The question of business ethics has been at the forefront of business studies for several decades. It is an issue that has been discussed by everyone from philosophers to economists, many of whom placed an emphasis on the social responsibility of corporations and their shareholders. With the unprecedented success and profits that corporations have experienced within recent history it is no surprise that ethical problems may arise. However, is it the responsibility of corporations to help eradicate such problems even if doing so is in direct conflict with shareholder interests? This paper will explain the stakeholder and stockholder theories of corporate management and argue in favor of the stakeholder theory on the basis of the harms the shareholder argument poses in terms of both social responsibility and the stability of the corporation. In order to fully concretize its argument it will use research of Edward Freeman, Milton Friedman, and John Boatright.

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Stakeholder theory is one of the most well-known theories of business management. Managing for stakeholders is based on a set of relationships among groups which have a stake in the activities that make up the business. This can include but is not limited to customers, suppliers, employees, stockholders, banks, etc. Executives play an integral role in the activity of the business since they are “expected to look after the health of the overall enterprise, to keep varied stakes moving in roughly the same direction, and to keep them in balance.” (Freeman R. E.: 2008, ‘Managing for Stakeholders’p.63) Freeman explains that the primary duty of the executive is to create as much value as possible for stakeholders. Where stakeholder interests clash, the executive is required to work to find solutions and bring these interests together. “Executives must understand that business is fully situated in the realm of humanity.” (Freeman R. E.: 2008, ‘Managing for Stakeholders’p.64)
The benefit of the stakeholder theory is that businesses, and the executives who manage them, actually do and should create value for customers, suppliers, employees, communities, and financiers (or shareholders). Edward Freeman explains in his paper “The Purpose of the Corporation” that the model of business is no longer workable, is resistant to change, not consistent with the law, and for the most part, simply ignores matters of ethics. He states, “each of these flaws is fatal in the business world of the twenty-first century.” (Freeman, R. E.: 2008, ‘Managing for Stakeholders’, pp. 56) By using the “stakeholder” as a basic unit of analysis, it is more difficult to ignore matters of ethics. To explain this, Edward Freeman argues that the primary responsibility of the executive is to create as much value for stakeholders as possible, and that no individual stakeholder’s interest is more important than that of another stakeholder. This in turn guarantees the rights of all the stakeholders. The problems that pose risk lie within the shareholders capitalism theory.
Furthermore, if the stakeholder theory is examined, one would find that all stakeholders have rights and if one is denied theirs, the others are undeniably affected. Edward Freeman further supports this with an argument about character. He explains that one of the strongest arguments for stakeholder theory concerns character because “it asks executives and entrepreneurs to consider the question of what kind of company they want to create and build.” (Freeman, R. E.: 2008, ‘Managing for Stakeholders’, p. 66) Finally, Freeman poses the pragmatist argument which seeks to know “how we can live better, how we can create both ourselves and our communities in ways where values such as freedom and solidarity are present in our everyday lives to the maximal extent.” (Freeman, R. E.: 2008, ‘Managing for Stakeholders’, p.66). For the pragmatist, business and its close relative capitalism have evolved into a social practice, an important one that we use to create value and trade with each other. Consequently, the stakeholder model is always aiming to find the best possible solution for all parties involved in the corporation. Its social responsibility lies within the company as a whole. Social responsibility comes in many forms and recognizing any one form means it is required to recognize all.
Conversely, Friedman states that if these are “social responsibilities, they are of individuals not of a business.” (Friedman, The Social Responsibility of Business is to Increase Its Profits, p.52) He contends that, in any situation, the executive would be spending someone else’s money for the social responsibility. For example, if the executive makes expenditures on reducing pollution beyond the amount that is in the best interest of the corporation; and he then must hire “hard-core” unemployed applicants instead of better qualified workmen, he is spending someone’s money by reducing returns to stockholders for his environmental responsibility and lowering wages of some employees by spending what he would have given to a more experienced employees. According to Friedman, if the employees, stockholders, or consumers, want to spend their money towards social responsibility then it is their money and their decision. Friedman concludes his paper by stating; “in my book Capitalism and Freedom, I have called it a ‘fundamentally subversive doctrine’ in a free society, and have said that is such a society, 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 stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” (Friedman, The Social Responsibility of Business is to Increase Its Profits, p.55)
Friedman’s point here can be used to understand the stakeholders benefit because it is its own form of social responsibility. Who is to say that social responsibility can only be defined in narrow terms? What is clear is that no one set of criteria can unequivocally define it and if under these ambiguous circumstances a corporation manages to achieve it, then it has guaranteed the rights of the stakeholders, thus creating social responsibility.
Moreover, John Boatright explains that advocates of stakeholder management are correct in their insistence that the modern for-profit corporation should serve the interests of all stakeholder groups. Where stakeholder management fails is in its refusal to recognize that a business organization working in the interests of shareholders does not have to be in conflict with the interests of stakeholder groups. Boatright assumes that this failure is due in large part, to a second mistake on the part of proponents of stakeholder management. Stakeholder management assumes that management decision making is the main vehicle by which the benefits of corporate wealth creation are distributed among stakeholders, but these benefits can also be obtained in other ways; namely by groups interacting with a corporation through the market. This is where Boatright is taking a risk in his argument because he wants the corporation to obtain its benefits externally when it can be done internally. The benefit of the stakeholder theory is that all the rights are guaranteed from the top down, top stakeholders all the way to the consumers at the bottom of the model. When all stakes have their rights preserved by the executive equally, there is no need for the corporation to act in the best interest of the shareholders solely.
The managerial model positions its “shareholders” at the center of the firm as the principal group for managers to worry about. Increasing shareholder value has become common wisdom in modern business and many companies have instituted “complex incentive compensation plans aimed at aligning the interests of executives with the interests of shareholders.” (Freeman, R. E.: 2008, ‘Managing for Stakeholders’ page.57) Edward Freeman poses three arguments in regards to shareholders. Firstly, he explains that management of the firm becomes separated from the ownership of the firm and in order to be successful the top managers of the company were required to satisfy the owners, employees, suppliers, unions, and customers. If managers worried about the shareholders only, the stakeholders will in turn be harmed. When the stakeholders are harmed, the whole corporation is harmed leading to instability.
From another angle, Freeman explains that the model poses harm and risk because it is so rigid. It unabashedly puts shareholders interests over and above the interests of customers, suppliers, employees, and others, as if these interests must conflict with each other. The only change that matters is the kind that is oriented toward shareholder value. In addition, Edward Freeman also explains that the law of corporations gives a less than clear answer to the question of in whose interest and for whose benefit the corporation should be governed. It has evolved to give a de facto standing to the claims of groups other than shareholders.
Even more harmful is the fact that the shareholder model is not consistent with basic ethics. Practically any business decision has some ethical content or concern. Milton Friedman refers to this by stating that, “responsibility of the executive is to make profits subject to law and ethical custom. The purpose of ethics is to create a better world for all of us.” (Freeman, R. E.: 2008, ‘Managing for Stakeholders’ p.60)
Numerous theorists have argued that the main reason that the dominant model of managing for shareholders is a good one is that it leads to the best consequences for all involved. “These arguments invoke Adam Smith’s idea of the invisible hand, whereby each business actor pursues her own self-interest and the greatest good of all actually emerges.” (Freeman, R. E.: 2008, ‘Managing for Stakeholders’ p.65) However, in reality, each business actor can have a different approach and a different idea of their own self-interest which in turn, may harm the corporation internally and externally. Although the stakeholder concept has been developed in various ways, it has expressed the moral prescription that managers, in making decisions, ought to consider the interests of all above those of the few.
This is proven in the laws that have evolved to protect the interests of local communities and employees of corporations through unionization. Laws such as The Equal Pay Act of 1963, the Civil Rights Act of 1964, The Clean Water Act of 1977, and the Clean Air Act of 1990, all have helped stakeholders to achieve a great level of equality. The laws that are relevant to business have evolved differently around the world, to take into account the interests of groups other than just shareholders. (page 58)
The dispute between stockholder and stakeholder management revolves around the question of how best to enable each stakeholder group or corporate constituency to benefit from the wealth-creating activity of business. Stakeholder management is correct in its emphasis on the moral requirement that every stakeholder group benefit from corporate activity and to make managers aware of their responsibility to create wealth for the benefit of everyone. The stakeholder management theory is superior to the shareholder theory because in such a system of corporate governance, all the groups would share the control of the firm. Hence, the interests of the involved stakes would be to maximize the profit for all stakeholders. The most important point, however, is the social responsibility of the managers to their corporations. As has been proven, the stakeholder management theory has the responsibility to assure the stakes interests and rights through a clear guideline that has been proven to work in modern day corporations.