The Shareholders vs. Stakeholders Debate

The stakeholder theorists smell blood. Scandals at Enron, Global Crossing, ImClone, Tyco International and WorldCom, concerns about the independence of accountants who are charged with auditing financial statements, and questions about the incentive schema and investor recommendations at Credit Suisse First Boston and Merrill Lynch have all provided rich fodder for those who question the premise of shareholder supremacy. Many observers have claimed that these scandals serve as evidence of the failure of the shareholder theory — that managers primarily have a duty to maximize shareholder returns — and the victory of stakeholder theory, which says that a manager’s duty is to balance the shareholders’ financial interests against the interests of other stakeholders such as employees, customers and the local community, even if it reduces shareholder returns. Before attempting to declare a victor, however, it is helpful to consider what the two theories actually say and what they do not say.

Both the shareholder1 and stakeholder theories are normative theories of corporate social responsibility, dictating what a corporation’s role ought to be. By extension, they can also be seen as normative theories of business ethics, since executives and managers of a corporation should make decisions according to the “right” theory. Unfortunately, the two theories are very much at odds regarding what is “right.”

Shareholder theory asserts that shareholders advance capital to a company’s managers, who are supposed to spend corporate funds only in ways that have been authorized by the shareholders. As Milton Friedman wrote, “There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it … engages in open and free competition, without deception or fraud.”2

On the other hand, stakeholder theory3 asserts that managers have a duty to both the corporation’s shareholders and “individuals and constituencies that contribute, either voluntarily or involuntarily, to [a company’s] wealth-creating capacity and activities, and who are therefore its potential beneficiaries and/or risk bearers.”4 Although there is some debate regarding which stakeholders deserve consideration, a widely accepted interpretation refers to shareholders, customers, employees, suppliers and the local community.<

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1. The theory is sometimes called the “stockholder” theory, but the term “shareholder” is used here for consistency with recent usage in the media.

2. M. Friedman, “Capitalism and Freedom” (Chicago: University of Chicago Press, 1962), 133.

3. Note that I am considering only the normative version of the theory, which states how managers ought to behave. There are also descriptive versions of the stakeholder theory, which describe actual behavior of managers, and instrumental versions, which predict outcomes (for example, higher profits) if managers behave a certain way. These distinctions are drawn crisply in T.M. Jones and A.C. Wicks, “Convergent Stakeholder Theory,” Academy of Management Review 24, no. 2 (April 1999): 206–221.

4. J.E. Post, L.E. Preston and S. Sachs, “Managing the Extended Enterprise: The New Stakeholder View,” California Management Review 45, no. 1 (fall 2002): 5–28.

5. W.M. Evan and R.E. Freeman, “A Stakeholder Theory of the Modern Corporation: Kantian Capitalism,” in “Ethical Theory and Business,” 3rd ed., eds. T.L. Beauchamp and N.E. Bowie (Englewood Cliffs, New Jersey: Prentice-Hall, 1988), 97–106. It is to this version of the normative stakeholder theory that the following description refers. Note, however, that Post, Preston and Sachs, who take a more instrumental than normative view of stakeholder theory, embrace a wider enumeration of stakeholders, including regulatory authorities, governments and unions.

6. Note that these are ethical rights. They may or may not correspond to legal rights or to rights established by professional/industry codes and so on.

7. Some authors — for example, see J. Hasnas, “The Normative Theories of Business Ethics: A Guide for the Perplexed,” Business Ethics Quarterly 8, no. 1 (1998): 19–42 — view the “social contract” theory as providing a third, and differing, normative viewpoint that is at an equivalent level to the shareholder and stakeholder theories. However, the most recent writings by the leading proponents of the social contract theory — including T. Donaldson and T.W. Dunfee, “Ties That Bind: A Social Contracts Approach to Business Ethics” (Boston: Harvard Business School Press, 1999), see especially chapter 9 — instead seem to view the “social contracts” perspective as a meta-theory that provides guidance in sorting through the stakeholder obligations.

8. Friedman, “Capitalism and Freedom,” 56, 61.

9. N.E. Bowie and R.E. Freeman, “Ethics and Agency Theory: An Introduction” (Oxford, England: Oxford University Press, 1992), 3–21.

10. R.R. Ellsworth, “Leading With Purpose: The New Corporate Realities” (Stanford, California: Stanford University Press, 2002). Here, Ellsworth argues for the primacy of customers’ interests over those of other stakeholders.

11. J. Cassidy, “The Greed Cycle,” The New Yorker, Sept. 23, 2002, 64–77. Also see Cassidy for a thorough and accessible treatment of the factors driving the shift to a “shareholder value” perspective.

12. M. Friedman, “The Social Responsibility of Business Is To Increase Its Profits,” New York Times Magazine, Sunday, Sept. 13, 1970, sec. 6, p. 32.

13. M.C. Jensen and W.H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics 3 (October 1976): 305–360.

14. Cassidy, “The Greed Cycle.”

15. J. Magretta, “What Management Is: How It Works and Why It’s Everyone’s Business” (New York: Free Press, 2002), 30–33.

16. Post, “Managing the Extended Enterprise,” 18.

17. See C. Hampden-Turner and A. Trompenaars, “The Seven Cultures of Capitalism: Value Systems for Creating Wealth in the United States, Japan, Germany, France, Britain, Sweden and the Netherlands” (New York: Doubleday, 1993). The percentage of managers choosing the first option varied from lows of 8% (Japan) and 11% (Singapore) to highs of 34% (Canada), 35% (Australia) and 40% (the United States).

18. J.W. Lorsch, “Pawns or Potentates: The Reality of America’s Corporate Boards” (Boston: Harvard Business School Press, 1989), 7–8.

19. Ellsworth, “Leading with Purpose,” 348.

20. R.A.G. Monks and N. Minow, “Corporate Governance” (Cambridge, Massachusetts: Blackwell, 1995), 38.

21. Ellsworth, “Leading with Purpose,” 349.

22. S. London, “An Uprising Against Stock Arguments,” Financial Times, Tuesday, Aug. 20, 2002, p.10.

23. Ibid.

24. M.S. Weisbach, “Outside Directors and CEO Turnover,” Journal of Financial Economics 20 (March 1988): 431–460.

25. S. Allgood and K.A. Farrell, “The Effect of CEO Tenure on the Relation Between Firm Performance and Turnover,” Journal of Financial Research 23, no. 3 (fall 2000): 373–390.

26. J.R. Franks and C. Mayer, “Hostile Takeovers and the Correction of Managerial Failure,” Journal of Financial Economics 40, no. 1 (January 1996): 163–181.

27. P. Behr and A. Witt, “Visionary’s Dream Led to Risky Business,” Washington Post, Sunday, July 28, 2002, sec. A, p. 1.

28. Ellsworth, “Leading with Purpose,” 327–357.


I am indebted to Bob Hebert for his research assistance and to Ram Baliga, Jim Flynn, John Hasnas and Gary Shoesmith for enlightening conversations. This research was supported by the Babcock Graduate School of Management at Wake Forest University, Research Fellowship Program.