Shareholders theory was introduced in 1970 by Milton Friedman. According to shareholders theory, Corporation has one responsibility that is to use resources for pursuing activities to increase its profits. Corporations should compete with other competitors without using any fraudulent activities. The aim of this model is to maximize the interest of the shareholders keeping in limits of social values and norms. This is one of the dominant theory and used by many businesses.
On the other hand, stakeholder’s theory was introduced in 1988 by Edward Freeman. Stakeholders are people that provide supports to the business. Examples of stakeholders include employees, suppliers, customers, shareholders, community, and an environment. According to this theory, Corporation has the duty of balancing the interest of shareholders and stakeholders. There is a continuous debate on implementing one out of two theories from them. These two models of corporate governance have different assumptions (Stout, 2012, p. 19).
Assumption of shareholders theory
The first assumption of shareholders theory is that environmental, the social and human cost of operating business internalized only as per to the extent demand by law. As per this assumption, this model can provide the best return to the society after maximizing shareholders interest. According to this assumption, Corporation should work to maximize revenue and minimize a cost of production with minimization of risk.
One approach to reducing cost is to externalize the cost through means like pollution etc. To increase revenue, goods are provided at higher costs to the society. The second assumption of this theory is that self-interest worked as the prime motivator for human beings. As per this assumption, people of the organization would work in their self-interest to increase the Corporation’s efficiency and society’s value. As per this underlying assumption, every individual can maximize the value of the society by acting within in the self-interest rationally. The third assumption of this model is that a firm is the nexus of contract works on these contracts to maximize profitability.
Assumption of stakeholder’s theory
There are different assumptions underlying this model of Corporate Governance. The first assumption in instrumental theory is that managing stakeholder leads towards greater profits. This theory provides a positive relationship between stakeholder’s satisfaction and profitability of the company. Normative aspect of the theory also contains assumptions. Stakeholder’s theory assumes that all stakeholders have intrinsic value for the Corporation and one stakeholder does not have interest priority over the other stakeholder.
Advantages and Disadvantages of shareholder model
There are different advantages of shareholders model. Satisfaction of shareholders may leads towards better profitability because shareholders are investors and their satisfaction is necessary for the success of an organization. It provides better profits and growth chances in future. There are different disadvantages like those that are focusing only on profit maximization are not good for Corporation.
Corporations are responsible for providing their role in communities. Working only on profit can effect on customers. Corporation can also reduce their loyal customers. Another disadvantage of this model is that it disturbs stakeholders like suppliers and community. With the passage of time, the government is taking more concern of the social responsibilities and ethical operations.
Advantages and disadvantages of stakeholder theory
One advantage of this model is that it cares all stakeholders. It is important to provide importance to all stakeholders for better growth. One important benefit of this theory is that it considers all members external and internal in the progress and better growth. Stakeholder’s theory provides value and creates value for the entire organization. A Much well-reputed organization like Coca-Cola, Starbucks has implemented this theory for better growth. Due to the application of this theory, they can improve their presence in the customers. One of a disadvantage with this theory is its underlying assumptions. This theory may also affect on shareholders satisfaction (Freeman, Harrison, Wicks, Parmar, & Colle, 2010, pp. 128-129).
In the 21st century, the best model is Stakeholders model of corporate governance. In this today’s global economy, stakeholder’s theory can provide better financial benefits to the Corporation. It is not advisable to satisfy only shareholders. Wealth can be generated by considering all stakeholders. No doubt, customers play important role in every organization. Customers are also as important as shareholders are. Customers create value in the form of high profits. For better performance, an interest of customers is also very important. Apple Inc has focused on its customers to create value in its organization.
Other stakeholders like suppliers and employees are also very important. These are considered only in stakeholder theory. This is the reason why companies like Google, Apple, are investing in their employees. Environmental laws are becoming stricter, and ethics and sustainability are important. This is only possible in stakeholder’s model. Employee’s laws are also demanding implication of stakeholder’s model (Rani & Mishra, 2009, pp. 36-37).
It is concluded that both models are prevailing in the Corporations as Corporate governance models. Shareholders theory only prefers profit maximization on the other hand stakeholders theory prefers all stakeholders. Advantages of stakeholder’s theory are value creation. In this century, stakeholder’s theory should be preferred.
Freeman, R. E., Harrison, J. S., Wicks, A. C., Parmar, B. L., & Colle, S. d. (2010). Stakeholder Theory: The State of the Art. Cambridge University Press.
Rani, D. G., & Mishra, R. K. (2009). Corporate Governance. Excel Books India,
Stout, L. (2012). The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public. Berrett-Koehler Publishers.