Shareholder Primacy

What is Shareholder Primacy?

Shareholder Primacy is a kind of corporate governance that keeps the interest of shareholders above any other party. In a corporation there are several parties involved, like creditors, debtors, employees, consumers etc. This kind of governance keeps its main focus to maximize shareholder’s wealth as they consider shareholder to be the owner of the company.

Explanation

The concentration on only the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more in shareholder primacy has been debated a lot. There are debates regarding the corporation’s duty towards the environment and consumers, but shareholder primacy focuses on the wealth creation of shareholders only. So the governance stipulates rules for accepting projects with the highest NPVNPVNet Present Value (NPV) estimates the profitability of a project and is the difference between the present value of cash inflows and the present value of cash outflows over the project’s time period. If the difference is positive, the project is profitable; otherwise, it is not.read more, even if that project is not environment friendly. The governance also focuses on charging the maximum competitive price to customers that increase shareholders’ wealth.

Shareholder Primacy

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Background of Shareholders Primacy

Adolf Berle and Gardiner Means published “The Modern Corporation and Private Property” in 1932. The book was regarding the foundation of United States Corporate Law. In the book, for the first time, the idea of “shareholders are the corporation’s true owner” was introduced.”

Later economist Milton Friedman added to the theory that the main purpose of corporations is to maximize shareholders’ wealth.

Criticism of Shareholders Primacy

Is Shareholders Primacy Legally Mandated?

The modern economic era considers shareholders’ wealth to be the primary factor for the corporation. There is still no law for shareholders’ primacy. Shareholder primacy in most places described as “norm” rather than “law.” Shareholders’ primacy is taken as a belief in most parts of the world.

Shareholder Primacy vs. Stakeholder Theory

All shareholders are stakeholders, but all stakeholders are not shareholders. So shareholder primacy only focuses on the well-being of shareholders, whereas stakeholder theoryStakeholder TheoryStakeholder theory refers to the ethical concept that addresses business decisions, trends, profits and their collective impact on all stakeholders, including the shareholders, employees, financers, government, customers and suppliers.read more focuses on the well-being of all related parties to a project. It is the management’s duty to identify the most important stakeholders and protect their interests. Important stakeholders could be consumers, environment, creditors, etc.

Advantages

  • Shareholders are considered the owner of a corporation, and shareholder primacy protects their interests. Governance allows the maximum wealth creation of shareholders. Shareholders take the maximum risk, so they should get the maximum wealth creation
  • As the earning of the company increases, so the share price also increases, which helps shareholders to sell shares at a higher price. Capital gains are taxed at low rates. So it is beneficial for the shareholders.
  • Shareholder primacy forces management to focus on profit maximization, which should be the ultimate goal of the management. The corporation needs profit to survive.
  • Companies opt for projects with the highest NPVs, so the chances of the project failing are less.

Disadvantages

Conclusion

Shareholders’ primacy is an outlook that portrays that shareholders are the owners of the corporation and other stakeholders are not so important. So the attention of the management should be to protect the wealth of shareholders. Other stakeholders are not considered. This conduct is debatable and has been criticized on many platforms. Many believe that shareholders should be the ultimate owner as they are taking the maximum risk.

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