Question

Give examples of situations where shareholders’ and other stakeholders’ interests are complementary. Give examples of situations where these interests are not complementary. If interests conflict, what should management do?

Answer 1

A firm's stakeholders include:

• Shareholders (Equity, preference)
• Debt-holders (Banks,Debenture holders, other creditors)
• Employees (including senior management)
• Suppliers
• Customers
• Government
• Society

Situations where where shareholders’ and other stakeholders’ interests are complementary:

Generally speaking, interests of all stakeholders are complementary as everyone wants the firm to perform well and generate high returns for all stakeholders. When a firm does well the shareholders are rewarded by way of dividends and capital appreciation, creditors get timely interest payments, customers, suppliers and government get their products, contractual payments and tax revenue.

Situations where shareholders’ and other stakeholders’ interests are non-complementary:

1. If the incentives of the management are framed in a manner where profit maximization is awarded or where employee bonus is linked to performance, there is a conflict of interest between the motives of the employees/management and shareholders. The shareholders primary interest is increase in intrinsic value of his share or wealth maximization for the business. The employee will aim for short term profit maximization or maximization of his own performance to get the linked bonus.
2. When a firm has a motive of business expansion, it incurs high fixed, one-time capital expenditure, higher short term marketing, sales, production expenses which lead to fall in profits for the short term. Such a plan may be supported by the managers, employees and suppliers who can visualize the benefits of scale and expansion. However, the shareholders may care more about the short term fall in profits, share price,etc and oppose such expansion.
3. Similarly, investing in new machinery to achieve greater efficiency may be supported by the shareholders to obtain long term benefit but opposed by the employees who are likely to lose their jobs due to mechanization.
4. There are firms in alcoholic beverages industry or the cigarette industry where the interests of all stakeholders except the society may be complementary. Society as a whole may benefit from lesser production and consumption of these goods. Other stakeholders, however may not care about such ethical issues and want the firm to perform better and increase revenue at any cost.

To resolves such conflicts of interest, management must ensure that incentives of the management or employees are not linked to short term performance, rather they should be linked to share price of the firm. Employees are given a stock options to align their incentives with the shareholders.

Management can work to educate the shareholders and employees on the benefits of new expansion or new machine to bring everyone on the same page.

The management of firms operating in the alcoholic beverages industry or the cigarette industry ensures that they adhere to the advertising norms set by the government. Even when there are no explicit guideline, such firms engage in socially responsible activities, incorporate health warnings on there product packaging, encourage safe consumption habits through their advertisements, etc.