Bridge over ocean
1 September 2015 CFA Institute Journal Review

Stakeholder Governance, Competition, and Firm Value (Digest Summary)

  1. Neeti Goyal

The authors analyze the impact of being a stakeholder-oriented firm versus a shareholder-oriented firm in the presence of uncertainty and compare their strategic behavior in the product market.

What’s Inside?

Different stakeholders have different interests in a firm that determine their strategic behavior in a product market. Whether stakeholder governance is imposed by law or society, it mandates that the needs of stakeholders be considered as well as the needs of shareholders. The authors focus on the effects of stakeholder orientation on product market competition and firm value compared with a pure shareholder-oriented firm. They also analyze which of the two firms performs better in globalized economies.

How Is This Research Useful to Practitioners?

In some countries (e.g., Germany), the legal system makes firms stakeholder oriented. In other countries (e.g., Japan), social conventions make firms stakeholder oriented. The authors analyze the pros and cons of stakeholder-oriented firms that take care of the interests of all stakeholders, including employees and suppliers, compared with firms that focus on taking care of the interests of shareholders. Stakeholder interests are met when firms survive and not just with value maximization. In a situation of demand uncertainty, stakeholder firms reduce prices to increase their probability of survival. This approach increases market competition and reduces firm value. Therefore, stakeholder governance is perceived as a reduction in shareholder value, and the interests of shareholders and stakeholders are not the same.

The authors find that in imperfect competition, stakeholder-oriented firms tend to have higher prices and lower output than shareholder-oriented firms. A stakeholder orientation benefits shareholders in times of cost uncertainty in the product market. Another interesting finding is that some firms are more valuable in a stakeholder orientation than in a shareholder orientation. In a globalized world, stakeholder firms and shareholder firms compete. The authors show that, in some situations, firms voluntarily try to be stakeholder oriented so that their value increases. The research is useful for corporate economists in positions to make decisions about entering a foreign market and for corporate finance professionals.

How Did the Authors Conduct This Research?

First, a two-period duopoly model is considered in which two shareholder-oriented firms with different products compete for market share. The firms’ objective function is to maximize value. The authors analyze the model for uncertainty of marginal cost of production and demand for products. First-period price is estimated based on the probability of surviving for a second period and profits for the first period. When firms have cost uncertainty, they tend to keep prices high to cover the costs, whereas when firms have demand uncertainty, they tend to keep prices low to achieve sales.

The authors then add to the model the requirements of other stakeholders, which increases the effect of uncertainty (i.e., in cost uncertainty, prices increase more than for a pure shareholder-oriented firm, and in demand uncertainty, prices reduce further). They also identify instances from globalization in which stakeholder firms are more valuable than shareholder firms and then compare this asymmetrical equilibrium with symmetrical equilibrium for both stakeholder firms and shareholder firms. The model is subject to financial constraints, the firm’s continuation of profits in a second period, and the possibility of the firm exiting.

Abstractor’s Viewpoint

The authors analyze the effects on shareholders of a stakeholder governance structure, which, in turn, depends on the type of uncertainty a firm faces. The findings suggest that stakeholder firms tend to have lower levels of debt in their capital structure. The research model is based on an imperfectly competitive product market, which is a major factor in an industrialized and globalized world economy. There are some alternative situations that would nullify the requirement of implementing stakeholder governance that have not been considered. Further research on those situations could be interesting.

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