Stakeholder theory

The most dominant theory used by existing CSR studies is stakeholder theory. Freeman (1984) asserts that firms have relationships with different stakeholders who both affect and are affected by the actions of the firm. He defines a ‘stakeholder’ as “any identifiable group or individual who can affect the achievement of an organisation’s objectives, or is affected by the achievement of an organisation’s objectives” (p.46). In accordance with this paradigm, stakeholders include customers, suppliers, employees, communities, and the general public, besides managers, stockholders and creditors. Freeman (1984) suggests that managers should understand a firm’s rationale, the organisational process used to mange relationships with stakeholders, and the set of transactions that takes place among the organizations and their stakeholders. Freeman’s (1984) stakeholder theory states that firms should use CSR as an extension of effective corporate governance mechanisms to resolve conflicts between managers and non-investing stakeholders.

Comparing with the shareholder theory that focuses on the shareholder primacy (Friedman, 1970); stakeholder theory posits firms are accountable to all stakeholders, not just their shareholders. Shareholders provide capital and bear residual risk; a firm should remain accountable to its shareholders through its management structure for maximising shareholders wealth. The accountability relationship towards shareholders is termed as ‘fiduciary duty’ under directors’ responsibility of Companies Act 2006. However, it can also be argued that when ‘Enron’ collapsed, it was not only the shareholders but also every one of the

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stakeholders suffered. Each of the stakeholders is compensated on the basis of agreements (e.g., employees are compensated through salary, and other suppliers of capital through return of their capital with interests), but they have a legitimate or moral right to claim on the value created by the firm.

As mentioned in section 2.2.2.4, Jo and Harjoto (2012) investigate the relation between CSR performance and corporate financial performance (CFP) and examine the relative importance of stakeholder theory and agency theory. After correcting for endogeneity bias, they find that CSR engagement positively influences CFP, which supports the conflict-resolution hypothesis based on stakeholder theory rather than the CSR overinvestment argument based on agency theory.

The instrumental aspect of stakeholder theory explains the relationships between stakeholder management practices and corporate performance. The instrumental stakeholder theory suggests a positive relationship between ESP and financial performance, and the satisfaction of various stakeholder groups is instrumental for organisational financial performance.

Enlightened shareholder theory

According to Solomon and Solomon (2004), stakeholder-agency theory so called enlightened shareholder theory2 argues that the implicit and explicit negotiation and contracting processes entailed by stakeholder–management relationships serve as monitoring and enforcement mechanisms that prevent managers from diverting attention from broad organisational financial goals. Furthermore, according to Orlitzky et al. (2003),

“by addressing and balancing the claims of multiple stakeholders (Freeman and Evan 1990), managers can increase the efficiency of their ’s adaptation to external demands. Additionally, according to a firm-as-contract analysis (Freeman and Evan 1990), high corporate performance results not only from the separate satisfaction of bilateral relationships (Hill and Jones 1992), but also from the simultaneous coordination and prioritization of multilateral stakeholder interests.” (p.405)

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There is a gradual broadening of the corporate governance agenda, characterized by a move away from a narrow agency theory view toward a broader, stakeholder-oriented view that embraces concepts of corporate social responsibility and sustainability. (Solomon and Solomon, 2004)

33 Enlightened stakeholder theory

Enlightened stakeholder theory argues that stakeholder theory should not be viewed as a legitimate contender to value maximization, because it fails to provide a complete specification of a firm’s purpose. According to Jensen (2010),

“…enlightened stakeholder theory, while focusing attention on meeting the demands of all important corporate constituencies, specifies long-term value maximization as the firm’s objective.” (p.33) “It can make use of most of what stakeholder theorists offer in the way of processes and audits to measure and evaluate the firm’s management of its relations with all important constituencies. Enlightened stakeholder theory adds the simple specification that the objectives function—the overriding goal—of the firm is to maximize total long-term firm market value.” (p.39).

Furthermore, Jensen (2010) argues in order to maximize a firm’s market value, managers who play a critical role in leading and sustaining the firm’s strategic vision, must not only satisfy, but also enlist the support of all corporate stakeholders. He states that enlightened stakeholder theory adds the simple specification of a firm’s objective function (i.e., to maximize total long-term firm market value), which differentiates from the (multi-objective) stakeholder theory as proposed by Freeman (1984). “Stakeholder theory gives them the appearance of legitimate political access to the sources of decision-making power in organizations, and it deprives those organizations of a principled basis for rejecting those claims” (Jensen 2010, p.42). In other words, it can be used

by managers to seek personal interests. However, enlightened stakeholder theory enables management to assess the tradeoffs among its stakeholders, which solves the problems arising from stakeholder theory.

It is necessary to point out the difference between the enlightened stakeholder theory and the enlightened shareholder theory. Enlightened shareholder theory would ultimately attribute priority to shareholders’ interests, but also encourage firms to balance short-term loss against longer-term business success (Macve and Chen, 2010). However, the enlightened stakeholder theory focuses on the firm’s objective, which is to maximize total long-term firm market value. Therefore, enlightened shareholder theory reflects an updating rather than a replacement of the traditional view of the corporation as an instrument for

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delegating to managers (as ‘agents’) the responsibility for maximising the wealth of shareholders’ (as ‘principals’) (Macve and Chen, 2010).