What is the Stakeholder Theory of Corporate Governance?

The Stakeholder Theory of corporate governance has been developed extensively in the UK, and has even been enshrined into law (Companies Act 2006). It figures markedly in the latest version of the Corporate Governance Code.

Tony Blair and the Stakeholder Theory

The idea of the stakeholder as a factor in corporate governance is quite new. Most of us were educated with conservative economist Milton Friedman’s view that the only purpose of a business is to make money for its shareholders.

But, in 1963, a group of economists at the Stanford Research Institute in California coined the idea that a business is actually responsible to a larger group: its stakeholders, including “employees, customers, suppliers, creditors and even the wider community and competitors”, according to British economist Andrew Gamble, who took up the concept. Everyone who has a “stake” in the future of the business, as the Oxford English Dictionary defines the term ‘stakeholder’, is included.

The idea didn’t really go far for many years, until Jan. 8, 1996, when then UK Prime Minister Tony Blair gave a speech in Singapore extolling the virtues of the “stakeholder economy”. The speech made the stakeholder idea world-famous, and it became an element in many types of speculative thought.

So it is not surprising that, in the UK, the “stakeholder theory of corporate governance” took shape. It arguably became the compromise between (what some call) “American shareholder capitalism” and “German socialised capitalism”.

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The Stakeholder Approach

The point of the stakeholder approach, like that of the shareholder approach, is to maximise the economic benefit of the business’s operations. It simply takes a different view on how that should be achieved:

“Firstly, there is the potential reduction in external costs imposed on stakeholders by the firm. Instead of the firm treating as many of its costs as possible as externalities and disclaiming responsibility for them, which leads to conflict in the shape of strikes, lawsuits, and government imposed controls and regulation, the stakeholder firm seeks to handle these costs through internal negotiation with its stakeholders. Secondly, the stakeholder approach encourages a better transfer of information between the various elements of the firm. Often the competitiveness of a firm will be affected by whether stakeholders (such as banks, sub-contractors, or workers) can reach agreements with managers which require the sharing of information and the generation of mutual commitment. A governance structure which encourages information disclosure will obviously be vital in generating these types of long-term relationships, or ‘implicit contracts’, between stakeholders,” Gamble explains. 

The UK has sought to implement this governance structure in law, using the concept of “Enlightened Shareholder Value (ESV)”. The inclusion of ESV principles in the Companies Act was recommended by the Company Law Review Committee. The Review Committee considered at some length whether the duty of loyalty for directors of UK companies should retain the shareholder focus of the common law, or should be reoriented along ‘pluralist’ lines, with directors obliged to give equal weight to the interests of constituencies such as company employees and creditors, alongside the interests of shareholders. The Committee declared itself to be in sympathy with the view that business affairs should be conducted with an eye to the long term and in a manner that enhanced the welfare of different groups in society, but felt that it was important the law placed a clear obligation on directors that ensured focused and competitive management and which did not turn them “from business decision-makers into moral, political or economic arbiters.”

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The form this takes is indeed somewhat general.

“Section 172 of the Companies Act enshrines the principle of enlightened shareholder value (‘ESV’) into UK company law by appending to the directors’ duty to ‘promote the success of the company for the benefit of its members as a whole’ a list of matters to which directors are required to ‘have regard’ in discharging the duty. The ESV principles in section 172 are stated with a high degree of generality. Nonetheless, section 171(1)(a)– (f) of the Act requires directors to have regard to following principles in discharging their core duty:

  • The likely consequences of any decision in the long term;
  • The interests of the company’s employees;
  • The need to foster the company’s business relationships with suppliers, customers and others;
  • The impact of the company’s operations on the community and the environment;
  • The desirability of the company maintaining a reputation for high standards of business conduct; and
  • The need to act fairly as between members of the company,” according to the Act.

But the Financial Reporting Council, which produces the UK Corporate Governance Code, incorporated these ideas in the latest version of the code (published on Dec. 5, 2017).

Stephen Haddrill, chief executive of the FRC, said: “Businesses which are successful in the long term support our economy and society by providing employment and contributing to economic growth and prosperity. In doing so, it’s increasingly important that companies develop and sustain meaningful relationships with a wider range of stakeholders. This clear and practical guide will be of great help to companies and promote good strategic and governance reporting.”

The UK Institute of Chartered Secretaries and Administrators has tried to provide more specific guidance in terms of corporate governance, for example:

The Stakeholder Voice in Board Decision Making should be determined according to the following points:

  • Is the amount of engagement with specific stakeholder groups compatible with the relative priority the board places on them?
  • What are the lines of reporting from these activities up to senior management and ultimately the board?
  • Who is responsible for designing and carrying out this engagement? Boards should not be designing engagement mechanisms for all levels of the business.
  • However, oversight is important to make sure that the processes are robust and regularly reviewed.
  • Is there a need for the board to be directly involved in engagement with particular stakeholders or on particular issues?

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The board should carry out such an assessment at regular intervals to determine whether the overall arrangements remain effective, and make changes if not.

There is clearly a push on in UK law to incorporate stakeholders into the decision-making process, even if specific means for this have not yet been finally determined.

As the UK Institute of Directors explains:

“Directors should ensure that the board identifies and knows the interests, views and expectations of all individuals and groups which the board judges have a legitimate interest in the achievement of company objectives and the way in which these objectives are achieved. They should ensure that communications with such parties are timely, effective and unbiased, subject to the needs of commercial security and regulatory compliance where appropriate.”

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