To What Extent Does A Company Exist Only To Benefit Its Shareholders?
Introduction
Most individuals mostly think of shareholders only as the owners of a company in which they invest, but such a conclusion makes little arguments for the real definition and functions of a shareholder. In the most elemental sense, the relationship amid a business and its shareholders is one, which is designed to benefit each other by engaging in activities that ensure that the both parties attain profits from the company. This relationship ensures that the sole purpose of the company is to benefit its shareholders only, and it is crucial for the current market economy and creates large amounts of wealth for the shareholders (Goergen, 2012).
Virtually all managers and directors of corporations acknowledge that creating benefits and value for shareholders is a critical corporate objective, in these cases; shareholders are seen as the only one of numerous other constituents competing for a preference in the evaluation of a company’s management of key decisions. Other constituents in a corporation include customers, suppliers, employees and the rest of the community, are also seen as critical elements in a corporation (Clarke & Chanlat, 2009). These competing and usually conflicting claims of preference in the allotment of the funds of a corporation have led to the development of distinctly, different schools of thought about what the governing objective of a corporation should be. Some, as it is with this article, believe that the best- managed corporations are those that consistently do business in a way that develops the most value for the company’s shareholders (Graved, 1995).
In another school of thought, are those who argue that the company’s management should constantly favor the interests of a group other than the interests of a company’s shareholders, for example, socialists point out that the interests of employees and the society should surpass those of shareholders and customers. Others seem to think that maximizing the satisfaction of a company’s customers should be the governing objective of a company. Another group argues for equal attention paid to all stakeholders of a company including the shareholders, customers, employees and the community (Harari, 1992). This paper will deal with one related question. It will consider whether the governing objective of a corporation should be to maximize the economic advantages and benefits to any other stakeholder group other than the shareholders, and to what extent this objective should run.
The governing goal for any company that is traded publicly should be to increase and maximize the value for the shareholders of the company. Attaining this objective not only serves and satisfy’s the interests of the owners of the company but also satisfy’s the economic interests of all the company’s stakeholders with time (Berle, 1931). While this argument may indicate that some stakeholders will face some harm economically in some cases, over any reasonable period, the economic interests of all the company’s stakeholders will be increased and maximized only from the decisions that the company makes to benefit its stakeholders. Generally, this is to mean that maximizing the value of a corporation’s shareholders is not just the best method but is the only way to enhance and maximize the economic interests of all the interested parties with time (Lazonick & O’Sullivan, 2000).
Among the numerous advantages resulting from adopting shareholder value maximization as the governing goal of a company, to stand out as particularly essential. The first advantage has everything to do with making of decisions. Running a company is a game of making choices, hundreds of decisions have to be made each day in such large firms that involve complex trade- offs between long term payoffs and current profits and gains or between maintaining a share in the market and profit margins (Rappaport, 1986). All large corporations require clear guidelines and an objective that has to be translated into a criterion for making decisions. Comparing the value effect of a number of tactful or strategic alternatives and choosing the options that develops the largest value for a company’s shareholders is both consistent and well outlined and can be made operation by a corporation that is both complex and large. The rest of criteria like global dominance, quality leadership, growth of profits and ROI will inevitably result to either growth without profits, overinvestment or harmful withdrawal from investments (Morck & Vishny, 1988).
One of the stakeholder groups that are seen to pose a grave dispute to the welfare of the primary shareholder is customers. It is clear to many that no company can create wealth for the shareholders without a stable and growing revenue base, which only results from having loyal and satisfied customers (Sun, 2009). However, this result in never automatic. It is likely to have a large base of loyal and satisfied customers and have no ability to translate this into adequate profits for the company’s stakeholders. From this statement a certain question arises that addresses the circumstances under which the objective of satisfying shareholder value conflict with the goal of a company to maximize its customer satisfaction (Letza, Sun & Kirkbride, 2004).
To answer this question, one real case example is crucial. A CEO of a textile compny known as Indian Head Mills pointed out that the goal of the company is to increase the intrinsic value of a company’s common stock. He argues that he is in business to improve the equity of the common shareholders in the company (Prahalad, 1994).
Other than the value perceived by the consumers, all commodities also make a considerable contribution to the value of the firm’s shareholders, the extent of this contribution usually depends on the price realized, volume sold, production and delivery costs and costs of required investments. These elements interact to result to a stream of cash flow for the company. The present value of the cash flow stream determines the economic advantages to shareholders of producing and selling the commodities (Shleifer & Vishny, 1997).
The means by which satisfaction of customers is translated into economic advantages to shareholders is crucial. As it follows, any strategy that requires investment increase of the resources of the company to increase the satisfaction of customers will increase the value of shareholders only if the return on such investments over time surpasses the cost of capital for the company (Prahalad, 1994).
If the company’s management invests more in satisfying its customers ahead of its competitors, the return is only realized from the enthusiasm of the consumers to compensate more for the increment of the received satisfaction. However, if the company’s management reacts to the advances of the competitors in satisfying customers, calculating and realizing economic returns and advantages becomes harder. In these cases, the return results from avoiding loss rather than attaining profits, this is to mean that if the company invests successfully to match the competitors, then the return will be realized by avoiding loss of a market share or need to face reducing margins and discount prices. In such cases, the economic gains are measured by looking at the effects of the investment in the value of the company (Martin & McConnell, 1991).
When a company pursues strategies that increase both shareholder value and customer, satisfaction there is usually no source of conflict. There are circumstances under which a company should sacrifice its shareholder value for satisfaction of its customers (Williamson, 1988). In some of these instances, it might be necessary to defend market shares that are highly profitable against an attack by competitors with a strategy that decreases incremental profits below the capital cost for a short period. This would be acceptable to shareholders whenever the loss value resulting from not matching the company’s competitors is more than the loss value resulting from not responding. In certain other cases, a complimentary commodity may counterbalance the value destroyed by a certain commodity as it is in the case with banking, where corporate loans serve as losses for profitable products based on fee (Keasey & Wright, 1993).
There are a number of theories used to explain the governing objectives of a corporation. One of these theories is called agency theory, which refers to a number of propositions in governing a contemporary firm, which is typically characterized, by a considerable number of owners or shareholders who allow separate individuals to direct and control the utilization of their collective capital for future benefits. These people may not usually have shares in the company, but have relevant skills to manage such a firm. The theory provides for numerous, essential ways to look at the associations between the managers of a corporation and its shareholders and verify how the final goal of maximizing value and profits to the owners is achieved, especially when the corporation’s managers do not own the resources of the corporation (Monks & Minow, 2004).
Agency theory suggests that a corporation can be seen as a nexus of contracts between a number of resource holders in the company. A relationship in an agency occurs whenever one or more people, principals, employ one more people, known as agents, to perform some service and make decisions relating to the company. The key agency relationships in companies are those (1) between managers and stockholders and (2) those between stockholders and debt holders. It is true that these associations are not usually harmonious: in fact, agency theory is concerned with the widely known agency conflicts, or conflicts of interest between shareholders or principals and agents. This has implications for a number of things, including the governance of the company and business ethics. When agency occurs, it has a tendency to give rise to agency, expenditure or costs, which are the expenses, acquired in an effort to sustain an effective agency association or relationship (Shankman, 1999).
There are number of negative implications associated with a company that implements or makes use of agency theory. The theory raises a significant issue in the organization’s self- interested behavior or tendencies. A manager of a company may have personal objectives that compete or limit the goals and objectives of the owners of maximizing the value and wealth of the shareholders. Since the owners or the principals authorized the agents or managers to administer the assets of a firm, a potential conflict of interests of the two groups exists. Another potential issue with agency theory is that the principals might find it hard to identify inappropriate behaviors of the agents or figure out whether the agents are behaving inappropriately because they give out the decision- making powers to the agents (Kehoe, 1996).
The theory argues that in imperfect markets and labor, managers are likely to seek to enhance their own value and benefits at the expense of the shareholders of a company. Agents possess the ability to operate in their own interests rather than for the benefits of the corporation because of asymmetric information and uncertainty (Zhou, 2000). In addition to this, myriad elements add to the results, and it may not be clear whether the agent caused them directly. Evidence of self- interested behavior of agents or managers of a firm include the misuse and consumption of corporate resources like perquisites and the avoidance of positions of optimal risks, in which case agents bypass profitable opportunities in which the shareholders would like to invest their capital (Fama & Jensen, 1983).
Agency costs are those costs that are borne by a firm’s shareholders to encourage agents or managers to maximize the value and wealth of shareholders rather than behave in a manner that serves their own interests. This concept is best explained by the argument that levels of debt of a firm and levels of management equity are both affected by a wish to limit or control agency costs (Hayne, 1998).
There are several alternatives to the agency theory. One of these is called the stewardship management theory, which Davis and Donaldson developed as a counter strategy to agency theory. Stewardship management theory and it alternative, the agency theory, both focus on the philosophies of leadership adopted by the owners or shareholders of a company. As it is the case with numerous companies, an owner or the shareholder manages and runs the company (Donaldson & Davis, 1991). As the company grows, the shareholder or owner eventually passes the leadership and management powers and responsibilities of the company to an agent or a manager who looks after it and runs the business. A crucial decision the shareholder has to make is how much control and authority the managers should get, stewardship and agency theories of management explores this decision and looks at the set of assumptions that the shareholder holds regarding the manager, in addition, to the affect the assumptions have on the process of making decisions (Eisenhardt, 1989).
The stewardship theory was created to be used as a model where senior managers act as stewards for a company and in the greatest benefit of the shareholders. The model of humans in this theory depends on the assumption that the agent or manager will make decisions in the best interest of the company, regarding collectivist options above options of self- serving. This kind of manager is motivated by acting for the benefit of the company, as she believes that he will ultimately benefit when the organization benefits. The steward agent or manager maximizes the performance of the company, working in the supposition that both the shareholder and the steward benefit from a strong company (Donaldson & Davis, 1991).
As opposed to the controls put in place by agency theory (Denis, Denis & Sarin, 1999), the principal or shareholders who espouse this theory will give power to the steward with the tools, information and authority to come to appropriate decisions for the organization. The principal, in this case, will completely enable the steward or the manager to act in the interests of the company, trusting that the agent will make decisions and choices that enhance the long- term profitability of the company. Actually, limiting or placing control elements on stewards will considerably de- motivates them and will lead them to become less productive leading to losses for the organization and the steward (Walton, 1985).
Despite all these potential benefits of the stewardship theory as opposed to the agency theory, most companies have not implemented the approach. This is because of a number of limitations associated with stewardship theories. The issues go back to the principal’s risk tolerance and the typical assumptions of shareholders. In most case, it becomes easier and safer for the stakeholder to presuppose agency theory and to not spend the energy and time needed to create the trusting relationship with the agent. The principal has to have the ability to overcome his inherent fear before he is able to place unlimited authority for the company in the hands of the agent or steward. Further, most schools of thought in business place considerable focus on neoclassic economic theory. Key to this theory is the assumption of maximization of utility, that people will maximize their utility during the process of making decisions (Block, 1993).
Another alternative to agency theory is the relationship constraints theory that is currently being recommended as an alternative to agency theory based on information. The relationship constraints theory argues that three elements affect the perceived efficiency and efficacy or a relationship constraint (McMullen, 1999). These three elements include the level of explicit knowledge, level of tacit knowledge and level of information asymmetry. The use of this theory, however, just like the other two theories presents organizations with a challenge. This becomes evident because of the fact that organizations die or live as complete or whole systems, as a set of discrete process. In the complex, dynamic environment of both tomorrow and today, individuals face a pressing limitation to make their systems function efficiently as machines that are well- integrated, rather than as a set of sub optimized, compartmented processes. The theory of constraints can be sees as a set of principles, concepts and measurements that emphasize on the ultimate output or results of the complete system, not just a component or part of it (Dettmer, 1996).
Conclusion
Virtually all directors and managers of companies that are publicly traded acknowledge that the most crucial corporate goal is to create and increase value for shareholders. The purpose of this paper was to show to what extent this objective is fulfilled in most companies, and it was found that most companies do exist to satisfy the needs of shareholders for value and profit maximization.
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