Shareholder vs Stakeholder Theory: A Historical Perspective in India

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Introduction to Shareholder Theory

“There is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”

-Milton Friedman[1]

“Shareholder theory” is a view that since shareholder are the part owners of the firm and since the managerial powers of the directors arise because of delegation by the shareholders hence the firm should be run in a manner that fulfils shareholders interest of profit maximization.

The legal mandate which directed directors to prioritize shareholder interest was first issued in the famous case of Dodge v Ford where the main issue was that John and Horace Dodge who were investors in Ford Motors company were not happy at all with the dividend pay-out per share even though the company was making hefty profits. While the dodge brothers argued that Henry Ford was using his control in the company restricting the number of dividends, Ford defended himself by saying that he prefers to use the money to provide cheaper cars and better wages to the employees at the factory. But the American Supreme court, in this case, stated that “A business corporation is organized and carried on primarily for the profit of the shareholders. The powers of the directors are to be employed for that end. The discretion of the directors is to be exercised in the choice of means to attain that end, and does not extend to other purposes”. Hence in this case the American judiciary followed the shareholder theory i.e. it ignored the interests of non-shareholding stakeholders such as Employees, community and environment et cetera and gave birth to a legal principle according to which Corporate law requires corporations to have a “Profit maximization purpose” and that directors, as well as managers, have a legal duty to put the interests of shareholders above interest of other stakeholders.

Shareholder Theory is often justified claiming that since shareholders are “Owners” of the corporation and are hence owed the corporate profits remaining, once accounting for various contractual costs and productive investments is done. This justification was used by Milton Friedman himself in his famous 1970 New York Times article where he argued that since shareholders are the “Owners of the corporation” the only social responsibility that corporation has is to maximize their profits. 

Shareholder Theory is also justified using a theory known as “Nexus of Contracts” which while agrees that non shareholding stakeholders do contribute a lot to corporation for example employees give their time, creditors lend their money et cetera which are necessary for corporation to succeeded yet since these stakeholder group participate in accordance as well as solely due to their explicit contracts which clearly state what they will get in return unlike shareholders who have  open-ended claim on as much open-ended corporate profit as possible while at the same time bearing the risk of loss  hence shareholders are the “Residual claimants” of the corporation.

Introduction to Stakeholder Theory

“Every business creates, and sometimes destroys, value for customers, suppliers, employees, communities and financiers. The idea that business is about maximizing profits for shareholders is outdated and doesn’t work very well, as the recent global financial crisis has taught us. The 21st Century is one of ‘Managing for Stakeholders’. The task of executives is to create as much value as possible for stakeholders without resorting to trade-offs. Great companies endure because they manage to get stakeholder interests aligned.”

-Ed Freeman

Stakeholder theory was backed by E. Merrick Dodd in the famous Berle Dodd  debate[2] published by Harvard law review where he said that  “there is, in fact, a growing feeling not only that business has responsibilities to the community but that our corporate managers who control business should voluntarily and without waiting for legal compulsion manage it in such a way as to fulfil those responsibilities.”. Hence the primordial principle of this theory is that the companies need to extend their objectives beyond shareholders wealth maximization. It needs to take into consideration the interests of other stakeholders which as per Freeman is “any group or individual who can affect or is affected by the achievement of the organization’s objectives”.

There are numerous advantages of Stakeholder theory over shareholder theory first one being that it reconciles the relationship between the company and non-shareholding group. For example, it is no surprise that in today’s competitive world a company needs to have loyal, qualified and well-motivated employees just to survive and same could be made sure by providing them good benefits and giving a sense of security.

Further for a company to succeed they must include the interests of local community and environment as well as taking them as stakeholders would avoid any short term profit at their expense which will be detrimental to the company in the long term. Moreover, in today’s world where climate change is one of the biggest threat to our whole civilization and since environmental protection rules reflect societies judgment, stakeholder theory suggests doing what law often states or community wants actively rather than passively. Importance of local community was seen in a recent case where Hindustan Coca-Cola Beverages had to close down its plant at Plachimada in Kerala as it had caused water depletion and water pollution which harmed the local community and environment due to which it was forced to close down in 2004 and remains closed.[3]

Also, stakeholder theory makes sure that the directors of the company have a lot more freedom to achieve long term goals by taking far-sighted decisions rather than having one objective of profit maximization.[4]

Corporate law in India during Colonial Rule on shareholder and stakeholder theory

In India, the very first corporate structure was seen in the East India Company that was achieved by a Royal Charter. Initially the East India Company had a sole monopoly to trade in India but with time government started giving similar privileges to numerous companies who no longer worked just for profit but rather for public service too.[5] Hence profit maximisation was not the main interest of the companies at that time.

While these companies traded in and out of India ever since the incorporation of East India Company since early 1600 a legislation specifically for companies was introduced in 1850 as “Registration of Joint Stock Companies Act”. This act was mostly based on the English Companies Act and it was the beginning of an era where from 1850 till 1947 India merely adopted the prevalent English company legislation as well as its reforms. The English law was transplanted into India to attract British businesses into India as symmetry of law will facilitate trade as well as investment between the two countries. While this approach successfully protected and attracted the British businessman it did little to protect the interests of local community and other constituencies.[6] Hence it will be fair to say that Corporate law at that time was enabling in nature, with main focus of promoting private interest with no mention at all whatsoever of interests of other stakeholders.

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Stakeholder Theory in India Post Independence

In 1947 once India finally got its Independence the economic situation in India was extremely fragile, it was evident by the absence of any corporate law in India protecting the rights of the non-shareholding constituencies while numerous laws were being made in order to protect shareholder to passively improve sentiments and gain the trust of investors and Businessmen.[7] While the Companies Act, 1956 had laissez-faire ideology where while numerous legislation existed protecting the corporates little existed for the protection of other constituencies.

Since 1960’s, the legislation began undergoing significant amendments primarily because of the various recommendations made by several committees appointed by our government which reflected the socialistic nature of our government. These amendments brought in law to protect employees, consumers, community and creditors. One good example would be inclusion of Section 529A into Companies Act, 1956 by The Companies Amendment Act, 1985 in which special right of preferential payment were given to employees for their dues in case the company was being insolvent.[8].Also various laws were made to enable them to convert the debt they have given to corporate into share and also to appoint nominee directors on board for its debtor companies which again reflected the inclination of Indian legislators towards the stakeholder’s interests.[9]

Further, Companies(Amendment) Act, 1963 added the element of “Public Interest” by the way of Section 397(2) according to which, is a company was found out to be carrying out an act which was not in consonance with public interest, the affected parties were given the right to exercise remedies.[10] Hence, Indian company law began recognizing the interests of various non-shareholding Stakeholders in a more sustained fashion during the 1960s with the onset of socialist ideology in the Indian legislative process. The express recognition of “public interest” in the companies legislation is demonstrative of its intention to re-conceptualize the notion of a company, and to extend the domain of company law from catering merely to private interests into one that specifically considers the societal impact of a company’s operations.

In this socialist era, judiciary too followed the steps of stakeholder theory much like legislature as it can be seen in National Textile Workers v. P.R. Ramakrishnan[11] where our Indian Supreme Court stated “The traditional view of a company was that it was a convenient mechanical device for carrying on trade and industry, a mere legal frame work providing a convenient institutional container for holding and using the powers of company management. This doctrine glorified the concept of a free economic society in which State intervention in social and economic matters was kept at the lowest possible level. But gradually this doctrine was eroded by the emergence of new social values which recognised the role of the State as an active participant in the social and economic life of the citizen in order to bring about general welfare and common good of the community. The adoption of the socialistic pattern of society as the ultimate goal of the country’s economic and social policies hastened the emergence of this new concept of the corporation. But, one thing is certain that the old nineteenth century view which regarded a company merely as a legal device adopted by shareholders for carrying on trade or business as proprietors has been discarded and a company is now looked upon as a socio-economic institution wielding economic power and influencing the life of the people.”

By late 1980’s however our government began a process of reconsideration of its economic policies. During that period our country’s foreign exchange had depleted significantly and hence the government was compelled to give way to its strict adherence to the socialist principles and instead had to begin the process of economic liberalization, which it did so in 1991[12]. This reconsideration had an immense impact on corporate law, which underwent some course correction in veering back to the focus on private interests with a view to attracting greater investment, both foreign and domestic. Arguably, the interests of the other stakeholders were temporarily crowded out, and did not receive much attention for two decades.

Corporate Law in India Post 1991 Financial Crisis

In 1991, the government introduced a new economic policy that ushered in an era of liberalization in order to enhance business activity and foreign investment for example, it reduced the requirement of obtaining licence to only a small range of industries, allowed issuing of capital freely, and opened up several sectors of the economy to foreign investment upon various recommendations by International Monetary Fund and other committees.[13]

As a result of these various policy changes corporate law too witnessed significant changes. The Companies Act, 1956 again underwent a series of amendments. Moreover, a slew of securities legislation was introduced to promote the stock markets. Related to this, the securities regulator required companies to adopt specific measures to enhance corporate governance. In my opinion these measures were solely introduced for protection of shareholders and to maximise the value of their investments. The emphasis on “Public Interest” and welfare of various other stakeholders was considerably played down.

During the period of liberalization, several changes were introduced in the Companies Act, 1956 that enabled companies to raise and restructure capital. Sufficient flexibility was provided to companies to engage in wider types of share offerings and to buy back securities. Also Monopolistic and Restrictive Trade Practice Act, 1969 was amended in order to allow mergers and acquisitions to be carried out smoothly without any restriction and government intervention. 

For the first time in India’s corporate history, the lawmakers began focusing on corporate governance, initially as a measure to attract greater foreign investment. In 1998, a task force constituted by the Confederation of Indian Industry recommended a “Desirable Code of Corporate Governance”, which few of leading Indian companies adopted. Thereafter, following a report submitted in 2000 by a committee under the chairmanship of Mr. Kumar Mangalam Birla, a leading industrialist, SEBI amended the terms of the listing agreement to impose essential corporate governance norms on large listed companies on a mandatory basis. These norms were further strengthened following the recommendations in 2004 by a committee established under the chairmanship of Mr. Narayana Murthy.

The Governments primary emphasis was on maximizing shareholder value, as shareholder were considered the essential beneficiaries of corporate governance norms. At the same time, stakeholder interests were not entirely ignored, although there was neither a clear definition nor enunciation of such interests. In that sense, shareholder value remained the touchstone, with stakeholders arguably receiving only rhetorical and passive treatment. [14]

Hence, during this era of Liberalisation, Privatisation, and Globalisation we can clearly see a shift from the erstwhile socialist policies towards a more market-oriented framework to enhance business opportunities in India and to attract greater foreign investment. In this process, the protection of shareholder became a priority and other stakeholders’ interests received less attention, if at all.

In the meanwhile, the calls for a complete fettle of the Companies Act, 1956 grew louder as the legislation had undergone a series of amendments over the years. A more recent reform effort led to the enactment of the Companies Act, 2013 that marks the current corporate law landscape in India. The policy imperatives that dictated the reform process are crucial to determine the nature and purpose of a company under the current dispensation.

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Stakeholder Theory in the Companies Act, 2013

Ever since the Financial Crisis in the late 1980’s several efforts were made to overhaul the Companies Act, 1956. While numerous bills were presented, none were made into legislation. In 2004 an Expert Committee on company law was established as J.J. Irani as its chairman which suggested streamlining of company law in India and while it was market friendly yet at the same time it subscribed to strict norms of corporate[15]. The committee also suggested constitution of a “Stakeholders relationship committee” with a view to protect stakeholders’ interests. Yet, majority of the norms and recommendations were focused primarily on shareholders, with some little mention of the requirement to protect the employee interests. Companies Bill, 2008 was based on bases of this report and was presented in Parliament.

Around the same time one of the biggest corporate scandals ever in India shocked the corporate India. It was known as Satyam Scam where the company misrepresented its accounts to its board, stock exchanges, regulators, investors and all other stakeholders.[16] In 2009 the chairman of the company itself confessed about the fraud of over one billion dollar. This scam was moreover a lesson for law makers in India to strengthen the corporate law and governance norms in India as well as to establish new laws to protect stakeholders. Yet after the scandal when Companies Bill 2009 was presented in the parliament, the legislatures made no changes to the proposed draft legislation compared to the old version of the bill.

Afterwards, under Mr Yashwant Sinha as chairman, Parliamentary Standing committee on finance was referred the Companies Bill, 2009.[17] Even though according to the bill the directors owed duties for the benefit of the members of the company as a whole[18] yet as per the standing committee a more broader and more inclusive Stakeholder approach was necessary in the corporate law as directors should also take into account the benefits of various stakeholders such as employees, the community, customers and environment too. Also, a provision relating to corporate social responsibility required big companies to spend few of their earnings to promote social causes. This required companies to have a corporate social responsibility policy including spending on CSR in the form of “at least two percent of its average net profits during the three immediately preceding financial years”.[19] In this context, in broadening the duties of directors of a company, the Standing Committee stated:

“The Committee welcomed the proposed changes with regard to the duties of a director to promote the objects of the company in the best interests of its employees, the community and the environment as well, particularly in the backdrop of Corporate Social Responsibility, which is proposed to be included in this statute…”

After the Standing Committee Report was taken into cognisance legislators introduced the Companies Bill, 2011 which consisted of significant changes from the 2009 Bill. After being referred back to the standing committee once again, Companies Act, 2013 was passed by both the Lok and the Rajya Sabha and received assent of the President of India on 31st August, 2013. Companies Act, 2013 clearly highlights the inclination of our Legislature again towards the Stakeholder theory which is clearly evident by namely 3 sections which didn’t exist in the 1956 act i.e. 135, 166(2) and 181. While 135 directs companies to contribute to social causes, 166(2) on the other hand broadens the duties of the directors and make them more inclusive towards interests of other non-shareholding stakeholders as well such as employees and environment. S. 181 however gives directors power to contribute Bona Fide to charities and other funds.


Despite considerable advancements in the corporate law discourse, substantial disagreements continue with regards to the nature and purpose of a company. In particular, there are two clashing view points on whether the Corporate and Directors should be either centric towards the interests of shareholder or be more inclusive and focus of interests of stakeholders as well. While the debate still continues, the paper sought to understand the historical evolution of this debate in India from the 1600s till the enactment of the Companies Act, 2013 while trying to find how our lawmakers have addressed the dichotomy between these two theories.

According to the researcher, the Indian Corporate Law has not been consistent while addressing this question of corporate purpose, since the enactment of first corporate law till 1960s Indian Corporate law was majorly Shareholder centric until socialist wave started to question the true purpose and duties of a company and it then started through amendments diverging English corporate law. After a few decades, India again had to come back to Shareholder centric approach post-1991 due to its economic and financial situation. However, since the enactment of the Companies Act, 2013 the Stakeholder model has demonstrated re-emergence and is now deeply entrenched in the Indian corporate law.  

While it may be hard to glean any consistent pattern in the approach our Legislators have favored, it is clear that the favor of any of the two has been driven by the economic and political imperatives of that time. Yet when the economic and political imperatives were stable India has shown its inclination towards the Stakeholder theory and has successfully legislated it in the corporate law instead of Shareholder theory. While the strong stakeholder model of corporate law makes India somewhat of a pioneer among jurisdictions, if history is any lesson, it is not clear how long this tendency will last.

[1]Milton Friedman (2009). “Capitalism and Freedom: Fortieth Anniversary Edition”

[2] Dodd EM. “For whom are corporate managers trustees” Harvard Law Rev.

[3]Perumatty Grama Panchayat vs State of Kerala  2004 (1) KLT 731

[4]Parkinson J,(1997). ‘Company Law and Stakeholder Governance’

[5] Stout, Lynn. (2017). “Corporate Entities: Their Ownership, Control, and Purpose”,  Oxford University Press.

[6] Birla, Ritu. (2009).” Stages of Capital: Law, Culture, and Market Governance in Late Colonial India, Durham and London” Duke University Press.

9Birla, Ritu. (2007). “From the Colonial to the Postcolonial: India and Pakistan in Transition” Oxford University Press.

[8] Companies Act, 1956, s. 529-A

[9]State Bank of India Act, 1955, s. 35A it

[10] Companies Act, 1956, s. 397(2)

[11]  (1983) 1 S.C.R. 9

[12]Kumar, Nirmalya. 2006. India Unleashed. Business Strategy Review 20: 4-15

[13]Supra 14

[14]Afsharipour, Afra and Shruti Rana. 2014. The Emergence of New Corporate Social Responsibility Regimes in China and India. UC Davis Business Law Journal 14: 175- 230.

[15] Irani Committee Report 2005. Report on Company Law, Expert Committee on Company Law.

[16]Union of India Vs. Satyam Computer Services Ltd. 2009(148)CC629

[17] Ministry of Corporate Affairs. 2010. Twenty-First Report- Companies Bill 2009, Fifteenth Lok

Sabha, Standing Committee on Finance (August).

[18] Clause 147(2) The Companies Bill,2009

[19]Supra 19