Company’s Stakeholders

Corporate governance may be defined as the system of internal controls, processes, and procedures by which a company is managed, directed, or controlled. Weak corporate governance practices have resulted in the failures of many companies.

Shareholder and Stakeholder Theories

Corporate governance practices tend to vary from country to country. It is, nevertheless, not uncommon for different corporate governance systems to coexist within a country. Corporate governance systems generally reflect the influences of either shareholder theory, stakeholder theory, or a convergence of the two. Current trends, however, point to an increase in convergence.

Shareholder theory posits that the most important responsibility of a company’s management is to maximize shareholder returns. In other words, the interest of other stakeholders such as creditors, employees, and society is only considered as long as they affect the shareholder value.

On the other hand, stakeholder theory emphasizes the need for a company to consider the needs of all its stakeholders. This theory dissuades a company from giving preferential treatment to its shareholders, such as customers, suppliers, creditors, employees, and essentially anyone who has an interest in the company at the expense of stakeholders. Intuitively, a stakeholder primarily advocates for environmental, social, and governance (ESG).

Consideration of ESG factors by the stakeholder theory comes with some setbacks:

• Complexity in considering multiple objectives.
• Costs associated with compliance with ESG.
• Difficulty in competing globally with companies that do not consider ESG.
• There is no clarity in the definition, measurement, and balancing of non-shareholder objectives.

Stakeholder Groups

Shareholders

By providing a company with equity capital, the shareholders of a company are considered its owners. Their interests lie primarily in the profitability of the company and anything which leads to an increase in the company’s equity. In the event of bankruptcy, shareholders receive proceeds only after all creditors’ claims have been paid.

Controlling shareholders hold sufficient shares in a company to control the election of its board of directors. Besides, they have the power to influence company resolutions. Minority shareholders, on the other hand, have far fewer shares and limited ability to exercise control in voting activities.

Creditors

The creditors of a company are the stakeholders who provide the company with debt financing. This category includes banks, private lenders, and public debtholders.

Banks and private lenders hold the debt of a company to maturity. Further, they can directly reach a company’s management and access non-public information concerning a company. As such, they significantly influence a company since they can be the largest source of capital. Therefore, they can lower debt restrictions and extend more credit.

Debtholders always hold onto the same perspective: lower financial leverage, then lower risks. However, some private lenders may have different risk appetites, behavior and approach, and relationships with the companies to which they provide capital. Some private lenders focus on asset value, equity positions, cashflows, value, and business forecasts.

On the other hand, public debtholders depend on public information and credit rating agencies in their decision-making. In return for the capital provided, public debtholders receive regular interest payments and capital repayment at maturity.

Public debtholders minimize downside risk thanks to their preference for operation stability and the performance of a company. This is usually in contrast to a company’s shareholders’ interests – tolerance of high risk for higher return potential.

Managers

Led by the chief executive officer (CEO), managers are tasked to formulate and implement the strategy of a company. They do this under the stewardship of the board of directors. Additionally, they ensure the smooth running of a corporation’s day-to-day operations.

Managers tend to benefit when a company performs well. Conversely, they are adversely affected when a company’s financial position weakens. As such, they seek to maximize the value of their total remuneration while securing their jobs. Their interests are, therefore, not surprisingly different from those of shareholders, creditors, and other stakeholders.

The Board of Directors

The board of directors is elected by the shareholders of a company. It is charged with the responsibility of protecting shareholders’ interests, providing strategic direction, and monitoring company and management performance. Also, the board hires the CEO of the company.

The board usually consists of inside directors and independent directors. The inside directors consist of leading shareholders, founders, and senior managers of the company. On the other hand, independent directors, as the name suggests, do not have any link with the company with respect to employment, ownership, and remuneration. As such, independent directors are elected because of their experience.

An optimal board of directors does not exist. As such, boards vary based on the company’s size, structure, and type of operations. However, most codes of governance stipulate that board members should reflect a different mix of expertise, backgrounds, and competencies.

Customers

Customers expect a company to satisfy their needs and give them the necessary benefits when they purchase its goods or services. Customers may receive continuous support, product guarantees, and after-sale service, depending on the products and services a company deals in.

Suppliers

Suppliers are the short-term creditors of a company whose main interest is to be paid as agreed for products or services delivered. Suppliers are interested in the financial health of a company and seek long-term relationships with it for mutual benefits.

Governments

Governments and regulators seek to ensure that companies comply with the law and act in a manner that safeguards the interests and well-being of the public. Moreover, governments collect taxes from companies.

Question

Corporate governance is a system that provides a framework that defines the rights, roles, and responsibilities of various groups. Which one is least likely one of these groups?

1. Directors.
2. Employees.
3. Shareholders.

Solution

The correct answer is B.

Corporate governance is a system that provides a framework that defines the rights, roles, and responsibilities of board members, shareholders and managers. However, it does not include employees as major stakeholders.