In the introductory post to this series, I posited that the relevant question when it comes to the law governing the ends of corporate governance is not "what is the corporate purpose" but rather "have the directors or officers violated their fiduciary duties by preferring the interests of one set of stakeholders over those of other sets?"
Despite the obvious centrality of this problem to the operation of business corporations, there are surprisingly few authoritative precedents on point. The law’s basic position on corporate social responsibility famously was articulated in Dodge v. Ford Motor Co.[1] In 1916, Henry Ford owned 58% of the stock of Ford Motor Co. The Dodge brothers owned 10%. The remainder was owned by five other individuals. Beginning in 1908, Ford Motor paid a regular annual dividend of $1.2 million. Between 1911 and 1915 Ford Motor also regularly paid huge “special dividends,” totaling over $40 million. In 1916, Henry Ford announced that the company would stop paying special dividends. Instead, the firm’s financial resources would be devoted to expanding its business. Ford also continued the company’s policy of lowering prices, while improving quality. The Dodge brothers sued, asking the court to order Ford Motor to resume paying the special dividends and to enjoin the proposed expansion of the firm’s operations. At trial, Ford testified to his belief that the company made too much money and had an obligation to benefit the public and the firm’s workers and customers.
The plaintiff Dodge brothers contended an improper altruism[2] towards his workers and customers motivated Ford. The court agreed, strongly rebuking Ford:
A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.[3]
Consequently, “it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others.”
Despite its strong rhetoric, Dodge does not stand for the proposition that directors will be held liable for considering the social consequences of corporate actions. To be sure, having found that Ford had failed to pursue shareholder wealth maximization, the court ordered Ford Motor to resume paying its substantial special dividends. Invoking the business judgment rule, however, the Dodge court declined to interfere with Ford’s plans for expansion and dismissed the bulk of plaintiff’s complaint. Recall the distinction between standards of review and of conduct. The shareholder wealth maximization norm set forth in Dodge is a standard of conduct, but the business judgment rule remains the standard of review. Consequently, Dodge does not stand for the proposition that courts will closely supervise the conduct of corporate directors to ensure that every decision maximizes shareholder wealth. As the court’s refusal to enjoin Ford Motor’s proposed expansion illustrates, courts generally will not substitute their judgment for that of the board of directors. If a proposed course of action plausibly relates to long-term shareholder wealth maximization, courts will not intervene. Ford’s proposed expansion plans did so, and thus were allowed to go forward. Ford’s refusal to pay a special dividend, while simultaneously lowering prices, compounded by his anti-profitmaking trial testimony, did not. Accordingly, the court ordered him to pay the requested dividend. As always, authority and accountability are in tension. In my work on director primacy, I have consistently argued that, absent self-dealing or other unusual circumstances, authority should prevail. Ford’s conduct lay at the outer boundary of defensible exercises of authority and the court appropriately slapped his wrist.[4]
As the law evolved, corporate altruism began to be seen as proper so long as it was likely to provide direct benefits to the corporation and its shareholders. Applying the business judgment rule, moreover, many courts essentially presumed that an altruistic decision was in the corporation’s best interests. Shlensky v. Wrigley[5] exemplifies this approach. Shlensky, a minority shareholder in the Chicago Cubs, challenged the decision by Wrigley, the majority shareholder, not to install lights at Wrigley Field. Shlensky claimed the Cubs were persistent money losers, which he attributed to poor home attendance, which in turn he attributed to the board’s refusal to install lights and play night baseball. According to Shlensky, Wrigley was indifferent to the effect of his continued intransigence on the team’s finances. Instead, Shlensky argued, Wrigley was motivated by his beliefs that baseball was a day-time sport and that night baseball might have a deteriorating effect on the neighborhood surrounding Wrigley Field.
Despite Shlensky’s apparently uncontested evidence that Wrigley was more concerned with interests other than those of the shareholders, the court did not even allow him to get up to bat. Instead, the court presumed that Wrigley’s decision was in the firm’s best interests. Indeed, the court basically invented reasons why a director might have made an honest decision against night baseball. The court opined, for example, “the effect on the surrounding neighborhood might well be considered by a director.”[6] Again, the court said: “the long run interest” of the firm “might demand” protection of the neighborhood. Accordingly, Shlensky’s case was dismissed for failure to state a claim upon which relief could be granted.
The rhetorical emphasis shifted significantly between Dodge and Shlensky. Where Dodge emphasized the directors’ duty to maximize profits, Shlensky emphasized the directors’ authority and discretion. Ultimately, however, they are consistent. The Illinois Appellate Court did not reject the profit-maximizing norm laid down by Dodge, but rather followed Dodge in holding that the business judgment rule immunized the directors’ decision from judicial review.
To be sure, a few cases posit that directors need not treat shareholder wealth maximization as their sole guiding star. A. P. Smith Manufacturing Co. v. Barlow, the most frequently cited example, upheld a corporate charitable donation on the ground, inter alia, that “modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities within which they operate.”[7] Ultimately, however, the differences between Barlow and Dodge have little more than symbolic import. As the Barlow court recognized, shareholders’ long-run interests are often served by decisions (such as charitable giving) that appear harmful in the short-run. Because the court acknowledged that the challenged contribution thus could be justified on profit-maximizing grounds, its broader language on corporate social responsibility is arguably mere dictum.
In any event, Dodge’s theory of shareholder wealth maximization has been widely accepted by courts over an extended period of time. Almost three quarters of a century after Dodge, the Delaware chancery court similarly opined: “It is the obligation of directors to attempt, within the law, to maximize the long-run interests of the corporation’s stockholders.”[8]
In sum, the law governing operational decisions has a somewhat schizophrenic feel. In most jurisdictions, courts will exhort directors to use their best efforts to maximize shareholder wealth. In a few, courts may exhort directors to consider the corporation’s social responsibility. In either case, however, the announced principle is no more than an exhortation. The court may hold forth on the primacy of shareholder interests, or may hold forth on the importance of socially responsible conduct, but ultimately it does not matter. Under either approach, directors who consider nonshareholder interests in making corporate decisions, like directors who do not, will be insulated from liability by the business judgment rule.[9]
The proposition that corporate directors should not be held liable for allegedly considering the effects of their decisions on nonshareholder constituencies and interests follows directly from the director primacy theory of the firm. As we have seen, authority and accountability are in constant tension. With respect to operational decisions, authority appropriately prevails. Sometimes consideration of nonshareholder interests is consistent with long-term shareholder interests, and sometimes it is not. In all operational cases, however, deciding whether nonshareholder interests are congruent with shareholder interests is a question for the board of directors. Courts therefore properly invoke the business judgment rule to insulate such decisions from review.
For more on that argument, see my book The New Corporate Governance in Theory and Practice.
[1] 170 N.W. 668 (Mich. 1919). For my critique of an interesting reinterpretation of Dodge, which argues that the shareholder wealth maximization norm originated as a means for resolving disputes among majority and minority shareholders in closely held corporations, see my post Is Dodge v Ford Motor Company a close corporation/controlling shareholder case?
[2] The term altruism is used herein to describe any decision motivated by considerations other than shareholder wealth maximization. It thus includes, but also is much broader than, the special case of corporate philanthropy.
[3] Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich. 1919). Despite its strong emphasis on the board’s obligation to pursue shareholder interests, the court recognized that, in many situations, ethical or humanitarian considerations are wholly consistent with long-term shareholder wealth maximization. Providing health care to employees costs money in the short-run, for example, but in the long-run healthy employees with high morale may be more productive. A board of directors thus may decide to incur such short-run costs in order to reap long-term gains without fear of liability: “The difference between an incidental humanitarian expenditure of corporate funds for the benefit of the employees, like the building of a hospital for their use and the employment of agencies for the betterment of their condition, and a general purpose and plan to benefit mankind at the expense of others, is obvious.”
[4] One can plausibly argue that Ford’s seemingly altruistic conduct in fact was a shrewd and ruthless attempt to stifle competition. In addition to being shareholders of Ford Motor Co., the Dodge brothers were also competitors. They founded the business that is now the Dodge brand of DaimlerChrysler. Their likely goal for this litigation was not only restoration of the special dividends, which they needed to finance their competing business, but also to prevent Ford from expanding capacity. Ford’s decisions effectively cut the Dodge Brothers off at the knees. The brothers had a large investment in Ford Motor Co. stock, which was producing minimal returns (absent the special dividends). Cancellation of those dividends would help fund expansion of the brothers’ main competitor. If so, however, why didn’t Ford explain all this to the court? Perhaps he feared antitrust litigation or perhaps he simply didn’t want to look like a robber baron.
[5] 237 N.E.2d 776 (Ill. App. 1968), see § ___. Accord Ella M. Kelly & Wyndham, Inc. v. Bell, 266 A.2d 878, 879 (Del. 1970); Union Pac. R.R. Co. v. Trustees, Inc., 329 P.2d 398, 401-02 (Utah 1958).
[6] Shlensky v. Wrigley, 237 N.E.2d 776, 780 (Ill. App. 1968).
[7] A. P. Smith Mfg. Co. v. Barlow, 98 A.2d 581, 586 (N.J. 1953). See also Theodora Holding Corp. v. Henderson, 257 A.2d 398, 404 (Del. Ch. 1969) (opining that corporate social responsibility is a desirable goal).
[8] Katz v. Oak Indus., Inc., 508 A.2d 873, 879 (Del. Ch. 1986). In Long v. Norwood Hills Corp., 380 S.W.2d 451 (Mo. Ct. App. 1964), the court observed: “Plaintiff cites many authorities [including Dodge] to show that the ultimate object of every ordinary trading corporation is the pecuniary gain of its stockholders and that it is for this purpose the capital has been advanced.” Id. at 476. The court further stated that it had “no quarrel with plaintiff insofar as the rules of law stated therein govern the actions of majority stockholders and the boards of directors of corporations.” Id.
[9] The principal exception to this rule is where directors rely on nonshareholder interests to justify takeover defenses, which do not necessarily get business judgment rule protection.
