Updated July 7, 2023
What is Stakeholder Theory?
The term “stakeholder theory” refers to the concept that intends to address the outcomes of business decisions, trends, profitability, etc., and their collective impact on all the stakeholders, including employees, lenders, shareholders, customers, suppliers, etc.
This theory was first presented in 1984 by Dr. R. E. Freeman, a professor of business administration at the University of Virginia, in his milestone book Strategic Management: A Stakeholder Approach. As per his theory, the shareholders of a company are just one of the many stakeholders involved in the business.
Some of the key takeaways of the article are:
- Stakeholder theory is the concept that tries to address the collective impact of business decisions, trends, profitability, etc., on all the organization’s stakeholders, including employees, shareholders, lenders, customers, suppliers, etc.
- The stakeholder theory is based on six principles – the principle of entry and exit, the principle of governance, the principle of externalities, the principle of contract cost, the principle of agency, and the principle of limited immortality.
- One of the significant benefits of the stakeholder theory is that it helps an organization by increasing its productivity, improving employee satisfaction, and lowering turnover rates.
- Many critics believe that the stakeholder theory lowers the management’s focus on the shareholders’ value creation.
Top 6 Principles of Stakeholder Theory
There are six different principles of the stakeholder theory.
1. Principle of Entry and Exit
The policies about employee recruitment and dismissal should be framed in plain and straightforward language so that anyone reading them can easily understand the context. In addition, it helps an individual develop the right mindset before joining the organization.
2. Principle of Governance
It states that the current rules and policies deployed for managing the relationship between an organization and its stakeholders can be amended with the help of unanimous consent.
3. Principle of Externalities
Anyone affected by an organization’s business decisions can be considered a stakeholder. This principle covers the people within the organization and people from outside.
4. Principle of Contract Cost
This principle is based on the concept of fairness, which states that the involved parties must bear the cost of doing the business to the extent of their involvement. Sometimes, it can be something other than money, making the task quite challenging to execute.
5. Principle of Agency
It signifies one of the significant challenges of a corporation, where the shareholders elect the management to act as agents and run the business on their behalf. Hence, the management is held responsible to the shareholders and stakeholders.
6. Principle of Limited Immortality
This principle indicates that an organization isn’t immortal, but its existence can be extended to the maximum period, which can benefit the stakeholders. An organization can remain in existence for an extended period through proper succession planning.
Examples of Stakeholder Theory
Examples of stakeholders include shareholders, investors, lenders, creditors, employees, the local community, etc. In short, a stakeholder can be any person or entity with a significant interest in both success or failure of an organization. Some stakeholders significantly influence the organization’s business decisions, operations, and finances. Therefore, stakeholders comprise a vast pool of individuals and entities that are involved in the business in one way or the other.
Stakeholder Theory vs. Shareholder Theory
Although many use these two terms interchangeably, they are quite different regarding their underlying concepts.
- The stakeholder theory is more managerially minded, while the shareholder theory is more economically oriented.
- Unlike the shareholder theory, the stakeholder theory states that fixating on maximizing shareholder value is not always the best approach. Instead, the best way is to create value for all the stakeholders.
- The shareholder theory may suggest that resources spent on employees and customers may no longer be available to the investors, indicating a trade-off. But on the other hand, the stakeholder theory focuses on the bigger picture and tries to increase the overall pie.
Benefits of Using Stakeholder Theory
Some of the significant benefits of using stakeholder theory are as follows:
- First, it helps an organization increase productivity, improve employee satisfaction, and lower turnover rates, making talent retention and acquisition easier.
- It also benefits an organization by using the positive feedback received from the customers. Happy customers act as unpaid marketers and help in increasing overall sales.
- It also helps manage the lenders and financiers properly, assuring them about the repaying capability of the organization.
Challenges of Stakeholder Theory
Some of the significant challenges of stakeholder theory are as follows:
- First, it focuses on everybody who may or may not be affected by the outcome of the organization’s business decisions. Many experts criticize this theory because it lowers the management’s focus on shareholder value.
- Although the shareholders have taken the maximum risk by investing their money, the management need not keep their interest as the primary focus.
- Many believe the theory intends to fulfill everyone’s interests, which is practically impossible. So, if the management attempts to meet the need of all the non-financial stakeholders, it may destroy the organization’s overall value proposition.
So, the stakeholder theory suggests that an organization can achieve success only by satisfying its stakeholders, not just the shareholders. It presents an organization as an ecosystem of related groups, all of whom should be happy to keep the overall entity healthy and prosperous in the long run.
This is a guide to Stakeholder Theory. Here we also discuss the definition, principles, and examples, along with benefits and challenges. You may also have a look at the following articles to learn more –