2. Table of Contents
Introduction
Theories of Governance
Management Obligation towards Stakeholder and Stakeholder Issues:
Stakeholder Concept in Law
The UK Companies Act of 2017
Indian Companies Act (2013)
The Whistle Blower Protection Act, 2011
Stakeholder Orientation
Stakeholder Analysis
Stakeholder Engagement
Stakeholder Relationship Management
3. Introduction
The governance of today’s knowledge worker is a difficult task and the workplace environment is becoming
increasingly challenging with every passing day.
The corporate leadership of today is seriously struggling with trust deficit and their activities are subjected to
thorough scrutiny.
It is the instrumental duty of the business to create long term wealth for the stakeholders served by the firm
and at the same time as a corporate citizen the business is obliged to honor the normative responsibilities that
it holds towards all the stakeholders.
4. Theories of Governance
There are four important theories of governance that try to answer the above quandary:
Agency Theory
Stewardship Theory
Shareholder Theory
Stakeholder Theory
5. Agency Theory: This theory aims to explain the complex relationship between a firm’s manager (Agent) and
the firm’s owners (Principals, stock holders or investors).
As per Agency Theory there is a separation of ownership and control in the modern organizations due to which
a clash of interest may happen between the principal (owner) and the agent (manager).
The Principals invest capital and establish firm to earn money. They frame the objectives and design the
governance system of the firm, but they may not have the necessary knowledge, skill, resources and time to
achieve the objectives of the firm on their own so they appoint agents (manager) and give them control over
business. The managers are thus expected to act in good faith and protect the interest of the principals (owners)
and remain faithful to the laid down objectives of the firm.
6. There is a contract between all the parties to
1. Maximize the value of the organization
2. Reduce the agency cost. The agency cost includes all those costs that owners or shareholders incur on
controlling the management. For example, if the managers are found guilty of misconduct then an inquiry and
legal proceedings against them involves the cost which is called an agency cost.
3. Adopting methods that most efficiently and transparently reflect the performance of the people in the
organization.
However, it is possible that the agents (managers) may have a different objective than principals (owners).
Principals (Owners) want to maximize wealth by earning higher dividend and Return on Investment. Agents
(managers) on the other hand have control of the business but they may have a different objective and
motivation like increased wages and bonuses, job security etc. which may not be in alignment with the interest
of the principals. Thus, within a company conflict of interest between principals and agents may arise. This is
called Principal-Agent problem.
7. Stewardship Theory: The theory is based upon the concept of steward which according to Cambridge
Dictionary means, “a person whose job is to organize a particular event or to provide services to particular
people or to take care of a particular place”.
This theory that was developed by Donaldson and Davis as an alternative view to the Agency Theory and it is
mainly value based. In stewardship it is presumed that manager will act as a steward or guardian to a
corporation and will work hard for the success of the firm.
The managers will fulfil their fiduciary duties towards the owners. Managers do not pursue individual goals,
but rather act as stewards whose motive is in alignment with the goals of the owners/principals.
The behavioural pattern of the management is collective, pro-organizational and trustworthy. The employees
are not treated as mere means to attain objective but instead they are valued as ends in themselves.
8. Matrix explaining the Choice between Agency and Stewardship Relationships: The matrix proposed by
Davis, Schoorman & Donaldson in 1997 explain the choice between Agency and Stewardship Relationship.
9. Shareholder Theory: Milton Friedman is considered as one of the most influential proponent of Shareholder
theory. This theory advocates that the business has sole obligation to maximize profit for its shareholders
because the shareholders are the owners of the business and in the long run, the pursuit of profit maximization
objective will ultimately lead to the economic benefits of everyone associated with the business.
Milton Friedman also criticized the view that business has a social responsibility and argued that these
responsibilities, should there be any, are to be shouldered by the managers of the business.
The owners of the business appoint managers to advance their economic interest which ultimately leads to a
fiduciary relationship between the shareholders (the owners of the business) and the managers of the business.
Thus we see that fiduciary relationship imposes upon managers a very broad “duty of loyalty” and “duty of
care” towards shareholders (in the same way that duties toward the patient form the core of professional ethics
for doctors, duties towards client the core of professional ethics for lawyers, etc.).
10. However, it is observed that shareholders have been vulnerable in their relations with managers. The scams like
ENRON, TYCO, SATYAM, PNB and others have exhibited the neglect, apathy and indifference of the
shareholders due to which the managers of these companies looted and enriched themselves at the cost of
shareholders. These scams were the result of unethical conduct by managers which were ignored by the
shareholders.
For example, Tyco CEO Mr. Dennis Kozlowski threw $2.1 million party on his wife’s birthday and the expenses
were half paid out by company’s fund.
11. Stakeholder Theory
R. Edward Freeman is considered as one of the main proponent of Stakeholder Theory. Freeman has
defined stakeholders in both narrow and broad terms.
In the narrow terms, Freeman defines stakeholder as groups that are vital to the success and survival of the
firm and in the broad terms, Freeman defines stakeholders as “any group who can affect or is affected by
the achievement of the organization's objective.”
Thus a stakeholder theory has two basic elements:
Principal of Corporate Legitimacy, which believes that the business should be managed for the benefit
of its stakeholders.
Stakeholder Fiduciary Principle, which maintains that managers have fiduciary responsibility towards
the stakeholders and to the corporation.
12. Management Obligation towards Stakeholder and
Stakeholder Issues
Shareholders and Investors: Investors and shareholders face following issues which should be addressed by
the managers;
Transparency in Communication:
Dividend and Protection of Assets:
Sound Financial Position:
13. Employees and Workers: Employees are important resources and assets of the organization and it is the duty
of the organization to take care of its employees and win their cooperation. Following employee related issues
should be addressed by the management:
Fair Compensation and Benefits
Training and Development
Employee Diversity
Good Working Condition
Recognition of Worker’s Right
14. Customers: Customers are the king and their satisfaction is one of the ultimate goals of any successful
organization. Therefore it is the duty of the organization and management to take care of following points:
Product Quality and Safety
Customer Grievance Redressal
Right Information and Fair Trade Practice
Regular flow of Goods
Suppliers: It is the duty of the organization to encourage its minority supplies and those from developing
countries. Organization should deal with them judiciously and courteously.
15. Community/Society: Organizations have responsibility towards society and community. The responsibilities of
business towards society are as following:
Public Health and Safety:
Efficient use of resources:
Employment Opportunities:
Socio Economic Objective:
Business Ethics
Environmental Groups: Business has responsibility to make optimum and efficient use of energy and
resources. It should minimize the emission of waste products and exercise restraint in causing the air, water, soil,
noise and other types of pollution. As a responsible organization it is expected to promote the use of
biodegradable and recyclable products.
16. Government: Every business has the responsibility to pay taxes with honesty and abide by the laid down rules
and regulations. It should refrain from promoting corruption, and other social evils.
Creditors: Business has following responsibilities towards its creditors:
provide accurate information about its financial potions to the creditors
It should ensure fair transactions and make prompt settlement of dues
17. Stakeholder Concept in Law
The stakeholder concept is reflected in the laws of many countries and these laws have been helpful in
governing and giving direction to the corporate for example; the tax laws, the environment protection laws, the
labor laws etc.
But, in the latest developments, the company laws have largely elaborated the duties of Company Directors.
Now it is the duty of the Directors to take care of Stakeholder’s interest.
Considering the judgement given by Justice Douglas in Pepper v. Litton, 308 U.S 295 (1939), we can presume
that Management bears a fiduciary relationship to the Stakeholders and the corporation should be managed for
the benefit of its stakeholders.
18. According to Berkeley Law Scholarship Repository, A moral obligation to exercise care in the performance of
one's role is also imposed on corporate directors and officers. This moral obligation is an aggregate comprised of
four relatively distinct duties, each of which requires separate analysis. These are:
o The duty of directors to reasonably monitor or oversee the conduct of the corporation's business, and, as a
corollary, to take reasonable steps to keep abreast of the information that flows to the board as a result of
monitoring procedures and techniques.
o The duty of inquiry, that is, the duty to follow up reasonably on information that has been acquired and should
raise cause for concern.
o The duty to employ a reasonable decision making process.
o The duty to make reasonable decisions.
o The business judgment rule in US maintains that until and unless the directors approve a criminal act in the
interest of maximizing profit, till then the director’s decision is not subject to any scrutiny in court.
19. The UK Companies Act of 2017 lays down certain duties for the company Directors towards the stakeholders.
Article 172, says that it is Director’s Duty to promote the success of the company
(1) A Director of a company must act in the way he considers, in good faith, would be most likely to promote the
success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other
matters) to-
(a) the likely consequences of any decision in the long term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.
20. (2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit
of its members, subsection (1) has effect as if the reference to promoting the success of the company for the
benefit of its members were to achieving those purposes.
(3) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in
certain circumstances, to consider or act in the interests of creditors of the company.
Article 175 of UK Companies Act of 2017 says that it is Director’s Duty to avoid conflicts of interest and
further Article 176 reads that it is the Director’s Duty not to accept benefits from third parties.
21. Indian Companies Act (2013)
In India, Section 166(2) of the Companies Act, 2013 states that, “A director of the company shall act in good
faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best
interest of the company, its employees, the community and the environment”. The act thus maintains that a
Director should further the objective of the company by maintaining balance between the interest of
company, employees, community and environment.
22. The Whistle Blower Protection Act, 2011: The Bill regarding protection of Whistleblower was introduced in
the Indian parliament on August 26, 2010 and was passed by Lok Sabha on December 27, 2011 and Rajya
Sabha on February 21, 2014 respectively. This bill aims at providing adequate protection to the complainants
who report willful misuse of power or willful misuse of discretion by a public servant. The Act will also provide
for punishment to the complainant if the allegations are found to be false or frivolous.
Stakeholder Orientation: It is the extent to which a firm is willing to attend and address the interest of its
stakeholder groups. A firm with a strong stakeholder orientation is likely to have a competitive advantage in the
market. Stakeholder orientation has four main relevant components that are common across the market and
industries; Customer, Competitor, Employee and Shareholder/Investors. As per Maignan and Ferrell, the
Stakeholder Orientation compromises of three sets of activities:
1. Organization wide generation of Data on various Stakeholder groups and assessment of the firm’s influence on
these stakeholder groups,
2. Dissemination of these information’s throughout the firm, and
3. Firm’s responsiveness to the disseminated information.
23. Stakeholder Analysis: Stakeholder analysis is a process of systematically gathering and analyzing qualitative
information to determine whose interests should be taken into account when developing and/or implementing a
policy or program.
Thus a Stakeholder analysis is one of the first steps that are taken in any project. It identifies the key stakeholders
of a project on the basis of attributes, interrelationship and interests, and study the ways in which these interests are
going to impact the viability and riskiness of the project.
Doing a stakeholder analysis can be helpful in understanding the interests of different stakeholders of a project and
maintaining a fine balance between the interest of these stakeholders in order to avoid any conflict of interest. It
also helps in determining the appropriate type of participation that may be extended by different stakeholders in the
project.
24. The stakeholder analysis is a four step process:
1. Identifying Stakeholders
Here we shall now be considering few important types of classification suggested by experts.
o Internal vs. External Stakeholders:
o Voluntary or Involuntary Stakeholders
o Primary vs. Secondary Stakeholders
o Normative vs. Derivative Stakeholders
2.Prioritize your Stakeholders
3.Understanding the Stakeholders and maintenance of Stakeholder Register
4.Manage your Stakeholders
25. Stakeholder Engagement
Stakeholder engagement helps the organizations to promote dialogue with all the essential stakeholders of the
project. The stakeholder engagement aims to identify the stakeholders, assess their needs and develop a plan
to maintain good relations and alliance with the stakeholders. The International Organization for
Standardization (ISO) has made the stakeholder engagement mandatory for all their new standards. The
Stakeholder engagement process involves following steps:
Fixing the objectives and goals of Stakeholders engagement
Identifying the Stakeholders and understanding their needs and interests
Determining the Strategy for Stakeholder Engagement
Evaluating the outcomes of Stakeholder Engagement and making necessary changes if required in the
stakeholder engagement strategy.
26. Stakeholder Relationship Management Strategies:
Maintaining a healthy relationship with the stakeholders is very important for the business. Experts have
suggested different models which throw light upon the manner in which a healthy relationship could be
maintained between manager and stakeholders. The basic purpose of these models is to understand how the
managers deal with the stakeholders and, how they represent their interest. However, each author holds
different view on it and they have no common consensus over it.
27. 1 Savage et al. Model (1991): This model suggests that organization should distinguish between the
important and unimportant stakeholders on the basis of two variables:
a. Potential for cooperation potential and
b. Capacity for competitive threat
28. Mitchell et al. Model: One major contribution comes from Mitchell et al.(1997) who had suggested another
important model to prioritize stakeholder relationship by putting forward three basic criterions or attributes to
organize the hierarchy of stakeholders in a firm:
- the stakeholders power to influence the firm,
- the legitimacy of the stakeholder relationship with the firm, and
- the urgency of the stakeholder claim of the firm.
29. Friedman and Miles Model (2002): Another model proposed by Friedman and Miles model is based on a
realist theory of social differentiation developed by Archer. Archer Model states that the organization
stakeholder relationship is based upon two distinctions:
a. Compatible or Incompatible in terms of set of ideas and/ or structure of material interests
b. Necessary or Contingent in terms of Connections. Necessary relationships are Internal and integrally connected
whereas Contingent relationships are not integrally connected.
30. Friedman and Miles have accepted the above mentioned four structural configuration of organization-stakeholder
relations model. According to Freedman and Miles, the organization-stakeholder relation has four structural
configurations.
31. Summary
The governance of today’s knowledge worker is a difficult task and the workplace environment is becoming
increasingly challenging with every passing day. A question that always bothers the management students is:
For whom should a corporation act for? Should it act for a shareholders and look for ways to maximize profit in
order to increase the wealth of its shareholders or should it be acting for some other parties apart from the
shareholders.
