Posted: May 25th, 2022

Accounting Theories and Business Decisions

Accounting Theories and Business Decisions: The Business World

Case Facts

Application of theories

Other cases of stakeholder theory application

Accounting theories and business decisions: The business world

There are many theories that explain the complexity of relationship between different groups of people directly and indirectly related to an organization. Two of the most comprehensive and most discussed theories are stakeholder theory and agency theory. Both the theories describe what the main purpose of each group is and how these groups ought to manage these relationships. In agency theory, it identified that agency relationship takes place when one or more than one principal, acting as owners, delegate their power to make decisions, to a person acting as their agent or steward. Thus, agency theory principally revolves around the relationship of principal and agent. While the principal delegates the authority or decision making power to agent (managers) to act in the best interest of principal (owner and shareholders), there may be a conflict between interest of agent and that of principal. Thus, in case of non-alignment between interests of principal and agent, the latter may make decision contrary to the interests of principal and thus deviate from his/her responsibility (Walsham 2005, 153).

The stakeholder theory also addresses the issue of presence of multiple interest groups but in a different context. Stakeholder theory states that an organization has many groups having stake in the successful functioning of the firm, such as the owners, shareholders, employees, government, and societal groups, therefore it is management’s obligation to strike a balance between the interest of all stakeholders and maximize benefit of all, thereby making corporate decisions that does not compromise interest of one stakeholder for the sake of other (Jensen 2010, 32-42). This theory is fundamentally contrary to the traditional perspective regarding a firm having primary responsibility to its owner or shareholders only. This paper is concerned with business world scenarios where real organizational employees made some decisions and how best did these decisions serve the interest of all stakeholders. We selected 4 business journal articles and assessed how they have interpreted a decision when analyzed from the perspective of agency accounting theory and stakeholder theory of corporate governance.

Case Facts

In a real business world case, stakeholder theory of corporate governance propagates what Ray Anderson, CEO of Interface tried to achieve. In an article titled ‘Executive on a mission: Saving the planet’, Cornella Deans of ‘The New York Times’ reported that after reading a book regarding biosphere and how businesses are damaging planet Earth, Anderson decided that his company will become ‘restorative’ enterprise, a sustainable operation that takes nothing out of the earth that cannot be recycled or quickly regenerated, and that does no harm to the biosphere” (Dean 2007, F1). Ray Anderson as CEO of the company (an agent in context of agency theory and one stakeholder out of many in context of stakeholder theory) along with his executive management team of Interface set 2020 as a target year when the company would not taking out anything from Earth that could not be reproduced or regenerated quickly. From 1994 till 2007, use of fossil fuels at Interface has decreased 45% whereas sales increased by 49%. Use of water for carpet production has been cut by one third whereas contribution to landfill decreased by 80% (Dean 2007, F1).

On the contrary, another case in business decision making, while analyzing from agency theory perspective, was that of Morgan Stanley and Barclays bank. Douglas Keenan wrote for the Financial Times those banks such as Morgan Stanley and Barclays were found manipulating London Interbank Offered Rate (LIBOR). It is a benchmark interest rate that British Association of Bankers (BAA) publishes daily based on which banks lend money to each other. A lower rate being reported by a bank represents that bank’s risk proneness is less whereas a higher LIBOR rate shows that a bank is risky to have been lent the money. This Morgan Stanley trader also revealed that (later confirmed by the U.S. Council of Foreign Affairs CFR as well) that many banks and their executive management has allowed for the manipulation of LIBOR rate. Keenan wrote that “There have been two distinct motivations for banks to misreport Libor rates. One motivation is discussed above: to directly increase profits. The other motivation arose during the 2008 financial crisis: to mask liquidity problems (Keenan 2012). Legal and regulatory proceedings against Barclays, UBS (Swiss banking giant), and RBS (Royal Bank of Scotland) resulted in heavy fines. Barclays paid $453 million, UBS $1.5 billion, and RBS $780 million to U.S. And U.K regulators (Westervelt 2011). This shows that the agents (managers of Morgan Stanley, RBS, Barclays, and UBS) did not act responsibly and only served their own interest of earning bonuses by showing profits but compromised severely the interests of principals (shareholders and owners of these banks). Stock prices fell and consumer confidence in these banking giants faded as a result of this fraudulent activity on part of management of these banks.

Application of theories

The stakeholder theory of corporate governance supports the notion that sustainability of an organization lies in management serving interests of all stakeholders of the firm, rather than only that of owners or shareholders. Ray Anderson while deciding to quit using synthetic nylon in carpets and also minimizing water and petroleum use and thus becoming a restorative firm acted principally in the interest of all stakeholders. After taking this decision, it was ensured that shareholder is not compromised for an ‘only moral’ agenda. By eliminating waste of resources in production process and introducing other sustainable production procedures, Anderson safeguarded the long-term interests of society while also reducing the costs of production. Costs went down and profits went up, these results made commit for an optimistic of 2020 as the year when Interface would literally not be taking anything from Earth. This, according to agency theory, is also a best case scenario where the agents (CEO and managers of Interface) safeguarded the interests of principals (owners and shareholders). Motives of agents were synchronized with those of principals and that were profitability and sustainability of business as well as the society where Interface operates. Since simple agency theory models assert that agent is not trustworthy and they will act in their own interest rather than principal’s interest, we observe that this model was carried out at Morgan Stanley as well as other banks where management executives operated in their own interest and did not refrain from defrauding the whole of the financial services system just for their financial incentives. The agents in this case totally ignored the long-term impact that such management practices could have been on shareholder’s interest. When it came to punitive action against the said banks, regulators fined the organizations thereby depriving shareholders of their dividends and owners of their equity. The agents remained harm-free and thus, it was proved that a simple agency theory relationship existed within agents and principals.

Other cases of stakeholder theory application

In the previous section, two articles from leading business world sources were compared with each and it was opined that both the cases involved actions of agents, as permitted by the decision making authority delegated to them. However, in case of Interface, the exercise of authority of decision making was practiced in good-faith and resulted in serving the interest of all stakeholders. Stock prices of Interface increased over a period of time, profits and revenues got increased, wasteful production reduced, and consumer confidence in the firm increased. Interests of all stakeholders were served by the agents. The Financial Times article is a contrast to first article, whereby it is indicated that agents were distrustful and only acted to serve their own short-term gains while risking the credibility and financial worth of principals. Rosabeth M. Knter wrote an article titled ‘How Great Companies think differently’ in Harvard Business Review magazine in which it was mentioned that during 2011, IBM executives allowed 300000 employees of IBM to sign up for 2.6 million hours of service on ‘global service day’ (Kanter 2011). This represented that IBM cares for the society it operates in, thereby becoming social contributor. In another case, on 16th November 2011, Johnson & Johnson CEO announced that the firm has decided to remove quaternium-15 and other harmful preservatives from its baby products. The decision was taken as a result of a report published by an NGO called The Campaign for Safe Cosmetics. Had the firm not decided so, it was obvious that share price of J&J would have dropped thereby robbing the company and shareholders from their equity. It is evident from the these two additional articles that while IBM was proactive in promoting community service so as to enhance interests of other stakeholders, J&J CEO only intervened when an imminent threat of compromise on shareholders’ and owners financial standing was faced.

Conclusion

The two main articles being reviewed indicate that corporations are an essential composition of agents and principals. There are different stakeholders of an organization and corporate governance ethics as well as agency theory drawbacks require managers to act in good faith and ensure the sustainability of operations. Short-term gains, as reaped by MS or RBS executives and traders could not match the long-term and sustainable business growth of Interface. It is therefore imperative for decision makers in corporate settings to comply with stakeholder’s theory assertions thereby serving the maximum possible interests of all relevant stakeholder groups while not disregarding the company’s bottom line.

Bibliography

Alessi, Chirstopher. 2013. “Understanding the LIBOR Scandal.” Council on Foreign Relations, Feb 6. Accessed August 23, 2013. http://www.cfr.org/united-kingdom/understanding-libor-scandal/p28729

Dean, Cornelia. 2007. “Executive on a mission: saving the planet.” New York Times, May 22. Accessed August 23, 2013. http://www.nytimes.com/2007/05/22/science/earth/22ander.html?pagewanted=all&_r=0

Jensen, Michael C. 2010. “Value maximization, stakeholder theory, and the corporate objective function.” Journal of applied corporate finance 22: 32-42.

Kanter, Rosabeth Moss. 2011. How great companies think differently. Harvard Business Review, November. Accessed August 24, 2013. http://hbr.org/2011/11/how-great-companies-think-differently/ar/2

Keenan, Douglas. 2012. “My thwarted attempt to tell of Libor shenanigans.” Financial Times, July 26. Accessed August 24, 2013. http://www.ft.com/international/cms/s/0/dc5f49c2-d67b-11e1-ba60-00144feabdc0.html#axzz2d6Dhqcz3

Walsham, Geoff. 2005. “Agency Theory: Integration or a Thousand Flowers.” Scandinavian Journal of Information Systems 17: 153-58.

Westervelt, Amy. 2011. “As Report Reveals Toxic Ingredients in Baby Shampoo, Johnson & Johnson Goes Public with Plans to Clean Up Products.” Forbes Jan 11. Accessed August 24, 2013. http://www.forbes.com/sites/amywestervelt/2011/11/01/as-report-reveals-toxic-ingredients-in-baby-shampoo-johnson-johnson-goes-public-with-plans-to-clean-up-products/

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