Question

Milton Friedman captioned his famous New York Times article as the ‘social responsibility of a business is to increase its profits’ (New York Times, September 13, 1970).

Required

Critically evaluate the above statement explaining the importance of corporate social responsibility in light of agency theory and stakeholder theory.

Answer 1

Corporate social responsibility:

Corporate social responsibility (CSR) is a self-regulating business model that keeps an organization is socially accountable to itself, its stakeholders, and the public. By practicing corporate social responsibility, organizations can be conscious of the type of impact they are having on all aspects of society, including social, economic, and environmental.

Researchers have proved that recent developments in corporate social responsibility and ethics help organizations to revive from the meltdown in the recession.

Agency theory in the context of corporate social responsibility:

Agency theory is fundamentally involved with the relationship between the shareholder and managers. Moreover, managers should take decisions that are linked with the objective of maximizing the wealth of the shareholder. As per Ross (1973) an agency is defined as one in which one or more persons engages another person to perform some service on their behalf which involve delegating some decision making power to the agent. Eisenhardt (1985) and Kosnik (1987) linked the development of agency theory with the organization's behavior and its strategic management.

Managers and agents are very eager in their wealth maximizing efficiency and they acquire this end though their salaries and commissions etc. When managers take decisions that are not in line with the objective of shareholder wealth maximization, then the agency problem arises. Jensen (1998) explaining the problem of the agency is such that agents are not absolute. Their interests do not match matches with the objectives of the principal and accordingly, if the authority is not enough then there will be a deviation from the objectives of interest to the owner of the resources.

The dormant agency issue between managers and their stakeholders is not only an agency problem that exists. Jensen and Mecking argued that the organization can face a series of agency relationships among the different interests of groups. As per the agency theory, principles can establish proper incentives for the agents on the basis of their level of interest and this may lead to the agency cost.

Jensen and Mecking suggested that there are two approaches to optimize managerial behavior to accelerate goal congruence between shareholders and managers. Overseeing the acts of management is the first one for shareholders. There are a number of ways to monitor management performance. For example, the use of independent auditors to audit the financials, additional reporting requirements.

So, total shareholder maximization encompasses advantages for the stakeholders. This includes the maximization of the value for the stakeholder.

Stakeholder theory in the context of corporate social responsibility:

Freeman Stakeholder theory’s origin is the proposal, in 1984, for the strategic management of the companies in the latter half of the 20th century. Over time, the theory got importance with the workers Clarkson, Donaldson and Preston, Mitchell, Rowley, and Foreman enabling both greater theoretical depth and development of this theory.

The origin of the stakeholder theory is based on the four areas namely economics, sociology, ethics, and politics. Freeman found that any group that can affect or be affected by the understanding of the company’s objectives.

To maximizing the shareholder's returns, the managers must try to give a good return to each group that comes under the stakeholders. As per the Mygind diversified stakeholder have various approaches and associations to other stakeholders and they have an evaluation of their own wellbeing which is only related to them and they also give different importance to the stakeholder’s satisfaction.

Earlier, maximizing shareholder wealth and corporate wealth totally based on the directors how they form the corporate strategies. In contrast, Mygind found that current developments move the pendulum towards the border view of value creation. The total shareholder maximization which is directly linked with corporate social responsibility should be fulfilled under limited circumstances.

The stakeholder theory diversified into many fields. The stakeholder theory grasp the relevance to human resource management, financial management, strategic management, research and development, organization ethics, corporate governance, and many more.