The Chancery Daily recently noted shareholder activist's James McRitchie lawsuit against Meta (f.k.a. Facebook):
Meta is the largest social media network company in the world, with 3.5 billion users -- 43% of humanity. Its business decisions inevitably create financial impact well beyond its own cash flows and enterprise value and have significant impacts on the global economy. While defendants have a duty to operate the Company as a business for the financial benefit of its stockholders, those stockholders are often diversified investors with portfolio interests beyond Meta's own financial success. If the decisions that maximize the Company's long-term cash flows also imperil the rule of law or public health, the portfolios of its diversified stockholders are likely to be financially harmed by those decisions. As fiduciaries at a corporation with a business model that depends upon maintenance of a powerful global network, the directors and officers of the Company cannot willfully blind themselves to this reality: where there is great power there is great responsibility.
For a corporation whose impact is so widespread, the well-established doctrine of stockholder primacy cannot be rationally applied on behalf of investors without recognizing the impact of portfolio theory, which inextricably links common stock ownership to broad portfolio diversification. The economic benefits from -- indeed the viability of -- a system of corporate law rooted in maximizing financial value for stockholders would vanish if it forced directors to make decisions that increased corporate value but depressed portfolio values for most of its stockholders. But this is precisely how the Company has operated: Defendants have ignored the interests of all of its diversified stockholders, making decisions as if the costs that Meta imposes on such portfolios were not meaningful to stockholders.
This is hardly a new argument. back in the heyday of hostile takeovers, Easterbrook and Fischel argued that:
If the portfolios are sufficiently diversified, these investors will be on both sides of tender offer auctions, holding positions in bidding corporations and target corporations alike. They cannot gain from the higher premium paid to the targets' shareholders because they lose as investors in bidders what they gain as investors in targets. And they lose more to boot. First, the costs of running the auctions are a dead weight loss to them and to society. Second, they lose because the increased costs of bidding lead to fewer offers and thus, as a result of decreased monitoring and higher agency costs, to lower prices for all firms that are neither targets nor bidders.
Investors holding diversified portfolios therefore would not ‘balance’ the size of premia against the frequency of offers. They view premia as transfers from one of their pockets to another, and they care solely about the effects of auctions on monitoring.
Frank H. Easterbrook, Auctions and Sunk Costs in Tender Offers, 35 Stan. L. Rev. 1, 8 (1982). Despite the fact that diversified investors would prefer to maximize the number of takeovers rather than the premium paid in any specific deal, Delaware law makes clear that in Revlon-land directors of a target company have a duty to maximize the size of the premium. They may not consider the global effect of their efforts to do so. See Bernard Black & Reiner Kraakman, Delaware's Takeover Law: The Uncertain Search for Hidden Value, 96 Nw. U. L. Rev. 521, 533 (2002) (observing that Delaware case law prioritizes “the interests of undiversified investors [over] those of diversified investors”); Franklin Gevurtz, Removing Revlon, 70 Wash. & Lee L. Rev. 1485, 1551 (2013) (“Accepting this sort of portfolio based approach to determining shareholder interest would radically rewrite corporate law in ways reaching far beyond Revlon.”).
More generally, Easterbrook and Fischel argued in The Economic Structure of Corporate Law that a diversified shareholder has "an investment in the economy as a whole and therefore wants whatever social or private governance rules maximize the value of all firms put together" and is "not interested in maximizing one firm's value if that comes out of the hide of some other corporation.” In contrast, however, Richard Booth argued that "Management duty should be thought of as owed to an undiversified stockholder and thus owed to the corporation." Richard A. Booth, Stockholders, Stakeholders, and Bagholders (or How Investor Diversification Affects Fiduciary Duty), 53 Bus. Law. 429, 434–35 (1998).
Booth in his article also offers the interesting and counter-intuitive claim in support of the use of the fictional undiversified shareholder concept that even diversified investors would prefer directors to act as though they owed their fiduciary duties solely to undiversified shareholders. He rests this claim primarily upon the argument that the widespread use of stock option compensation for senior corporate management, which in most instances places those managers in the position of relatively undiversified corporate shareholders because of the large size of those stock option positions relative to the managers' overall wealth, evidences a desire on the part of the diversified shareholders that the managers behave in accordance with the interests of undiversified shareholders.
Gregory Scott Crespi, Maximizing the Wealth of Fictional Shareholders: Which Fiction Should Directors Embrace?, 32 J. Corp. L. 381, 411 (2007) (disagreeing with Booth's argument).
I disagree with both points of view. On the one hand, as I have long argued:
In addition to being doctrinally questionable, the notion that directors owe duties to the corporate entity is inconsistent with the dominant contractarian theory of the firm.91 The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.
In other words, the corporation is not a thing to which duties can be owed, except as a useful legal fiction.
Stephen M. Bainbridge, Much Ado About Little? Directors' Fiduciary Duties in the Vicinity of Insolvency, 1 J. Bus. & Tech. L. 335, 352–53 (2007).
On the other hand, I am dubious about whether managers have the training or expertise to manage a company in the interests of diversified investors at large. Suppose managers have come up with an idea for a new product. Do we really think they can--or should--evaluate whether selling the new product would injure competitors and thus be adverse to the interests of diversified investors?
Another way of looking at the problem is to note that corporate law is not concerned with the merits of board decisions. Instead, it is concerned with minimizing agency costs. Diversified investors have diversified away the risk of management mistakes and errors of judgment; hence, the business judgment rule. But they cannot diversify away the risk of self-dealing, which the business judgment rule does nt protect. Hence, corporate law focuses on the individual corporation rather than the universe of public corporations.
