Instrumental Stakeholder Theory: A Synthesis of
Ethics and Economics
Thomas M. Jones
The Academy of Management Review, Vol. 20, No. 2
(Apr., 1995), pp. 404-437
The Instrumental Approach
Describe what will happen
If
managers or firms
behave in certain ways
Establishes connection
between certain
practices and certain
end states
Stakeholder Theory Overview

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
Jones (1995) develops instrumental stakeholder theory
by delving into the reasons why acting ethically should
(or at least is likely to) lead to competitive advantage.
His arguments are based on economics literature, which
focuses on information imperfections in markets, and in
particular on the costs involved in attempts to overcome
those imperfections.
Jones proposes that a reputation for acting ethically
will, to some degree, overcome consequences of those
information imperfection in a much less costly, or even
costless manner.
Assumptions about firm-stakeholder relationship
1.
2.
3.
Firms have relationships, called contracts, with many
stakeholders and can therefore be seen as a “nexus
of contracts” or a set of principal-agent
relationships, between themselves (as agents), and
their stakeholders (as principals);
Firms are run by professional managers who are
their contracting agents
Firms exist in markets in which competitive pressures
do influence behaviour but do not necessarily
penalize moderately inefficient behaviour.
The Basic Instrumental Stakeholder Proposition
If firms….contract (through their
managers) with their stakeholders on
the basis of mutual trust and
cooperation, then these firms will
have a competitive advantage over
firms that do not (1995:422)

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The rational connection between the “if” and the “then”
sides of instrumental proposition is based on costs of
solving agency problems, transaction cost problems and
team production problems.
These problems arise because markets are not perfect (in
particular because information is not freely available) and
those imperfection allow economic agents, manager in
particular, to behave opportunistically.



They can misrepresent their activities or efforts
Cost are then incurred either because opportunism succeeds
(and returns to the firm and/or to other stakeholders are
less, as opportunistic managers reap the benefit of their
guile);
or because one or more parties to the relationship spend
resources to reduce opportunism.
An Agency Theory Perspective
The separation of ownership and control can lead
to conflicts

Agency theory suggests a way to understand the
conflict that often arises between shareholder goals
and top managers’goals

Agency relation occurs when one person (the
principle, i.e. shareholders) delegates decisionmaking authority to another (the agent, i.e.
managers)
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8
Agency Problem

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Agency problem: a problem in determining managerial
accountability that arises when delegating authority to
managers
Shareholders are at information disadvantage compared to top
managers;
It takes considerable time to see the effectiveness of decisions
managers may make;
A moral hazard problem exists when agents have the
opportunity and incentive to pursue their own interests;
Very difficult to evaluate how well the agent has performed
because the agent possesses an information advantage over
the principal.
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Solving the Agency Problem


In agency theory, the central issue is to overcome the
agency problem by using governance mechanisms that
align the interests of principles and agents
The role of the board of directors:




Monitor and question top managers decisions
Reinforce and develop a code of ethics
Find the right set of incentives to align the interests of managers
and shareholders
Governance mechanisms include
Stock-based compensation schemes that are linked to the
company’s performance
 Promotion tournaments and career paths10
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Cost incurred due to opportunism or to reduce it
1
Agency costs arise due to principals having
insufficient information about the quality of
managers before the contract is struck (adverse
selection) or about they way they perform under
contract (moral hazard). Opportunism can be
reduced by incurring monitoring and bonding
costs.
Cost incurred due to opportunism or to reduce it
2. Transaction cost arise due to lack of information
about the quality of contracting partners and the
resources they have to offer. Cost of transacting
include costs of:
a.
b.
c.
d.
Searching
Monitoring
Enforcing, and
Insuring and diversifying
3. Monitoring costs associated with team production arise
to counteract the “free rider” problem whereby team
members shirk without detection and receive rewards
disproportionate t
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
Jones contends that managers who relate to stakeholders
on the basis of mutual TRUST and COOPERATION, as
long as they can be identified as such, will be recognized
as efficient potential contracting partners.
How can managers of this type be identified?
 Sincere
Manner or Reputation
 Reputation is a good guide for moral sentiments because it is
difficult for someone who is merely prudent to maintain
reputation for honesty because, on pure self-interest
calculations, dishonest action will often be regarded as
coming with acceptable risk.
Corporate Morality


Is identifiable, largely through the absence of
corporate policies that would indicate lack of moral
sentiments such as massive lay-offs to boost profits
or no-returns policies on merchandise.
System of incentives and sanctions employed within
the firm, the language used, and other internal
reflections of top management moral sentiments.
“Firm morality, like individual morality, is
difficult to fake”
Instrumental Stakeholder Proposition

Emphasizes what companies should NOT do
strategically in order to fulfill the conditions of
the instrumental proposition, rather than
specifying ways in which they should deal with
stakeholders to advance corporate objectives.
Instrumental Stakeholder Proposition
1. Mechanisms to deter takeover:


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Shark repellents – anti-takeover charter amendments
Poison pills – contingent securities that burden an acquiring firm with
various obligation after takeovers
Greenmail – purchases of large blocks of shares from potential takeover
raids
2. High level of executive compensation
3. Particular supplier relation patterns:


Having many suppliers indicating that some are being kept on line
competing for business
Changing suppliers often, thus not building long-term contracts on mutual
trust
4. Contracting out work normally done by employees
5. Reliance on external rather than internal labour markets
6. Monitoring employees closely
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Inefficient production processes, uninspired
marketing plans, and obsolete products can
outweigh a reputation for trusting relations with
stakeholders.
Individual propositions may not be verified
empirically because the relationship are not
independent.
Questions??