International Business Plan
2/1/21, 4:20 PMGovernance and Accountability
Page 1 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
Governance and Accountability
Who Owns the Corpora!on? The Legal Debate
Do shareholders own the company? To most people, this idea is so axioma!c that the ques!on hardly seems
worth asking. However, the long-simmering debate about the age-old argument over the board's
responsibili!es to shareholders versus the rights of all company stakeholders flared up again recently,
drawing a"en!on once again to that central ques!on (Bernstein, 2008).
In the latest round of this debate, two leading corporate governance experts—Lucian Bebchuk, Harvard Law
School professor and ardent shareholder-rights proponent, and Mar!n Lipton, founding partner of Wachtell,
Lipton, Rosen & Katz and a stalwart defender of the view that management's preroga!ve is to act in the
best interest of the corpora!on—squared off in the pages of the Virginia Law Review (see Bebchuk, 2007, p.
675; Lipton & Savi", 2007, p. 733). The central issue in this debate is whether directors of a public company
owe their primary fiduciary duty to its shareholders, as Bebchuk insists, or if they have to consider the
preroga!ves of all the stakeholders, as Lipton maintains.
Bebchuk (2007) cites a widely quoted 1988 ruling by the Delaware courts that "the shareholder franchise is
the ideological underpinning upon which the legi!macy of directorial power rests" and points out that
corporate law gives boards the authority to hire and fire management and set the company's overall
direc!on. Next, he argues that since directors are expected to serve as the shareholders' guardians,
shareholders must have the power to replace them. Thus, the fear of being replaced is supposed to make
directors accountable and provide them with incen!ves to serve shareholder interests.
He con!nues by no!ng just how infrequently US directors are actually challenged, much less removed, and
concludes that shareholder power to replace directors in the United States is largely a myth. To make
shareholder power real, he supports the proposal that directors be elected by a secret ballot open to rival
candidates nominated by shareholders. To put them on an equal foo!ng with the slate proposed by the
board's nomina!ng commi"ee (usually with management input), he suggests that challengers be reimbursed
by the corpora!on if they receive a threshold number of votes.
Taking the opposing view and challenging the widely accepted argument that a company's primary goal is to
maximize shareholder value, Lipton challenges the very no!on that corpora!ons are the private property of
stockholders. "Shareholders do not own corpora!ons," he says. "They own securi!es—shares of stock—
which en!tle them to very limited electoral rights and the right to share in the financial returns produced by
the corpora!on's business opera!ons" (Lipton & Savi", 2007, p. 733). Directors, he argues, are not merely
representa!ves of shareholders who have a legal responsibility to put investor interests first. Instead, the
role of the board is simply and du!fully to seek what is best for the company itself, which means balancing
the interests of shareholders as well as other stakeholders, such as management and employees, creditors,
regulators, suppliers, and consumers. He concludes that Bebchuk's no!on that a board's primary fiduciary
obliga!on is to shareholders is a myth of corporate law.
Learning Topic
2/1/21, 4:20 PMGovernance and Accountability
Page 2 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
Focus of US Governance Law: Conduct or Accountability?
Governance in the United States has evolved as a medley of federal law—including not only corpora!on law
but also tax and labor law—state law, and a series of codes of various self-regula!ng authori!es ranging
from the NYSE to the accoun!ng industry. State law has tradi!onally been the ul!mate arbiter of
governance issues. In contrast, in the United Kingdom, corporate reform can be affected simply through an
act of Parliament.
This unusual history of governance law in the United States has created an opening to support different
interpreta!ons of a variety of its provisions. For example, the law not only iden!fies shareholders as the
owners of the corpora!on but also defines them as investors who receive ownership in the corpora!on in
return for money or assets they invest. It s!pulates that shareholders are responsible for elec!ng a board of
directors, the operators of the corpora!on who have overall responsibility for the business of the
corpora!on, but it does not meaningfully address the implementa!on of this statute. It also specifies that
the board of directors, rather than its shareholders, directs a company's business and affairs.
Addi!onal guidance about a board's fiduciary role is contained in statutes governing the role and conduct of
individual board members. Specifically those defining a director's obliga!on in terms of such principles as
the duty of care, duty of loyalty, and the business judgment rule. The duty of care requires directors to be
informed, prior to making a business decision, of all material informa!on reasonably available to them in the
exercise of their management of the affairs of a corpora!on. The duty of loyalty protects the corpora!on
and its shareholders. It requires directors to act in good faith and in the best interests of the corpora!on and
its shareholders. The prevalent legal standard is that the duty of loyalty requires that the director be
"disinterested," such that he or she "neither appears on both sides of a transac!on nor expects to derive any
personal financial benefit from it," and his or her decision must be "based on the corporate merits of the
subject before the board rather than extraneous considera!ons or influences" (The American Law Ins!tute,
1994, p. 61). The business judgment rule protects directors from liability for ac!on taken by them if they act
on an informed basis in good faith and in a manner they reasonably believe to be in the best interests of the
corpora!on's shareholders. The business judgment rule does not apply in cases of fraud, bad faith, or self-
dealing.
As long as these principles are adhered to and as long as directors are careful and loyal to corporate and
shareholder interests, they have wide discre!on to exercise their business judgment as they see fit. None of
these principles provide clear guidance to the central ques!on of who owns the corpora!on.
Corporate Purpose: A Societal Perspec!ve
One reason that US governance law is some!mes indeterminate is that the enormous differences between
the two legal views described above reflect a broader, philosophical debate on the role and purpose of
corpora!ons in society. Indeed, opposing views on the purpose and accountability of the corpora!on—
shareholders versus stakeholders, or private (property) versus public (social and poli!cal en!ty) concep!ons
of the corpora!on—have been part of the governance debate for well over 100 years.
Shareholder capitalism, un!l recently prevalent mainly in the United States and the United Kingdom, holds
that a company is the private property of its owners. From a legal perspec!ve, the Anglo-American
corpora!on is essen!ally a capital market ins!tu!on, primarily accountable to shareholders, charged with
crea!ng wealth by exploi!ng market opportuni!es. Stakeholder capitalism, on the other hand, embodies a
more organic view of the corpora!on in which companies have broader obliga!ons that balance the
interests of shareholders with those of other stakeholders, notably employees but also including suppliers,
2/1/21, 4:20 PMGovernance and Accountability
Page 3 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
distributors, customers, and the community at large. Under this set of beliefs, the corpora!on is seen as an
ins!tu!on with a con!nuing purpose, and therefore, with a life of its own. Shareholders and wealth crea!on
for owners do not dictate its priori!es. Rather, a deep concern for employees, suppliers, and customers, and
implicitly for its own con!nued existence, defines the corporate mission.
Stakeholder capitalism can take different forms, reflec!ng the degree of commitment to different
stakeholders. Germany's legal system, for example, makes it clear that firms do not have a sole duty to
pursue the interests of shareholders. Under Germany's system of codetermina!on, employees and
shareholders in large companies hold an equal number of seats on the companies' supervisory boards, and
the interests of both par!es must be taken into account in decision making. In Denmark, employees in firms
with more than 35 workers elect one-third of the firm's board members, with a minimum of two. In Sweden,
companies with more than 25 employees must have two labor representa!ves appointed to the board.
These employee board members have all the rights and du!es of other board members.
The situa!on differs somewhat in France. French firms with more than 50 workers have employee
representa!ves at board mee!ngs, but they do not have the right to vote. More conven!onal
codetermina!on systems exist for former public-sector French firms that have been priva!zed. These
systems can be introduced voluntarily by companies. In Finland, companies can also voluntarily adopt
employee representa!ves on the board. Across the European Union (EU) as a whole, another type of worker
par!cipa!on in decision making is the works council, a group that has a say in such issues as layoffs and
plant closures. A corpora!on with at least 1,000 employees, of which there are 150 or more in at least two
EU countries, must have a European Works Council.
Japanese firms also differ from those in the United States and the United Kingdom. Japanese execu!ves do
not have a fiduciary responsibility to stockholders, but they can be liable for gross negligence in performing
their du!es. At the same !me, it is accepted prac!ce in Japan that managers align their priori!es with the
interests of a variety of stakeholders. For example, a recent survey revealed that if Japanese execu!ves feel
that the company is going through a tough period financially, keeping their employees on the job is much
more important than maintaining dividends to shareholders. Specifically, only 3 percent of Japanese
managers said companies should maintain dividend payments to stockholders under such circumstances.
This compares with 41 percent in Germany, 40 percent in France, and 89 percent in both the United States
and the United Kingdom.
In the United States, these issues also con!nue to be debated. Some !me ago Reason (2005) magazine
featured a spirited debate featuring the late Milton Friedman, former senior research fellow at the Hoover
Ins!tu!on and Paul Snowden Russell Dis!nguished Service Professor of Economics at the University of
Chicago; John Mackey, founder and CEO of Whole Foods Market; and others, on the purpose of the
corpora!on. Friedman, a Nobel laureate in economics and the author of a famous 1970 New York Times
Magazine ar!cle !tled "The Social Responsibility of Business Is to Increase Its Profits," had no pa!ence with
capitalists who claimed that "business is not concerned 'merely' with profit but also with promo!ng
desirable 'social' ends; that business has a 'social conscience' and takes seriously its responsibili!es for
providing employment, elimina!ng discrimina!on, avoiding pollu!on, and whatever else may be the
catchwords of the contemporary crop of reformers" (Friedman, 1970).
He wrote that such people are "preaching pure and unadulterated socialism. Businessmen who talk this way
are unwi$ng puppets of the intellectual forces that have been undermining the basis of a free society these
past decades."
2/1/21, 4:20 PMGovernance and Accountability
Page 4 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
Mackey disagreed vehemently with Friedman. A self-described ardent libertarian who likes to quote Ludwig
von Mises on Austrian economics and Abraham Maslow on humanis!c psychology, and is a student of
astrology, Mackey believes Friedman's view of business is too narrow and underes!mates the humanitarian
poten!al of capitalism. Selected por!ons of this debate are reprinted below, beginning with Mackey's
passionate, personal vision of the social responsibility of business.
In 1970 Milton Friedman wrote that "there is one and only one social responsibility of business—to use
its resources and engage in ac!vi!es 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 compe!!on without decep!on or fraud." That's
the orthodox view among free market economists—that the only social responsibility a law-abiding
business has is to maximize profits for the shareholders.
I strongly disagree. I'm a businessman and a free market libertarian, but I believe that the enlightened
corpora!on should try to create value for all of its cons!tuencies. From an investor's perspec!ve, the
purpose of the business is to maximize profits. But that's not the purpose for other stakeholders—for
customers, employees, suppliers, and the community. Each of those groups will define the purpose of
the business in terms of its own needs and desires, and each perspec!ve is valid and legi!mate.
(Friedman, Mackey, & Rodgers, 2005)
Mackey con!nues, "We have not achieved our tremendous increase in shareholder value by making
shareholder value the primary purpose of our business…the most successful businesses put the customer
first, ahead of the investors. In the profit-centered business, customer happiness is merely a means to an
end: maximizing profits. In the customer-centered business, customer happiness is an end in itself, and will
be pursued with greater interest, passion, and empathy than the profit-centered business is capable of."
Not surprisingly, Friedman respected Whole Foods' success but took issue with its business philosophy.
"Maximizing profits is an end from the private point of view," he wrote. "It is a means from the social point of
view. A system based on private property and free markets is a sophis!cated means of enabling people to
cooperate in their economic ac!vi!es without compulsion; it enables separated knowledge to assure that
each resource is used for its most valued use, and is combined with other resources in the most efficient
way."
Mackey replied, "While Friedman believes that taking care of customers, employees, and business
philanthropy are means to the end of increasing investor profits, I take the exact opposite view: Making high
profits is the means to the end of fulfilling Whole Foods' core business mission. We want to improve the
health and well-being of everyone on the planet through higher-quality foods and be"er nutri!on, and we
can't fulfill this mission unless we are highly profitable. High profits are necessary to fuel our growth across
the United States and the world. Just as people cannot live without ea!ng, so a business cannot live without
profits. But most people don't live to eat, and neither must a business live just to make profits" (Friedman,
Mackey, & Rodgers, 2005).
Mackey's logic was perhaps most effec!vely first ar!culated by Peter Drucker in 1974 in his famous book
Management: Tasks, Responsibili!es and Prac!ces. "The purpose of a business is not to make a profit,"
Drucker wrote. "Profit is a necessity and a social responsibility. A business, regardless of the economic and
legal arrangements of society, must produce enough profit to cover the risks of commi$ng today's
economic resources to the uncertain!es of the future; to produce the capital for the jobs of tomorrow; and
to pay for all the non-economic needs and sa!sfac!ons of society from defense and the administra!on of
jus!ce to the schools and the hospitals, and from the museums to the boy scouts. But profit is not the
purpose of business. Rather a business exists and gets paid for its economic contribu!on. Its purpose is to
create a customer" (Drucker, 1974, p. 67).
2/1/21, 4:20 PMGovernance and Accountability
Page 5 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
This discussion raises ques!ons that transcend the legal debate on fiduciary obliga!ons. It asks us to
consider ques!ons, such as, What does society want from corpora!ons? What are the moral obliga!ons and
responsibili!es of business? Who has the right to make such decisions in a public company? Is shareholder
wealth maximiza!on the right objec!ve? What obliga!ons does a company have to other stakeholders, such
as employees or suppliers, and the community at large? Are these objec!ves necessarily in conflict with
each other? If so, how should trade-offs be made? Furthermore, the discussion suggests that to be
consistent and effec!ve, directors and boards should have ready answers to many, if not all, of the ques!ons
and know where they agree or disagree. As we shall see, regre"ably, this is not true. Not only has the United
States, as a society, changed its perspec!ve on this issue several !mes, but also, today, the majority of
directors remain confused, some!mes in!midated, by the law and o&en are unwilling or unable to debate
these issues openly.
The Primacy of Shareholder Interests: A Historical Perspec!ve
During the first part of the nineteenth century, the corpora!on was viewed as a social instrument for the
state to carry out its public policy goals, and each instance of incorpora!on required a special act of the
state legislature. The func!on of the law was to protect stakeholders by making sure corpora!ons would not
pursue ac!vi!es beyond their original charter or state of incorpora!on. By the end of the nineteenth
century, states began to allow general incorpora!on, which fueled an explosive growth in the crea!on of
companies for private business purposes. In its a&ermath, concern for stakeholder welfare gave way to the
concept of managing the corpora!on for shareholders' profits. This sec!on draws on Sundaram and Inkpen
(2004).
In 1919 the primacy of shareholder value maximiza!on was affirmed in a ruling by the Michigan State
Supreme Court in Dodge vs. Ford Motor Company. Henry Ford wanted to invest Ford Motor Company's
considerable retained earnings in the company rather than distribute it to shareholders. The Dodge
brothers, minority shareholders in Ford Motor Company, brought suit against Ford, alleging that his
inten!on to benefit employees and consumers was at the expense of shareholders. In their ruling, the
Michigan court agreed with the Dodge brothers:
A business corpora!on is organized and carried on primarily for the profit of the stockholders. The powers
of the directors are to be employed for that end. The discre!on of directors is to be exercised in the choice
of means to a"ain that end, and does not extend to a change in the end itself, to the reduc!on of profits, or
to the non-distribu!on of profits among stockholders in order to devote them to other purposes (Dodge v.
Ford Motor Co., 1919).
In The Modern Corpora!on and Private Property, published in 1932, Adolph Berle and Gardiner Means
provided important intellectual support for the shareholder value norm. In this now classic book, the authors
called a"en!on to a new phenomenon affec!ng corpora!ons in the United States at the !me. They noted
that ownership of capital had become widely dispersed among many small shareholders, yet control was
concentrated in the hands of just a few managers. Berle and Means warned that the separa!on of
ownership and control would destroy the very founda!on of the exis!ng economic order and argued that
managing on behalf of the shareholders was the sine qua non of managerial decision making because
shareholders were property owners.
Following the 1929 stock market crash and the Great Depression, stakeholder concerns were being voiced
once again. If the corpora!on is an en!ty separate from its shareholders, it was argued, it has ci!zenship
responsibili!es (Dodd, 1932, p. 1145–1163). According to this point of view, rather than being an agent for
shareholders, the role of management is that of a trustee with ci!zenship responsibili!es on behalf of all
2/1/21, 4:20 PMGovernance and Accountability
Page 6 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
cons!tuencies, even if it means a reduc!on in shareholder value. In the following years, states adopted a
number of stakeholder statutes reflec!ng this new sense of corporate responsibility toward
nonshareholding cons!tuencies, such as labor, consumers, and the natural environment.
By the end of the twen!eth century, however, despite state-level legisla!ve efforts to the contrary,
American-style market-driven capitalism had prevailed and the pendulum swung back to the shareholder.
Friedman's (1970) view that the "sole social responsibility of business is to increase profits" energized a push
back on corporate social responsibility. In the mean!me, agency theory emerged. Agency theory is directed
at the dilemma in which one party (the shareholder as the principal) delegates work to another
(management as the agent) who performs that work. Agency theory is concerned with resolving two
problems that can occur in such a rela!onship. The first is the agency problem that arises when (1) the
desires or goals of the principal and agent conflict and (2) it is difficult or expensive for the principal to verify
what the agent is actually doing. The issue here is that the principal cannot verify that the agent has
behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent
have different a$tudes toward risk. In this situa!on, the principle and the agent may prefer different ac!ons
because of the different risk preferences and the concept of the corpora!on as a nexus of contracts
(Easterbrook & Fischel, 1991). The nexus of contracts theory views the firm not as an en!ty but as an
aggregate of various inputs brought together to produce goods or services. Employees provide labor.
Creditors provide debt capital. Shareholders ini!ally provide equity capital and subsequently bear the risk of
losses and monitor the performance of management. Management monitors the performance of employees
and coordinates the ac!vi!es of all the firm's inputs. The firm is seen as simply a web of explicit and implicit
contracts establishing rights and obliga!ons among the various inputs making up the firm.
To protect the interests of other stakeholders, 30 states in the United States enacted stakeholder statutes
that allowed directors to consider the interests of nonshareholder cons!tuencies in corporate decisions.
Thus, the law gave boards la!tude in determining what is in the best long-term interests of the corpora!on
and how to take the interests of other stakeholders into account. Nevertheless, the mainstream US
corporate law remains commi"ed to the principle of shareholder wealth maximiza!on.
Governance Without a Shared Purpose?
The lack of a clear, shared consensus about why a company exists, to whom directors are accountable, and
what criteria they should use to make decisions—in the law as well as in society at large—is a significant
obstacle to increasing the effec!veness of the corporate governance func!on. When boards operate with
tacit assump!ons about their objec!ves and loyal!es, they may hide poten!al disagreements among their
members and sacrifice effec!veness. Such hidden disagreements make it difficult to get consensus on
complex issues, such as what qualifica!ons a CEO should have, whether or not to outsource parts of the
value chain, or how to evaluate and compensate top management.
Lorsch (1989) first iden!fied the confusion among directors about their accountabili!es. Based on their
beliefs, he categorized directors as belonging to one of three groups: tradi!onalists, ra!onalizers, or broad
construc!onists. Each has a different vision of what the modern corpora!on's fundamental purpose is and,
therefore, to whom and for what a board should be held accountable.
Tradi!onalists see themselves as accountable to shareholders only. For them, there is no need to debate the
fundamental purpose of the modern corpora!on—it is and always has been the maximiza!on of shareholder
value. They do not believe there is a conflict between pu$ng the shareholder first and responding to the
needs of other cons!tuencies, and therefore experience li"le role ambiguity or conflict. Members of this
2/1/21, 4:20 PMGovernance and Accountability
Page 7 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
group find support for their posi!on in a narrow interpreta!on of current state and federal law. They also
tend to view the highly publicized abuses at Enron, WorldCom, Vivendi, and other companies as anomalies
made possible by imperfec!ons in the current system, rather than as indicators of more systemic problems.
A second, larger group—the ra!onalizers—experiences more anxiety about their role as directors. They
recognize that, in today's complex, global economy, real tensions can occur between the interests of
different cons!tuencies and that not all decisions can be reduced to the simple formula that assumes what
is good for the shareholder is good for everyone else. Examples include whether or not to close a domes!c
plant in favor of manufacturing in a low-cost, foreign loca!on; whether or not to outsource produc!on to
lower cost suppliers; or how to respond to pressures for greener opera!ons.
The final group, which Lorsch labels the broad construc!onists, recognizes specific responsibili!es to
cons!tuencies other than shareholders and is willing to act on its convic!ons. Directors belonging to this
group constantly struggle to balance their views with the more tradi!onal view of a director's
accountabili!es and—to stay within the boundaries of the law—frame their decisions in terms of what is in
the best long-term interest of the corpora!on as a whole.
Lorsch summarized his findings sta!ng, "Thus we found the majority of directors felt trapped in a dilemma
between their tradi!onal legal responsibility to shareholders, whom they consider too interested in short-
term payout, and their beliefs about what is best, in the long run, for the health of the company." He further
observed that in many boards a group norm had evolved, prohibi!ng open discussion of a board's true
purpose and that a lot of directors were unaware of recent rulings in the evolving legal context that grant
them the la!tude to consider cons!tuencies other than shareholders.
In recent years the issue of a board's primary role and accountability has, if anything, become even more
confusing. Despite strong rhetoric from many quarters advoca!ng maximiza!on of shareholder value as a
company's primary goal, there is a growing recogni!on that a company and the board have broader
responsibili!es. This trend reflects the fact that real—that is, economic and psychological rather than legal—
ownership of the corpora!on is moving from shareholders to employees, customers, and other stakeholders
that make up the human capital of the firm.
This trend has created problems for directors. As Carter & Lorsch (2004) note, "Boards have a real challenge
in deciding to whom they are really responsible and where their commitments ul!mately lie. Directors must
think about and discuss among themselves the cons!tuencies and the !me horizons they have in mind as
they think about the board's responsibili!es. Many boards have skirted discussion of these complex issues.
They seem too abstract, and reaching a consensus among board members about them can take more of that
most precious commodity—!me—than directors want to devote."
Is Shareholder Value Maximiza!on the Right Objec!ve?
In their widely cited book The Value Impera!ve—Managing for Superior Shareholder Returns, McTaggart,
Kontes, and Mankins (1994) write, "Maximizing shareholder value is not an abstract, shortsighted,
imprac!cal, or even, some might think, sinister objec!ve. On the contrary, it is a concrete, future-oriented,
pragma!c, and worthy objec!ve, the pursuit of which mo!vates and enables managers to make substan!ally
be"er strategic and organiza!onal decisions than they would in pursuit of any other goal. And its
accomplishment is essen!al to the welfare of all the company's stakeholders, for it is only when wealth is
created that customers will con!nue to enjoy a flow of new, be"er, and cheaper products and the world's
economies will see new jobs created and old ones improved."
Implicit in this statement are three important assump!ons, all of which can be challenged:
2/1/21, 4:20 PMGovernance and Accountability
Page 8 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
Shareholder value is the best measure of wealth crea!on for the firm.
Shareholder value maximiza!on produces the greatest compe!!veness.
Shareholder value maximiza!on fairly serves the interests of the company's other stakeholders.
With respect to the first assump!on, it can be argued that firm value, which also includes the values to all
other financial claimants, such as creditors, debt holders, and preferred shareholders, is a be"er indicator of
wealth. The importance of dis!nguishing between firm value and shareholder value lies in the fact that
managers and boards can make decisions that transfer value from debt holders to shareholders and
decrease total firm and social value while increasing shareholder value.
The second assump!on—that shareholder value maximiza!on produces the greatest long-term
compe!!veness—can also be challenged. An increasingly influen!al group of cri!cs, which also includes a
substan!al number of CEOs, thinks product-market rather than capital-market objec!ves should guide
corporate decision making. They worry that companies that adopt shareholder value maximiza!on as their
primary purpose lose sight of producing or delivering a product or service as their central mission, and that
shareholder value maximiza!on creates a gap between the mission of the corpora!on and the mo!va!ons,
desires, and capabili!es of the company's employees who only have direct control over real, current,
corporate performance. They note that shareholder value maximiza!on is simply not inspiring for
employees, even though they o&en share in some of the gains through benefit, bonus, or op!on plans. To
many of them, shareholders are nameless and faceless, under no obliga!on to hold their shares for any
length of !me, never sa!sfied, and always asking, "What will you do for me next?" Worse, they say, not only
does shareholder-value apprecia!on fail to inspire employees, it may encourage them to view maximizing
one's financial well-being as a legi!mate or even the only goal. Instead, they want companies to create a
moral purpose that not only provides a clear focus on crea!ng compe!!ve advantage for the company but
also unites its purpose, strategy, goals, and shared values into one overall, coherent management framework
that has the power to mo!vate cons!tuents and the legi!macy of the corpora!on's ac!ons in society
(Ellsworth, 2002, p. 6).
The third assump!on—that shareholder maximiza!on is congruent with fairly serving the interests is the
firm's other stakeholders—is perhaps most controversial. Proponents of shareholder value maximiza!on—
including many economists and finance theorists—are adamant that maximizing shareholder value is not only
superior as a fiduciary standard or management objec!ve but also as a societal norm. Jensen (2001), for
example, writes, "Two-hundred years of research in economics and finance have produced the result that if
our objec!ve is to maximize the efficiency with which society u!lizes its resources (that is to avoid waste
and to maximize the size of the pie), then the proper and unique objec!ve for each company in the society is
to maximize the long-run total value of the firm. Firm value will not be maximized, of course, with unhappy
customers and employees or with poor products. Therefore, consistent with stakeholder theory value-
maximizing firms will be concerned about rela!ons with all their cons!tuencies. A firm cannot maximize
value if it ignores the interest of its stakeholders."
McTaggart et al. (1994) also believe shareholder value maximiza!on allows managers and boards to resolve
any conflicts to everyone's long-term benefit. Consider, for example, their prescrip!on for resolving trade-
offs between customer- and shareholder-focused investments. "As long as management invests in higher
levels of customer sa!sfac!on that will enable shareholders to earn an adequate return on their investment,
there is no conflict between maximizing shareholder value and maximizing customer sa!sfac!on. If,
however, there is insufficient financial benefit to shareholders from a"empts to increase customer
sa!sfac!on, the conflict should be resolved for the benefit of shareholders to avoid diminishing both the
financial health and long-term compe!!veness of the business."
2/1/21, 4:20 PMGovernance and Accountability
Page 9 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
Not surprisingly, stakeholder theorists take a different point of view. They argue that shareholders are but
one of a number of important stakeholder groups and that, like customers, suppliers, employees, and local
communi!es, have a stake in and are affected by the firm's success or failure. To stakeholder theory
advocates, an exclusive focus on maximizing stockholder wealth is both unwise and ethically wrong. Instead,
the firm and its managers have special obliga!ons to ensure that the shareholders receive a fair return on
their investment. But the firm also has special obliga!ons to other stakeholders, which go above and beyond
those required by law (Freeman, 1984, p. 17).
More recently, Ian Davis, managing director of McKinsey, cri!cized the shareholder value maximiza!on
doctrine on altogether different grounds. He observed that, in today's global business environment, the
concept of shareholder value is rapidly losing relevance in the face of the larger role played by government
and society in shaping business and industry elsewhere in the world. "In much of the world," he wrote,
"government, labor and other social forces have a greater impact on business than in the U.S. or other more
free-market Western socie!es. In China, for example, government is o&en an owner. If you're talking in
China about shareholder value, you will get blank looks. Maximiza!on of shareholder value is in danger of
becoming irrelevant (Davis, 2006).
Finally, a growing number of par!es, including CEOs, while not ques!oning that shareholder value
maximiza!on is the right objec!ve, are concerned about its implementa!on. They worry that the stock
market has a bias toward short-term results and that stock price, the most common gauge of shareholder
wealth, does not reflect the true long-term value of a company. Lucent Technologies CEO Henry Schacht,
for example, has stated, "What has happened to us is that our execu!on and processes have broken down
under the white-hot heat of driving for quarterly revenue growth" (Loomis, 2003).
Stakeholder Theory: A Viable Alterna!ve?
Although the recogni!on of stakeholder obliga!ons has been with us since the birth of the modern
corporate form, the development of a coherent stakeholder theory awaited a shi& in legal thinking from a
perspec!ve on shareholders as owners to one of investors, more on a par with providers of other inputs that
a company needs to produce goods or services. Whereas the ownership perspec!ve, rooted in property law,
provides a natural basis for the primacy of shareholder rights, the view of the corpora!on as a bundle of
contracts permits a different view of the fiduciary obliga!ons of corporate managers. According to Freeman
and McVea (2001), "The stakeholder framework does not rely on a single overriding management objec!ve
for all decisions. As such it provides no rival to the tradi!onal aim of 'maximizing shareholder wealth.' To the
contrary, a stakeholder approach rejects the very idea of maximizing a single-objec!ve func!on as a useful
way of thinking about management strategy. Rather, stakeholder management is a never ending task of
balancing and integra!ng mul!ple rela!onships and mul!ple objec!ves.
To pragma!sts, the rejec!on of a single criterion for making corporate decisions is problema!c. Directors
occasionally face situa!ons in which it is impossible to advance the interests of one set of stakeholders and
simultaneously protect those of others. Whose interests should they pursue when there is an irreconcilable
conflict? Consider the decision whether or not to close down an obsolete plant. The closing will harm the
plant's workers and the local community but will benefit shareholders, creditors, employees working at a
more modern plant to which the work previously performed at the old plant is transferred, and communi!es
around the modern plant. Without a single guiding decision criterion, how should the board decide?
The problem is not just one of uncertainty or unpredictability. Ul!mately, the stakeholder model is flawed
because of its failure to account adequately for what Bainbridge (1993) calls "managerial sin." The absence
of a single decision-making criterion allows management to freely pursue its own self-interest by playing
shareholders off against nonshareholders. When management's interests coincide with those of
2/1/21, 4:20 PMGovernance and Accountability
Page 10 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
shareholders, management can jus!fy its decision by saying that shareholder interests prevailed in this
instance, and vice versa. The plant closing decision described above provides a useful example: Shareholders
and some nonshareholder cons!tuents benefit if the plant is closed, but other nonshareholder cons!tuents
lose. If management's compensa!on is !ed to firm size, we can expect it to resist any downsizing of the firm.
The plant likely will stay open, with the decision being jus!fied by the impact of a closing on the plant's
workers and the local community. In contrast, if management's compensa!on is linked to firm profitability,
the plant will likely close, with the decision being jus!fied by management's concern for the firm's
shareholders, creditors, and other cons!tuencies that benefit from the closure decision.
It has been argued that shareholders, in fact, are more vulnerable to management misconduct than
nonshareholder cons!tuencies. Legally, shareholders have essen!ally no power to ini!ate corporate ac!on
and, moreover, are en!tled to vote on only very few corporate ac!ons. Under the Delaware code,
shareholder vo!ng rights are essen!ally limited to the elec!on of directors and the approval of charter or
bylaw amendments, mergers, sales of substan!ally all of the corpora!on's assets, and voluntary dissolu!ons.
As a formal ma"er, only the elec!on of directors and the amendment of the bylaws do not require board
approval before shareholder ac!on is possible.
In prac!ce, of course, even the elec!on of directors, absent a proxy contest, is predetermined by the
exis!ng board nomina!ng the following year's board. Rather, formal decision-making power resides mainly
with the board of directors. As a prac!cal ma"er, of course, the sheer mechanics of undertaking collec!ve
ac!on by thousands of shareholders preclude them from meaningfully affec!ng management decisions. In
effect, shareholders, just like nonshareholder cons!tuencies, have but a single mechanism by which they can
nego!ate with management—withholding their inputs (capital). But withholding inputs may be a more
effec!ve tool for nonshareholders than it is for shareholders. Some firms go for years without seeking equity
investments. If the management groups in these firms disregard shareholder interests, the shareholders have
no op!on other than to sell out at prices that will reflect management's lack of concern for shareholder
wealth. In contrast, few firms can survive for long without regular infusions of new employees and new debt
financing. As a result, few management groups can prosper while ignoring nonshareholder interests.
Nonshareholder cons!tuencies o&en also are more effec!ve in protec!ng themselves through the poli!cal
process. Shareholders—especially individuals—typically have no meaningful poli!cal voice. In contrast, many
nonshareholder cons!tuencies are represented by cohesive, poli!cally powerful interest groups. Unions, for
example, played a major role in passing state an!takeover laws. Environmental concerns are increasingly a
factor in regulatory ac!ons. From this point of view, it can be argued that an explicit focus on balancing
stakeholder interests is not only imprac!cal but also unnecessary because nonshareholder cons!tuencies
already have adequate mechanisms to protect themselves from management misconduct.
Resolving the Conflict: Toward Enlightened Value Maximiza!on?
Jensen (2001) believes the inherent conflict between the doctrine of shareholder value maximiza!on and
the objec!ves of stakeholder theory can be resolved by melding together "enlightened" versions of these
two philosophies:
Enlightened value maximiza!on recognizes that communica!on with and mo!va!on of an
organiza!on's managers, employees, and partners is extremely difficult. What this means in prac!ce is
that if we simply tell all par!cipants in an organiza!on that its sole purpose is to maximize value, we
will not get maximum value for the organiza!on. Value maximiza!on is not a vision or a strategy or
even a purpose; it is the scorecard for the organiza!on. We must give people enough structure to
understand what maximizing value means so that they can be guided by it and therefore have a chance
to actually achieve it. They must be turned on by the vision or the strategy in the sense that it taps into
2/1/21, 4:20 PMGovernance and Accountability
Page 11 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
some human desire or passion of their own—for example, a desire to build the world's best automobile
or to create a film or play that will move people for centuries. All this can be not only consistent with
value seeking, but a major contributor to it.
Indeed, it is a basic principle of enlightened value maximiza!on that we cannot maximize the long-term
market value of an organiza!on if we ignore or mistreat any important cons!tuency. We cannot create
value without good rela!ons with customers, employees, financial backers, suppliers, regulators, and
communi!es. But having said that, we can now use the value criterion for choosing among those
compe!ng interests. I say "compe!ng" interests because no cons!tuency can be given full sa!sfac!on
if the firm is to flourish and survive. Moreover, we can be sure—again, apart from the possibility of
externali!es and monopoly power—that using this value criterion will result in making society as well
off as it can be. (Jensen, 2001, p. 16)
Thus, Jensen defines "enlightened" stakeholder theory simply as stakeholder theory with the specifica!on
that maximizing the firm's total long-term market value is the right objec!ve func!on. The words "long-
term" are key here. As Jensen notes, "In this way, enlightened stakeholder theorists can see that although
stockholders are not some special cons!tuency that ranks above all others, long-term stock value is an
important determinant (along with the value of debt and other instruments) of total long-term firm value.
They would recognize that value crea!on gives management a way to assess the tradeoffs that must be
made among compe!ng cons!tuencies, and that it allows for principled decision making independent of the
personal preferences of managers and directors (Jensen, 2001, p. 17).
Even though shareholder value maximiza!on is increasingly being challenged on pragma!c as well as moral
grounds, its roots in private property law, however—a profound element in the American ethos—guarantee
that it will con!nue to dominate the US approach to corporate law for the foreseeable future. As a prac!cal
ma"er, the courts have given boards increasing la!tude in determining what is in the best long-term
interests of the corpora!on and how to take the interests of other stakeholders into account. This la!tude
makes it impera!ve that directors openly and fully discuss these issues and agree on a clear, unambiguous
statement of purpose for the corpora!on.
Glossary
agency theory a theory that a"empts to reconcile the rela!onship between shareholders and the agent of the shareholders (for example, the corpora!on's
managers)
board of directors an elected group of business individuals who have overall responsibility for the business of the corpora!on
broad construc!onists directors who recognize and are willing to act on responsibili!es to cons!tuencies other than shareholders
business judgment rule a rule that protects directors from liability if they act on an informed basis in good faith and in a manner they reasonably believe to be in the best
interests of the corpora!on's shareholders. This does not apply in cases of
fraud, bad faith, or self-dealing
duty of care a statute that requires directors, before making a business decision, to be informed of all material informa!on reasonably available to them in
exercising their management of the corpora!on's affairs
duty of loyalty a statute that protects a corpora!on and its shareholders by requiring directors to act in good faith and in the corpora!on's and shareholders'
2/1/21, 4:20 PMGovernance and Accountability
Page 12 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
References
American Law Ins!tute. (1994). Principles of corporate governance: Analysis and recommenda!ons.
Philadelphia: Author.
Bainbridge, S. M. (1993). In defense of the shareholder wealth maximiza!on norm: A reply to Professor
Green. Washington and Lee Law Review, 50, 1423.
Bebchuk, L. (2007, May). The myth of the shareholder franchise. Virginia Law Review, 93(3), 675.
Bernstein, A. (2008). Lipton vs. Bebchuck. Directorship, 33(6), 20–25.
Carter, C. B., & Lorsch, J. W. (2004). Back to the drawing board—Designing corporate boards for a complex
world. Boston: Harvard Business School Press.
best interests
enlightened stakeholder theory
a theory that corporate value cannot be maximized unless the corpora!on
concerns itself with all its cons!tuent stakeholders, with the specifica!on
that maximizing the corpora!on's long-term market value is the right goal
enlightened value maximiza!on
a theory that recognizes that corporate decision-makers need to be more
sensi!ve to nonshareholder cons!tuencies, that maximizing shareholder
value does not produce the most value for the organiza!on
management execu!ves who act in a trustee manner toward a corpora!on's nonshareholders, including labor, consumers, and the environment
ra!onalizers directors who recognize the tensions that occur in the interests among different cons!tuencies but who nevertheless act primarily for the sake of
shareholders
shareholder capitalism an economic system of capitalism that holds that a company is the private property of its owners
shareholder value the value of profit that a corpora!on earns for employees, suppliers, and other creditors
shareholder value maximiza!on
a doctrine that holds that a company's ul!mate success can be measured
by the extent to which shareholders' wealth and stock value are increased
stakeholder capitalism an economic system of capitalism that holds that companies balance the interests of shareholders with those of other stakeholders, primarily
employees but also suppliers, distributors, customers, and the community
at large; holds the view that companies have a broader obliga!on than
shareholder capitalism
stakeholder theory a theory that corporate value cannot be maximized unless the corpora!on concerns itself with all its cons!tuent stakeholders
strategy a method for guiding management's choices about where to compete-- which customers to serve, with what products and services, and how to
deliver those products to customers effec!vely and profitably
tradi!onalists directors who see themselves as being accountable only to shareholders
value maximiza!on the maximiza!on of a corpora!on's common stock by increasing the wealth of that corpora!on's shareholders
2/1/21, 4:20 PMGovernance and Accountability
Page 13 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
Davis, I. (2006, November 1). Maximizing shareholder value doesn’t cut it anymore. Knowledge@Wharton.
Dodd, M. E. (1932). For whom are corporate managers trustees. Harvard Law Review, 45, 1145–1163.
Dodge v. Ford Motor Co., 170 NW, 668 (Mich 1919).
Easterbrook, F. H., & Fischel, D. R. (1991). The economic structure of corporate law. Cambridge, MA:
Harvard University Press.
Ellsworth, R. R. (2002). Leading with purpose: The new corporate reali!es. Stanford, CA: Stanford University
Press.
Freeman, R. E. (1984). Strategic management: A stakeholder approach. Boston: Pitman.
Friedman, M. (1970, September 13). The social responsibility of business is to increase profits. New York
Times Magazine, 32–33, 122, 124, 126.
Friedman, M., Mackey, J., & Rodgers, T. J. (2005). Rethinking the social responsibility of business. Reason.
Jensen, M. C. (2001). Value maximiza!on, stakeholder theory, and the corporate objec!ve func!on.
European Financial Management Review, 7(3), 297–317.
Lipton, M., & Savi", W. (2007, May). The many myths of Lucian Bebchuk. Virginia Law Review, 93(3), 733.
Loomis, C. J., (2003). The whistleblower and the CEO in the lucent scandal, the ex-boss will walk. Fortune.
Lorsch, J. (with MacIver, E.). (1989). Pawns and potentates—The reality of America’s corporate boards.
Watertown, MA: Harvard Business School Press.
McTaggart, J., Kontes, P., & Mankins, M. (1994). The value impera!ve—Managing for superior shareholder
value. New York: Free Press.
Sundaram, A. K., & Inkpen, A. C. (2004, May–June). The corporate objec!ve revisited. Organiza!on Science,
15(3), 350–363.
Resources
Corporate Governance
(h"p://link.galegroup.com.ezproxy.umgc.edu/apps/doc/CX3273100058/GVRL?
u=umd_umuc&sid=GVRL&xid=2b6c3a24)
Licenses and A"ribu!ons
2.1 Who Owns the Corpora!on? The Legal Debate (h"ps://saylordotorg.github.io/text_corporate-
governance/s04-governance-and-accountability.html) from Corporate Governance v. 1.0 was adapted by
Saylor Academy and is available under a Crea!ve Commons A"ribu!on-NonCommercial-ShareAlike 3.0
Unported (h"ps://crea!vecommons.org/licenses/by-nc-sa/3.0/) license without a"ribu!on as requested
by the work's original creator or licensor. UMUC has modified this work and it is available under the original
license.
2/1/21, 4:20 PMGovernance and Accountability
Page 14 of 14https://leocontent.umgc.edu/content/umuc/tgs/mba/mba670/2211/learning-topic-list/governance-and-accountability.html?ou=541222
© 2021 University of Maryland Global Campus
All links to external sites were verified at the !me of publica!on. UMGC is not responsible for the validity or integrity of informa!on located at
external sites.