Business Ethics Theories – Stockholder Theory – Part Two – Chuck Gallagher Business Ethics Speaker Comments

So when the question was asked, “Which theory of business ethics do you follow” I admit my response was unexpected and certainly not scholarly or academic.  My response?

“The theory that keeps you out of federal prison!”

As you might expect from reading the former article – see here – the conversation quickly turned in a different direction.  However, the original question was valid.  As there are three leading practical theories of business ethics – the Stockholder, the Stakeholder and the Social Contract Theories.

In Part Two – we’ll explore in layman’s terms the Stockholder Theory and look at how it might apply in business today!

If you spent some time reviewing business ethics history (something I am not real fond of – but perhaps a necessary evil), you will note that the Stockholder Theory is the oldest of perceptions or theories related to business ethics.  Today, well let’s say that it might be out of favor as this theory is one that would resonate with the 1% not the “Occupy Wall Street” crowd who seem to favor “social responsibility” over capitalism.

Let’s first start with why a business is formed…    Businesses (organizations) take many forms – for profit, not-for-profit, associations, education, government, etc.    As such the  business person’s responsibilities are to manage the business and use business resources to accomplish the businesses mission or purpose.  Example – Apple Computer (now the world’s most valuable company) has a mission statement as follows:

Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork and professional software. Apple leads the digital music revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App Store, and is defining the future of mobile media and computing devices with iPad.

Ethically then the employees and management of Apple Computer are obliged to conduct themselves in a way that accomplishes Apple’s objective and business purpose.  Let’s see how the Stockholder Theory would apply as it relates to our example – Apple.

THE STOCKHOLDER THEORY

Businesses are created for a purpose and owned by individuals – stockholders (although the ownership form may vary – in other words this would apply to other forms of business ownership – partnership, LLC, etc.) and therefore, the responsibility of those who are hired to run the business are, in a sense, fiduciaries  of the owner’s interests.  Under this theory, the actions (ethical choices) of those empowered to run the business are limited to expending business resources in ways that meet the stockholders interests or are aligned with the stockholders interests.

If, for example, the stockholders have created the business that is designed to maximize profit for the stockholders – then one might assume that business choices will be focused on maximizing revenue and minimizing costs – even if that includes using cheap labor in a foreign country.  On the other hand, if a company is formed with stockholders directing that part of the company mission is to provide local jobs, then ethics would dictate that management choices would favor the objective over the cost minimization.  The significant issue under the Stockholder Theory is that the stockholders rule over any other “social responsibility” that might be perceived by outsiders.

Milton Friedman states, “there is one and only one social responsibility of business–to use its resources and 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.”

Friedman uses two words that seem to define the boundary of ethics in this stockholder theory – “deception or fraud”.   From a practical perspective, in the stockholder theory, management is obligated to advance the business purpose and increase the value of the business for the benefit of the stockholders by using any means short of “deception or fraud.”

A great example that has caught media attention (this is election season – November 2012) is the example of several business owners who are strongly encouraging their employees to be active in the election of the candidate that they feel will provide favorable business conditions for their business.  Emails stating attend the rally of a specific candidate “or less” or mandates that require phone calls to be made to encourage a “get out the vote” have come under media scrutiny.  The question is – are such actions “unethical”?  Using the stockholder theory – if they advance the objective of the stockholder (in this case the advancement of his/her business interests) and they are not deceptive or illegal (fraudulent) then one would conclude that they are ethical.

Keep in mind…this is just a THEORY!

The challenge with the Stockholder Theory is – it is based on the idea of true capitalism – a real free market economy.  Nice to write, but non-existent.  Today we live in a world where businesses are competing  by gaining government subsidies, tax breaks, having state-conferred monopoly status (cable TV franchises are an example) and an environment where governmental regulations dictate the form and format of business enterprise.  Management is no longer focused solely on the stockholder’s profit in the pure sense, but rather focused on how to maneuver through the entangled mess of governmental bureaucracy that we find so prevalent today.

Back to Apple.  Under the Stockholder Theory if Apple had only the bottom line to consider then hiring cheap labor in China would be ethical and no problem.  Yet, we know different.  Since there is a concept of social justice (fairly compensating someone for work performed in a humane way) when it comes to employees, Apple had to listen to concerns from the public (consumers) who complained that Apple’s bottom line was not enough.  Based on the Stockholder Theory, if enough people were concerned that Apple was not socially responsible, then enough people might elect not to buy Apple’s product, therefore it is in the best interest of the stockholders to add a bit of social responsibility into the mix to preserve and protect Apple’s financial interest from the ultimate power – the purchaser.

Ethics – making the right decision based on all the facts and circumstances – in the case of the Stockholder Theory – to satisfy the needs and demands of the stockholders from whom the business got it’s start and for whom the business ultimately serves.

WHAT ARE YOUR THOUGHTS?  YOUR COMMENTS ARE WELCOME!

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8 Responses to Business Ethics Theories – Stockholder Theory – Part Two – Chuck Gallagher Business Ethics Speaker Comments

  1. Carolyn says:

    I liked it, but it wouldn’t accept “me.” I’ll try again.

  2. Pingback: Business Ethics Theories – Stockholder Theory – Part Two – Chuck Gallagher Business Ethics Speaker Comments | Ethics Alive – Business Ethics Speaker Chuck Gallagher shares Ethics Alive « denniscoble

  3. Yagya Gaire says:

    Those are some of the great thoughts, that you presented above. What is ethical and what’s not depends on the circumstances of the cases and is a matter of fact. However, if one considers a social viewpoint in their business before taking decisions, then it would always be ethical and in the benefit of society and human well-being. However, these are all theory, practically man is (rational and) business oriented who tries to seek profit (either in monetary terms or other) in every act he does.

  4. John Ebey says:

    I had never seen Apple’s Mission Statement. Interestingly different from those I have read before, usually I see lots of fluff and puffery. Good read, thanks Churck.

  5. michelle.s says:

    I really enjoyed reading your blog today. Being a business ethics student this semester it is refreshing to find a blog that is written in such an easy way to understand.

    In relation to your comment regarding the fact that the stockholder theory would not resonate with the “Occupy Wall Street” crowd, do you think that is true? I agree that there is beginning to be a shift towards more socially responsible larger, more profitable companies whose business strategies involve more socially responsible acts, for example tackling climate change and equality of employment, but do “wall street firms “on the whole” characterise what a socially responsible firm is? According to Rinaldo Brutoco (2012, http://worldbusiness.org/from-the-current-business-paradigm-to-the-second-renaissance/), “the vast majority of business executives and most of Wall Street (excluding the large, growing, and more profitable funds that operate in the socially responsible investment arena) actually believe the mantra that business exists to maximize shareholder value.” Let me illustrate using my take on what a typical Wall Street firm is and how this so strongly correlates to firms who operate in line with the stockholder theory of ethics.

    A Wall Street firm is one who is listed on the stock exchange and its primary purpose is to invest its money in order to provide a return to stockholders. The stock exchange’s structure focuses on maximising short term profits due to its requirements to provide quarterly results to stockholders to show they are making money in return for their continued investment. Investors are interested in whether or not they are receiving an adequate return on their capital in comparison to available alternatives. These firm’s bottom lines are constantly under scrutiny along with the business executives who run them. The executives too are encouraged to maximise profits to increase their own wealth, as their incentive schemes are based largely upon how the firm performs in terms of profits. It is also not uncommon for firms on the stock exchange to split companies up in order to create higher stock prices than would be realised if they were to remain combined. This is another example of how these firms operate to maximise profits to the stockholders and increase the value of the capital stock to stockholders.

    It is clear from the collapse of Enron and others in the early 2000’s, along with the recession which began in 2008, to conclude that the quest for short term profits and other profit maximisation strategies has been the leading reason behind these collapses. The short term quests for profit ultimately eroded the long term sustainability of these firms, and as a result decreased stockholder wealth to a point where it disappeared in these firms altogether. This detrimental effect is not what the business executives running the firms had envisaged at the time I’m sure, but by striving towards maximising profits to increase stockholder wealth, business failure has ultimately become the result. As outlined in your blog above, Milton Friedman stated “there is one and only one social responsibility of business–to use its resources and 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 collapse of so many of these wall street firms has been a result of these firms stretching Milton Friedman’s mantra out to the full extent of the “without deception or fraud” aspect to enable them to maximise profits. With a barrage of legislation, rules and regulations these days it is no wonder there are people out there who investigate ways in which to find loopholes in them, in order to exploit the system with the intention of finding a way to gain a competitive advantage. These loopholes at the time are legal and therefore “within the rules of the game”, however they can have damaging effects on different stakeholders with which the firm interacts. Is this consistent with firms who claim to be “socially responsible?”

    I’d like to touch on another claim you make in your blog in regard to cheap labour in China – “Under the Stockholder Theory if Apple had only the bottom line to consider then hiring cheap labor in China would be ethical and no problem. Yet, we know different.“ Do you think it is unethical to hire cheap labour in China? If you look at hiring cheap labour in China on a different level then it could actually be consistent with the social responsibility to provide employment to different segments of society who is in need of a boost in their economy. I guess it depends a lot on what is defined as “cheap labour”. Labour is cheaper in China because the standard of living is somewhat behind what it is in the U.S. Therefore what Apple may be paying in wages in China may be quite a lot in terms of what those Chinese employees can do with the money. Is that a social injustice? Wouldn’t Apple be being socially responsible in providing employment to these people? Surely those communities in China would be happy for the employment? I wonder if Apple’s consumers would be as concerned with the fact that they hired cheap labour if the price of their products went up.

    Brutoco, R. (2012). From the Current Business Paradigm to the Second Renaissance.
    Retrieved from http://worldbusiness.org/from-the-current-business-paradigm-to-the-second-renaissance/

    Dorman, P. (2012). Maximize the Likelihood of Being Profitable, Not Profits.
    Retrieved from http://econospeak.blogspot.co.nz/2012/08/maximize-likelihood-of-being-profitable.html

    WordPress. (2012). Fabulous Friedman or Paradise Lost?
    Retrieved from http://beyondfriedman.wordpress.com/

    The Open Polytechnic of New Zealand. (2009). Module 3. 71203 Business ethics. Lower Hutt, NZ: Author

    • It’s an interesting question about social responsibility to employee Chinese labors. I imagine that Apple employees folks from China because they are cheap and contribute to a lower cost to produce the product. I doubt that they employee folks in China because it’s socially responsible. Doesn’t social responsibility relate to your frame of reference? That seems to be true as folks complain about Apple because they don’t employee American workers.

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