As noted in a prior post, Senator Elizabeth Warren has introduced a bill that would require "corporate directors to consider the interests of all major corporate stakeholders—not only shareholders—in company decisions. Unlike state non shareholder constituency statutes, which are merely permissive, her bill would mandate such consideration.
As Stefan Padfield has noted:
There should be no doubt that imposing mandatory consideration of stakeholders on directors in carrying out their oversight responsibilities carries meaningful risk of undermining the wealth creation and innovation benefits of the corporate form as currently constituted.This general criticism has been well vetted elsewhere, and I will not rehash the debate here, though my declining to do so should not be construed as my being dismissive of relevant concerns regarding statism.
Stefan J. Padfield, Corporate Social Responsibility & Concession Theory, 6 Wm. & Mary Bus. L. Rev. 1, 32–33 (2015).
Because shareholder wealth maximization is the right rule, as we discussed in the preceding post, mandating that directors consider non-shareholder interests in making corporate decisions is clearly wrong in and of itself.
There is a broader problem here, however, which is that federal corporate governance rules--such as the quack rules established in SOX and Dodd-Frank (yes, Matt, I stand by the term quack--are almost always mandatory rather than permissive.
In contrast, many rules of state corporate law are enabling rather than mandatory. This is efficient because default rules are preferable to mandatory rules in most settings.[1] So long as the default rule is properly chosen, of course, most parties will be spared the need to reach a private agreement on the issue in question. Default rules in this sense provide cost savings comparable to those provided by standard form contracts, because both can be accepted without the need for costly negotiation. At the same time, however, because the default rule can be modified by contrary agreement, idiosyncratic parties wishing a different rule can be accommodated. Given these advantages, a fairly compelling case ought to be required before we impose a mandatory rule.[2] Mandatory rules are justifiable only if a default rule would demonstrably create significant negative externalities or, perhaps, if one of the contracting parties is demonstrably unable to protect itself through bargaining.
The use of mandatory rules at the federal level is particularly deplorable. If a state adopts an inefficient mandatory rule (see, e.g., much of California corporate law) corporations can respond by reincorporating in a state whose law is more enabling. Obviously, however, few corporations will seriously consider shifting their corporate headquarters to another country to avoid inefficient federal corporate laws. (Having said that, of course, many companies might go private (a.k.a. go dark) in response, as many did in response to SOX and Dodd-Frank.)
Unlike Delaware corporate law, which is typically updated annually to correct errors and improve the law, the federal government rarely revisits mistakes like SOX and Dodd-Frank. So we get stuck with bad federal rules.
All in all, it's yet another aspect of the bill that makes no sense.
[1]Probably the best introduction to this debate is Symposium, Contractual Freedom in Corporate Law, 89 Colum. L. Rev. 1395 (1989). See also Robert B. Thompson, The Law's Limits on Contracts in a Corporation, 15 J. Corp. L. 377 (1990). In conjunction with the mid-1990s revisions to the Uniform Partnership Act, there was also a considerable blossoming of contractarian and anti-contractarian scholarship dealing with the central question of the extent to which freedom of contract trumped fiduciary obligation. See, e.g., J. Dennis Hynes, Fiduciary Duties and UPA (1997): An Inquiry Into Freedom of Contract, 58 Law & Contemp. Probs. 29 (1995); Larry Ribstein, Fiduciary Duty Contracts in Unincorporated Firms, 54 Wash. & Lee L. Rev. 537 (1997); Allan W. Vestal, Advancing the Search for a Compromise: A Response to Professor Hynes, 58 Law & Contemp. Probs. 55 (1995); Allan W. Vestal, The Disclosure Obligations of Partners inter se under the Revised Uniform Partnership Act of 1994: Is the Contractarian Revolution Failing?, 36 Wm. & Mary L. Rev. 1559 (1995); Allan W. Vestal, Fundamental Contractarian Error in the Revised Uniform Partnership Act of 1992, 73 B.U. L. Rev. 523 (1993); see also Larry Ribstein, Unlimited Contracting in the Delaware Limited Partnership and its Implications for Corporate Law, 16 J. Corp. L. 299 (1991).
[2]Cf. In re Pace Photographers, Ltd., 525 N.E.2d 713, 718 (N.Y. 1988) (“Participants in business ventures are free to express their understandings in written agreements, and such consensual arrangements are generally favored and upheld by the courts.”).
