of the agency theory and on the other hand, promote inclusiveness of the stakeholder theory. Moving forward, it is therefore evident that the stakeholder theory will remain more relevant to corporate governance. However, as noted in this paper, there must be checks and balances that will mean that this approach will not be exclusively adopted by organizations. Management of corporate organizations should therefore analyze their industry situation, organizational goals and the operational environment to be able to come up with prudent governance structures for the success of organizations as well as satisfaction of all interested parties. Bibliography Ahmad, F. 2012. Corporate Governance: Frameworks. Indian Journal of Science & Technology. Sep2012, Vol. 5 Issue 9, p3353-3361  Clarke, T. 2004. Theories of Corporate Governance. London: Routlegde publishers Freeman, E et al. 2010. Stakeholder Theory: The State of the Art. Cambridge: Cambridge University Press. Gregg, S. 2001. ‘Stakeholder’ Theory. Policy, Winter2001, Vol. 17 Issue 2, p33 Kate, F. 2011. The Assumption of Agency Theory. London: Routlegde publishers Mulili, B and Wong, P. 2011. Corporate Governance Practices in Developing Countries. International Journal of Business Administration Vol. 2, No. 1; February 2011 p14-18 Philips, R. 2011. Stakeholder Theory: Impact and Prospects. Cheltenham, UK: Edward Elgar Publishing. Stinj, V et al., 2012. The Governance of Nonprofit Organizations: Integrating Agency Theory with Stakeholder and Stewardship Theory. Nonprofit & Voluntary Sector Quarterly, Jun2012, Vol. 41 Issue 3, p431-451 Read More