My remarks at the AALS panel:
We are convened to discuss “Rising Tensions Among Corporate Stakeholders.” Really?
The call that brings us together informs us that “Tensions among corporate stakeholders are rising. Managers and shareholders continue to battle for primacy as power tilts toward shareholders with the ongoing rise of institutional investors. … Amazon's dust-up in New York City shows the influence of communities and the resurgence of popular movements. Exxon's recent experience over climate change illustrates the power of environmental concerns even for investors in traditional energy companies” Really?
I see something very different happening. The corporate social responsibility debate continues, but some key players have switched sides.
Investors—including the big three of Blackrock, Vanguard, and State Street—increasingly at least purport to care about ESG issues.
And this fall, The Business Roundtable—a center of corporate C-suite elitism—purportedly switched sides, as well.
What’s going on?
As we all know, a couple of months ago, the BRT released a statement on the purpose of the corporation in which it made a major break from its longstanding position. Starting in 1997, the BRT had issued a series of statements positing that corporations exist principally to serve their shareholders. In its recent statement, however, the BRT announced that going forward its members would recognize that “we share a fundamental commitment to all of our stakeholders.” The 181 signing CEOs committed themselves to leading “their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders.”
The BRT statement was met with enthusiastic praise in some quarters, condemnation in others, and skepticism in still others. Much of the commentary, however, failed to correctly assess either the effect of the statement or the reasons the BRT felt moved to issue it.
In most cases, the BRT statement likely will prove no more than an irrelevant and innocuous platitude, which may make some people feel a bit better about the role big corporations play in our lives, but which will not affect corporate decision making. Most business decisions, after all, do not directly oppose the interests of stakeholders and shareholders. To the contrary, most business decisions are potentially win-win scenarios. The proverbial rising tide usually does lift all boats.
This is true even of decisions that in the short-run seem to favor stakeholders at the expense of shareholders. Providing health benefits for employees may increase expenses and reduce profits in the short term, for example, but often leads to greater productivity in the long term. Focusing on environmental sustainability can be a useful means of engaging with customers and thereby building brand reputation. Indeed, companies such as Walmart and Coca-Cola have used sustainability in their messaging with success.
Occasionally, however, a business faces a true zero-sum decision. It cannot make both stakeholders and shareholders better off either in the short- or in the long-run. In such a case, would we really expect the signers of the BRT statement to put stakeholders interests ahead of shareholders?
Obviously, the BRT has no power to change the law and the law remains clearly contrary to the BRT’s new commitments. One hundred years ago, in Dodge v. Ford Motors, the Michigan Supreme Court held that: “A business corporation is organized and carried on primarily for the profit of the stockholders.”[1] Much more recently, in eBay v. Newmark, the Delaware Chancery Court likewise held that directors of a company incorporated in Delaware—as are most BRT companies—are obliged to “promote the value of the corporation for the benefit of its stockholders.”[2] The court therefore held that “a business strategy that openly eschews stockholder wealth maximization” was inconsistent with the directors’ fiduciary duties to the company’s shareholders.
In a 2015 Wake Forest Law Review article, former Chief Justice of the Delaware Supreme Court Leo Strine—arguably the leading corporate law jurist of our era—took what he called a “clear-eyed look at the law of corporations in Delaware,” on the basis of which he concluded “that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare.”
He therefore rejected arguments by various academics that Delaware law allowed executives and directors to make tradeoffs between shareholder and stakeholder interests, stating that “Dodge v. Ford and eBay are hornbook law.” Anyone who argues to the contrary, he said, was pretending. Let’s pause to savor that word: “pretending.”
To be sure, the business judgment rule usually insulates directors from liability for decisions that depart from a short-term focus on maximizing shareholder wealth. But the prudential judgment that courts generally should defer to board of director business decisions does not change the legal obligation of the board and in appropriate cases officers and directors can be held liable for putting stakeholder interests ahead of those of shareholders.
Whether the BRT likes it or not, its statement doesn’t change that rule.
Just as the BRT statement does not change the signers’ legal duties, it does not change the governance structures that constrain their freedom to act as they see fit.
CEOs are appointed by the board of directors. Boards of directors are elected by the shareholders. Until recent decades, of course, none of that mattered very much. Boards of directors passively rubberstamped the wishes of imperial CEOs. As a result, the predecessors of the CEOs who signed the BRT statement had broad discretion to make decisions that put the interests of stakeholders ahead of those of shareholders.
That world no longer exists. In response to new obligations imposed by state and federal laws, boards of directors have become more independent and less willing to acquiesce in a CEO’s wishes. At the same time, share ownership has shifted from individual retail investors to institutions. Some of those institutions—especially activist hedge funds and some pension funds—have made corporate governance activism a central part of their business model. Such investors are constantly on the lookout for managers who are failing to maximize shareholder value and are willing to pressure their boards for change.
Granted, governance activism by shareholders is somewhat offset by social justice activism by ESG-oriented investors. Even so, managers and boards that put stakeholder interests ahead of (or even on a par with) shareholder interests are likely to face proxy contests and other forms of activism from activist hedge funds and their allies. Managers and directors who too often shortchange shareholder value in the name of social responsibility may well find themselves on the losing end of such contests.
Given that nether the legal rules nor the governance environment in which the BRT’s members must operate were changed by the new statement, what purpose was served by issuing the statement? What are the signers up to?
- Some of the signatories are themselves social justice warriors. Oligarchs like Salesforce.com CEO Marc Benioff, for example, promote “social activism among American chief executives.”
- The BRT leaders are responding to perceived consumer and labor demand.In particular, millennials apparently prefer to work for and purchase from companies that are perceived as socially and environmentally responsible. Accordingly, there is an increasingly widely held view in the business community that to attract Millennial and Generation Z workers and customers, companies must project an image as social justice activists. Nike’s embrace of Colin Kaepernick is but the most obvious example of this phenomenon, but even such heartland companies as Walmart are embracing socially progressive stances, despite the risk of alienating their Red State customer base.
- The BRT may be trying to head off regulation by progressive politicians. As Wall Street Journal columnist David Benoit has observed, “Democratic presidential candidate Elizabeth Warren has argued that the primacy of shareholder returns has worsened economic inequality, enriching wealthy investors at the expense of workers.” With the mainstream of the Democratic Party seemingly moving in Warren’s direction on business and finance issues, the BRT’s members may have hoped that a voluntary—and perhaps intentionally ambiguous—embrace of corporate social responsibility platitudes would help them fend off more intrusive regulation in the event of a Democratic presidential victory in 2020.
- 4. The BRT may be responding to pressure from a few very powerful investors, especially the big three institutional investors. Institutional investors long have offered funds that focus on corporations perceived as socially responsible, which generally has been understood to mean companies pursuing progressive goals. As I noted at the outset, however, a growing number of major institutional investors, however, have embraced social activism in support of progressive goals with respect to all of the funds they manage. But this simply pushes the question further up the corporate finance food chain, since it fails to explain why investment fund managers like Fink are pursuing that agenda.
- Some BRT members may crave a return to the days of imperial CEOS. This is the flip side of #3. Aside from a brief period in the 1980s, when the hostile takeover was viable, CEOs were virtual emperors for most of the last 100+ years. Over the last decade or two, however, shareholder activists have grown in number and power. Unlike the gadflies of old, the new activists—mainly hedge funds—have been all about shareholder return. We have seen repeated cases where hedge fund activism has forced out CEOs (and entire boards), resulted in massive changes in corporate strategy, and even led to companies being broken up.
By embracing stakeholderism, the BRT leaders may hope to restore a measure of freedom.
Indeed, to my mind this is the basic problem with CSR. Suppose Acme's board of directors is considering closing an obsolete plant. The board is advised that closing the plant will cost many long-time workers their job and be devastating for the local community. On the other hand, the board's advisors confirm that closing the existing plant will benefit Acme's shareholders, new employees hired to work at a more modern plant to which the work previously performed at the old plant will be transferred, and the local communities around the modern plant. Assume that the latter groups cannot gain except at the former groups' expense. By what standard should the board make the decision?
Shareholder wealth maximization provides a clear answer: close the plant. Once the directors are allowed to deviate from shareholder wealth maximization, however, they must inevitably turn to indeterminate balancing standards. Such standards deprive directors of the critical ability to determine ex ante whether their behavior comports with the law's demands, raising the transaction costs of corporate governance.
Worse yet, absent the clear standard provided by the shareholder wealth maximization norm, managers and directors will be tempted to allow their personal self-interest to dominate their decision making. If the CEO’s interests favor keeping the plant open, the plant likely will stay open, with the decision being justified by reference to the impact of a closing on the plant's workers and the local community. In contrast, if the CEO’s interests are served by closing the plant, the plant will likely close, with the decision being justified by concern for the firm's shareholders, creditors, and other benefited constituencies.
Some BRT leaders probably would be quite content to see that kind of freedom restored to the C-suite.
In sum, the BRT statement changes nothing. Neither the law nor the governance system in which the BRT’s members must function has changed. Shareholder wealth maximization remains the law. And anyone who says otherwise is, to again quote Leo Strine, pretending.
