presentation, stakeholder vsshareholder diagnostic and valuation of firms

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Stakeholder vs. Shareholder TheoryDiagnostic & Valuation of Firms Pierre-Olivier HIGI

Stijn Moens, Linda Pantera, John Regner, Wenlu Wang, Yiwei Ding, Benjamin Rudaz, Siwen Meng, Wenjie Zhang, Dimitri Bellas, Ivana Matuskova

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Structure

1. Definitions

2. Measurements of stakeholder values

3. Stakeholder Theory: Pros and Cons

4. May stakeholder value replace shareholder value ?

1. Definitions1.1 Shareholders

1.2 Stakeholders

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1.1 Definition – Shareholder theory

Milton Friedman, 1962

"There is one and only one social responsibility of business: to use its resources to engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.”

The purpose of business is to make money for the owner or shareholders

1. Definitions

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1.2 Definition – Stakeholder theory

Stakeholder theory:

Businesses exist not only to serve the interest of their owners, but to benefit all who have an effect on the company and who are affected

Objective of management is to balance stakeholders’ competing interests

1. Definitions

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1.2 Definition – Stakeholder

2 different approaches: 1963 – Stanford Research Institute:

Stakeholders: « those groups without whose support the organization would cease to exist »

Shareowners, employees, customers, suppliers, lenders and society

2004 – R. Edward Freeman: Stakeholders: « any group or individual who can affect or is

affected by the achievement of the organization’s objectives » Everyone is a stakeholder UN Definition of Sustainable Development:

The ability of present generations to meet their needs while allowing future generations to meet their own needs

1. Definitions

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1.2 Definition – Freeman’s approach

Customers

Investor groups

Employees

Suppliers

Unions

Communities

Media

NGOs

Government

Universities

Societal Stakeholder

s

Economic Stakeholder

s

1. Definitions

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1.2 Definition – Freeman’s approach

Dramatically increases the number of stakeholders Not just those in whom the organization has a stake, but

those who have a stake in it Excludes all criteria of materiality, immediacy and

legitimacy

Stakeholders are all those who can affect or are affected by an organization

Competing interests How should the management prioritize? How should the benefits be measured?

1. Definitions

2. Measurements of stakeholder values2.1 Balanced Scorecard

2.2 How one could link the Balanced Scorecard to corporate strategies

2.3 The stakeholder strategy: a practical approach

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2.1 The Balanced Scorecard

Vision and

Strategy

Financial: encourages the identification of a few relevant high-level financial measures. In particular, designers were encouraged to choose measures that helped inform the answer to the question "How do we look to shareholders?“

Customer: encourages the identification of measures that answer the question "How do customers see us?“

Internal Business Processes:encourages the identification of measures that answer the question "What must we excel at?“

Learning and Growth:encourages the identification of measures that answer the question "Can we continue to improve and create value?"

1. Definitions 2. Measurements

Financial

Internal Busines

s Process

es

Learning and Growt

h

Customer

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2.2 How one could link the Balanced Scorecard to corporate strategies

Vision and Strategy

Shareholder

Financial Success FactorFinancial Measures

Customer

Customer Success FactorCustomer Measures

Process Success FactorProcess Measures

Learning and Growth

Learning and growth success FactorGrowth Measures

Strategy

Goals

Balanced Scorecard


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2.3 The stakeholder strategy: a practical approach


3. Stakeholder Theory: Pros and Cons3.1 The impracticalities of stakeholder value

3.2 Should a firm’s objective be single-valued?

3.3 Shareholders’ property rights

3.4 Stakeholders and ethics

3.5 Creating shareholder value by focusing on stakeholder value

3.6 Examples

3.1 The Impracticalities of Stakeholder Value

1. Definitions 2. Measurements 3. Pros & Cons

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How do you identify stakeholders and benefits?

It is difficult to define and prioritize all relevant groups of stakeholders

Even with a contained list of stakeholders, identifying benefits to all stakeholders groups is an onerous task for managers Within the same notional group, stakeholders may hold

significantly different views of what is beneficial How can a balance be struck between stakeholders within

the same notional group?


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Quantifying effects is complex

Are all stakeholder groups equal? What outside criteria would be used to order them?

It is complicated to assign values to abstract effects on different stakeholder groups

How do you deal with conflicting stakeholder interests?


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The stakeholder approach provides a new perspective and a source of innovation

It can be said that the stakeholder value approach at least helps managers understand better the company’s strategy and the drivers of value in their businesses

Ex. Shaw Industries

Shaw Industries Managers

Environmental Concerns

related to PVC

Cost Drivers of PVC

Health Concerns

related to PVC

EcoWorxinnovation

Half the weight = savings on shipping

Pick up of EcoWorx at end of product life = feedback loop on materials

Call for pick up from customer = a selling opportunity

By end of the year, EcoWorx = 50% of all carpet sale

1. Definitions 2. Measurements 3. Pros & Cons +

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Value-maximization can short-change the long-term in favor of short-term gains

While proponents of value-maximization speak in terms of long-term value, in practice this is often not the case

Concrete metrics give managers a false sense of understanding

Shareholder view is more susceptible to moral myopia

Profit objective offers no guidance for managers of how to deal with the moral and legal challenges they face in the day-to-day activities of the firm


.


3.2 Should a Firm’s Objective Be Single-Valued?

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Multiple objectives is no objective

Scorecard is more like an ‘instrument panel’ than a single goal in itself, so cannot be used as objective

Even if stakeholder values could be identified, their prioritization is left up to the manager’s discretion

Allows for politicization, and leaves managers with power and room to act in their own interest


3 7 5 2

Employees

Environment Society

Shareholders

Scorecard

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Multiple goals leave managers the opportunity to act in their own interests

For organization strategy to be implemented effectively each person must clearly understand how performance measures will be constructed

Stakeholder theory does not offer a framework against which managers can be concretely judged

Without a uniform objective function anything can be justified as in the interest of “stakeholders”

Managers will favor the stakeholder approach, as it leaves them with more freedom


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Shareholder value is a focused stakeholder value

Inefficient for a company to define specific goals for each stakeholder value

More efficient to maximize shareholder value, a function of stakeholder values

Leaves the employees the freedom to most efficiently prioritize and manipulate the drivers involved to reach the goal


Objective = A × Possession + B × Shots on Target

+ C × Passing Percentage + …

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Single-valued objectives oversimplify and distort

Having a single objective function has historically not necessarily led to good company governance

It oversimplifies complex reality

Takes moral responsibility away from managers (not my fault – my goal is solely to create profit…)


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Optimum solution is irrelevant

All objective functions are too complex to maximize

Objective functions serve to show how to improve

Stakeholder values theory should be viewed as an opportunity to get different stakeholders to cooperate and agree


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Value is derived from a number of dimensions


3.3 Shareholder’s Property Rights


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Shareholders’ property rights are sacred

It denies the duty agents owe to principals

It denies owners the right to determine how their property will be used

Any rights given to stakeholders take away from shareholders’ property rights


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Key notions of accountability

An agent is accountable to a principal for an outcome

Requires the existence of a legitimate authority — stemming from certain types of relationships and agreements. (Fiduciary duty)

Accountable individuals and institutions are answerable for what they do — there exists a system that metes out reasonable incentives (positive & negative)


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Stakeholders’ theory still takes into account shareholders’ rights

Shareholders are stakeholders

Stakeholders’ views should be taken into account, and conflicts among them minimized, so they: do not exit the deal use the political system to appropriate value for

themselves regulate the value created for others

Stakeholders have become increasingly vocal, organized and active due to advances in technology Heightened risk and impact of negative publicity


3.4 Stakeholders and Ethics


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Monopolies and externalities should be considered

Externalities: internalizing profits, externalizing costs

Avoidance of competitive behavior destroys potential value

Negative ExternalitiesPollutionTraffic

Positive ExternalitiesEducationHealthcare Infrastructure

’Deadweight loss’ of the marketBusinesses lack incentives to innovate and increase efficiency


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Just profits, no ethics?

Ethics

Profit Maximization

Government Laws &

Regulations

Do regulations give companies the freedom of separating business from ethics?

Freeman’s ’separation thesis’: ethical issues can be neatly separated from business issues

Is it the government’s role to define specifically what is and isn’t ethically allowed? And should companies engage purely in shareholder value maximization within these rules?


3.5 Creating Shareholder Value By Focusing on Stakeholder Value


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All stakeholders should be considered for value-generating partnerships

Value-generating partnerships with economic stakeholders have been common throughout history but partnerships

with other stakeholders have often been overlooked


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Stakeholder values are sometimes value-destroying

Public perceptions are often more important in stakeholder values than scientific facts

For example, radical difference in public perception of tobacco and alcohol unrelated to relative health risks

Company reputation and branding is often more important than company actions


3.6 ExamplesGeneral Electric, Enron, Merck, FIGHTON


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GE – Placing shareholders in the centre…

When Jack Welch assumed the position of CEO, he centered the company policy around shareholder value maximization

Streamlining the company

Reduced salaries and severe lay-offs

High performance targets for executives


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GE – ...understanding the needs of all stakeholders

Market value increased from $14 billion in 1981 to $410 billion in 2004

”Shareholder value is a result, not a strategy... your main constituencies are your employees, your customers and your products” - Jack Welch, CEO


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Enron – Shareholder focus led Enron to ”success” in the nineties

Enron's stock rose by over 300%

1991 1992 1993 1994 1995 1996 1997 1998 1999

The stock increased by 56%

The stock increased by a further 87%, Enron’s market capitalization

exceeded $60 billion, 70 times earnings and 6 times book value

2000

By the end of 2001, Enron had filed for bankruptcy

2001


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Enron – …and to bankruptcy in 2001

Many reasons for its demise, which can arguably be traced back to an extreme misapplication of shareholder value maximization

Corporate policy based around immediate shareholder value maximization

This led the Enron management to become risk-prone, to engage in levered speculation, and to ‘cook the books’

Disregard for any other stakeholders, decisions focused around increasing the stock price in the short-term


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Merck – Curing river blindness on the cost of shareholders

Merck discovered that an anti-parasite drug for animals was effective against a parasite similar to the one that causes river blindness in humans

Developing and testing a human version of the drug would cost a large amount of money

The target countries could not afford the drug if it was developed


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Merck – What would you do?

Forget the drug and let poor people suffer from blindness

Develop the drug with a loss

Turn the preliminary

findings over to the WHO


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Merck – Medical and Financial Success

Has saved 600 000 people from blindness

Big costs, but the predicted branding gains much bigger

Would this have been possible in a shareholder focused company


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FIGHTON – Mixing business with politics…

Business venture manufacturing power supplies, metal stampings and vacuum cleaners to revive deprived black community of Rochester, NY

Cooperation between Xerox and FIGHT, a local community organization

Grass roots philosophy conflicted with business practices, nearly leading to company’s demise


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FIGHTON – …led to unclear objectives and priorities

On the brink of bankruptcy

before change of policies

Politics interpreted

as firm policy, and

no clear guidelines

Lots of political

infighting and unprofitable operations


4. May stakeholder value replace shareholder value ?4.1 Summary

4.2 A middle route:

- Enlightened Value Maximization/Enlightened Stakeholder Theory

- Ethical Decision Model

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4.1 Summary

Stakeholders theory is unpractical because it lacks a clear objective and makes managers unaccountable for their actions

However, a firm cannot maximize value if it ignores the interest of its stakeholders

The real issue is what corporate behavior will get the most out of society’s limited resources

1. Definitions 2. Measurements 3. Pros & Cons 4. Conclusion

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Stakeholder Theory: Strategic Objective vs. Performance Metric

Pros

Expands the set of business unit objectives beyond summary financial measures

Captures the critical value-creation activities created by skilled, motivated organizational participants

Reveals the value drivers for superior long-term financial and competitive performance

Cons

Balanced Scorecard lacks one number that defines success

The number of stakeholders that need to be taken into account can spiral out of control very quickly (assumes limited common sense on the part of the manager)

All methods remain vague as to how managers should quantify trade offs


4.2 A Middle Route ?


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Enlightened Value Maximization /Enlightened Stakeholder Theory

It utilizes much of the structure of stakeholder theory but accepts long-term value maximization as the firm’s objective

Value maximization provides the following answer to the tradeoff question: Spend an additional dollar on any constituency provided the long-term value added to the firm from such expenditure is a dollar or more


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Pros of Enlightened Value Maximization /Enlightened Stakeholder Theory

Prevents short-term profit maximization at the expense of long-term value creation by taking into account all important constituencies of the firm not only shareholders but also employees, customers, suppliers and communities etc.

Allows for principled decision making independent of the personal preferences of managers and directors

Makes managers and directors accountable for the assets under their control because the value scorecard provides an objective yardstick against which their performance can be evaluated


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Ethical Decision Model

Ordinary decency

Distributive justice

Maximize long-term

owner value

CompatibleSocial Responsibility


Can be a management tool

Business ethics:

Stakeholders can profoundly influence business’s direction: “The invisible hand” — The definitive business purpose

positively requires that the stakeholder preferences are taken into account

“Conscientious stakeholding” — Individual’s own choices of moral values to support social and economic institutions

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Ethical Decision Model

1. Clarify the question- What is at issue?

2. Determine the question’s relevance for this business- Does the issue relate to maximizing the long-term owner value?

3. Identify the circumstantial constraints- Laws & regulations, Contractual, Cultural, Physical, Economic considerations

4. Assess the available options - Long-term owner value while respecting ordinary decency and distributive justice

5. Right course of action - Which action actually maximizes owner value?

Five steps:


Thank youQuestions?

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