This theory took form in the 1980s with R. Edward Freeman's book, Strategic Management: A Stakeholder Approach. Freeman argued that the economic theories that were prevalent in the 70s, (e.g. shareholder primacy), were outdated and in desperate need of restructuring. The general idea has come a long way since then, but aspects of the theory are still being debated today as it becomes more and more prevalent in literature and corporate governance.
The theory itself, being in direct opposition to shareholder primacy, holds that stakeholders are inherently valuable to the company and as a result, they should be treated as such in the management of the affairs of the company. Stakeholder means anyone with an asserted or real interest, claim or right, whether legal or moral or an ownership share in an undertaking while generally risking something in the process of a corporation's actions.
Now, what does this mean? Well, let's go back to shareholder primacy. This theory holds that the primary goal of a corporation is to make a profit for the shareholders, and every other stakeholder is only a means to that end goal. In comparison, stakeholder theory says that shareholders aren't the only ones with a stake in the performance of the company. It is of utmost importance that corporations be managed for the benefit of and with accountability by all stakeholders, not just shareholders.
Stakeholder theory, according to Andrew Keay of researchgate.net, views the corporate goal as "providing a vehicle to serve in such a way as to co-ordinate the interests of stakeholders, and it is concerned about the damage that externalities can have on participants in the corporate enterprise."
There are six commonly held groups of primary stakeholders: financiers, employees, customers, suppliers, and the local community. It also must be mentioned that no one stakeholder has primacy above another. It is the director's job to manage the interests of the various groups of stakeholders; thereby, judging which claim requires immediate attention.
One of the most notable pieces of legislation supporting a stakeholder type approach to managing a company is the UK Companies Act of 2006, which was enacted in stages with the last part of the Act being implemented in 2009. This piece of legislation brought a significant update to the UK's existing body of corporate law and attempted to streamline a number of aspects of the incorporation process. The specific section of the Act concerning the duties of directors and managers of a corporation is of utmost importance. It's as follows:
"A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
the likely consequences of any decision in the long term
the interests of the company's employees
the need to foster the company's business relationships with suppliers, customers and others
the impact of the company's operations on the community and the environment,
the desirability of the company maintaining a reputation for high standards of business conduct, and
the need to act fairly as between members of the company."
The Companies Act clearly states that a director needs to act in good faith promoting the success of the members of a company and to have regard for the company's employees, business relationships, the community, and the environment. In 2010, the UK government published a study trying to ascertain the effects of the piece of legislation.
With regard to a director's duties, it said, "Overall, one-fifth of those who had responded agreed the statutory statement had an impact on the way directors discharged their duties, and almost three-fifths were aware of the changes to the procedure for bringing about a derivative action for breach of duty (59%). Of those companies not initially aware of the changes relating to directors’ duties, over one-third indicated that they would now take advice from the company’s accountant on the nature of their requirements."
The overall message of the study though said that it is still a bit early to tell the effects of the UK Companies Act of 2006, or whether or not it helped clarify aspects of corporate law in the UK.
There are some issues with stakeholder theory, though; critics present three major problems with the idea. First, depending on one's definition of who is a stakeholder, the number of stakeholders can be almost endless with huge variations between them and their interests.
This leads to the second issue. Since the sheer number of stakeholders can be quite large, how does a director effectively balance the interests of all these groups? Let's say a director of a company has a decision between choice A and choice B. Choice A will benefit stakeholder groups A and B but hurt stakeholder groups C and D. Choice B is the reverse benefitting groups C and D instead of A and B. What does he do?
Finally, we come to the issue of the "too many masters" problem. The saying is, "A manager who is told to serve two masters is essentially freed of both and answerable to neither." Since there can be quite a number of stakeholder groups each with competing interests, and there is no clear standard for a director to balance these interests against, doesn't that practically give a director free reign to do what he wants? If the standard for a director's conduct is to balance stakeholder interests, practically any decision they make could be easily argued in defense of that standard. The directors are effectively unaccountable and free to act as they choose with specific regard to what might most benefit themselves in the end.
In spite of all this, stakeholder theory is quickly gaining popularity among the general public because it puts forth the idea that there is more to business than maximizing shareholder wealth. It promotes trust and co-operation between the various groups of stakeholders and charges the corporation with seeking out that trust and co-operation between everyone involved. It emphasizes long-term profitability through the cementing of these stakeholder relationships that managers and directors deal with on a regular basis. It treats all stakeholders as ends and not means; therefore, creating a moral and economic obligation to truly consider all competing interests in a corporation's actions.