Shareholder Primary Theory - Example

Running Head: FINANCIAL MANAGEMENT Financial Management Student Name Institution Date Introduction In recent years, shareholder value or shareholder dominance has been viewed as an aspect of corporate governance. There has been an argument that the increase in shareholder primacy usually has a harmful impact on the interests of firm employees. This argument suggests that under a particular form of capitalism, and especially that which distinguishes market-based other than relational styles of production schemes, the shareholders interests are regarded as paramount by directors above and over those of all other stakeholders like employees. Therefore this view implies that corporate managers will tend to favour the short term shareholders financial interests or shareholder value driven by capital markets fixed on share price together with short term terms. Shareholder primary theory The shareholder primary theory views the maximization of shareholder value as the major way of sustaining financial growth and survival of the corporation. The conventional finance model places the maximization of shareholder wealth as the principal goal of corporate management. This model is built on the classic competitive markets. Fundamentally, there is an assumption that all participants who make transaction with the firm including customers, lenders, suppliers and employees are viewed as willing partakers in free and competitive market and are wholly compensated at fair market prices for their supplies or services or obtain fairly valued services or products for the costs they pay. The shareholders are distinctive since they are outstanding participants and do not possess prior implicit or explicit claims. They may add to their capital only after gratifying earlier claims of all other participants. They put up with all risks of failure and thus it is the sole fair that they receive rewards. This paradigm also presumes that there are no externalities or any damage or harm posed on any participant who is not in the transaction (Eugene, 2002). As a result of these postulations, maximization of shareholder wealth is beneficial to the shareholders and also to the society since the shareholders wealth originates from wealth produced but the corporation after wholly compensating every person involved together with the society for every resource exploited. The shareholder wealth maximization model is viewed as ethical and moral. Any lawful market transaction where all partakers are willing and free partakers is regarded as moral. The wealth of society is maximized when the corporation maximizes the total market value of every financial claim including preferred stock, warrants and debt not only the value of shares. A theorem in financial economics and maximization of shareholder wealth holds that the modern day share price reflects market value of future growth and profits that will ensue to the corporation. In regard to this presumption, the shareholder model holds that the interests of shareholders are best served through maximizing share value in the short run (Jensen, 2001). The share price acts as an indicator of performance of corporations and stock market is the sole goal assessment of management performance. If corporations underperform, their share price will be less which offers an opportunity for outsiders to purchase the corporation’s stock and operate them more effectively with a motive of obtaining a greater reward. The risk of takeover offers management with a motivation to put more efforts to perform excellently and maximise the return or shareholders so as to make their corporation bid- proof. Thus, it the division of control and ownership allows the behaviour of mangers to diverge from the shareholders value of maximisation of profit, the pressure of takeovers and capital markets are viewed as the most efficient disciplines upon managerial discretion. Corporations strive for expanding shareholder value especially through reorganising or restructuring business including takeovers, mergers, vertical disintegration methods and privatisation of enterprises under public ownership and employees often suffer as a result of loss of jobs and in several cases, inferior working conditions. The corporate directors are responsible for work reorganisation and corporate restructuring and their work is to establish the strategic direction of the company for growth and profit. The shareholder primacy perspective of the corporation appears to have surfaced from the concept that directors and professional managers who effects corporate strategy are fundamentally shareholders agents and therefore under a primary responsibility to manage the corporation in the interests of shareholders. However, directors do not owe any legal obligations directly to shareholders in corporate rules. These legal responsibilities influences the overall tactical decision making by board of directors, are not much owed to shareholders but to the corporation. Directors are supposed to legally act in the paramount interests of the corporation and the corporation interests are often considered by courts as those of shareholders within the corporation. Jensen (2001) argues that majority of stakeholder theory claims do not offer an apparent organizational goal and does not identify how to make essential tradeoffs between the competing interests of several shareholders. Jensen admits that corporations are not able to maximize value if they ignore the interests of stakeholders. He recommends the enlightened value maximization and the enlightened stakeholder model. Long term maximization of value is identified as corporation’s objective. This goal can be satisfied by corporation together with support of every relevant stakeholder. The role of management is vital in motivating every stakeholder and ensuring cooperation. According to Jensen, (2001), stakeholder theory and enlightened value maximization resembles the instrumental version of stakeholder model and points out that maximization of value makes the general public better off, the purposeful behaviour of manger needs a single valued goal function and the stakeholder model do not specify the tradeoffs needed to be made so as to satisfy every stakeholder. He also points out that the system of market scheme of exchange with property rights and prices has resulted to huge increases in human welfare along with freedom of action. Enlightened stakeholder model implies that corporation value is the objective, but the audits and processes suggested stakeholder theorists must create basis of action to motivation of all major stakeholders. Stakeholder theory Stakeholder theory is related to business ethics, business and the society. Corporate management is supposed to look beyond shareholders and include the stakeholder perspective in management of the firm. The relationship of a company with its stakeholders is identified as affecting its profitability and therefore ethical executives must regard this portion of their fiduciary responsibility to shareholders. Social responsibility acts may be strategically used by corporations in seeking wealth maximization of the corporation. If a company is to maintain long term profitability it needs to conserve amicable relationships with the stakeholders it deals with. The stakeholder theory is based on the concept that beyond shareholders there are numerous agents who have concern in the decisions and actions of corporations. Stakeholders are individuals or groups who gain from or are injured by, and whose rights are respected or violated by the actions of the corporation. In addition to shareholders, stakeholders consist of creditors, employees, suppliers, customers and the entire community. Stakeholder theory affirms that corporations have a social accountability that needs them to reflect on the interest of every party influenced by their activities. Management should not only consider its shareholders in financial decision making procedure but also all other stakeholders affected by its business decisions. The stakeholder perspective embraces that any corporation goal is or must be the thriving of the corporation and its major stakeholders. According to Clarkson (2002) primary stakeholders are those who the company cannot operate without and they include investors and shareholders, suppliers and customers, employees, and also communities and governments that offer markets and infrastructures, whose rules and regulations should be obeyed and to whom taxes and other obligations may be due whereas secondary stakeholders are those who affect or influence or are affected or influenced by the company but are not involved in transactions with the corporation and are not fundamental for its endurance. Some of difficulties with stakeholder model lie in the difficulty of judging mute stakeholders such as the natural environment and the absent stakeholders like potential victims or future generations. The problem of regarding the natural environment as a stakeholder is valid since many of the descriptions of stakeholders often treat them as individuals or groups thus reject the natural environment as a subject of definition since it is not a human community or group as are consumers or employees. Donna (2007) argues that humans only may be regarded as corporation stakeholders and censure efforts to offer the natural environment a stakeholder status. The major way of viewing the natural environment as a stakeholder is by the interests of upcoming generations. Therefore, it is not possible to seek the view of the future generation or natural environment and thus they are not members of organizational consultative committee. Therefore the difficulty is that people are the only ones able to generate the fundamental obligation for development of stakeholder position and of the essential wish in the approval of gains of a jointly useful cooperative system. However, if future generations and natural environment is among the interests of stakeholders they should be contemplated by being represented in decision making schemes whether of corporations or of the entire society. The stakeholder model can be used in an empirical or descriptive way when it is applied in description and at times of particular corporate behaviours or characteristics, or in the instrumental way when it is used in identification of links or lack of links between management of stakeholder and the accomplishment of conventional corporate goals like growth and profitability. It can also be used in a normative way in interpretation of the functions of corporations and identification of philosophical or moral guidelines that must be adhered to with regard to their management and operation. The instrumental approach towards the stakeholder model is concerned in the way stakeholders may be considered in a manner that promotes financiacial efficiency and performance. This approach regards stakeholders as features to be considered and managed as the corporation engage in shareholder wealth maximization. The underlying argument is that the stakeholder’s interests are regarded as means of attaining greater leave objectives like profit maximization, survival and growth (Hillman, & Keim, 2001). The shareholder theory holds that decisions to promote efficiency are made in order to expand shareholder value while results to imposition of costs on other stakeholders and views it as a suitable trade off. According to the stakeholder theory these costs are not suitable unless it can be established that they are beneficial for the society. The existent deviations amid short run effects of business actions and the long term alignment of social interests and business in wealth creation leave a sufficient possibility for abuse of market power or irresponsible conduct. According to Gioia, (2003), the leitmotif of wealth generation can simply result to both financial manipulation and moral misconduct which are destructive to social purposes and welfare of stakeholders. The enlightened value maximization utilizes the stakeholder model to consider that a corporation is not able to maximize capital if it ignores or mistreats any significant stakeholder. However, it upholds as the decisive factor for making the basic tradeoffs amid the long term value maximization of its stakeholders. Enlightened stakeholder theory reflects on ling term value maximization as the goal function of the corporation and helps in solving the difficulties that emerge from considering numerous goals as in conventional stakeholder theory. Conclusion The shareholder primary theory view shareholder wealth maximization as a way of managing financial growth and survival of a corporation. Therefore this perspective suggests that corporate managers will tend to consider the short term shareholders financial interests or shareholder wealth driven by capital markets fixed on share price together with short term terms. The stakeholder theory view is that corporate management is supposed to look beyond shareholders and include stakeholder view in management of the firm. I support this theory because the relationship of a company with its stakeholders affects its profitability and growth. Therefore, if a corporation is to maintain long term profitability it is required to preserve amicable relations and consider all needs of stakeholders. However, corporations strive in expanding shareholder wealth through reorganising work or restructuring business including mergers, takeovers, and privatisation of publicly owned enterprises and this pose negative effect on stakeholders as a result of job loss and in many cases, poorer working condition. References Eugene, B., (2002) Financial Management: Theory and Practice, 10th Edition. Harcourt: Harcourt College Publishers. Donna C., (2007). Stockholders and Stakeholders: The battle for Control of the Corporation. Cato Journal, 27 (1); 1-22. Hillman, J. & Keim, D., (2001). Shareholder value, stakeholder management, and social issues: Strategic Management Journal, 22 (2): 125-139. Jensen, M. C (2001). Value Maximization, Stakeholder Theory, and the Corporate Objective Function. Journal of Applied Corporate Finance, 14 (3): 8-21. Gioia, D., (2003). Practicability, Paradigms, and Problems in Stakeholder Theorizing. Academy of Management Review 24(2): 228-32. Clarkson, E., (2002). A Stakeholder Framework for Analysing and Evaluating Corporate Social Performance. Academy of Management Review, 20(1): 92-117. Read More