Shareholder theory vs Stakeholder theory in governance

  1. Introduction

The 1930 Berle-Dodd debate dealt with shareholder primacy versus the stakeholder approach. Though this debate was not specifically extended to the concept of corporate governance at that time, with the advancement of law, governments, academicians and advocates now question the viability of various theories for the purpose of corporate governance. Amongst various papers and researches carried out in establishing the dominance of any one theory, especially of Shareholder Primacy, one argument advanced by Keay stands out. Keay, in dealing with the concept of Shareholder versus Stakeholder approach, points out that every author and institution has assigned and/or interpreted and/or assumed different meaning of Shareholder Primacy. This, in agreement with Keay, I believe is one the major reasons due to which the debate of shareholder versus stakeholder, or in this case, other theories and models, can never be settled. Freeman, Stout, Blair, Friedman, Hansmann – Krakmann and many others have argued it time and again and their differences in interpretation of the Shareholder Primacy, though not apparent, is very much noticeable. Somewhere in between this never-ending debate lies the issue of corporate governance. It is one thing to argue the dominance of Shareholder Primacy, which I support, when it comes to the shareholders being corporate residual claimants or the fiduciary duties of managers or even their voting powers. But, it is very different on the point of corporate governance. Or, is it not?

This paper will not delve into the ethical debate of governance. Rather, it will go beyond and will critically analyse other forms of corporate governance. Convergence towards a model cannot be solely argued from a theoretical basis; therefore, I will be offering a practical note for my arguments. This paper will revisit the discussions that have taken place, and establish that the shareholder primacy model, compared to others, is the best suited model for effective and efficient corporate governance and that all other models are now aiming at characteristics of the Shareholder Primacy and thus, converging towards it. A disclaimer here needs to be placed though; I do not believe that the shareholder primacy model is perfect. It is not. There are flaws, just like in every other theory. Irrespective of that, I’ll be concluding that amongst various models of corporate governance in discussion today, shareholder primacy model is the moon amongst stars and that its flaws can be overcome in order for it to succeed. If so, what about the flaws of other theories? Can they not be dealt with in a similar manner? I believe, and as I shall express, that they are different and thus cannot be dealt in the same manner. Hence, it is not practically an option in pursuing them since they will eventually converge in the model of the Shareholder Primacy.

  1. Failure of Other Theories

Due to restriction of space, I would be critically analysing only few of the major prevalent models of corporate governance in this section and establish that the shareholder primacy model, as opposed to the others, is still the best model available and why all others will either work in the same manner or converge to being like it.

  1. The Managerial/Director Primacy Approach

The first and foremost model that I would challenge is one of the highly influential and discussed models of corporate governance: the Managerial Model and Director’s Primacy. The support for the Manager Oriented Governance Model is not new. Amongst others, it was very strongly advanced earlier by Dodd, Galbraith and Berle. The most avid modern supporter of the Director’s Primacy approach today is Bainbridge. In a number of publications, Bainbridge has argued and tried to establish that the Directors or the Managers of the corporation should be the governing entity and that Shareholders do not make the best decisions when it comes to corporate governance.

It is to be noted that most of the arguments in support of this model are based on the notion that since the Directors know the daily working of the business, they are in the best position to effectively govern the corporation. This approach also assumes that since the Managers/Directors are professionals in their respective fields of appointment they are the best persons to manage the corporation. Another assumption that follows is that they are disinterested appointed persons who will properly serve the fiduciary duties of the corporation and accordingly guide the corporation towards greater interest, usually argued to be towards the stakeholder approach. Bainbridge, and few other authors, looks at the managerial governance in the form of a hierarchy. This model was supported earlier. In the form of a comparative analysis, Mason draws our attention to the specific applications of it in the earlier days. Since these assumptions are the very pedestal of arguments advanced by the authors, I would, after critical examination, nullify them.

Firstly, Directors and Managers can never act in isolation. They are treated as trustees of the Shareholders since the Shareholders are treated the owners of the corporation. Bainbridge and Stout address this argument but fails to look at the other side of the theory. The Managers and Directors can never work independently, away from the checks of the Shareholders. Since the managers owe fiduciary duties towards the corporation, owner of which are the shareholders, they automatically become accountable to the shareholders, thus eliminating the presence of, if any, independence.

Secondly, assuming that managers can be independent and impartial, it is also important to note that they are very few in number. Since there are very few or none other to keep a check on them, their chances of serving themselves disproportionately are very high. This argument is further strengthened by the fact that they knowing the in and out of the business make it easy for them to cook the books. This logical and perceptible reasoning has been accepted in the recent debates and hence great discretion is now required in appointment of managers and directors. Adding to this is the price and cost factor. Hansmann-Kraakman adds further that the though it may seem that managerial firms with stakeholder approach are more successful, they also are highly inefficient when it comes to a comparative analysis with those who are shareholder primacy based.

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Finally, considering that managers are, nevertheless, needed for the running of the corporation: they are, and forever should be, accountable only towards the shareholders. In a direct manner, the managers are accountable to the corporation. But who are the owners of the corporation: The one who owes the equity and bear the maximum risk of the corporation. Thus, the managers are indirectly accountable to the shareholders. This is the legal position today. Why otherwise would the shareholders have the power of appointing and dismissal of managers?

That being said, even indirectly then, the directors and managers thus work for the shareholders. This clearly concludes that that the shareholders have the reign of the managers in their hands and they are free to appoint or oust managers based on their performance or otherwise. Managers are the trustees of the shareholders and, therefore, there is not managerial model of governance per se. It is only the shareholder model in an indirect way with the managers being the trustees of the shareholders. And even if it is argued, as put forth by various authors above, that a Director model does exist and makes a difference, it is ultimately converging to the benefit of the shareholders themselves. Hence, and to conclude, the managerial model is no where a challenge to the shareholder primacy model and neither can the managerial model supersede the shareholder primacy. It can only converge towards the shareholder primacy model.

  1. Stakeholder Approach

The next model I would be considering is the (in)famous Stakeholder approach for corporate governance. Forthrightly, this is as flawed as it can be. The definition by one of the most staunch stakeholder supporter, Freeman states: Stakeholders means any individual, group or organisation which can or is affected by the working of the corporation. This, by the very definition, includes, amongst others: Creditors, employees, customers, suppliers, government, society, shareholders etc.

If a corporation appoint a representative of each class of stakeholder in the board for the purpose of governing, practically and reasonably, can that corporation ever expect the board to function properly? Firstly, Interest of every stakeholder differs, which can though be measured in monetary terms, but the mode and intensity of achieving it varies. While agreeing with Blair and Stout, that a corporation is the work of a team, I believe that the team also needs someone to hold control and sovereignty. I also agree with Hansmann-Kraakman that stakeholder approach is just another version of the managerial model or the labour model. Very evidently, irrespective which stakeholder group governs the firm, their own interest will always be a priority and most probably at the cost of the other.

That stakeholder group will always have a ‘disproportionate prominence in their decision making.’ That class of stakeholder can and will always make decisions to favour themselves at the cost of other stakeholders. Adding to that would be the problem of challenging each and every action of the corporation in the court of law. Macey points out that every decision can be justified for benefiting the corporation or a class of stakeholder, but that decision has to be taken for the benefit of the corporation and not just one class of stakeholder. This argument is a double edged sword and it is highly unlikely for the courts to come up with a decision of nullifying the board’s decision which is governed by a class of fixed claimant. Ironically, Freeman and Reed published a paper a few years back in which, surprisingly coming from Freeman, being a strong supporter of the Stakeholder theory, argued that stakeholder approach is actually not a good idea when it comes to corporate governance. Keay has also brought to light the problems of stakeholder approaches when it comes to corporate governance.

Here, the obvious question arises: Wouldn’t governance by shareholders share the same flaw of making decisions to only benefit them at the cost of other? I will be addressing this, along with few other questions in the next section of this paper.

  1. Governance through Labour Unions:

The issue of collective bargaining through labour unions is a big issue today. Like any other stakeholder, labour unions also have their selfish downside. From a point of view of a labour or an employee, the things which matter are: job security, yearly bonus, medical insurance, additional family perks, paid holidays etc. Practically, they do not have interest in increasing the overall value of the firm. They are too, fixed claimants who wants to be paid a monthly salary and be on way to their homes. For various reasons, the European Community’s Fifth Directive Proposal on Company Law never actually became a law. Various authors have discussed this with almost the same solution: it doesn’t work well. The workers may be represented in the Board through a representative, but handing them the reigns of corporate governance is not an acceptable model or solution. They are not experienced in the decision making and running of a corporation efficiently.

  1. Shareholder Primacy – The Most Viable Model

The first question that arises is: What makes the Shareholder Primacy the most viable theory in the world today? I believe that corporate governance cannot be looked in isolation taking into account only the managerial and/or administrative aspect of it. Governance doesn’t only mean keeping a check on the happening and non-happening of business. It also means to govern a corporation in a manner which promotes efficiency, growth, societal value and most importantly, the value of the corporation as a whole. Proper corporate governance also establishes the rights and duties of all entities involved with the corporations and take into account their interests as well. Of course, any decision can be justified for benefiting a specific class of stakeholder, but effective and proper governance should benefit all, though it might not happen at the same time. The Shareholder Primacy model has materialized not only because of the consensus amongst governmental institutions, authors and academicians, but also because practically, its economic implications are better that the other discussed models.

  1. Objective Clause
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Every stakeholder has a different interest in the working of the corporation. But whose interests supersede the others? None, you might argue. But, then, do they all promote the growth of the corporation as a whole? As Friedman puts it, ‘There is one and only one social responsibility of Business, to use its resources and engage in activities designed to increase its profits…’ Now, the topic of social responsibility is outside the scope of the question of this paper. But gathering from the above statement and supported by various other authors, it can be concluded that Shareholders are the best class of stakeholders to monitor the corporation and increase its overall value, including the aspect of social responsibility.

Since all other stakeholders are fixed claimants, the shareholders have the maximum incentive in maximising the value of the corporation and hence benefiting other stakeholders and the society on a whole as well. It cannot be denied that when shareholders make money, it is understood that every other stake holder is making money too. It also means that the societal wealth is also increasing by the increase in the value of the corporation as a whole. Further, the interest of equity shareholders cannot be completely and absolutely protected by contractual implications as in the case of other stakeholders. Instead of the contractually guaranteed sum of money, shareholders are given the right to control the corporation. Further, few believe that even if some system of contractual interests for shareholders could be created, it would be more problematic rather than solution based.

This control is practised through voting. The shareholders have the most right and privilege of voting in a corporation. Other stakeholders have somewhat limited in comparison to the shareholders. This voting makes the governance of the corporation a strong incentive and means to maximize the value of the cooperation as a whole by choosing ventures that may yield higher profits.

If governance is left to fixed claimants, they would probably go for low-risk-low-profit ventures because they so not have any incentive in maximising the value of the corporation as long as they are getting their due. Under this situation, the overall value of the corporation will remain stagnant. But is this scenario justified for the equity shareholders who bear the most risk? Definitely not. The shareholders will not earn anything from such a corporation and would eventually have to back out with their value of the shares and invest somewhere else. Consequently, the corporation will shut down since there would be no equity shareholders to bear the risk.

Freeman and Stout have time and again raised the issue of social responsibility of corporations too. Considering a curbing argument that corporations which harm the environment and the society should be closed down or regulated by other modes such as stakeholders and/or government. My opinion to that would be making the public aware of it. There are sufficient examples for corporations which have been accused of environmental damage and enough has been argued on the point of accountability of such corporations. If, upon awareness, the public stops buying products or using services of such corporations, then the respective corporations would be forced to think and change their ways of working. The corporations will realise this factor and then work accordingly. However, if the public continues to buy their product or use their services, then it can be concluded that the public doesn’t care as much about the environment as they care about their products and services.

It is also argued that managers or directors have little incentive in increasing the value of the corporation as a whole since they do not get much out of it.

  1. Conclusion

As propounded by some of the staunch supports of shareholder primacy argument, who, not surprisingly, believe that there exists no serious competitor against the view of shareholder primacy that in absence of other satisfactory approach(s) only the shareholder primacy will prevail. I agree with the crux of Hansmann and Kraakman, but I disagree with the factual and unobvious conclusion that authors, governments, or academicians now only support, or do not contest, the shareholder primacy argument.

There are authors, as analysed above, who still believe in the stakeholder or the director’s primacy arguments. There are also authors who believe in the shareholder primacy, and then there is Keay, who concludes that none of these models are good enough. Like I stated in my introductory paragraph, no model is perfect. All needs change in accordance with time and improvisation in accordance with the circumstances. However, all being said, the Shareholder Primacy model is the best mode of governance. There are major jurisdictions like the UK and India which follow the shareholder primacy model of corporate governance and have been very successful.

All other forms, as demonstrated above, either replicate a form of each other or the shareholder primacy model. Either way, the results that they produce, or have the ability of producing, in no way challenges, defeats or are better than that of the results of the Shareholder Primacy Model. Under these circumstances, and in agreement with the statement of this paper, I believe that the Shareholder Primacy model is, in practicality, actuality and in terms of its viability, destined to become universal in due course of time. All other models of governance will either wither away or replicate and eventually congregate in the Shareholder Primacy Model, but they (the other models) can definitely not diverge from the Shareholder primacy Model.


Andrew Keay, ‘Shareholder Primacy in Corporate Law: Can it Survive? Will it Survive?’ [2010] 7(3) European Company and Financial Law Review 369.

R. Edward Freeman Strategic Planning: A Stakeholder Approach (Pitman Publishing 1984) 46.

Lynn Stout, ‘Bad and Not-so-bad Arguments for Shareholder Primacy’ [2002] 75 Southern California Law Review 1189.

Margret Blair and Lynn Stout, ‘A Team Production Theory of Corporate Law’ [1999] 85(2) Virginia Law Review 247.

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Milton Friedman Capitalism and Freedom (University of Chicago Press Chicago 1962).

Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ [2001] 89 The Georgetown Law Journal 439.

E. Merrick Dodd, ‘For Whom are the Corporate Managers Trustees’ [1932] 45 Harvard Law Review 1145.

John Galbraith The New Industrial State (Princeton University Press Princeton and Oxford 1967).

Adolph Berle Power Without Property: A New Development in American Political Economy (Harcourt, Brace and World New York 1959); Adolph Berle, ‘For Whom Corporate Managers are Trustees: A Note’ (1932) 45 Harvard Law Review 1365; Adolph Berle, ‘Corporate Powers as Powers in Trust’ (1931) 44 Harvard Law Review 1049.

Stephen M. Bainbridge, ‘Director v. Shareholder Primacy in the Convergence Debate’ [2002] 16 Transnational Lawyer 45; Stephen M. Bainbridge, ‘Director Primacy and Shareholder Disempowerment’ [2006] 119(6) Harvard Law Review 1735; Stephen M. Bainbridge, ‘Director Primacy: The Means and Ends of Corporate Governance’ [2003] 97(2) Northwestern University Law Review 547.

Stephen M. Bainbridge, ‘Director Primacy: The Means and Ends of Corporate Governance’ [2003] 97(2) Northwestern University Law Review 547; Peter Drucker Concept of the Corporation (The John Day Company New York 1946); Alfred Chandler Jr. The Visible Hand: The Managerial Revolution in American Business (Belknap Press Cambridge 1977) Lynn Stout, ‘Bad and Not-so-bad Arguments for Shareholder Primacy’ [2002] 75 Southern California Law Review 1189.

Edward Mason The Corporation in Modern Society (Harvard University Press 1959).

Supra, note 10.

Lynn Stout, ‘Bad and Not-so-bad Arguments for Shareholder Primacy’ [2002] 75 Southern California Law Review 1189.

Supra note 10, see also, Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ [2001] 89 The Georgetown Law Journal 439.

Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ [2001] 89 The Georgetown Law Journal 439.

Ian B. Lee, ‘The Role of Public Interest in Corporate Law’ 106, 108; Revlon v. MacAndrews, (1986) 506 A.2d 173 (Del.): Unocal v. Mesa Petroleum, (1985) 493 A.2d 946 (Del.); Revlon v. MacAndrews, (1986) 506 A.2d 173 (Del.); Paramount Communications Inc. v. Time Inc., (1989) 571 A.2d 1140 (Del.): Paramount Communications Inc. v. QVC Network Inc., (1994) 637 A.2d 34 (Del.); Dodge v. Ford Motor Co., 170 N.W. 668.

Michael Jensen and William Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ [1976] 3(4) Journal of Financial Economics 305; Adolf A. Berle, ‘Corporate Powers as Power in Trust’ [1931] 44(7) Harvard Law Review 1049.

R. Edward Freeman Strategic Planning: A Stakeholder Approach (Pitman Publishing 1984), at 46.

Margret Blair and Lynn Stout, ‘A Team Production Theory of Corporate Law’ (1999) 85(2) Virginia Law Review 247.

Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ [2001] 89 The Georgetown Law Journal 439.

Ibid., at 448.

Jonathan R. Macey, ‘An Economic Analysis of the Various Rationales for Making Shareholders the Exclusive Beneficiaries of Corporate Fiduciary Duties’ [1991] Faculty Scholarship Series (Paper 1713) 23; [1991-1992] 21 Stetson Law Review 23.

R. Edward Freeman and David L. Reed, ‘Stockholders and Stakeholders: A New Perspective on Corporate Governance’ [1983] 15(3) California Management Review 88.

Andrew Keay, ‘Shareholder Primacy in Corporate Law: Can it Survive? Will it Survive?’ [2010] 7(3) European Company and Financial Law Review 369.

Henry Hansmann, ‘Worker Participation and Corporate Governance’ [1993] 43 University of Toronto Law Journal 589; Margit Vutt, ‘Legal Regulations of the Board Structure of Public Limited Companies in the Light of Regulatory Communications between the European Union and the Member States’ [2006] 11 Juridica International 118; Mark Roe, ‘German Securities Markets and German Codetermination’ [1998] Columbia Business Law Review 167.

Jonathan R. Macey, ‘An Economic Analysis of the Various Rationales for Making Shareholders the Exclusive Beneficiaries of Corporate Fiduciary Duties’ [1991] Faculty Scholarship Series (Paper 1713) 23; [1991-1992] 21 Stetson Law Review 23: Elaine Sternberg, ‘The Defects of Stakeholder Theory’ [1997] 5(1) Scholarly Research and Theory Papers 3: R. Edward Freeman and William M. Evan, ‘Corporate Governance: A Stakeholder Interpretation’ [1990] 19(4) Journal of Behavioural Economics 337.

Milton Friedman Capitalism and Freedom (University of Chicago Press Chicago 1962) at 133.

Frank H. Easterbrook and Daniel R. Fischel The Economic Structure of Corporate Law (Harvard University Press 1991); Henry Hansmann, ‘Ownership of the Firm’ [1988] 4(2) Journal of Law, Economics and Organization 267; Leo Strine Jr., ‘The Social Responsibility of Boards of Directors and Stockholders in Change of Control Transactions: Is There Any “There” There?’ [2002] 75(5) Southern California Law Review 1169; E. Merrick Dodd, ‘For whom are the Corporate Managers Trustees’ [1932] 45 Harvard Law Review 1145, 1148.

Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ [2001] 89 The Georgetown Law Journal 439 at 449.

Ringling Bros. Barnum & Bailey Combined Shows v. Ringling, (1947) 52 A.2d 441 (Del.).

Tom Young, ‘Corporations Cause $2.2T in Environmental Damage Every Year’ [2010] Available at <> accessed 11 April 2014.

Alison Shinsato, ‘Increasing the Accountability of Transactional Corporations for Environmental Harms: The Petroleum Industry in Nigeria’ [2005] 4(1) Northwestern Journal of International Human Rights 186; Dennis Rondinelli and Ted London, ‘How Corporations and Environmental Groups Cooperate: Assessing Cross Sector Alliances and Collaborations’ [2003] 17(1) Academy of Management Executive 61; Richard Smith, ‘Defining Corporate Social Responsibility: A System for Approach for Socially Responsible Capitalism’ [2011] University of Pennsylvania ScholarlyCommons Masters of Philosophy Theses. Available at <> Accessed 12 April 2014.

Stephan M. Bainbridge, ‘The Board of Directors as Nexus of Contracts’ [2002] 88 Iowa Law Review 3.

Henry Hansmann and Reiner Kraakman, ‘The End of History for Corporate Law’ [2001] 89 The Georgetown Law Journal 439.

Ibid.

Andrew Keay, ‘Shareholder Primacy in Corporate Law: Can it Survive? Will it Survive?’ [2010] 7(3) European Company and Financial Law Review 369.

Preamble of the Report of the SEBI Committee on Corporate Governance 2003. Available at <> accessed 12 April 2014.

Christine Mallin, ‘Corporate Governance Developments in the UK’ Chapter 1 in Handbook on International Corporate Governance Analyses (Edward Elgar Publishing Limited 2011).


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