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Which Wealth should Corporations Maximize?

In the sixteen hundreds, John Donne wrote his Meditation XVII poem, which included the ever infamous line of “no man is an island”. If I may draw similarities between corporations and individuals, given their environmental complexities, then one may adapt Donne’s line to: no corporation is an island. A corporation is set up by pooling resources of investors, known as shareholders, in order to create for them more wealth. But “money on its own produces nothing … it is only in combination with human, and at times, physical capital that a corporation comes alive” (Simpson, p.2). When Johnson & Johnson’s former CEO, Ralph Larsen, was asked “Do you serve shareholders, or do you serve stakeholders?” (Simpson, p.2), his reply was both; which emphasizes the fact that in order to create additional wealth for the shareholders, a corporation must keep a keen eye on the needs of the various stakeholders. But given the inescapable economic problem of scarcity, what should the corporate objective be? Maximizing the wealth of the shareholders, or that of the stakeholders?

When I was a young kid, my father once took me for a paddle boat ride at the lake. I wanted to take charge of the boat, by controlling the navigation rod; to which my father gladly agreed. The boat was drifting aimlessly, and all our paddling effort was going to waste; I was navigating, paddling, talking to my sister and feeding the ducks. It is when my father told me to focus on navigating, and aim for the far mountain, that the boat went in a straight line.

Using that story in the corporate world, we notice that by maximizing stakeholder wealth, a company must satisfy various constituencies [employees, suppliers, environment, communities, etc.], that the overall wealth-creation effect is dampened. There is no clear focus on how to chose amongst the various stakeholders; and what constitutes them in the first place. Yet, we must not forget that shareholders are also stakeholders. As a matter of fact, by corporations maximizing shareholder value, they are in effect also maximizing total stakeholder value. The reason is that shareholders only have claims to the “residual cash flows” (Sundaram); after all the stakeholders have been paid. Thus, by catering to the final link in the chain, the shareholders, all the other links would also been catered to in the process, resulting in the maximum wealth creation for all parties.

The above shareholder theory logic, have been contested by the stakeholder theory advocates, stating that, since Aristotle’s times, it has been known that “if you want to maximize a particular thing … you should perhaps not try to do it consciously … in a complex world, order [always] emerges” (Freeman, p.367). Thus their claim is that, by focusing on the stakeholders, the shareholder’s wealth will be maximized as a by-product.

In my opinion, such view is invalid, given that stakeholders are only interested in so far as getting their own benefits; why must a corporation engage in further risk after they [the stakeholders] get their cash flow? Entities are motivated only when “satisfiers (factors that cause satisfaction)” (Kotler and Keller, p.203) are present; as explained by Fredrick Herzberg. Thus given that shareholder wealth creation comes after that of the stakeholder, then the stakeholder rebuttal must be necessarily false. Stakeholder theory “politicizes the corporation” (Jensen, p.237), adding complexity to better defining a company goal; while shareholder theory, the goal is “single-valued metric … observable and measurable” (Sundaram, p.355).

Another argument that is often used against shareholder theory, is that such narrow view of wealth maximization will lead to greed, and eventually create value loss for stakeholders; one needs to look no further than the not so-long-ago corporate scandals such as Enron, Tyco and Worldcom. It should be understood that these scandals were a result of individuals trying to benefit themselves, regardless of which theory management has subscribed to. The individuals were playing outside the “rules of the game”; as Milton Friedman calls it. Enron’s CFO, Andrew Fastow, admitted to that; “I … engaged in schemes to enrich myself and others at the expense of Enron’s shareholders” (Sundaram and Inkpen).

At the end of the day, both shareholder and stakeholder theory “seek a path to a promised land in which accountable corporations managed by ethical decision makers create the greatest value for the greatest number of stakeholders” (Sundaram and Inkpen). There is an Arabic saying, that goes along the lines of: ‘the boat that does not have anything for God, will sink’; in that respect, the company’s main objective is to maximize shareholder wealth, while taking at a secondary level the requirements of the environment it engages with – the stakeholders.

~ Youssef Aboul-Naja

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  1. February 13, 2010 at 9:56 AM

    I like how you incorporate different sources and evidence to support your point. The variety—a poem, an anecdote, quotes from business figures, etc.—makes the piece well-rounded and strengthens your stance. It keeps the info fresh and avoids monotony.

    Bringing in your personal story gives this post a more intimate voice. You’re utilizing a widely familiar scene to explain what may be perplexing for someone who’s trying to learn more about the business world. Very effective.

    Nice post.

  2. September 9, 2013 at 6:05 PM

    What’s up to all, how is all, I think every one is getting more from this web site,
    and your views are pleasant in support of new users.

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