A Stakeholder Approach to Value Creation and Leadership

123 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership CHAPTER 7 A Stakeholder Approach to Value Creation and Leadership JOHANNA KUJALA, HANNA LEHTIMÄKI & R. EDWARD FREEMAN Takeaways for Leading Change This chapter builds on the notion that in contemporary societies, leaders need to pay attention to a broad array of stakeholders and understand how value is created in stakeholder relationships. Stakeholder research considers how firms can create value simultaneously for multiple stakeholders (Freeman, Harrison, & Wicks, 2007), and how value is created in stakeholder relationships (Myllykangas, Kujala, & Lehtimäki, 2010). The key message in this chapter is that organisations and their leaders need to understand value-creating stakeholder relationships. The chapter proposes the SVC model with an emphasis on joint interests, the ability to collaborate, and trust in stakeholder relationships. For those working in leadership positions, the SVC model provides a tool for considering value creation with and for a wide-ranging variety of stakeholders. 124 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership T his chapter argues that those working in leadership positions must understand that value is created in relationships with a broad variety of stakeholders. Beyond increasing the value of investment made by owners, business organisations must fulfil the needs and expectations of various stakeholders, such as employees and customers, suppliers and distributors, investors and local communities. Public organisations need to address and engage a variety of stakeholders including citizens, non-profit organisations and local authorities, to accomplish their mission. In this chapter, we introduce the stakeholder approach and describe what kinds of tools it proposes for understanding value creation. The traditional view of value creation examines how companies create value by using resources to make products to be sold in the market. In the value creating chain, actors are subcontractors, vendors, employees, and sales agencies, to mention a few. The input of each actor continuously adds value to the product until it reaches the customer. (Porter, 1985.) This view of value creation sees companies as production machines between inputs from suppliers, investors and employees, and outputs to customers (Donaldson, 1995). The chief executive officer (CEO) acts as an agent of the owners who have invested their money in the business and expect returns on their investment. In other words, the owners hire the CEO to act as their agent in the company whose primary objective is to produce the maximum return on the money invested in the company. This view is also called the neo-classical view of the firm where the purpose is in maximising firm value rather than optimising collective value (cf. Bosse, Phillips, & Harrison, 2009; Donaldson & Walsh, 2015). The traditional view can be criticised along several lines. First, it may lead to serious malpractices resulting from individual benefit-seeking and short term profit maximisation by the owners and CEO. This comes at the cost of long term profitability. Corporate scandals such as the cases of Enron or Siemens illustrate this problem. In the Enron case, financial reporting and disclosures covered problems of corporate governance and Those working in leadership positions must understand that value is created in relationships with a broad variety of stakeholders. 125 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership leadership. Profit margins and the share price was manipulated from the late 1990s into the early 2000s. As a result, 4,500 employees lost their jobs, investors lost USD 60 billion, and trust in the American economic system was eroded. In the Siemens case, hundreds of employees gave bribes amounting up to EUR 1.3 billion to business partners and government officials between 1999 and 2006. The practice resulted in the dismissal of numerous top managers in the company, the payment of EUR 500 million in back-taxes, EUR 1 billion in investigation costs and repairing the damage to the company’s reputation in the eyes of the public (Global Ethic, 2009). Second, the traditional view allows and even encourages the exploitation of natural resources. For example, air pollution and waste are considered the unwanted but inevitable outcomes of economic activity. However, with growing scientific consensus on the effects of global warming, running a business to the detriment of the natural environment has become increasingly unacceptable in the eyes of the public. A recent Finnish example, the Terrafame mine case, illustrates this tension. While the company brought jobs and economic well-being to a remote and economically depressed region in North-Eastern Finland, it was nevertheless criticised for the damages its mining activities caused to the local environment. Third, the traditional view does not sufficiently take into account the needs and expectations of various stakeholders in society. It justifies the focus on profit maximisation without paying attention to societal outcomes. We argue stakeholders such as employees, citizens as well as local and national authorities have a legitimate right to expect and claim socially acceptable and beneficial behaviour from organisations and their leaders. The stakeholder approach is an alternative to the traditional profit maximisation view. According to Freeman (1984; 2010), stakeholders are groups and individuals that can affect or can be affected by an organisation. For private organisations, the argument is that business is not only about increasing the value of the investment made by owners, but about fulfilling the needs and expectations of various stakeholders. The theory argues that the reason for a firm’s existence can and should be found in value-creating stakeholder relationships (Freeman, Harrison, Wicks, Parmar, & de Colle, 2010; Näsi, 1995a). Companies bring together employees and customers, 126 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership suppliers and distributors, investors and communities with the purpose of creating new jobs, products and services needed and desired by various stakeholders. Value not only accrues to owners and investors, but to all stakeholders (Garcia-Castro & Aguilera, 2015). The collective value created reflects the value created in all stakeholder relationships (Bosse et al., 2009). For public organisations, organisational objectives are connected to stakeholders through joint activities. In this way, public organisations fulfil their mission and create value for all involved parties (Heikkinen, Kujala, & Inha, 2018). Interestingly, the origin and evolution of the stakeholder concept can be traced to Scandinavian management literature dating back to the 1960’s; the basic concepts and ideas of stakeholder thinking were developed by Swedish researcher Eric Rhenman (Rhenman, 1964; Rhenman & Stymne, 1965; see also Strand & Freeman, 2015). In the 1970s, the “stakeholder approach enjoyed an almost dominant role in the Finnish university management teaching” (Näsi, 1995b, p. 98). Among the promoters of stakeholder thinking was Finnish professor Juha Näsi. He was influential not only in international theory development from the 1970s to the 2000s, but also in advancing stakeholder thinking in the strategic management of Finnish companies. Since R. Edward Freeman’s seminal work in 1984, the stakeholder approach has gradually increased its importance in organisational studies worldwide. Over the years, the stakeholder approach has been established as an important approach in conceptualising the relationship between business and society. The approach has been used to examine multiple phenomena in various fields such as strategic management (e.g., Haksever, Chaganti, & Cook, 2004; Harrison, Bosse, & Phillips, 2010; Sachs & Rühli, 2011), corporate responsibility (e.g., Sachs & Maurer, 2009; Smith & Rönnegard, 2016; Strand et al., 2015), business ethics (e.g., Phillips, 1997; Purnell & Freeman, 2012; Wicks, 1996), international business (e.g., Lehtimäki & Kujala, 2017), and non-profit organisations (Heikkinen et al., 2018). At first, stakeholder scholars were primarily interested in identifying the most important stakeholders and their interests; in other words stakes, in business (e.g., Clarkson, 1995; Mitchell, Agle, & Wood, 1997). More recently, the focus has shifted toward examining interaction between diverse stakeholders (Neville & Menguc, 2006), understanding 127 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership stakeholder dialogue (Burchell & Cook, 2006; van Huijstee & Glasbergen, 2008), and learning from multi-stakeholder networks (Roloff, 2008). The interest lies in stakeholder interaction and the nature of stakeholder relationships (Evan & Freeman, 1988; Mitchell et al., 1997; Rowley, 1997). Advocates promote the idea that the interests of different parties in stakeholder organisations should be incorporated into the process of value creation (Freeman et al., 2010). Value, in this sense, is created not only for stakeholders but also with stakeholders (Freeman et al., 2010). The key argument in stakeholder theory that, in the long run, an organisation must operate in such a way that each stakeholder is satisfied with what they give and with what they receive, i.e. stakeholder interests must be balanced over time (Freeman et al., 2007; Näsi, 1995a). In business organisation, the stakeholder approach argues it is necessary to broaden organisational goals beyond profit maximisation and include the interests and claims of non-stockholding groups (Mitchell et al., 1997). One of the main arguments is that the development and maintenance of favourable and productive stakeholder relationships are essential in creating value (Post, Preston, & Sachs, 2002; Svendsen, Boutlier, Abbott, & Wheeler, 2002). Seeking to serve the interests of a broad array of stakeholders will create more value over time (Freeman, 1984; Harrison et al., 2010). As society changes, the stakeholder approach can help organisations and their leaders in determining what issues to address in order to facilitate the creation of new innovations and value (Harrison & Wicks, 2013). In this chapter, we present two approaches to understanding stakeholder interests and firm-stakeholder relationships. First, we introduce the Responsiveness Approach in stakeholder management. It proposes that organisations operate in a stakeholder environment and proposes ways in which organisations can pit responding to stakeholder needs and interests at the core of its strategic operations. Second, we introduce the Stakeholder Value Creation (SVC) model in stakeholder management. This model In the long run, an organisation must operate in such a way that each stakeholder is satisfied with what they give and with what they receive. 128 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership views organisations and their stakeholders as interdependent. The SVC model highlights the importance of understanding how organisations pursue joint interests. We will conclude with a discussion on these two approaches and their impact on understanding how companies and other organisations operate. The Responsiveness Approach The key argument in the responsiveness approach is that organisations decide their societal engagement based on stakeholder needs and demands (Frederick, 1978; Wood, 1991). The strategic outcome is that organisations which respond to stakeholder needs and interests are better off in the marketplace and can gain a competitive advantage over organisations which do not pay attention to the views and expectations of their stakeholders. Since the early days of stakeholder theorising, the discussion has focused on the question of who stakeholders are, identifying their stakes and understanding the nature of stakeholder driven organisations. The responsiveness approach seeks to identify the most important stakeholders, analyse the interests and needs of these stakeholders, and measure responses to stakeholder expectations. Measures for analysing the connection between social responsibility and social performance have also been developed (e.g., Berman, Wicks, Kotha, & Jones, 1999; Kobeissi & Damanpour, 2009; Orlitzky, Schmidt, & Rynes, 2003). Mitchell et al. (1997) made an important contribution to the stakeholder theory by defining the principle of who and what really counts in stakeholder management. They identified three attributes that serve as a basis for stakeholder salience: power of the stakeholder, urgency of the demand made by the stakeholder, and the legitimacy of the stakeholder demand. Their theoretical framework, the salience model, is one of the best-known models for the responsiveness approach (Figure 1). In the salience model, power refers to “a relationship among social actors in which one social actor, A, can get another social actor, B, to do something that B would not have otherwise done”. Legitimacy, in turn, is defined as “a generalized perception or assumption that the actions of an entity are 129 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership desirable, proper, or appropriate within some socially constructed system or norms, values, beliefs, definitions.” Urgency, as the third dimension of the model, addresses “the degree to which stakeholder claims call for immediate attention” (Mitchell et al. 1997, p. 869). According to this model, the more attributes a stakeholder claim has, the more salient it is. Salience is defined as “the degree to which managers give priority to competing stakeholder claims” and stakeholder salience analysis is argued to reveal the definitive stakeholders and provide a foundation for analysing stakeholder relationships (Mitchell et al. 1997, p. 869). The stakeholder salience model has served as a tool for empirical analysis in previous research. For example, Myllykangas et al. (2010) used the salience model in a longitudinal study to depict stakeholder dynamics in strategic change of a company. The results of the study showed that over time, in the different strategic periods, the stakeholders both lost and FIGURE 1. The stakeholder salience model (Mitchell et al. 1997, p. 874) POWER 1 Dormant Stakeholder 2 Discretionary Stakeholder 3 Demanding Stakeholder 4 Dominant Stakeholder 5 Dangerous Stakeholder 6 Dependent Stakeholder 7 Definitive Stakeholder 8 Nonstakeholder LEGITIMACYURGENCY 130 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership gained attributes. With the salience model, they were able to show that stakeholder relationships are processes that change and evolve over time (Myllykangas et al., 2010, p. 68). The salience model has been also used to measure and assess stakeholder influence (Aaltonen, Kujala, & Oijala, 2008; Eesley & Lenox 2006; Neville & Menguc 2006; de Vries, 2009), to examine stakeholder prioritising (Boesso & Kumar, 2009; Harvey & Schaefer, 2001; Parent & Deephouse, 2007), and to study responsibility reporting (Weber & Marley, 2012). It has also been used to identify stakeholder management strategies in supply chain collaboration (Co & Barro, 2009; Magness, 2008), to create corporate stakeholder cultures (Jones, Felps & Bigley, 2007), and to analyse the dynamics of stakeholder relationships (Jawahar & Mclaughlin, 2001). Despite the wide use of the stakeholder salience model in empirical analysis, many researchers have criticised the model for its limited understanding of stakeholder relationship dynamics (Friedman & Miles, 2002), the role of dependent stakeholders (Calton & Payne, 2003), and stakeholder interface and networks (Pajunen, 2006; Frooman, 1999; Rowley, 1997; Rowley & Moldoveanu 2003). Moir, Kennerley & Ferguson (2007) and Derry (2012) point out that the stakeholder salience model does not work because salient stakeholders change over time and managers need to tackle constantly changing stakeholder relationships. For this reason, a better understanding of how stakeholders influence organisations, how organisations should engage with stakeholders, and how to evaluate the impact of organisational activities on stakeholders is needed. According to Freeman (2010), stakeholder theorising needs to escape the trap of building trade-offs among stakeholders and move toward redefining how we think about value creation. In the next section, we discuss the mutuality and jointness of value-creating stakeholder relationships in more detail. Stakeholder Value Creation Stakeholder value creation is seen as the ability of an organisation to create enduring relationships with its stakeholders (see Dyer & Singh, 1998; Freeman, Wicks & Parmar, 2004; Goyder, 1999; Hillman & Keim, 2001; 131 Leading Change in a Complex World: Transdisciplinary Perspectives A Stakeholder Approach to Value Creation and Leadership Wheeler & Davies, 2004). There are many ways to examine how value is created in interactions between organisation and its stakeholders and even among stakeholders themselves. Scholars have recognised that value is a complex concept with different dimensions. Mele and Colurcio (2006) identified five value dimensions: customer value, human resource value, shareholder value, firm value, and societal value. Lerro (2011) presented four stakeholder value dimensions: economic value, socio-cultural value, environmental value, and knowledge value. Harrison and Wicks (2013), in turn, identified four stakeholder utility factors representing the different kinds of value sought by stakeholders: stakeholder utility associated with actual goods and services, stakeholder utility associated with organisational justice, stakeholder utility from affiliation, and stakeholder utility associated with perceived opportunity costs. More recently, Garriga (2014) argued that instead of stakeholder utility, understanding stakeholder capability is sufficient to understand value creation in stakeholder relationships. She identified the following stakeholder capabilities as significant to value creation: being employable, being autonomous, being innovative, being entrepreneurial, being responsive, being socially integrated, being emphatic, being “green”, and being healthy (Garriga, 2014). The Stakeholder Value Creation (SVC) model focuses on the stakeholder relationship. It seeks to understand how value is defined in organisational relationships. It argues that instead of seeking to define what is valuable for whom, leadership should seek to understand value-creating stakeholder relationships and their characteristics. It is crucial, on the one hand, to recognise that different stakeholders have different expectations toward the firm, and on the other, to understand the importance of bringing stakeholder interests together over time (Freeman et al., 2006). There is a distinction between what counts as value for a single organisation and what counts as valuable in general (Donaldson & Walsh, 2015). 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