I’m running a conference today, which is why I haven’t been blogging. As part of the conference, I commented on four very interesting papers by Einer Elhauge, Larry Ribstein, Lynn Stout, and Cindy Williams. I commend the papers to you, and offer up the comments I gave on them:
Back in 2001 Henry Hansmann and Reinier Kraakman published a well-known essay The End of History for Corporate Law, in which they argued that global corporate governance rules are converging towards “the ‘standard shareholder-oriented model’ of the corporate form.” The title of their article, of course, was a riff on Francis Fukuyama’s book The End of History.
As we’ve all learned, Fukuyama was wrong. History has definitely not ended.
I think these four papers demonstrate that Hansmann and Kraakman also erred. All four to some extent call into question what Hansmann and Kraakman called the “standard shareholder-oriented model” and I call shareholder primacy.
These four papers thus each go to the core goals we set for this conference.
As our call for papers put it, most of us here at UCLA believe that shareholder primacy operates in a two dimensional space. Along one axis are the means of corporate governance: i.e., who is in charge? Lynn Stout’s presentation forcefully makes the case for what she and I have taken to calling “director primacy”: i.e., the idea that the corporation is a vehicle by which directors hire factors of production and the corollary proposition that shareholders have only the very limited set of control of rights for which they have bargained. (You know, Lynn, if we could just get together on the ends issue, we would have the makings of a distinctive UCLA School of Thought.) I should acknowledge that my thinking on this subject owes much to the work of Mike Dooley, especially his article Two Models of Corporate Governance, but he should not be blamed for the misuses to which I’ve put it. In any case, at the other end of the spectrum on this axis lie folks like Lucian Bebchuk, who equally forcefully argue for reuniting ownership and at least ultimate control in the hands of shareholders.
The other axis along which the shareholder primacy debate plays out relates to the ends of corporate governance. What is the decisionmaking norm that guides corporate governance? At one end of that axis lie folks like myself who believe that Dodge v. Ford Motor Co. meant what it said; namely, that the end of corporate governance is shareholder wealth and that the discretion of directors must be exercised towards that end. Larry clearly is with me on this. In contrast, Einer, Lynn, and Cindy have all staked out positions towards the stakeholderism end of the spectrum. Each seeks to temper the Friedmanesque notion that the corporation’s social responsibility is to maximize its profits.
Let me now say just a few words about the individual papers. Cindy Williams mounts a provocative challenge to Hansmann and Kraakman’s claim that the world is converging on shareholder primacy. I don’t think any of us can quibble with Cindy’s positive account. As last week’s Economist magazine observed:
Companies at every opportunity now pay elaborate obeisance to the principles of corporate social responsibility. They have CSR officers, CSR consultants, CSR departments, and CSR initiatives coming out of their ears.
Of course, the Economist isn’t convinced that that’s a good thing; and neither am I. Since Cindy’s paper assumes the normative desirability of CSR, however, let me turn to Einer, whose paper expressly sets out to make the case for CSR.
I’m afraid I must disagree with Einer’s account of the relevant legal rules. Yes, the business judgment rule gives directors a lot of discretion, including the kind of non-profit-maximizing discretion we see in that old chestnut Shlensky v. Wrigley. As I explained in my Northwestern article on director primacy, however, the case law, properly understood, does not stand for the proposition that directors have discretion to make trade-offs between nonshareholder and shareholder interests. Instead, the cases stand for the proposition that courts will abstain from reviewing the exercise of directorial discretion even when the complainant alleges that directors took nonshareholder interests into account in making their decision.
As Mike Dooley argued over a decade ago, the business judgment rule ensures judicial deference to the board’s authority as the corporation’s central and final decisionmaker. Put another way, the business judgment rule is the doctrinal mechanism by which courts on a case-by-case basis resolve the competing values of authority and accountability.
The discretion to pursue non-profit-maximizing behavior of which Einer makes so much is thus a byproduct rather than an intended consequence of the law and policy. (It is a question here of means versus ends.) I’ll refer you here to my recent article in Vanderbilt on the business judgment rule for my usual verbose working out of the argument.
As for the fact that none of the 50 states has a statute mandating wealth maximization, this is not very probative. In general, the fiduciary duties of directors have been worked out in the case law rather than by statute.
Yes, states have charitable contribution statutes. But their adoption was driven mostly by the historical anachronism of the old ultra vires rule. And, in any case, given the feeble level of corporate philanthropy, these statutes cannot be read as having given executives wide license to pursue non-profit-maximizing conduct.
Finally, as for the nonshareholder constituency statutes, Einer’s paper nicely summarizes my view of them – special interest legislation designed to insulate managers from takeovers. And here’s a key fact. In my corporate governance seminar last semester, I had a very pro-CSR student do a paper on these statutes. He could not find a single case in which these statutes were dispositive; indeed, he could only find a couple in which they were even mentioned. They are at the margins of corporate law.
Attention also should be paid to how executives describe their function. What do executives think the law requires of them? A 1995 National Association of Corporate Directors (NACD) report stated: “The primary objective of the corporation is to conduct business activities with a view to enhancing corporate profit and shareholder gain,” albeit with some mushy qualifying language. A 1996 NACD report on director professionalism set out the same objective, without any qualifying language on nonshareholder constituencies. The 2000 edition of Korn/Ferry International’s well-known director survey found that when making corporate decisions directors consider shareholder interests most frequently, although it also found that a substantial number of directors feel a responsibility towards stakeholders. In contrast, a 1999 Conference Board survey found that directors of U.S. corporations generally define their role as running the company for the benefit of its shareholders.
As for Einer’s normative argument, this is an issue for which more than a few trees have given their lives. I will not detain you with a lengthy rehash. Instead, let me offer a cautionary anecdote. Cindy is right that many institutional investors are getting on the CSR bandwagon. One of them is CalPERS. Back during the Southern California grocery strike a year or so ago, CalPERS made a very bid deal about Safeway’s allegedly socially irresponsible behavior. As it happens, Sean Harrigan, then head of CalPERS board was also the president of the main union representing Safeway employees. The take home lesson? CSR advocates often have an agenda inconsistent with the interests of shareholders. Indeed, as the Economist observed last week, they often have an agenda inconsistent with capitalism itself. Managers with the sort of discretion with which Einer wishes to vest them are rendered all too vulnerable to that agenda.
This brings me to Larry’s paper. For a number of years now, Larry has been pushing the question: Why Corporations? In his paper for our conference, Larry rebuts Einer’s normative argument by claiming that markets effectively constrain anti-social corporate conduct. Accordingly, he argues, the real issue is the principal-agent problem: managers have too much slack and we should deprive them of that discretion by moving to partnership-like governance.
Hence, he makes the provocative proposal that we could retain the decisionmaking efficiencies of centralized management while adapting certain features of partnership law that would dry up management’s control over free cash flow.
Count me a skeptic; mostly for prudential reasons – the devil you know and all that. The director primacy-based system of
Despite the alleged flaws in its governance system, the U.S. economy has performed very well, both on an absolute basis and particularly relative to other countries. U.S. productivity gains in the past decade have been exceptional, and the U.S. stock market has consistently outperformed other world indices over the last two decades, including the period since the scandals broke. In other words, the broad evidence is not consistent with a failed U.S. system. If anything, it suggests a system that is well above average.
And so I ask: Why mess with success?
Update: Tom Smith of the Right Coast blog (his day job is corporate law professor at University of San Diego) weighs in with comments on my conference last week:
Well, I spent Friday and Saturday morning at Steve Bainbridge's conference up in LA on the Means and Ends of the Corporation, sponsored by the Sloan Foundation (a billion and a half dollars, started by the first CEO of GM, looking for ways to advance our understanding of business). It was actually a pretty good conference, and this comes from someone who usually regrets going to any given conference. There were a number of papers that were that rare thing in a piece of legal scholarship, interesting. Einer Euhlange of Harvard started off with a very closely argued paper that, for all of its logical rigor, managed to avoid addressing what I thought were some pretty obvious objections. He wanted to explain why it was good corporate directors should have lots of discretion, as this would allow them to do good things. But what to do if shareholders didn't concur on what was good, he did not really address. I was grateful for the paper, though, as it gave me something to attack in my five minutes in front of the class. Henry Manne nodded and smiled approvingly at my complaints, so I least I knew I was appealling to the law and econ crustaceans in the crowd, of whom I suppose I count as one. Ed Rock of Penn had a very interesting paper applying the "discursive dilemma" to corporations. Without getting into it, this is a way that promises to revive somewhat the wrongly discredited idea of corporate personality. Two economists from Harvard gave more or less incomprehensible presentations, but one of them, by Oliver Hart, a very distinguished theorist of the firm, seemed very promising, even if I didn't really follow a lot of it. He had a simple model that purported to explain why parties sometimes agree to some terms (such as price) and then go on to negotiate the rest of the deal later, still holding the fixed term as fixed. Of course, we do that all the time in contracts, and it is a bit hard to understand theoretically. So that may be a paper worth struggling through at some point. Bill Bratton gave a very interesting historical paper on the evolution of corporate law reforms, using some evolutionary game theory as part of its story. I like evolutionary game theory, and the paper had the ring of truth about it. Stephen Presser made the point in his paper, which I think is a profound truth about corporate law, but I didn't know anybody else thought so, that it has a strong republican strain, having the object of democratizing ownership (and I would say control, too) of business enterprizes across this land of ours.
You can download all the papers here.
Update: Law professors and bloggers Larry Ribstein and Gordon Smith have posted some thoughts on the corporate governance conference I ran on Friday and Saturday. Both offer substantive analysis of some of the issues that came up during the sessions. My thanks to both for their thoughts and participation. The papers presented at the conference were all provocative and insightful; you can download them here.
