What is shareholder theory? Business theories can often be difficult to wrap your head around, so this article breaks shareholder theory down into simple terms, explaining what it is, how it works, its advantages and disadvantages, and how it applies to the tourism industry.
What is shareholder theory?
Shareholder theory is a business theory established in 1970 by Milton Friedman, an economist. It is sometimes also referred to as the Friedman Doctrine. The main basis of shareholder theory is that it is a business’ main responsibility to increase profits. It says that because shareholders are the ones funding a business, it should be them who the firm has social responsibility towards. According to MIT Sloan, shareholder theory is an example of a ‘normative theory of corporate social responsibility’, aiming to dictate what a corporation’s role should be.
Friedman set out the idea in an essay published in The New York Times Magazine on 13 September 1970, titled A Friedman Doctrine: The Social Responsibility of Business Is to Increase Its Profits. He argued that a company’s managers are employees of its owners, and so their responsibility is to make as much money for shareholders as possible while staying within the rules of the game – that is, engaging in open and free competition without deception or fraud. In his view, individual shareholders were free to spend their own money on social causes if they wished, but it was not the role of the business to do so.
What (or who) is a shareholder?
A shareholder is someone who holds (owns) shares in a company’s stock. This is known as equity. Shareholders are essentially joint owners of a business, and profits go back to them as increased stock valuations or payments known as dividends. If there were no profits or profits were to go down, the value of each share would drop.
The Corporate Finance Institute says ‘A shareholder can be a person, company, or organization that holds stock(s) in a given company. A shareholder must own a minimum of one share in a company’s stock or mutual fund to make them a partial owner. Shareholders typically receive declared dividends if the company does well and succeeds. Also called a stockholder, they have the right to vote on certain matters with regard to the company and to be elected to a seat on the board of directors.’
How does shareholder theory work?
The way shareholder theory works is actually quite simple. As mentioned in the definition of what the theory is, it suggests that businesses should only be focused on increasing profits for their shareholders. This, in reality, means not engaging in any form of philanthropy; e.g, no charitable donations, unless the donation would lead to a benefit (to the business or shareholders) equal to or greater than the donation itself.
The whole premise of shareholder theory is basically that the shareholders are more important than other stakeholders, like employees and the local community, all of whom have a stake (interest) in the business.
Shareholder theory is often contrasted with stakeholder theory, developed by R. Edward Freeman in 1984, which argues that businesses have responsibilities to everyone with a stake in the organisation, not just its shareholders.
Benefits of shareholder theory
There are certain advantages and disadvantages of shareholder theory and applying it to the way a business is run. First of all, let’s look at the benefits of shareholder theory and how it can be a good thing for businesses…
- The goal of shareholder theory (i.e. to increase value for shareholders) is measurable. This means management can put a plan in place knowing exactly what they need to do in order to achieve this goal.
- This goal is a narrow one, which should theoretically make it simpler to achieve.
- Responsibility is only towards one set of people – the shareholders – meaning there are usually fewer people to satisfy than when applying stakeholder theory, where there could be thousands if not millions of people who a business feels responsibility towards.
- The theory is more than 50 years old, meaning there is a lot of research and information to back it up.
Disadvantages to shareholder theory
As with all theories, there are downsides too. Here are some of the negatives and disadvantages which go along with shareholder theory…
- Shareholder theory fails to take into account anyone other than the shareholders. This means that employees, consumers, the local community and so on are not being taken into consideration, which can damage the company’s reputation.
- Shareholder theory does not look at sustainability. With natural resources being limited, a business making no effort to be sustainable because it is only focusing on profit may not last as long as it could.
- The theory mostly ignores the other factors that go into creating a ‘good’ or successful business in favour of focusing on shareholder satisfaction. This can result in unhappy and therefore unproductive employees, for example, due to low wages being paid in order to drive further wealth to shareholders.
- By focusing so much on increasing profits to please shareholders, businesses might be tempted to cut corners and ultimately deliver a below-standard product to customers.
- Shareholder theory can create a close relationship between the corporate world and the political one. Because a government can create a policy or law which reduces shareholder value, businesses may lobby or donate money to political parties to ‘get them on side’, which critics argue can lead to governments acting in the best interest of businesses rather than individuals or communities.
Criticism of shareholder theory
As outlined above, there are a variety of disadvantages that go along with shareholder theory. For this reason, the theory has been criticised by a number of commentators and experts. In 2019, the Business Roundtable – a group representing the chief executives of many of America’s largest companies – issued a statement, signed by 181 CEOs, redefining the purpose of a corporation as delivering value to all stakeholders rather than to shareholders alone.
Naomi Klein
Naomi Klein, a left-wing activist and author, is particularly opposed to the free-market ideas associated with Friedman. In her 2007 book The Shock Doctrine, she argued that these ideas consistently impoverish communities while actively enriching the lives of the corporate elite. Her book was a criticism of what she calls ‘disaster capitalism’. In it she says “When it comes to paying contractors, the sky is the limit; when it comes to financing the basic functions of the state, the coffers are empty.”
Paul Tudor Jones
Hedge fund manager/investor Paul Tudor Jones is someone who also vehemently opposes shareholder theory, despite being a billionaire and therefore someone who you might think would be in favour of it.
He has linked shareholder theory and the Friedman doctrine to the opioid epidemic in the United States, arguing that a focus on profit maximisation contributed to the unethical practices of Purdue Pharma, owned by the Sackler family. Purdue aggressively marketed its prescription opioid OxyContin while downplaying its risk of addiction, and pleaded guilty to federal criminal charges in 2020; in 2025, Purdue and the Sackler family agreed a settlement worth around $7.4 billion. According to the US Centers for Disease Control and Prevention (CDC), more than 263,000 people died in the US from overdoses involving prescription opioids between 1999 and 2020. This is an extreme example, but it illustrates the potential dangers of putting profit above all else.
Lawrence Mishel
Lawrence Mishel, formerly president of the Economic Policy Institute in Washington, has linked shareholder theory – and Friedman – to the stagnation of wages for typical workers in the US over recent decades, as a growing share of income has gone to shareholders and top executives.
Mishel has argued that wages are low because businesses and corporations work hand in hand with the government to block reforms that might change this. This is directly beneficial to the shareholders who get more of the profit. It fails to account for employee dissatisfaction, however. Mishel goes on to say that workers have become disempowered thanks to wage suppression, wage inequality, poor labour standards, changes to the corporate structure and excessive unemployment keeping wages low.
Shareholder theory and the tourism industry
Shareholder theory is highly relevant to the tourism industry, where many of the biggest companies – such as airlines, cruise lines, hotel groups and online travel agencies – are publicly listed and answerable to shareholders. A strict shareholder approach might lead a tourism business to minimise costs, maximise occupancy and growth, and avoid spending on initiatives that do not directly increase profits.
However, there is growing pressure on tourism businesses to consider their wider impacts on destinations, local communities and the environment. Concerns about overtourism, carbon emissions and fair pay for tourism workers have led many companies to adopt corporate social responsibility (CSR) and sustainable tourism strategies, reflecting a shift towards stakeholder thinking. Supporters of this approach argue that protecting destinations and communities is also in shareholders’ long-term interests, since tourism businesses depend on them.
Shareholder theory: FAQs
Below are answers to some of the most common questions about shareholder theory.
What is shareholder theory in simple terms?
Shareholder theory is the idea that a business’s main responsibility is to maximise profits for its shareholders, the people who own shares in the company, while staying within the law.
Who created shareholder theory?
Shareholder theory is most closely associated with economist Milton Friedman, who set out the idea in a 1970 essay in The New York Times Magazine. It is often called the Friedman Doctrine.
What is the difference between shareholder theory and stakeholder theory?
Shareholder theory says a business is responsible mainly to its shareholders, while stakeholder theory, developed by R. Edward Freeman in 1984, says it is responsible to everyone affected by it, including employees, customers, suppliers and local communities.
What are the advantages of shareholder theory?
Its advantages include a clear, measurable and narrow goal, accountability to a single group of people and a large body of research behind it.
Why is shareholder theory criticised?
Critics argue that it ignores employees, communities and the environment, discourages sustainability, can encourage corner-cutting and has contributed to wage stagnation and corporate scandals.
Further reading
Shareholder theory has a lot of background and accompanying research, and this article has aimed to simplify the concept. In short, shareholder theory is the idea that maximising profits for shareholders should be a business’s top (or sole) priority.
If you found this article on shareholder theory useful, these articles may also be of interest:
- Stakeholder theory: A simple explanation
- What is responsible tourism?
- What is sustainable tourism?
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