In a prior post, I argued that the common law of corporations mandates, as the court put it in the seminal Dodge v. Ford Motors Co. case, that "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."
In a comment to the Haskell Murray post that triggered my interest in addressing these issues, Lyman Johnson posited that:
I must dissent from the view that it is clear as a matter of positive law that corporations in general must maximize shareholder wealth. ... And of course, constituency statutes in almost 30 states further complicate assertions about positive law.
Typically, these statutes amend the existing statutory statement of the director’s duty of care. They commonly authorize the board of directors, in discharging its duty of care, to consider the impact a decision will have on not only shareholders, but also on a list of other constituency groups, such as employees, suppliers, customers, creditors, and the local communities in which the firm does business. In addition to the laundry list of constituency factors, some statutes more generally authorize directors to consider both the long- and short-term effects of the decision.
Most nonshareholder constituency statutes are permissive. Directors “may,” but need not, take nonshareholder interests into account. There are no express constraints on the directors’ discretion in deciding whether to consider nonshareholder interests and, if they decide to do so, which constituency groups’ interests to consider. As a result, the statutes should not be interpreted as creating new director fiduciary duties running to nonshareholder constituencies and the latter should not have standing under these statutes to seek judicial review of a director’s decision.[1]
Beyond this, however, the nonshareholder constituency statutes uniformly are silent on many key issues. Among the issues left open by almost all statutes are such critical questions as: How should directors decide whether particular claimants fall into one of the protected constituent categories, some of which, such as customers and communities, are very amorphous? What weight should directors assign to shareholder and nonshareholder interests? What should directors do when those interests cannot be reconciled? What should directors do when the interests of various nonshareholder constituencies conflict amongst themselves? What standards should courts use in reviewing a director’s decision not to consider nonshareholder interests? What standards of review apply to director action claimed to be motivated by concern for nonshareholder constituents? Nor is there, as yet, any significant guidance from the courts. The statutes have rarely been cited outside the takeover setting, and even there they have not received authoritative interpretation. To the contrary, the decisions generally are limited to the not very startling observation that the statutes permit director consideration of stakeholder interests.[2] The waters thus remain quite murky.
Plausible interpretations of nonshareholder constituency statutes fall on a spectrum between two extremes. At one end of the spectrum is a reading that allows directors to ignore shareholder interests in making corporate decisions. At the other end is a reading under which the statutes simply codify the pre-existing common law, including an unmodified shareholder wealth maximization norm. Neither extreme seems likely to emerge as the prevailing interpretation. Instead, we will end up somewhere in the middle. But where?
At a minimum, if the statutes do anything beyond merely codifying present law, they presumably permit directors to select a plan that is second-best from the shareholders’ perspective, but which alleviates the decision’s impact on the firm’s nonshareholder constituencies. In other words, the directors may balance a decision’s effect on shareholders against its effect on stakeholders. If the decision would harm stakeholders, the directors may trade-off a reduction in shareholder gains for enhanced stakeholder welfare.
This interpretation is virtually compelled by the statutory language. What purpose is there in giving the directors the right to consider nonshareholder interests if the directors cannot protect those interests? Without the right to act on their deliberations, the right to include stakeholder interests in those deliberations is rendered nugatory. If the statutes are to have any meaning, they must permit directors to make some trade-offs between their various constituencies.
How then might these statutes change the outcome of specific cases, if at all? Assume the XYZ Company operates a manufacturing plant nearing obsolescence in an economically depressed area. XYZ’s board of directors is considering three plans for the plant’s future. Plan A will keep the plant open, which will preserve the jobs of two hundred fifty workers, but will reduce earnings per share by ten percent as long as the plant remains open. Plan B will close the plant immediately, which will put the two hundred fifty plant employees out of work in an area where manufacturing jobs are scarce, but will cause earnings per share to rise by ten percent. Plan C contemplates closing the plant, but implementing a job training and relocation program for its workers as a supplement to state-provided programs. Plan C will cause a ten percent reduction in earnings per share for one year.
A shareholder threatens to bring a derivative action against the directors charging breach of their duty of care if they pick any plan other than Plan B. Under traditional corporate law principles, as espoused by Dodge, XYZ’s board is required to choose the plan that maximizes shareholder wealth: Plan B. However, because the statutes permit directors to balance shareholder and stakeholder interests, the board should be free to adopt either Plan A or Plan C without fear of liability if a shareholder challenges the board’s decision.
As a practical matter, however, the result would be no different under traditional common law rules. The business judgment rule undoubtedly would preclude judicial review of the board’s decision. In Shlensky v. Wrigley,[3] Wrigley’s stubborn opposition to lights probably cost the shareholders money over the short term, but the business judgment rule prevented Shlensky’s lawsuit from going forward. In Dodge v. Ford Motor Co.,[4] Ford’s concern for his workers and customers likewise may have harmed the other shareholders, but again the business judgment rule shielded him from liability in connection with the plant expansion decision. Just so, the business judgment rule would shield our hypothetical XYZ board’s decision from judicial review. In theory, of course, absent a nonshareholder constituency statute, a shareholder might be able to rebut the business judgment rule’s presumption of good faith and hold directors liable for considering nonshareholder interests. In practice, however, cases in which the business judgment rule does not shield operational decisions from judicial review are so rare as to amount to little more than aberrations. In sum, the probability of holding directors liable for operational decisions was so low before the nonshareholder constituency statutes came along that the statutes could not further lower it.
Accordingly, despite the considerable hand-wringing the statutes have generated among some commentators, the nonshareholder constituency statutes’ effect on review of operational decisions actually is quite limited. Granted, the statutes modify the common law’s rhetorical command to maximize shareholder wealth. Because the business judgment rule will continue to shield operational decisions from review, however, just as it did at common law, one might argue that the statutes do no more than to bring the law’s rhetoric into line with its reality.
Having said that, however, one might argue that the statutes do nothing as a practical matter. First, given Delaware's unchallenged position as the preeminent corporate law jurisdiction, Delaware's failure to adopt such a statute leaves the nonshareholder constituency statutes on the fringes of the law at least insofar as public corporations are concerned. So too does the lack of any meaningful case law applying and interpreting the statutes.
(Mohsen Manesh notes that "Delaware is only one state." Which, in context, is sort of like saying Delaware is only one 800-pound gorilla.)
Second, the statutes plausibly can be regarded as special interest legislation designed to protect corporate managers from hostile takeovers. Courts therefore may treat them as being limited to the hostile takeover context, even though most statutes on their face apply to all corporate decisions. In fact, this may partly explain the continuing dearth of cases applying the statutes. If so, the shareholder wealth maximization norm may survive even in states with nonshareholder constituency statutes.
[1] Although most statutes are silent on this point, the New York and Pennsylvania statutes explicitly state that they create no duties towards any party. N.Y. Bus. Corp. Law § 717(b); 15 Pa. Cons. Stat. § 1717. Some commentators assert that the nonshareholder constituency statutes are, or should be, enforceable by stakeholders; alternatively, some posit that the nonshareholder constituency statutes create, or may lead to the creation of, management fiduciary duties to the stakeholders. See, e.g., Morey W. McDaniel, Bondholders and Stockholders, 13 J. Corp. L. 205, 265-313 (1988); William R. Newlin & Jay A. Gilmer, The Pennsylvania Shareholder Protection Act: A New State Approach to Deflecting Corporate Takeover Bids, 40 Bus. Law. 111, 114 (1984); see generally Marleen A. O’Connor, Introduction to the Symposium on Corporate Malaise—Stakeholder Statutes: Cause or Cure?, 21 Stetson L. Rev. 3 (1991). Whatever the policy merits of creating fiduciary duties running from the directors to the stakeholders, it is difficult to find such a duty in the statutory language. Even a leading proponent of creating fiduciary duties running to stakeholders has recognized this point: “Because these statutes do not mandate that directors consider nonshareholder constituents, these [stakeholder] groups probably do not have standing to enforce these statutes.” Marleen A. O’Connor, Restructuring the Corporation’s Nexus of Contracts: Recognizing a Fiduciary Duty to Protect Displaced Workers, 66 N.C. L. Rev. 1189, 1233-34 (1991). Given that the extrinsic information about legislative intent suggests that the legislatures saw the statutes as making only minor changes in the law, the legislative history likewise provides no basis for reading such a duty into the current statutes. See Stephen M. Bainbridge, Interpreting Nonshareholder Constituency Statutes, 19 Pepperdine L. Rev. 971, 992-93 (1992). Finally, it is important to note that at common law the board of directors has no duty to consider nonshareholder interests. See, e.g., Local 1330, United Steel Workers v. U.S. Steel Corp., 631 F.2d 1264, 1280-82 (6th Cir.1980). Accordingly, judicial creation of such a duty should require a clearer legislative statement. Put another way, proposals for stakeholder standing seem more appropriately addressed to legislatures than to courts interpreting the existing statutes.
[2] See, e.g., Keyser v. Commonwealth Nat’l Fin. Corp., 675 F. Supp. 238, 265-66 (M.D. Pa.1987); Baron v. Strawbridge & Clothier, 646 F. Supp. 690, 697 (E.D. Pa.1986).
[3] 237 N.E.2d 776 (Ill. App. 1968).
[4] 170 N.W. 668 (Mich. 1919).
