Essay Sample: Value Maximization and Stakeholder Theory

Published: 2022-03-09 17:38:34
Essay Sample: Value Maximization and Stakeholder Theory
Type of paper:  Essay
Categories: Business Financial management
Pages: 7
Wordcount: 1797 words
15 min read

Value maximization is defined as the maximization of a company's share price with the intention of increasing its value and consequently increasing the wealth of the owner (Edmans, Gabaix & Jenter, 2017). The objective of maximizing a firm's value guides decision making by business managers. In an economic setting, shareholders own a firm, and therefore, the wealth of the shareholder represents the firm's value. Therefore, the value maximization theory is also known as the shareholder's wealth maximization theory. Considering the foundational principles of this theory, long-term value creation, then supersedes short-term profit-making contrary to popular belief. It is common therefore for business managers to forego immediate profits in favor of lasting benefits. The aim is to maximize profit in the long run (Lindsey, Mauck and Olsen, 2017). As a result, business managers may choose to invest heavily is such short-term expenditures as research and development, expensive promotion campaigns, and new capital equipment.

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Conversely, the stakeholder theory refers to the posit that business managers bear the responsibility of maximizing value for all stakeholders and that their interests must be taken care of in a manner that is ethical and legal (Horisch, Freeman and Schaltegger, 2014). Unlike the value maximization theory whose end goal is maximizing the shareholder's interest, the stakeholder theory seeks to increase value for not only the shareholder, but the customers, employees, suppliers, and the community. The business's approach, in this case, is holistic in whom it seeks to benefit. The stakeholder theory is centered on the ethical position that a business is responsible for a group that is much wider than the shareholders are. It is the reason it has been embraced as an essential part of corporate governance. It bears such favorite concepts as corporate social responsibility, consumer engagement, and employee value (Mok, Shen and Yang, 2015). Further, a business that embraces the stakeholder theory recognizes that all stakeholders contribute towards creating value for the shareholder and a moral stance demands that they receive value for the same.

The first difference between the two theories lies in their definitions, which outline the goals of each theory. In value maximization theory, the business manager's decision is affected by what it will contribute to bottom line profits and consequently the wealth of the shareholder (Tantalo and Priem, 2016). Decisions that positively contribute to the wealth of the shareholder, either in the long or short run are favored under the value maximization theory, despite the effect they have on the value of other stakeholders. The stakeholder theory, in contrast, focuses on the value that can be accrued to the stakeholder in a manner that ensures that one stakeholder does not benefit at the expense of another. The business manager under the stakeholder theory has the responsibility of aligning the interests of stakeholders primarily. It calls for sacrifice and compromise for some of the stakeholders. For instance, the shareholder may have to forfeit some wealth in the short run to ensure that employees receive adequate compensation for their effort. In the same vein, employees may have to work overtime for a season, to take care of the interests of the customer.

The shareholder theory is considered unethical primarily because in most cases, it promotes shareholder interest at the expense of other stakeholders (Cordeiro and Tewari, 2015). One of the most common examples of this is environmental degradation and the fact that communities suffer the consequences of this directly. A business manager operating under the value maximization theory might overlook issues such as air pollution if the decision resulted in wealth creation for the shareholder. A business manager operating under stakeholder theory would either forego an environmentally degrading decision to protect the interests of the community or find an alternative that would result in wealth creation without hurting the community (Jones et al., 2016). The stakeholder theory is also best placed for taking care of consumers and given the rationale behind its approach; it is bound to result in more considerable success in the long run. Consumer loyalty results in a stable and growing market share and consumers show loyalty to brands that repeatedly prove that they have their interests at heart.

The stakeholder theory does focus on profitability, and sometimes it applies the notion of short-term loss to foster long-term profits. However, unlike the shareholder theory, morals play a huge role in decision-making. Certain short-term losses, such as short-changing the customer, overworking and underrecompensing employees, and polluting the environment, are not an option regardless of their potential long-term benefits (Mitchell et al., 2016). Stakeholder theory acknowledges that businesses must make profits, but it advocates for profit-making within the constraints of ethics and morality. This holistic approach is continually being adopted in many corporate circles, not just for its nobility, but also for its sustainability. The truth is that while stakeholder theory results in slow growth, this growth is more stable and likely to result in lasting benefits (Bonnafous-Boucher and Rendtorff, 2016).

Under the stakeholder theory, business managers align stakeholder interests through any of the following three significant processes. The first is the descriptive approach. This approach is centered on communication with stakeholders. The business managers communicate the interests of stakeholders with the intention of getting them to understand how they all contribute to the working of a business and help them make informed choices on how to best work together (Bridoux and Stoelhorst, 2014). Stakeholders find it much easier to cooperate and sometimes compromise if they are well informed. The second approach is the instrumental approach. It requires strategy because it focuses on finding links between performance and stakeholder strategies. The business manager, in this case, works merely to implement processes and systems that make it easier to align stakeholder interests. The third approach is known as the normative approach, and it entails having the business manager interpret the function of an organization from a moral standpoint. They merely ensure that the organization's mission and vision are aligned with maximizing the interests of all stakeholders from an ethical point of view.

Impacts of Value Maximization and Stakeholder Theory on the Financial Objectives of Profit-Seeking Organizations

The shareholder theory has been found to be unsustainable; a large number of massive corporate entities that have collapsed over the past two decades evidences this. According to business research studies, neglecting some stakeholders is not only unethical but also detrimental to the long-term sustainability of an organization. This is because; stakeholders are only loyal to entities that take care of their interests (Harrison, Freeman and Abreu, 2015). When their interests are ignored, they not only embrace the chance to switch loyalties, but they rarely offer their best to steer the vision of the organization.

Economic scholars in (Eskerod, Huemann, and Ringhofer, (2015) posit that the notion of a business's value has been oversimplified by being limited to economic returns only. They go on further to claim that stakeholder value not only includes economic returns, but also encompasses so much for. Based on this assertion, the perception of stakeholder value in regards to stakeholder expectations and business management responsibility must incorporate the complexities of this notion. In the same vein, there needs to be a new way of measuring this complex value that stakeholders are privy to and in many cases expect. Stakeholder theory, therefore, formulates strategies and financial objectives, bearing in mind that while they are essential, they are not the only priority. In line with this, in many cases, stakeholders may prioritize value in items and positions that are not necessarily held by business managers. For instance, consumers may value utility over quality if the latter translates to higher prices. Functionality may be of higher priority compared to attractiveness (Moriarty, 2014). In such a case, it would do the business no right to invest extra resources in providing a product feature such as aesthetics that the consumers would not appreciate notably if it translated to increased retail prices.

That said, it is fundamental for businesses to understand their stakeholders and what they consider value for them. A common misconception among business managers who uphold the stakeholder theory is that the perception of value is unanimously shared among stakeholders (Pige, 2017). A misconception of values among stakeholders may cause the organization to incur expenses they do not have to, or miss opportunities to maximize profit. While the stakeholder theory is ethical and stakeholder inclined, it does not overlook the fact that businesses must make a profit to remain relevant. When stakeholder interest results in consistent loss-making, then the business is not sustainable. It pays, therefore, to be informed of what constitutes value and the extent to which this is the responsibility of the business. In some cases, the business may be incurring extra costs, creating value that is beyond the expected. For instance, corporate social responsibility can be costly, and while it is noble, it is for the most part voluntary. It would be useful, therefore, for businesses to pick an activity that they could afford without straining the organization's resources too much.

The stakeholder theory, therefore, takes into account several value considerations when they come up with financial objectives. It is not an excuse to aim low, but a constraint that ensures economic returns do not solely determine their choices. Stakeholder theory, therefore, applies different considerations when determining the feasibility of a business venture or decision (Andriof et al., 2017). A business decision considers the value of all stakeholders and in some cases; this may result in short-term losses or long-term losses. The former can be allowed if it translates to long-term benefits. An example would be incorporating employee value by advocating for training and increased compensation. This decision can lead to employees' increased productivity and in the long run, form the initial investment in their value. In other cases, stakeholder value may significantly affect bottom line profits making the business decision unviable.

While there are many instances where value creation translates into increased costs, there are many others where value does not necessarily need financial investment. In many cases, investing in non-monetary resources is always converted to potential financial implication even when this should not be the case. A vital value perception among customers, for instance, is engagement. It includes such strategies as involving them in marketing campaigns and organizational festivities. It may cost time and effort, without necessarily costing potential income because the time and effort invested would otherwise have lain dormant (Narbel and Muff, 2017). The difference between the shareholder and stakeholder theory is that the former would only consider putting in the extra time and effort if it somehow translated to monetary returns. The latter would invest the same for the sole purpose of creating value for their consumer whether or not it translated to monetary returns. Herein lies the difference between the two when it c...

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