Assignment 2 (Case Study)
Demonstration of knowledge of the issues and evidence of wide reading to support your analysis
Demonstration of your ability to apply the knowledge to identify keys issues leading to your recommendations
Evidence of sound reasoning and the exercise of professional judgement to support your recommendations
Development and statement of concise recommendations for presentation to the AICD
Overall structure and professional presentation of the report to the AICD
High quality written communication of concepts and terms in ordinary English as not all readers of the report can be assumed to be specialists competent in corporate governance
‘As a separate
thrive. Shareholder value is not the objective of the corporation; it is an outcome of the corporation’s activities. While shareholders entrust their stakes in a corporation to the board of directors, shareholders are just one audience among others that the board may consider when making decisions on behalf of the corporation.
These audiences, typically called stakeholders, may also include other financial stakeholders, such as bondholders, and nonfinancial stakeholders, such as employees, customers, suppliers, and NGOs representing various concerns of civil society. In the face of limited resources, no matter how large the corporation, directors must make choices regarding the significance of the corporation’s many audiences.’
Source: Robert G Eccles and Tim Youmans (2015) ‘Why Boards Must Look Beyond Shareholders’, MIT Sloan Management Review http://sloanreview.mit.edu/article/why-boards-must-look-beyond-shareholders/
Due Date: Length:
legal person, a corporation has two basic objectives: To survive and to
Assume you have been employed as a corporate governance consultant by the Australian Institute of Company Directors (AICD). The AICD is concerned that many company directors hold the opinion that the company’s board of directors has a responsibility to place the interests of shareholders above all other stakeholder interests.
Your assignment is to prepare a report to be submitted to the AICD evaluating the evidence that the responsibility of a company director is to place shareholder interests above those of other stakeholders. Specifically, the AICD has requested that your report contain evidence, examples and recommendations for company directors that will guide them when making board decisions so they are responsive to diverse stakeholder audiences. The AICD has advised you that they intend to make your report a public document and it will be uploaded to the website so it can be read by both corporate governance specialists and non-specialists.
Company shareholders entail individuals who own part of the corporation through stock ownership. Stakeholders, on the other hand, entail individuals or groups interested in the performance of the company and include parties such as bondholders, customers, suppliers, and employees. While both shareholders and stakeholders are significant figures in the company, the issue of whose interests should be taken into consideration during the company decision-making process has created controversies among policy makers, company directors and interested individuals in Australia and the globe at large.
Corporate social responsibility advocates for the consideration of stakeholders’ interests in the decision making the process as compared to the interests of the shareholders. The Australian Insitute of Company Directors, on the other hand, advocate for shareholders’ interests above the interest of all stakeholders. Why should we all put the interest of our shareholders above those of our stakeholders? Shareholders are considered the largest stakeholders in the company because they are directly affected by the short-term or long-term performance of the company. Company directors have been assigned the responsibility for overseeing and ensuring the long-term success of a company. This report aims to elaborate on why company directors should consider the interests of shareholders above those of stakeholders as put across by the Australian Institute of Company Directors (AICD).
Structure of the Report
- Differences between stakeholders and shareholders and their role in the company
- The Shareholder Primacy Theory
- Why Directors should consider the interests of shareholders above those of stakeholder
- Conclusion and Recommendations
Stakeholders Vs. Shareholders
While shareholders can be considered the stakeholders of a company, stakeholders are not accredited as shareholders in a corporation. Company stakeholders entail individuals or parties interested in the performance of the company for diverse reasons. Stakeholders are composed of employees, who depend on their wages in the company to earn a living, customers, who rely on the company’s goods and services, suppliers, bondholders, among many more parties
Role of Stakeholders in the Company
Long-term company Relationships
Stakeholders are considered important to the company since they contribute to the sustainability of the company through positive long-term relationships with the company.
Stakeholders can positively impact the success of the company through feedback, which is meant to enhance product development.
Corporate Social Responsibility
Corporate social responsibility is perceived a significant factor in enhancing company success. By portraying a sense of identity through company stakeholders, companies are more likely to thrive in the market.
Shareholders, on the other hand, form part of the company’s ownership, but are limited by the number of shares they own in the company. The decision-making power, personal liability and profit entitlement among shareholders are, therefore, limited to the number of shares owned by the company.
Role of Shareholders in the Company
Shareholders have the ultimate role of investing in the company shares
Upon dissolving of the business, shareholders have the responsibility of contributing to the debts of the company within their liability (Mallin, 2013).
Powers of Directors
Shareholders must appoint company directors, decide on the powers of the directors, including their salaries, relieving directors from their positions and making exceptional decisions beyond the powers of the directors (Mallin, 2013).
The Shareholder Primacy Theory
The shareholder primacy theory advocates for the consideration of shareholders’ interests above those of other stakeholders. The origin of the theory can be traced back to the 1930’s debate between Berle and Dodd regarding the characteristics and future of the corporate law (Stewart Jr, 2010). Precisely, the debate revolved around the central idea that shareholders were company owners and that corporations have the responsibility of operating within the interest of shareholders. Therefore, according to the theory, directors have the duty of ensuring the sustainability of the business for the benefit of the company shareholders. Fundamentally, the shareholders primacy theory relied on Milton Friedman’s perspective of the purpose of companies. Precisely, according to Milton Friedman, companies should strive to enhance their profitability, to remain competitive in the market (Smith, 2017).
Why Should Company Directors place the Interests of Shareholders above those of company stakeholders?
Although the issue of company ownership has been widespread, with the separation of ownership and control creating contradictions regarding the perspectives that shareholders are owners of the company, it is widely accepted that shareholders are indeed the owners of the company. Why do we rely on the notion that shareholders are owners of the company? Shareholders are considered individuals who invest in the company through shares. Logically, the number of shares owned by all shareholders determines the size of the company. As owners of the company, the longevity, and sustainability of the company rely on the directors’ decisions regarding the operation of their company.
Therefore, since the sustainability of the company relies on the verdict of the shareholders, directors should act in the interests of the shareholders to enhance sustainability for the benefit of other stakeholders in the company. Moreover, as mentioned in the role of shareholders, it is clear that shareholders have the role of appointing and releasing directors from their duties, depending on their performance. Therefore, according to the Australian Insitute of Company Directors, directors have the corporate responsibility of acting in good faith, and within the interest of their companies. Acting in the interest of shareholder, in this case, does not mean exploiting the rights of other stakeholders for the benefit of shareholders, but acting within a good governance culture for the benefit of both shareholders and stakeholders to the company.
Shareholders are considered the residual claimants of a company upon company closure. Therefore, the interests of the shareholders are directly affected by either the profit or loss of the company. Precisely, the company shareholders are responsible for the company liability upon liquidation. Therefore, shareholders incur losses, not only from their shares, but also other assets, once the company incurs a loss. Questions may arise as to why stakeholders are not considered residual claimants of the company since they also face risks of company closure? It is no doubt that company stakeholders will be affected upon liquidation of the company in various ways. For instance, while employees face the risk of being unemployed during a financial crisis, suppliers will endure delays in payment. However, company shareholders have always been considered the only residual claimants of a company, since they are legally entitled to company remnants upon the payment of any company obligations. According to various traditional theorists, including Milton Friedman, shareholders are perceived the only residual claimants since they incur the greatest risk in the corporation (Goergen, 2010). Since the wealth of the shareholders is affected by the decisions made in the company, Australian Insitute of Corporate Directors advocates for stakeholder engagement to enhance the decision-making process for better performance. Precisely, due to the risks put across by current dynamics in the financial market, the Insitute of Corporate directors, in 2015, called a meeting advocating for stakeholders’ engagement in financial decisions in the company.
Considering the 1919 case between Dodge and Motor Corp, the Michigan Supreme Court ruled its decision with regards to the shareholder primacy theory, where it held the notion that business corporations are organized for the benefit of the stockholders (Keay, 2011). Therefore, company directors have the responsibility of managing corporations with the aim of maximizing the wealth of the shareholders. Maximizing company profit, however, does not entail undermining the rights of the stakeholders for the benefit of the shareholders. In conjunction to putting the interests of the shareholders ahead, competent directors should consider the corporate social responsibility for the long-term benefit of the business.
Company directors are responsible for the general performance of the business. Precisely, they have to ensure the company operates with regards to its missions and objectives for the desired outcomes. While companies trust their directors in enhancing the company growth, performance appraisal is effective in determining the directors’ conduct in the company. Precisely, many companies have put aside agency costs, to investigate the performance of the directors. Agency costs are more likely to be costly to the company. However, if directors perform their duties of maximizing the interests of the shareholders, the company’s operating costs will be at a minimum since less or no agency costs will be needed in the company. Moreover, it is clear evidence that directors are more likely to work effectively with one clear goal, such as profit maximizations, as compared to institutions with multiple goals (Vranceanu, 2014). Precisely, operating under one goal is more likely to enhance the decision-making process. Therefore, since shareholders are stakeholders who aim to increase their wealth in a company, directors should consider their interests first above those of other stakeholders.
The Agency Theory
The agency theory provides another justification as to why directors should consider the interests of shareholders above those of other stakeholders (Benn & Bolton, 2011). Fundamentally, the agency theory was developed to capture the stockholder-management relationship in a company. The agency theory, therefore, serves the purpose of observing roles of directors of a company. Therefore, as stewards of a company, directors have the responsibility of delegating their duties, as specified by the shareholders. The agency theory also deters the directors from considering self-interests. Therefore, although directors do not owe fiduciary rights to shareholders, they should perform their duties effectively for the benefit and sustainability of the company.
Conclusion and Recommendations
Overall, shareholders bear greater risks in a company than any other stakeholders. For instance, as residual claimants, shareholders suffer the loss of profit incurred by the company, after settling the company’s liability. Therefore, although stakeholders determine the sustainability of the company, shareholders dictate the company performance in the long-run and should be considered first then other stakeholders. However, executives and Board of Directors should consider paraphrasing their language to create a sense of identity among other stakeholders. For instance, instead of operating with the slogan of maximizing the value of the stakeholders, the board should paraphrase to a slogan that accommodates all stakeholders such as maximizing the value of our company.
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Stewart Jr, F., 2010. Berle’s Conception of Shareholder Primacy: A Forgotten Perspective for Reconsideration During the Rise of Finance. Seattle UL Rev., 34, p.1457.
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