Stakeholder Theory

What is Stakeholder Theory?

Stakeholder theory refers to the ethical concept that addresses the outcome of business decisions, trends, profits etc and its collective impact on all stakeholders including the shareholders, employees, financers, government, customers, suppliers, etc.

6 Principles of Stakeholders Theory

Stakeholder Theory

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Source: Stakeholder Theory (wallstreetmojo.com)

  1. Principle of Entry & Exit – An entity should have clear rules for hiring, firing & work profile of the employees with no ambiguity.
  2. Principle of Externalities – The decisions taken by an entity may affect people who have no relations with the entity. The theory suggests that people who may be affected by the decisions of a business are also to be treated at par with other stakeholders.
  3. Principle of Agency – The management of the company is appointed by 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 to run the business of the entity. Management is not the owner of the entity but an agent acting on behalf of the company.
  4. Principle of Governance – Any changes affecting the relationship between stakeholders and the company needs to be approved by them on a unanimous basis.
  5. Principle of Contract Cost – The stakeholder should bear any cost on an equal basis, i.e. one should not bear more than another. Either the cost-sharing should be equal or in proportion with the amount of advantage gained.
  6. Principle of Limited Immortality – The firm should operate with long-term objectives at focus & not for the motivation of short-term perks. Longevity ensures confidence in the stakeholders of the entity. A stakeholder is concerned with the long-term goals of the entity.

Example – Domino’s Pizza Inc

As an example of Stakeholder theory, we take highlights from the 2020 report of Domino’s Pizza Inc.

  • The company is concerned about the corporate responsibility through which it ensures the satisfaction of its people & customers, top quality of its products, enrichment of its community and protection of its environment.
  • The company runs with a CSR statement “Do the right things because it’s the right thing to do”. This focusses on their approach towards the community.
  • The Chief People and Culture Officer of the Company, David Klages, said that “This is a people business as much as a pizza business”. This further shows their concerns about customers, suppliers, employees.
  • The report further states that every minute a supply truck is arriving at a Domino’s Pizza Enterprises Ltd store, somewhere in the world. This show the level of procurement the company is involved.
  • Overall, the company is much concerned about the satisfaction of its customers. For every delivery it makes, the customer is asked to provide feedback on their order. This makes the company responsible for each order.

Evolution of Stakeholder Theory

  • In 1983 Freeman first coined the concept of stakeholder theory in his article.
  • In 1995, Thomas Donaldson published an article named “The Stakeholder Theory of the Corporations: Concepts, Evidence, Implications in the academy of Management Review with Lee Preston.
  • Further in the year 1999, he took forward the concept through a journal article named “Response: Making Stakeholder Theory Whole”.
  • In the year 2002, a journal was published with the name “The Stakeholder Revolution and the Clarkson Principles.
  • As and when the concept matured, more people understood the relationship of people beyond, around, within & outside the entity.

Impact of Stakeholders Theory

  • Normally when you run a business, the owners are concerned with the profit it earns. Stakeholder theory takes the thought process further.
  • It requires the management to re-align their focus from just short-term profits to long term sustainability of the business. Stakeholders are concerned with the continued businesses since liquidated entities are big turn off for the economy.
  • With the increased importance of corporate social responsibility, the concept is taken seriously by many organisations and have also made sufficient provisions to cater to the needs of various people connected with the entity.

Benefits of Stakeholder Theory

Criticism

  • Stakeholder theory focuses on all people who are or may be affected by the results or decisions of the entity. However, the theory is majorly criticized with the management focusing lower on the shareholders of the entity.
  • The shareholders have invested their money to maximise their returns. The management is obliged to keep their interest in focus as compared to others.
  • The theory is also criticized since the entity cannot fulfil each and everyone’s interest. You cannot provide a higher quality product by not increasing the prices. You cannot suffer just to meet the hunger of various non-financial stakeholders. If there is a lower demand for the products, you cannot just pile up your inventory to please the suppliers. With an increase in pay of your employees, you cannot please the providers of finance who are concerned with the cashflows retained by the entity.

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This has been a guide to stakeholder theory and its definition. Here we discuss its 6 principles along with an example, evolution, benefits and criticism. You may learn more about financing from the following articles –