FINANCIAL MANAGEMENT

“Shareholder Wealth Maximization Should Be The Primary Goal of Corporate

Managers”

As businesses become aware of the importance of stakeholders to their survival, they

look for ways to manage them effectively. But this risks undermining the very

relationships they need to cultivate.

The theory of stakeholder management taught in most business schools today focuses on

the mechanisms by which organizations understand and respond to the demands of their

stakeholders. Theorists have argued that stakeholder relationships can be managed using

techniques such as issue analysis, consultation processes, external communications, and

contracts or agreements. The managerial role is to direct and control interactions between

a corporation and its stakeholders, and to buffer the organization from the negative

impacts of stakeholder activities, preserve goodwill, and avoid public relations fiascoes.

The job of a public affairs or community relations manager, for instance, is to anticipate

how the company’s activities will affect public stakeholders and minimize negative

reactions by instituting damage control.

Within this more traditional perspective, responsibilities for various stakeholder groups

are assigned to separate divisions. Marketing deals with customer relations, community

relations deals with local organizations, public affairs deals with the media, and so on.

The relationships that develop between managers and stakeholders are shaped by the

interests and values of managers rather than by the company’s strategic business goals

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and corporate values. This idiosyncratic approach has arisen out of the belief that

corporations need to take steps to defend themselves from the demands of stakeholders.

There is, however, another more dynamic approach to stakeholder relations that serves to

create, rather than simply maintain corporate value. It is based on the view that

companies are both defined by and part of their sociocultural environment. Within this

context, relationships with stakeholders are as essential to survival as air or water. Rather

than defending the company against the demands of stakeholders, managers are

responsible for building collaborative, mutually beneficial relationships with

stakeholders. (John Freer, “The Management of Business Finance”, 1 st Edition, 1980,

Pg. 111-113)

Agency Theory

Agency theory is the branch of financial economics that looks at conflicts of interest

between people with different interests in the same assets. This most importantly means

the conflicts between:

 Shareholders and managers of companies

 Shareholders and bondholders.

Agency theory explains, among other things, why:

 Companies so often make acquisitions that are bad for shareholders.

 Convertible bonds are used and bonds are sometimes sold with warrants

 Capital structure matters.

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Agency theory is rarely, if ever, of direct relevance to portfolio investment decisions. It is

used to by financial economists to model very important aspects of how capital markets

function. However, investors gain a better understanding of markets by being aware of

the insights of agency theory.

One particularly important agency issue is the conflict between the interests of

shareholders and debt holders. In particular, following a more risky but higher return

strategy benefits the shareholders to the detriment of the debt holders.

It can easily be seen why debt holders lose out: a more risky strategy increases the risk of

default on debt, but debt holders, being entitled to a fixed return, will not benefit from

higher returns. Shareholders will benefit from the higher returns (if they do improve),

however if the risk goes bad, shareholders will, thanks to limited liability, share a

sufficiently bad loss with debt holders.

This conflict can be addressed by the use of debt covenants, or by providing debt holders

with a hedge against such action by the shareholders by issuing convertible debt or debt

bundled with warrants. (Roy C. Smith & Walter I, “Global Financial Services” 2 nd

Edition, 1999, Pg. 71-73)

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Stakeholders Defined

Stakeholders have been defined by R. E. Freeman in his book Strategic Management: A

Stakeholder Approach as “any group or individual who can affect or is affected by the

achievement of the firm’s objectives.”

Primary stakeholders have interests that are directly linked to the fortunes of a company.

They typically include shareholders and investors, employees, customers, suppliers, and

residents of the communities where the company operates. Some have also added the

natural environment, nonhuman species, and future generations to this list.

Secondary stakeholders have an indirect influence on an organization or are less directly

affected by its activities. They include the media and pressure groups, regulators,

competitors, and others that form the social ecology of an organization.

Stakeholder groups can also be differentiated by the type of interests or stakes they hold.

Stockholders’ and directors’ stakes, for example, are based on equity. Individual

stockholders have invested money in the company, while directors and senior managers

have invested their time and reputations. Other stakeholders (customers, competitors,

suppliers, debt holders, and unions) have economic stakes or interests in a company.

They can affect or be affected by a corporation’s financial success. Community groups,

environmentalists, and consumer advocates, on the other hand, have “sustainability”

interests. Their stake is in the company’s impact on people and the environment. (Coase,

R. H., "The Nature of the Firm" Economica (New Series, IV, 1937), Pg. 386-390)

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Building good relationship with the stakeholders

Collaborative relationships with stakeholders can increase an organization’s stability in a

turbulent environment, enhance its control over changing circumstances, and expand an

organization’s capacity rather than diminish it. For example, suppliers will be more likely

to show optimal responsiveness to company needs (as well as flexibility in demanding

payment in times when cash flow is limited) if there is a trusting relationship. Similarly,

if a company has a good working relationship with the community, it is more likely to get

cooperation when it comes time to expand facilities or engage in activities that will affect

the community. An integrated, company wide approach to identifying and building

strategically important stakeholder relationships offers the greatest benefits. In addition to

increasing organizational effectiveness and consistency of response, this kind of holistic

approach also allows the organization to build on the synergies that occur when positive

relationships with one stakeholder group, such as a local community, start to have a

beneficial impact on another stakeholder group, such as customers.

When a company establishes collaborative relationships with stakeholder groups it is

much like the process individuals go through to find and develop lasting interpersonal

relationships. We decide what we want from a relationship, consider how our existing

relationships measure up or fall short, and decide whether there is some obvious gap.

Enduring relationships are based on a foundation of common values and history, the

sense of “we.” In successful marriages or friendships, the partners develop mutual

interdependence but also define their boundaries so that each benefits from the success of

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the other while retaining his or her own identity. Partners in successful relationships also

learn how to deal with conflict, resolve power struggles, and come to some agreement

about behavior with the “in-laws” and friends. The same is true with building long-term

corporate-stakeholder relationships.

A brief description of the stages an organization will likely go through in establishing

collaborative relationships with key stakeholders is given in the adjacent box. Given the

growing importance of such alliances, and the limited amount of time that is available for

such initiatives, companies must ensure that their efforts are as efficient and effective as

possible. By making the steps involved in building relationships more apparent and the

potential pitfalls and opportunities involved in this process more defined, organizations

can achieve greater success. (Boatright, John R. Ethics in Finance, Blackwell

Publishers, 1999, Chapter 6, Pg. 171-175)

Good Stakeholder Relations Pay Off

Research is showing that companies that establish a good reputation, trusting

relationships with suppliers and community members, and sustainable environmental

practices are more profitable.

In a recent prize-winning research paper, Sandra Woddock and Samuel Graves

established the link between stakeholder relations, financial performance, and quality of

management. Their analysis of the Fortune 500 reputation survey results shows that

building positive stakeholder relationships is not a zero-sum game but that solid financial

performance is consistent with good treatment of other stakeholders such as employees,

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customers, and communities. They also found that companies that treat their stakeholders

well are also rated by their peers as having superior management.

John Kotter and James Heskett, Harvard researchers and authors of a recent book,

Corporate Culture and Performance, note that successful, visionary companies such as

Hewlett-Packard, Wal-Mart, and Dayton Hudson share a stakeholder perspective: “All

their managers care strongly about people who have a stake in the business (customers,

employees, stockholders, suppliers).” Their study showed that over an 11-year period,

stakeholder-balanced companies showed four times the growth in sales and eight times

the employment growth when compared to shareholder-focused companies.

A study by Max Clarkson, director of the Centre for Corporate Social Performance and

Ethics at the University of Toronto, indicated that over the longer term, firms that rate

highest on ethics and corporate social performance make the most money. His research

suggests that companies that concentrate exclusively on the bottom line often make

poorer decisions, perhaps because they lack the information to anticipate opportunities

and to solve problems before they become large and costly to remedy. A 1997 national

study of consumer attitudes conducted by Cone/Roper found that 76 percent of

consumers would be likely to switch to a brand associated with a good cause. In 1993, 63

percent responded this way.

A 1995 survey of Canadian consumers by the Market Vision Group indicated that 26

percent of Canadians were actively involved in boycotting goods or services for reasons

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that had nothing to do with price or quality (the companies were simply viewed as bad

corporate citizens).

(Coase, R. H., "The Nature of the Firm" Economica (New Series, IV, 1937), Pg. 391-395)

Case Study of Daewoo – The reasons for the failure of Daewoo

The Daewoo Group was a conglomerate, with operations in a wide variety of industries.

The company of particular interest in this case, Daewoo Motors, was in the auto

manufacturing industry.

The downfall of Daewoo Motors. Virtually everything that could be done wrong was

shown by Daewoo management. It bought into a troubled venture (Saehan Motor

Company), produced poor-quality cars, planned poorly, over-borrowed, and had

criminally fraudulent senior managers. It seems that the only purpose Kim had for the

company was to enrich himself. If the CEO views the company as a personal piggybank

instead of an organization that should serve a variety of stakeholders’ interests, there is

little that other managers or workers can do.

This case shows that Kim was the main person who was responsible for the failure of

Daewoo. This shows clearly that Kim ran the company as a dictator, with no checks and

balances. The similarities to Enron, WorldCom, and other U.S. corporate scandals are

not to be dismissed.

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The Southeast Asian financial crisis certainly played an important part in the Daewoo

story. However, other Korean and Japanese auto manufacturers suffered through the

same conditions without imploding as Daewoo did. Economic downturns can be

weathered by sound planning and financial controls, neither of which occurred at

Daewoo. It is quite possible that Kim’s ties to the South Korean government allowed

him to acquire businesses without sufficient capital behind him, and for which he had no

knowledge or expertise. If Kim really did view the Daewoo Group as his personal money

machine, it is not surprising that the conglomerate collapsed. The globalization of the

auto industry certainly affected events at Daewoo. Kim wanted to make Daewoo one of

the top 10 auto manufacturers in the world, which put the firm in direct competition with

the likes of Honda, Toyota, Ford, and GM. These are not rivals to be taken lightly. If

Daewoo did not have the capitalization or expertise to compete effectively with these

companies, setting sights on being in the upper echelon may have speeded up its

destruction.

Future objectives – The only future objective that is relevant in this case is Kim’s stated

desire to make Daewoo one of the world’s top 10 auto manufacturers. This goal was

completely unrealistic in the short term, given Daewoo’s starting point. Over expansion

and excessive borrowing contributed to the company’s eventual demise.

Resources – Daewoo’s primary resource must have been Kim’s relationship with high-

ranking government officials. He received special assistance from South Korean

President Park to start the Daewoo Group in 1967, and then was allowed to buy a 50%

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interest in Saehan Motor Company. General Motors, the owner of the other 50% share,

apparently had little say in who its next partner would be. There seemed to be precious

few other resources within the Chaebol.

Financial – Daewoo’s finances were a disaster. Part of this was a result of incredibly

poor management and part was due to intentional deception and fraud.

Steps for Building Collaborative Stakeholder Relationships

1. Establish a foundation for relationship building

 Assess relationship building as a strategic direction

 Review and refine social mission, values, and ethics

 Communicate corporate commitment

2. Develop a relationship-building strategy and action plans

 Inventory and assess existing relationships

 Identify strengths and weaknesses and gaps

 Set priorities and goals

 Benchmark best practices

 Consult with stakeholders

 Refine goals and prepare outreach strategy

 Form stakeholder teams

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3. Align systems and structures to support collaboration

 Assess organizational readiness

 Identify gaps and inconsistencies

 Assess systems and structures

 Make changes as needed

4. Form a collaborative group

 Invite stakeholder leaders to meet

 Exchange information and clarify expectations and perspectives

 Develop organizational structures

 Clarify roles and responsibilities

 Develop and implement projects

5. Harness the power of long-term relationships

 Deepen mutual understanding

 Explore and integrate ideas

 Generate new options and solutions

 Manage expectations

 Identify and resolve areas of conflict

 Ensure availability of resources

6. Evaluate and continuously improve relationships

 Design and conduct stakeholder audits

 Celebrate successes

 Learn from failures

(Coase, R. H., "The Nature of the Firm" Economica (New Series, IV, 1937), Pg. 394-399)

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Managers relation with the stakeholders

Managers are the main persons in the company on whom the company’s success is

dependent. It’s the managers who drive the company towards the successful and

profitable way. Stakeholders are the main persons by whom the company runs. Without

stakeholders it is not only difficult, but also impossible to run the organization. So the

main prime responsibility of the managers is to develop good relation with the

stakeholders. If the relationship is not good with the stakeholders, then there are no

chances that the company will move forward and gain success. If the managers are

successful in developing good relationship and maintaining the relationship for longer

period of time with the stakeholders then it is obvious that the company will gain profits

more likely. The mangers should not be concerned about any personal conflicts, likes

and dislikes and other personal issues, instead they need to focus on the aims and

objectives of the company and should know in detail about what stakeholders are

expecting from the company and try to fulfill their needs and demands and thus making

the company more profitable.

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CONCLUSION

Stakeholders are the main building blocks of most of the organizations. They need to be

taken special care. If the relation between the stakeholders and the managers are not

good, then there is do doubt that the company will not succeed and very soon the

company will see problems in the company and eventually the company will fail. So it

becomes very important that the organizations take better care of the stakeholders and

avoid the company from falling in crisis.

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REFERENCES

 John Freer, “The Management of Business Finance”, 1st Edition, 1980: Great

Britain.

 Roy C. Smith & Walter I, “Global Financial Services” 2nd Edition, 1999: Row

Publishers, New York.

 Boatright, John R. Ethics in Finance, Blackwell Publishers, 1999, Chapter 6, "The

Financial Theory of the Firm"

 Brennan, Michael J. "Incentives, Rationality, and Society" address given at the

University of Maryland, April 2, 1993, reprinted in The New Corporate Finance,

edited by Donald H. Chew (2nd edition, 1999), McGraw-Hill, pages 20-28.

 Coase, R. H., "The Nature of the Firm" Economica (New Series, IV, 1937), pages

386-405, reprinted in Readings in Price Theory (Irwin), pages 331-351.

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