Shareholders vs Stakeholders Debate: South African Perspective

Corporate governance in its narrow definition[1] entails control and management of the company’s business under the mantle of the governing body, the board of directors (the ‘board” or the “directors”) on behalf of the shareholders. Shareholders as defined by the Companies Act, 2008 are persons holding issued shares by a company.[2]  Stakeholders on the other hand are defined as group of persons or persons who are likely or are reasonably expected to be affected by operations of a business either internally or externally.[3] The board is tasked with performing different roles with the main being managing the business and affairs of a company.[4] It is while performing the erstwhile role that the board finds itself in a state of dilemma between advancing shareholders’ interests and considering the interests of other stakeholders as the wider definition[5] of corporate governance provides.

The shareholder/stakeholder debate genesis can be traced back to the Harvard Law Review publication in 1932[6] between renowned author Adolph A. Berle and Professor Merrick Dodd of Harvard Law School. Berle supported shareholder supremacy as powers granted to the directors were to be exercised solely for the benefit of the shareholders whereas Professor Dodd argued that the sole purpose of business and its directors is not profit making but also ensuring stakeholders welfare for instance in job security, production of quality products and services for consumers and the general welfare for society and the environment.[7] The nature of the debate can be narrowed down to identifying what is the main purpose of a business and the role of board; is it to benefit only the shareholders or to also consider interests of other stakeholders? This paper seeks to examine the complexities surrounding each approach and highlight the views that exist on this debate. In agreement to the Bad and Not-So-Bad Arguments for Shareholder Primacy article, Lynn Stout appreciates that there has been significant intellectual progress that followed the 1932 debate that is still currently present.

Shareholder Primacy Approach

In 1970 Milton Friedman, an economist, argued that the sole purpose of the directors as executive employees of the corporation is to manage the business and make profits for the employers, the shareholders.[8] This was an approach that had been taken by a Michigan Hall of Justice Court in 1919 in the case of Dodge v Ford Motor Car Company where the court held that “the business corporation is organized and carried on primarily for the profit of stockholders. The powers of the directors are to be employed for that end.” [9] This proposal had also received government support with the UK government under the leadership of Prime Minister Margaret Thatcher and US President Ronald Reagan calling for economic freedom focusing on profit making.[10] Institutions such as King I also supported this proposal.[11] Critics to Milton’s advancement have argued that his argument was ‘ferocious’[12] while some saying that being an economist, he failed to appreciate the legal perspective that shareholders merely own a stock in the business and therefore, cannot be said to own the entire business.[13]

Proponents of the shareholder primacy approach have also claimed that shareholders unlike other stakeholders remain as the only claimants[14] having unprotected risk of the business sustainability. This is because unlike other stakeholders, shareholders lack contractual protection to their investment[15] and merely rely on the fiduciary agency relationship between themselves and the directors therefore, proposing that their interests should take prominence over others.[16] However, critics to this proposal have argued the only time shareholders are called to rescue the business is when the business faces insolvency.[17] In the absence of the risk of bankruptcy the shareholders have a right to elect directors and to receive dividends[18] which control is with the directors depending on the business performance to issue dividends.[19] Further, the South African courts have held that the shareholders’ derivative action offers protection to the shareholders and it would be inaccurate to say shareholders suffer risk in the business,[20] besides, other stakeholders suffer risk of job insecurity, lack of production of goods and quality services for the consumers among others.[21]

Shareholders’ primacy supporters have asserted that most of the derivative actions that are claimed to support shareholders are class actions with success rate being mostly in favor of defendants and if the shareholders won the payment of damages would be to the corporations.[22] Further, the supporters of the shareholder primacy have maintained that nothing prevents the non-holding stakeholders such as employees, suppliers or customer from being issued business stock and becoming shareholders however, the reverse as they argue is not an easy process.[23]

There is also another proposition that maximizing shareholders’ value results in maximizing the entire business’s economic value.[24] This happens when shareholders who remain as claimants have control rights and can decide that after every stakeholder has been paid and the business is said to be a going concern the remaining cashflow can be invested in a risky business that will increase the economic value if it succeeds and if not, the shareholders could lose their investment.[25] Investing in risky business is something other stakeholders with fixed claims from the business would be reluctant to engage in after all, stakeholders would have their fixed claims adjusted to cushion them from the risk. This proposal has however been countered as explained below.

Stakeholder Theory Approach

Dr. Edward Freeman, first recounted that the stakeholder theory entails any person invested or affected by a company’s operations.[26] Stakeholders include employees, suppliers, consumers, society, lenders and government among others.[27] All these group of individuals demonstrate an interconnected business environment that a company should consider their interests for the long term value of the business operations.[28] The stakeholder theory has been alluded to entail two major questions.[29] The first being what is the main purpose of the business and the other being what are the values of the business in relations to its stakeholders.[30] Advocates of this theory argue that economic value creation requires a good working relationship with stakeholders for it to be achieved not forgetting the shareholders are part of the process, terming the process as coming together of ethics and economy.[31]

King IV’s definition of the stakeholder theory approach is the taking account of all relevant stakeholders’ interests, expectations, and their reasonable needs by the board while performing the company’s best interest on a long - term value.[32] Resultantly, King IV recommends stakeholder management[33] for the proper understanding of the stakeholders’ interests and needs in establishing the business plan for achieving economic value. The stakeholder management is done not on an equal basis as alleged by critics but on the concept of meritocracy[34] over the different classes of stakeholders.

It would be incorrect to say that the stakeholder approach has received no scorn[35] having dissociated itself from the notion of profit making for the shareholder as a business goal but rather as an outcome realized from the economic value.[36] This notwithstanding, it is important to first understand that shareholders cannot claim to be the owners of a business and expect directors to only consider their interest. This is because a business is a legal person existing separately from the shareholders with the capacity to negotiate and enter contracts, sue, be sued and own property. Therefore, directors have the fiduciary duty to the business in the same breadth they do to the shareholders.[37]

Critics to the stakeholder theory approach have argued that it is difficult for managers to be able to identify all relevant stakeholders to consider while running the business, and those not important terming the process as ‘overwhelming’.[38] While supporting the difficulty in stakeholder identification, the critics alluded to the different subgroups in stakeholders for example in employees there are casual laborers, middle managers, and shop attendants, among others.[39] They also argued that establishing business core values that align with that of the different stakeholders was an unrealistic for the directors to be expected to achieve.[40] Further, they argued that decision making process is likely to be  interfered and delayed whenever the directors have to juggle between the interests of all stakeholders and consequently they end up in a state of confusion.[41] 

In response to the above allegations by the critics of stakeholder theory, advocates for the stakeholder theory have appreciated that truly aligning all interests of stakeholders would not make it possible for a detailed day-to-day decision-making strategy.[42] However, all these different interests that have to be considered on a balance of meritocracy potentially lead to an improved accountability[43] by the directors as each group of stakeholders would be keen to know why their interests were considered against in the decisions made.

The stakeholder theory supporters also countered the shareholder’s argument that maximizing shareholders’ value maximizes stakeholders’ value by stating that involving stakeholders in the process of decision making of business investments would ensure fairness and acceptance in the final distribution of either risks or benefits accruing from the investment decision made.[44]

Contribution of Social and Ethics Committee in Shareholder/Stakeholder Debate

The Companies Act, 2008, section 72(4) read together with the Regulation 43 of the Companies Regulations, 2011 provides that a minister may mandatorily require certain companies such as state or listed public companies to establish a social and ethics committee (the “SEC”). Regulation 43(5)[45] provides for the functions of the SEC which includes but is not limited to monitoring a company’s operations in relation to social and economic development, corporate citizenship, environment, health and public safety, consumer relationships, labor, and employment. The SEC is mandated to not only monitor the company’s implementation of the above but to also bring it to the attention of the board matters regarding the above and to report to the shareholders during the annual general meeting implementation of the above.[46] On the other hand, the King IV report stipulates[47] that the mandate of the social and ethics committee is to oversee and report over the company’s implementation of ethics, responsibility of good corporate citizenship, engagement in stakeholder relations and ensuring sustainable development.

Consequently, the SEC gets its mandate from both the statute and the King IV report. Obligations under the statute require compulsory implementation whereas application of the King IV report is ‘apply and explain’ for all organizations[48] regardless of them being state owned or listed. This ensures that all companies in South Africa have SEC approving reviewed policies and strategies pertaining to the company’s implementation program of  social conscience requiring a good corporate citizen performance.[49] Therefore, the oversight and reporting role of the SEC encapsulate a shift away from the focus of shareholder primacy by ensuring that stakeholders’ interests are considered and protected in decision making of a company.[50] The SEC protection ensures company’s values are aligned with social and economic development of not only the local environment but also international environment such as the United Nations Global Compact Principles and the Organization for Economic Co-operation and Development (OECD) recommendations regarding corruption.[51]

Conclusion

Considering the above discussion, it is notably that the winner-take-all system of shareholder primacy no longer holds water but there is a shift and focus on social contract.[52] Businesses are called upon to support the concept of shared value which entails enhancing a company’s competitiveness while advancing the socio-economic environment in which it operates.[53]This complements the enlightened shareholder value[54] which more or less speaks the stakeholder theory language of maximization of shareholders’ return on investment on condition that companies ensure the long term value of a company’s sustainable growth with acknowledgement of stakeholders interests, expectations and reasonable needs. It is undeniable that the stakes are high in the shareholder/stakeholder debate. Each theory has over time tried to convince the other side of why its theory is if not the gospel truth but the solution to business growth.

Various critics’ arguments against shareholder primacy theory as discussed above have proved that it is no longer tenable for business to put too much effort only on maximizing the returns on the shareholder’s investment. The same has been said of stakeholder theorist that it is difficult to establish on what exactly are the interests, expectations, and reasonable needs of all relevant stakeholders. One is then left to weigh the proposals brought forth by the two-competing theorist. In agreement with the different authors the purpose of any business is not to make profit, this is an end-result to the core purpose of the business. The core purpose of the business is that which leaves an imprint or better yet a legacy on the shareholders, employees, customers, suppliers, society, environment, government, and anyone else it may impact.

While appreciating the stakeholder theory’s flaw, it is my opinion that no business is perfect but what matters is that there is continuity of the business and the environment in which it operates is fairing on well as is the business. This in mind, it is my opinion that the enlightened shareholder theory which as demonstrated above reads closely to the concept of stakeholder theory provides the solution for sustainable business growth. The current stakeholder theory propositions have the potential for improvement in areas as follows. Firstly, companies should provide a platform where stakeholders can express their expectations and interests from the business as it has been demonstrated some stakeholders remain reluctant in expressing themselves whereas some do not where to present their ideas or reservations.

Secondly, it is also important for companies to ensure compliance of policies and strategies reviewed and approved by the SEC. Studies[55] have shown that most of these policies remain pretty in the boardroom files while companies run the business operations against what has been considered and approved by the SEC and other board committees.

Lastly, board of directors need to understand that the company exist independently of the shareholders and the stakeholders. Therefore, they owe their fiduciary duty to the business, shareholders and stakeholders as is appropriate to their needs and interests. Implementation of the above recommendations and making further improvements as needed will ensure a lasting solution in the socio-economic development of a business. 

[1] Tobi Wiese, Corporate Governance in South Africa: With International Comparisons, (2nd Edn Juta and Co. Ltd, 2017) page 2.

[2] Companies Act No. 71 of 2008, Chapter 1, s 1.

[3] Institute of Directors in Southern Africa, King IV Report on Corporate Governance for South Africa, (1st November 2016).

[4] Ibid n 2, s 66 (1).

[5] Wiese, n 1, page 2.

[6] Lynn A. Stout, ‘Bad and Not-So-Bad Arguments for Shareholder Primacy’ (2002) 75 Cornell Law Faculty Publications 1189

[7] Ibid.

[8] Steve Denning, ‘The Origin Of 'The World's Dumbest Idea': Milton Friedman’ (Forbes, 26 June 2013) < https://www.forbes.com/sites/stevedenning/2013/06/26/the-origin-of-the-worlds-dumbest-idea-milton-friedman/?sh=6a4e9dae870e> accessed on 28 April 2021.

[9] Kamal K. Jabbar, ‘Profit and Purpose – shareholder primacy and the promise of tomorrow’ (Kamal K. Jabbar 24 September 2019) < https://www.kamaljabbar.com/profit-and-purpose/> accessed on 28 April 2021.

[10] Kamal n 9.

[11] Ansie Ramalho, ‘Corporate governance and the call for stakeholder inclusivity, Do Shareholder Lose Out’ (2009) page 19.

[12] Ibid n 8.

[13] Ibid n 6, page 1191.

[14] Ibid, page 1192.

[15] Ibid n 11.

[16] Ibid, page 18.

[17] Lynn n 6, page 1193.

[18] Ibid n 11.

[19] Lynn n 6, page 1194.

[20] Ibid n 11.

[21] Lynn n 6, page 1194-1195.

[22] Anant K. Sundaram and Andrew C. Inkpen, ‘The Corporate Objective Revisited’ Organization Science’ (May – June 2004) Vol 15(3) page 355 - 356 < https://pubsonline.informs.org/doi/pdf/10.1287/orsc.1040.0068> accessed on 29 April 2021.

[23] Ibid page 355.

[24] Ibid page 354

[25] Ibid.

[26] Becky Simon, ‘What Is Stakeholder Theory and How Does It Impact an Organization?’ (Smartsheet 23 November 2016) < https://www.smartsheet.com/what-stakeholder-theory-and-how-does-it-impact-organization> accessed on 29 April 2021.

[27] Ibid.

[28] Klaus Schwab and Peter Vanham, ‘What is Stakeholder Capitalism’ (The Davos Agenda, 22 January 2021) < https://www.weforum.org/agenda/2021/01/klaus-schwab-on-what-is-stakeholder-capitalism-history-relevance/> accessed on 29 April 2021.

[29] R. Edward Freeman, Andrew C. Wicks and Bidhan Parmar, ‘Stakeholder theory and "The Corporate Objective Revisited"’ (May- June 2004) Institute for Operations Research and the Management Sciences, Organization Science, Vol 15(3) < https://go-gale com.ezproxy.uct.ac.za/ps/i.do?p=AONE&u=unict&id=GALE|A118957400&v=2.1&it=r> accessed on 29 April 2021. 

[30] Ibid.

[31] Ibid.  

[32] King IV ibid n 3, page 17.

[33] Ibid, page 5.

[34] Phillips Robert, Edward R. Freeman and Wicks Andrew C, “What Stakeholder Theory Is Not” (2003) 13 Business Ethics Quarterly, page 488 < https://web-b-ebscohost-com.ezproxy.uct.ac.za/ehost/pdfviewer/pdfviewer?vid=1&sid=340eaa07-d775-4434-8c57-3f6bfbcf792d%40sessionmgr102> accessed on 29 April 2021.

[35] Ibid, page 479

[36]  Ibid, n 29.

[37] Ibid, n 34 page 483.

[38] Anant ibid n 22, page 352.

[39] Ibid, page 353.

[40] Ibid.

[41] Ibid, page 354.

[42] Philips n 34, page 485.

[43] Ibid, page 484.

[44] Ibid, page 487.

[45] Companies Regulations 2011, regulation 43(5(a) (i-v))

[46] Ibid, regulation 43 (5(b-c))

[47] King IV n 3, page 29.

[48] Ibid, page 7.

[49] Deloitte, ‘ The Companies Act The Social and Ethics Committee and the management of the Ethics Performance of the Company’ (2014) page 2 < https://www2.deloitte.com/content/dam/Deloitte/za/Documents/governance-risk-compliance/ZA_SocialAndEthicsCommitteeAndTheManagementOfTheEthicsPerformance_24032014.pdf> accessed on 1 May 2021.

[50] Tangeni N. Ndafapawa, ‘The structure of the social and ethics committee in South Africa and the protection of non-shareholder constituencies’ (OpenUCT 2020) page 12 < https://open.uct.ac.za/handle/11427/32935> accessed on 1 May 2021.

[51] Ibid n 46.

[52] Addisu Lashitwe, ‘Stakeholder Capitalism arrives at Davos’ (Brookings World Economic Forum, 21 January 2020) page 2 < https://vula.uct.ac.za/access/content/group/1450b929-e2d3-4a4e-930b-b8449d0d8b22/Course%20Materials/Unit%20B%20_22-28%20March_/Materials/2%20-%20Brookings%20World%20Economic%20Forum%20Blog%20-%20Stakeholder%20capitalis.pdf> accessed on 2 May 2021.

[53] Professor Michael E. Porter, ‘The Future of Corporate Citizenship: Creating Shared Value’ (NYSE, 100 Best Corporate Citizen, 2 March 2011) page 5 < https://www.hbs.edu/ris/Publication%20Files/20110302_-NYSE%20Top%20100%20Corporate%20Citizens-%20FINAL_cebf89b0-e42d-4032-b8a3-71d768519dfe.pdf> accessed on 2 May 2021. 

[54] David Millon, ‘Enlightened Shareholder Value, Social Responsibility, and the Redefinition of Corporate Purpose Without Law’ (2010) Millon, Washington & Lee Legal Studies Paper No. 2010-11, < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1625750#:~:text=Enlightened%20shareholder%20value%20(ESV)%20is,range%20of%20relevant%20stakeholder%20interests.> accessed on 2 May 2021. 

[55] The True Cost Film on fashion industry https://www.youtube.com/watch?v=5-0zHqYGnlo accessed 2 May 2021.