DEFINING CORPORATE GOVERNANCE: SHAREHOLDER VERSUS STAKEHOLDER MODELS

Collins G. Ntim, Professor of Accounting and Head of Department of Accounting, Centre for
Research in Accounting, Accountability and Governance (CRAAG), Southampton Business
School, University of Southampton, Southampton, UK, c.g.ntim@soton.ac.uk

Synonyms: corporate governance, shareholder perspective, stakeholder perspective

Definition: Corporate governance has generally been defined as the “…system by which
companies are directed and controlled (Cadbury, 1992, s.2.5)”.

State of art: Defining corporate governance

The last three decades has seen the term ‘corporate governance’ emerged clearly as
an independent field of study (Gillan, 2006). Its scope has also witnessed great expansion such
that it is now an amalgam of different disciplines, including accounting, economics, ethics,
finance, law, management, organisational behaviour, and politics, among others, with no
universally accepted definition (Mallin, 2007). As a corollary, there exists a large number of
definitions of corporate.
Despite the existence of heterogeneous definitions, however, researchers frequently
classify the existing corporate governance definitions as either ‘narrow’ or ‘broad’. As a
prelude, the narrow-broad dichotomisation is based on the extent to which a corporate
governance regime essentially focuses on satisfying the parochial interests’ of shareholders
or meeting the broader interests of diverse societal stakeholder groups (Sternberg, 2004).
The Cadbury Report (1992, s.2.5) narrowly defines corporate governance as being
concerned with the “system by which companies are directed and controlled”. This definition
suggests that in order to maximise the wealth of owners, three key corporate governance
structures of the corporation emerge, namely; a general assembly of shareholders, a board
of directors, and an executive management. In this case, the corporation is primarily
accountable to shareholders, and as such they have the power to appoint directors and to
satisfy themselves that the right governance mechanisms have been instituted.
Also, and at least in theory, the shareholders have the power to reject decisions of the
board or remove them from office in a general meeting. By contrast, the board of directors’
has the responsibility to ensure that the company is properly governed. These responsibilities
include setting the company’s strategic aims, appointing or firing the management team,

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supervising the management team and reporting to the owners of the company on their
stewardship.
In short, a governance structure of a firm is considered as ‘narrow’ if it mainly
concentrates on how key internal governance mechanisms interact to maximise its value
primarily for the benefit of shareholders instead of enhancing the interests of other potential
stakeholder, like customers, employees, creditors, suppliers and the local community,
amongst others.
Contributing to the foreword of the World Bank Report (1999, p.vii), Sir Adrian
Cadbury defines corporate governance broadly as being “…concerned with holding the
balance between economic and social goals and between individual and communal goals…the
aim is to align as nearly as possible the interests of individuals, corporations, and society”. This
definition implies that corporate governance goes beyond the immediate internal corporate
structures to include external corporate governance mechanisms and stakeholders. Typically,
and as has been explained above, internal corporate governance structures may include the
general assembly of shareholders, the board of directors, and the executive management. By
contrast, the external corporate governance mechanisms may consist of the legal system, the
market for managerial labour and corporate control, regulators, local communities, cultural,
political, social and economic policies, and institutions within which corporations operate.
In this case, the corporation is considered to be a social entity that has accountability
and responsibility to a variety of stakeholders, encompassing shareowners, creditors,
suppliers, customers, employees, management, government and the local community (Mallin,
2007). The aim of corporate governance is to facilitate the efficient use of resources by
reducing fraud and mismanagement with the view not only to maximise, but also to align the
often conflicting interests of all stakeholders.
In brief, and in contrast to the ‘narrow’ characterisation, a ‘broad’ corporate
governance structure’s central pre-occupation is to examine how both external and internal
governance mechanisms can be run to maximise firm value and/or performance for the
mutual benefit of shareholders and other potential stakeholders.

State of art: The main corporate governance models

This section discusses the state of art knowledge relating to main corporate
governance models within the extant literature: the ‘shareholding’ and ‘stakeholding’ models.

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Specifically, the general theoretical assumptions, characteristics, solutions and weaknesses of
the ‘shareholding’ and ‘stakeholding’ models will be discussed. Table 1 below contains a
summary of the theoretical assumptions, features and solutions underlying the ‘shareholding’
and ‘stakeholding’ models of corporate governance. For brevity and comparability purposes,
they have been put together, and therefore will be referred to throughout the rest of this
essay. The first subsection of this section will examine the ‘shareholding’ model, whilst the
following subsection will present the ‘stakeholding’ model.

The shareholding model of corporate governance

Theoretical assumptions, features, and solutions of the shareholding model

To begin with, and as Table 1 shows, the shareholding corporate governance model is
usually common in the UK, US and other commonwealth countries. Central to the
shareholding corporate governance model is the doctrine of shareholder value and primacy.
It suggests that a firm must be run to primarily advance the interests of its owners. This is
based on a basic assumption that ownership is separate from control in an Anglo-American
model (Table 1). That is, in this corporate governance system, the providers of capital
(owners/shareholders) surrender the day-to-day management (control) of the business to a
group of managers, consisting of a ‘unitary’ board of directors and executive management,
who are frequently not owners of the corporation themselves. Of close relevance is that
through multiplicity of shareholders, ownership in this corporate governance model is quite
often relatively widely diffused (Berle and Means, 1932).
A major implication from dispersed ownership is that the power of shareholders to
exercise control over the way their business is run is greatly impaired (Table 1). This raises
serious agency problems, which is the central theoretical framework that underpins this essay.
Briefly, however, the agency theory suggests that since shareholders (principals) have to
delegate the control of their business to a few directors and managers (agents) to run the
company on their behalf, there is a potential risk that directors and managers will pursue their
own interests to the detriment of the eventual owners – shareholders (Smith, 1776). This is
also based on the premise that managers are both opportunistic and rational such that, on
average, they are more likely to pursue their self-interests than those of shareholders
(Weimer and Pape, 1999).

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Table 1: Summary of the theoretical assumptions of the shareholding and
stakeholding models of corporate governance
Summary Shareholding model Stakeholding model
Theoretical assumptions:
Purpose of corporation Maximisation of shareholder Maximisation of all
value. stakeholders' wealth.
Problem of governance Agency problem. Absence of stakeholders’
participation.
Cause of problem Shareholders do not have Governance failure to
enough control. represent stakeholders’
interests.
Background Separation of ownership and Different style of capitalism.
control.
Assumptions about Self-interest human Traditional mentality of
causation behavior. private capitalism.
Type of economic Rational economic unit with Social economic unit with
organisation profit motive. stakeholder welfare motive.
Proposition Market efficiency of Social efficiency of economy.
economy.
Rejection Any external interventions. The principal-agent model.

Source of discipline External market forces. Internal social forces.

Major features:
Board structure One-tier (executive and non- Two-tier (executive and
executive board). supervisory boards).
Major source of finance Equity from the capital Debt from banks.
markets.
Role of capital markets High. Low.
Role of banks Low. High.
Ownership concentration Low/Diffused. High/concentrated.
Regulatory orientation Self-regulation. Statutory regulation.
Legal system/origin Common law/Anglo- Civil law/Continental
American: UK, Europe: France, Germany
US/Commonwealth. and Japan.

Time horizon of economic Short-term. Long-term.

benefits

Major solutions:
Solution Removing restrictions on
markets. Strengthening the
incentive system.
Introducing a voluntary
code of governance.
Trust and long-term
contractual associations
between the firm and
stakeholders. Inter-firm co-

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 Introduction of a operation. Employee
combination of efficient participation. Introducing
contracts. business ethics.
Sources: Compiled from Keasey et al. (1997); Weimer and Pape (1999); Letza et al. (2004).

In response, the shareholding model offers several solutions to the agency problem.
Firstly, it suggests that restrictions on factor markets must be removed in order to encourage
competition (Letza et al., 2004). Secondly, it calls for the introduction of a voluntary corporate
governance code of ethics and conduct, which is usually underpinned by the universal
business principles of accountability, discipline, fairness, independence, responsibility, and
transparency to regulate director and managerial behaviour (Cadbury, 1992). Thirdly, it
recommends the strengthening of the managerial incentive system by instituting
performance-linked executive compensation schemes to help align shareholder-managerial
interests (Weimer and Pape, 1999). Finally, it calls for the introduction of efficient contracts
to govern the relationship between owners of capital and labour (Letza et al., 2004).
By contrast, the shareholding model rejects external interventions and additional
obligations imposed on corporations by government and central authorities because it may
distort free market operations (Table 1). Rather, it sees a firm’s existing governance
arrangements as the outcome of a bargaining process, which has been freely entered into by
corporate insiders and outsiders (Keasey et al., 1997). More specifically, as a rational
economic model, it assumes that factor markets (capital, managerial labour and corporate
control) are efficient and subsequently, self-regulation backed by additional voluntary
mechanisms, such as a voluntary corporate governance code are more effective in reducing
divergent activities of managers (Letza et al., 2004).
The rejection of external interventions by central regulatory authorities, but heavy
reliance on a free market regulation, is also based on a core premise that the major source of
finance to corporations is equity rather than debt. That is, equity capital is expected to be
raised mainly from efficiently operated capital markets. In such a market, capital is assumed
to freely move to investments that offer the highest risk-adjusted returns (Friedman, 1970).
Finally, and as a corollary, equity markets tend to be relatively better developed in
Anglo-American countries, such as the UK and US than in Continental European countries like
Germany and France (Weimer and Pape, 1999). This implies that shareholders can easily
either transfer their capital from a poorly-governed company to a better-governed one or a

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poorly-governed company may be acquired by a better-governed firm through the inherent
efficient markets for corporate control. Similarly, and at least in theory, poorly performing
managers can easily be fired and replaced with an efficient team, hence, providing the most
effective restraints on managerial discretion.

Major criticisms of the shareholding model

Despite its dominance as a major corporate form worldwide (Keasey et al., 1997), the
shareholding model suffers from several weaknesses (Sternberg, 2004). These weaknesses
generally concern shareholder power and democracy, stakeholder interests, social morality
and ethics, efficient factor markets, and excessive short-termism (Letza et al., 2004).
Firstly, it has been suggested that shareholders lack sufficient power to control
management and prevent misuse of corporate resources as purported by the shareholding
model. Central to this model is the axiom of shareholder primacy, which presupposes that
corporations should mainly be managed for the welfare of shareholders. Arising out of such
a presupposition is that theoretically a residual power rests with the shareholders so that they
can choose the persons to whom operational power is delegated. It also entitles them to
participate in major corporate decisions, including exercising the power of hiring or firing the
board of directors, usually at an annual general meeting (AGM).
In practice, however, it has been contended that the ability of shareholders to
meaningfully exercise such control over the direction of their company is severely limited by
the very procedures, which govern such meetings and corporate officers elections (Sternberg,
2004). For example, it is directors rather than shareholders that typically set the agenda of an
AGM, and by implication directors determine the issues that come up for voting. By contrast,
it has been shown that it is either difficult or impossible for shareholders to get binding
resolutions of their own onto the agenda (Sternberg, 1997).
Secondly, and closely associated with the lack of real shareholder power, is that
directors, who are expected to be the first line of defence for shareholders, also suffer from
many defects. Sternberg (2004) suggests that because executive directors of a corporation
are also normally its managers, they are less willing to recognise, criticise or correct their own
mistakes. Non-executive directors’ accountability to shareholders is also usually impaired by
the ways in which they are nominated, officially appointed and remunerated (Sternberg,
1997). In an Anglo-American model, the appointment procedure is such that most non-

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executive directors are nominated by the chief executive or by the board themselves
(Sternberg, 2004). This makes them insufficiently independent of management, and
insufficiently accountable to shareholders.
It is, however, acknowledged that with the recent increase in the proliferation of
codes of good corporate governance, especially among Anglo-American countries (Aguilera
and Cuervo-Cazurra, 2009), the procedures for board appointments are gradually improving.
The UK’s 2006 Combined Code, for example, requires listed firms to establish independent
nomination committees. It also requires the nomination committees to be constituted and
chaired by independent non-executive directors. Requirements of these nature imposed by
codes of good governance on firms have generally improved board accountability,
independence and monitoring of company executives and senior management.
Short-termism is a third criticism that has usually been levelled against the Anglo-
American corporate governance model. Opponents (Letza et al., 2004) of the shareholding
model contend that it is significantly flawed by its excessive fixation on short-term financial
performance – short-term returns on investments, short-term corporate profits, short-term
management performance, short-term share prices, and short-term expenditures. This arises
out of the substantial reliance on and the existence of efficient capital markets, which put
huge pressure on managers.
In principle, a higher short-term share return, for example, is preferred to a lower one
in this corporate governance model. By contrast, a comparatively lower share price, for
instance, makes a firm more vulnerable to receiving takeover bids, including hostile ones. This
huge market pressure from investors and competitors leads to managerial preference for
investments with shorter payback period in order to boost short-term profits, while
disfavouring long-term capital investments, like research and development expenditure
(Keasey et al., 1997).
Finally, and by far the most compelling attack and formidable challenge to the Anglo-
American model has come from stakeholder theorists (Freeman, 1984). Generally,
stakeholder theorists have criticised the shareholding model on two main grounds that: (i) it
ignores the social, ethical and moral responsibilities of the corporation as an important
societal institution; and (ii) it offers a narrow definition of the stakeholders of the firm
(Sternberg, 2004).

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 Firstly, stakeholder theorists (Freeman, 1984) argue that rather than running the firm
to primarily maximise the wealth of shareholders (Berle and Means, 1932), the firm should
equally serve the interests of a wider stakeholder group. These may include employees,
creditors, suppliers, customers and local communities that have long-term relationships with
the firm, and thus affect its long-term success. As a result, it has been contested that the
Anglo-American model’s exclusive emphasis on the powers and rights of shareholders results
in the negligence of the interests of other legitimate stakeholders (Sternberg, 1997).
Secondly, a close criticism from stakeholding theorists is that the shareholding model
lacks the capacity to give serious consideration to ethical and moral issues. A popular, but
sometimes controversial ethical and moral criticism is that the Anglo-American governance
model encourages excessive or even ‘obscene’ executive remuneration (Sternberg, 2004,). It
is reported, for example, that the average CEO of a medium-sized American corporation earns
531 times as much in pay, bonuses and stock options as the average factory worker. It has
been argued, however, that good corporate governance is expected to empower the weaker
sections of society.
In this case, the shareholding governance model is criticised for ‘unethically’
strengthening further the already rich and powerful societal segments – shareholders and
managers rather than empowering the weaker sections of society – lower level employees,
local communities, the poor, women and children. In this case, the 2007/2008 global financial
markets offers classic anecdotal examples. In spite of receiving multibillion-pound British
Government bailouts (Turner Review, 2009), and reported record of multibillion-pound losses
at some major British Banks, including the Royal Bank of Scotland and Lloyds Banking Group,
reports within the popular media suggest that senior executives continued to pay themselves
millions of pounds of bonuses (Walker Review, 2009). Arguably, this may further transfer
wealth from ordinary taxpayers to already rich senior corporate bank executives.
Due to the above weaknesses, stakeholder governance theorists purport to offer a
better alternative to the shareholding governance model. The next subsection, therefore, will
discuss the stakeholding corporate governance concept. For purposes of comparison, Table 1
will be referred to throughout the next subsections. Specifically, the first subsection will
present theoretical assumptions and solutions, whilst the subsequent subsection will examine
the major weaknesses of the stakeholding model.

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The stakeholding model of corporate governance

Theoretical assumptions, features and solutions of the stakeholding model

To start with, and as Table 1 suggests, the stakeholding model of corporate

governance is often found in France, Germany, Japan and other European or Asian countries.
A central underlying assumption of the stakeholding corporate governance model is that the
purpose of the corporation is to maximise the welfare of a number of stakeholders of the firm
rather than those of shareholders alone (Table 1). That is, unlike the shareholding model that
encourages firms to ‘exclusively’ advance the interests of shareholders, it suggests that
companies should ‘inclusively’ pursue the interests of a group of identifiable stakeholders
who may either directly or indirectly be affected by or can affect the success of the firm.
Past stakeholder theorists have offered classical exposition of the ‘inclusive’
governance concept (Jensen, 2002). They suggest that a firm consists of social groups in which
each group can be seen as supplying the firm with important resources (contributions) and in
return expects its interests to be promoted (inducements).
For example, it is suggested that shareholders supply the firm with capital. In exchange,
they expect to maximise the risk-adjusted return on their investments. Creditors provide the
firm with loans. In return, they expect their loans to be repaid on time. Local communities
supply the firm with location and local infrastructure. In exchange, they expect the firm to
improve their quality of life. Managers and employees provide the firm with time and skills.
In return, they expect to receive a sustainable income, and this has been argued to be true
for every reasonably conceivable constituency of the firm (Jensen, 2002).
As a result, and unlike the shareholding model, the stakeholding governance model
presupposes that the governance problem arises out of the absence of broader stakeholder
participation in the running of public corporations (Table 1). Like the shareholding model,
however, it subscribes to the idea that the separation of ownership and control in modern
public corporations creates a governance problem (Keasey et al., 1997). It also concurs with
the shareholding model’s assumption that the resulting agency conflicts may be reduced by
the firm through a nexus of contracts between the various stakeholders of the firm, and that
the firm should be run rationally in economic terms to broadly maximise its wealth (Table 1).
By contrast, it rejects the assumption that shareholders and managers are the only
important participants in such a relationship (Table 1). Further, while it shares the assumption

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that markets can be efficient (Table 1), it also recognises the existence of short to medium-
run market inefficiencies. This implies that there may be a need for occasional external
interventions, including statutory legislations to establish equilibrium in order to maximise
the broader societal wealth (Weimer and Pape, 1999).
In response, the stakeholding model offers several solutions. Firstly, it proposes a two-
tier corporate board structure as a way of achieving a broader representation of the interests
of a larger group of stakeholders of the firm (Mallin, 2007). Thus, in a typical stakeholder
governance framework, like in Germany, companies will normally have a dual board structure:
(i) a supervisory board, and (ii) a management one. The supervisory board is usually
constituted by many stakeholders, including investors (shareholders and creditors/banks),
employees (union groups), suppliers, customers, and government appointees representing
broader segments of society. In this case, it mandates the managing board to run the
company in the best interests of a number of stakeholders. This implies that the interests of
shareholders should only be pursued to the extent that they are not detrimental to the
interests of the other stakeholders of the firm (Mallin, 2007).
Secondly, it encourages corporate management to focus on building trust and long-
term contractual relationships between the firm and its stakeholders (Letza et al., 2004). In
particular, it supports inter-firm co-operation, including cross-shareholdings (especially in
Japan) and employee participation in decision-making through the supervisory board
(particularly among German firms). Similarly, it encourages closer contact between
shareholders, creditors, managers, employees and suppliers, as well as the integration of
business ethics as a solution to achieving a balance among the various stakeholder interests
(Table 1).
One consequence of the stakeholding model’s insistence on balancing the interests of
the various stakeholders is that it may render it less appealing to equity investors. As such,
companies tend to rely heavily on debt rather than equity as a major source of finance
(Weimer and Pape, 1999). The corollary as Table 1 shows is that equity markets (stock
exchanges) tend to be underdeveloped relative to the debt markets (banks) with relatively
high level involvement by credit granting banks in providing capital for public corporations.
Finally, block shareholdings from the various stakeholders, such as employee unions,
government and banks, lead to a situation in which ownership is often highly concentrated.
Concentrated ownership and close managerial monitoring, especially from the supervisory

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board reduce agency costs. Concentrated ownership may also be associated with weak
investor protection, particularly minority investors, which could normally be explained by the
legal system of countries often associated with the stakeholder governance framework.
Specifically, La Porta et al. (1998) demonstrate that there is a negative relationship
between ownership concentration and investor protection, which can be explained by legal
origin. They show that Anglo-American countries (common law family, like the UK and US)
have dispersed ownership with higher investor protection in comparison with Continental-
European-Asian (civil and Scandinavian law origin, such as France, Germany, and Japan)
countries, which tend to have relatively high ownership concentration with weaker investor
protection.

Major criticisms of the stakeholding model

The stakeholding governance model has also received several criticisms. These include
its incompatibility with the concepts of business, governance and private property rights
(Letza et al., 2004).
Firstly, a central criticism of the stakeholder governance model is that it is not
compatible with the concept of business (Letza et al., 2004). It proposes that corporations
must strive to achieve a fair balance in distributing the benefits of the firm to a number of
stakeholders, and as such prevents the firm from pursuing a single objective function that
favours particular groups (Sternberg, 1997). This is, however, not consistent with the notion
of business, which involves the investment of one’s capital in a commercial firm to primarily
maximise its long-term value (Letza et al., 2004). Jensen (2002) suggests that if a business is
prevented from operating efficiently by focusing on maximising owners’ profits (purposeful
behaviour), it will simply collapse in the long-run. This will negatively affect social value and
welfare of all stakeholders.
Secondly, the definition of stakeholders appears to be vague sometimes. Since
stakeholders are all those who can affect or are affected by the business, the number of
people whose benefits need to be taken into account is simply infinite (Sternberg, 2004). This
means that stakeholders by definition could be anybody or anything from anywhere or
everywhere, and as such could range from employees, creditors, government to terrorists,
corporate armed-robbers, and the sea, amongst others. Yet, it mandates that a balance be
struck in the distribution of benefits to all stakeholders, but ambiguous stakeholder definition

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means that balancing divergent stakeholder interests is also an unworkable objective (Jensen,
2002).
Thirdly, the stakeholding governance model is incompatible with the notion of
corporate governance. A key corporate governance concept is accountability: the
accountability of directors to shareholders; the accountability of managers to directors; and
the accountability of corporate employees and other corporate agents to shareholders
through managers and directors (Sternberg, 1997). Stakeholding, however, suggests that
firms should be accountable to all their stakeholders rather than to their shareholders alone
(Letza et al., 2004). By contrast, it has been argued that multiple accountability works if the
purpose is unambiguous to everyone involved (Sternberg, 2004). In fact, the 2002 King Report
of South Africa suggests that an organisation that is accountable to everyone is actually
accountable to no one. Thus, accountability that is diffuse is effectively non-existent and
unworkable in governance terms.
Finally, an associated criticism is that the stakeholder model provides no effective
objective standard against which corporate agents can be judged (Sternberg, 2004).
Corporate agents are mandated to run the business primarily to balance all stakeholders’
interests. It is, however, contested that it does not serve as an effective objective
performance measure because it allows corporate agents responsible for its interpretation
and implementation, excessive freedom to pursue their own narrow interests, including
perquisites consumption and other private benefits of control (Sternberg, 1997).

Conclusion: Future perspectives

This essay has attempted to define corporate governance. The central rationale has
been to paint the broader corporate governance picture within which the international
corporate governance reforms, codes, policies, research and context that is could easily be
understood by corporate governance academics, especially research students and early
career academics, policy-makers and regulatory bodies.
In this regard, the essay began by offering a working definition of corporate
governance. While it acknowledged that corporate governance has no universally accepted
definition, it suggested that the existing numerous definitions can be classified into two
groups: narrow and broad. At the narrow level, it defined corporate governance as referring

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to internal governance structures, such as the executive management, the board of directors
and the general assembly of shareholders, by which companies are directed and controlled.
At the most expansive form, however, it contended that corporate governance goes beyond
immediate internal governance mechanisms to include external structures and stakeholders,
such as the legal system, the efficient factor markets, local communities, the regulatory
system, as well as the political, cultural and economic institutions within which companies
operate.
Overall, the essay identified two major types of corporate governance within the
international literature and context: the ‘shareholding’ and ‘stakeholding’ models. In simple
terms, it suggested that the shareholding model refers to the narrow definition of corporate
governance, in which the interests of shareholders are considered as paramount, and is
usually found in Anglo-American countries, such as the UK and US. In contrast, the
stakeholding model refers to the broader definition of corporate governance, which attempts
to equally cater for the interests of a number of stakeholders of the firm, and is normally
predominant in Continental European and Asian countries, like Germany and Japan. It also
acknowledged, however, that the shareholding and stakeholding dichotomisation of modern
corporate governance systems might be an over-simplification. This is because due to
increased globalisation, greater global stock market integration through cross-listing, and the
proliferation of national and trans-national codes of corporate governance, amongst others,
corporate governance practices are increasingly converging across different countries and
systems. Further, for each corporate governance model, the underlying theoretical
assumptions, major features and proposed solutions as found within the international
corporate governance literature were discussed. Of crucial relevance is that the extant
literature shows that both models suffer from several weaknesses. This raises an important
public policy question as to whether it will be more valuable to formally combine some of the
main features of the ‘shareholding’ and ‘stakeholding’ models to form a ‘hybrid’ corporate
governance model that will be capable of addressing their current respective weaknesses.

Cross-references: Corporate governance and sustainability, Corporate governance reform,

Corporate governance mechanisms and developing stock exchange

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Electronic copy available at: https://ssrn.com/abstract=3096612