Advantages And Disadvantages Of Shareholder Theory

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a) The stakeholder theory is a strategy that takes stakeholders into consideration when making decisions to achieve higher business performance. Stakeholders are people who affect and are affected by a business’ performance. Other than shareholders or owners, customers, government, employees, and suppliers are some examples of stakeholders. The theory provides an alternative to the shareholder theory, which states that companies must focus only on maximizing the market value of the equity of its existing shareholders. Edward Freeman, who was the first to completely express the theory in 1984, developed the theory to address that era’s business issues, most of which are related to external pressures (e.g. activism, foreign competition, government …show more content…
First, its goal of maximisation of equity is measureable and thus, managers can set concrete steps to achieve it. Second, the theory has a long history backed up by economic principles and empirical research, which makes it more stable and predictable. Third, it also specifies the scope of a firm’s responsibility, concerning itself only with its existing shareholder’s interest. This narrow focus makes a company’s goals simpler and easier to achieve. However, the disadvantage of shareholder theory is that it largely ignores other factors that affect the company’s performance. When taken into account, these factors, which include the interests of stakeholders, may benefit the firm in different ways (e.g. happier employees leads to higher productivity, obeying government regulations lessens penalties, sustainable business processes leads to less pressure from environmental activists, social awareness entices customer loyalty, etc). In contrast, stakeholder theory focuses on what the first theory ignores. The changes in business environment that Freeman (1984) took note of in the 1980’s are still affecting firms today. People have become increasingly aware of environmental and social issues and their power to close or change a ‘bad’ business. Unlike shareholder theory, the holistic view of stakeholder theory also considers sustainability—an important reminder that natural and human resources are limited. However, many are against stakeholder theory. One argument against it is that it allows people to use the firm’s resources for their own needs (Jensen, 2002), perhaps even exacerbating the agency problem where managers can start to dubiously distribute the wealth of shareholders to ‘stakeholders’ (Sundaram and Inkpen, 2004). The theory is also sorely lacking in empirical support and some evidence even point to how adherence to the theory affects financial performance negatively (Meznar,

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