ProfessorBainbridge.com

Alex Edmans on following the science with respect to 10 ESG propositions

@aedmans on following the science on 10 propositions about #ESG https://t.co/LYV8sMEnV1 pic.twitter.com/7b8M6KCQm7

— Steve Bainbridge (@PrawfBainbridge) March 31, 2023

Martin Lipton advocates extending Caremark liability to ESG issues, which I think is a serious mistake

Lipton writes:

... the complex stakeholder issues that companies face today are integral to corporate sustainability, responsible risk management and value creation; indeed, addressing these risks is consistent with directors’ fiduciary duty of care and the board’s legal obligation under Caremark to implement and monitor systems to identify material risks and to address risks once identified.

Personally, I think that is a serious misstatement of the law and a fundamentally misguided policy recommendation. See my article Don’t Compound the Caremark Mistake by Extending It to ESG Oversight, 77 The Business Lawyer 651 (2022). The published version is behind the ABA's paywall, but a working draft is available at SSRN. There's also a summary at the CLS Blue Sky blog, from which the following excerpt is taken:

First, Caremark was wrong from the outset. Caremark’s unique procedural posture, which precluded any appeal, gave Chancellor Allen an opportunity to write “an opinion filled almost entirely with dicta” that “drastically expanded directors’ oversight liability.”[8] In doing so, Allen misinterpreted binding Delaware Supreme Court precedent and ignored the important policy justifications underlying that precedent.

Second, Caremark was further mangled by subsequent decisions. The underlying fiduciary duty was changed from care to loyalty, with multiple adverse effects. In recent years, moreover, there has been a steady expansion of Caremark liability. Even though the risk of actual liability probably remains low,[9]there is substantial risk that changing perceptions of that risk induces directors to take excessive precautions.[10]

Finally, applying Caremark to ESG issues will undermine Delaware’s clear law of corporate purpose by extending director oversight duties to areas of social responsibility unrelated to corporate profit. Caremark can be justified as ensuring that a corporation complies with applicable laws, but ESG compliance remains voluntary. Advocates of extending Caremark to encompass ESG compliance thus likely hope doing so will push companies to adopt what they regard as socially responsible policies but which they have not been able to mandate through the political process.[11] Asking corporate executives to take on governmental functions not only asks them to undertake tasks for which they are untrained and for which their enterprise is unsuited, it also subverts the basis of a liberal democracy. Government efforts to solve social problems are inherently limited by the checks and balances baked into the American political system. Mandated board attention to ESG risks would erode those checks and balances by asking unelected executives to undertake solving social ills.

Should ESG skeptics make an exception for corporate patriotism?

Michael Peregrine suggests that corporations serve stakeholders by providing "a public, and practical, reminder of the civil rights and liberties guaranteed to American citizens." 

Peregrine's proposal raises the question of whether skeptics of corporate social responsibility should make an exception for corporate patriotism. Tentative view: No. Government should decide if there are national security implications to a business and, if so, regulate it.

Query whether those of us who are skeptical of #ESG and woke corporate political speech ought to make an narrow exception for this sort of civic education about freedom. Tentative view: No. But it's a project for the future.

David Yosifon devotes a chapter to corporate patriotism in Corporate Friction: How Corporate Law Impedes American Progress and What to Do about It.

Foundation announces the second edition of Bainbridge & Anabtawi's Mergers & Acquisitions casebook

Here is the book's homepage.

Delaware Vice Chancellor Laster cites my new book, The Profit Motive, in recent opinion

From In re Riviera Resources Inc.: 

Interviewed re The Profit Motive

An interview with the UCLAW news department about my new book The Profit Motive.

Pondering the analogies between Citigroup and SVB for Caremark liability purposes

1/ Possible shareholder litigation against #SVB: Securities fraud claims against the bank: Probably Rule 10b-5 and 14a-9. Securities fraud claims against officers and directors: Ditto. Fiduciary duty claims against bank board.

— Steve Bainbridge (@PrawfBainbridge) March 14, 2023

3/ Assuming #SVBBBank board approved decision to invest in long-term Treasuries, bad--even dumb--decisions do not give rise to liability. The board would be protected by the business judgment rule. See Kamin v. American Express pic.twitter.com/A1E4DPY97k

— Steve Bainbridge (@PrawfBainbridge) March 14, 2023

5/ Plaintiffs claimed Citigroup's board had failed to exercise adequate oversight of the bank's risk management. Which I assume would be the claim in #SVBank's case. The Citigroup plaintiffs lost. pic.twitter.com/OcxRNXaXBp

— Steve Bainbridge (@PrawfBainbridge) March 14, 2023

7/ The question is whether Caremark has evolved enough so that the Delaware courts would no longer follow the Citigroup decision. One hopes not.

— Steve Bainbridge (@PrawfBainbridge) March 14, 2023

Samuel Gregg reviews my book, The Profit Motive, for Law & Liberty, and says I drove a stake through the heart of stakeholder capitalism

Dr Gregg calls his review "A Stake Through the Heart of Stakeholder Capitalism":

In his new book, The Profit Motive: Defending Shareholder Value Maximization, Stephen M. Bainbridge has systematized his many criticisms of the BRT’s 2019 statement and used it as one of his “principal foils” for a systematic takedown of the very idea of stakeholder capitalism. This is accompanied by a rigorous defense of shareholder primacy on Bainbridge’s part. He not only shows that maximizing shareholder value is “descriptively accurate” of the corporation’s purpose. He also claims that it can be “normatively appealing.” Bainbridge thus seeks to steal the ethical thunder that stakeholder theorists generally assume to be their ace-in-the-hole. ...

Bainbridge’s general approach is reminiscent of the classic scholastic method: he states a clear proposition, the best case for views contrary to his own, critiques their arguments, answers objections, and then explains why his own position meets the tests of reason. ...

Thus, having put a stake through the heart of stakeholder capitalism, Bainbridge provides a powerful moral rationale for shareholder primacy—one far more robust than those which underpin stakeholder theory.

I am, of course, delighted. Please go read the whole thing.

I asked ChatGPT to write a review of my book The Profit Motive

Here's the result:

Stephen Bainbridge's book The Profit Motive is an insightful and thought-provoking exploration of the role of profit in modern business and society. The book is divided into two parts, with the first half providing a historical and philosophical overview of the profit motive, and the second half examining its practical implications for business leaders and policymakers.

One of the key themes of the book is the importance of understanding the profit motive in its broader context, beyond simply making money. Bainbridge argues that profit is not just a financial metric, but also a measure of a business's ability to create value for society as a whole. He highlights the importance of entrepreneurship, innovation, and risk-taking in driving economic growth and improving people's lives.

Bainbridge also examines the various criticisms that have been leveled against the profit motive, including concerns about income inequality, environmental degradation, and corporate social responsibility. While acknowledging these concerns, he argues that they can be addressed through a combination of market forces and regulatory interventions, rather than by abandoning the profit motive altogether.

Overall, The Profit Motive is a well-written and engaging book that offers a nuanced and balanced perspective on a topic that is often oversimplified or misunderstood. Whether you are a business leader, policymaker, or simply someone interested in the role of profit in society, this book is definitely worth reading.

Obviously, the review’s positive tone pleased me to no end. But then I thought about how students could use this technology to produce surprisingly polished analyses in essay exams and research papers.

One word came to mind: Yikes.

Here's a screen grab as proof:

And here's your chance to buy the book:

Companies retreating on the DEI component of ESG

Bloomberg reports:

• Over the last six months, more than 300 DEI professionals have exited companies across the economy, including Amazon.com Inc., Twitter Inc., and Nike Inc., per research from workforce analytics firm Revelio Labs.
• Observers are questioning whether pledges made during the wave of protests in 2020 were merely reactionary, superficial moves to lower reputational risk. The situation could get complicated at companies where investors have pushed for disclosure of workforce diversity data.

In my book The Profit Motive, I argued that much (arguably most) ESG activity is greenwashing. The retreat on DEI would seem to support that argument.

Maybe Caremark is not the Chicken Heart After All: VC Laster Disposes of Shareholder Suit over McDonald's Corporate Culture

In January, I noted considerable concern over a decision by Delaware Vice Chancellor Travis Laster involving potential Caremark liability for McDonalds due to allegations of a pervasive atmosphere of sexual harassment. I also took issue with the suggestion in the opinion that an officer breaches his fiduciary duties by engaging in sexual harassment. It should go without saying, but in today's environment probably does need to be emphasized, that nothing in that post was intended to excuse (let alone endorse!) sexual harassment!  It is a pernicious evil that deserves severe punishment. But through employment law not corporate fiduciary duties.

Others, such as Kevin LaCroix, expressed similar concern. 

In expressing my concerns about the decision, however, I noted a safety valve:

VC Laster thereby transformed sexual harassment—and who knows how much more of employment and civil rights law—into cognizable corporate law claims.

To be sure, VC Laster anticipated just such a complaint:

Some might ask whether the Court of Chancery should be hearing sexual harassment claims and worry that recognizing such a claim will open the floodgates to employment-style litigation. ...

... Like an oversight claim, a claim for breach of duty based on the officer’s own acts of sexual harassment is derivative, so all of the protections associated with derivative claims apply.

But so what? Is Laster saying that if Fairhurst had moved to dismiss for failure to make demand on the board per Rule 23.1 that Fairhurst would have won?

Whether Fairhurst would have escaped liability remains uncertain, but in a very recent opinion VC Laster dismissed the claims against the defendant directors:

The plaintiffs are stockholders of the Company who have sued derivatively on its behalf. They allege that from 2015 until 2020, the Company’s directors ignored red flags about a corporate culture that condoned sexual harassment and misconduct. They contend that the Company suffered harm in the form of employee lawsuits, lost employee trust, and a damaged reputation. As defendants, they have named nine directors who served during the critical period (the “Director Defendants”).

In advancing this claim, the plaintiffs rely on the principle that corporate fiduciaries cannot act loyally and in the best interests of the corporation they serve if they consciously ignore evidence indicating that the corporation is suffering or will suffer harm. To state a claim under this theory, the plaintiffs must allege facts supporting an inference that the directors knew about a problem—epitomized by the proverbial red flag—yet consciously ignored it. The plaintiffs must do more than plead that the directors responded in a weak, inadequate, or even grossly negligent manner. The pled facts must indicate a serious failure of oversight sufficient to support an inference of bad faith.

Laster concludes that the defendant directors "knew about a problem with sexual harassment and misconduct at the Company," but he goes on the explain:

What the complaint does not support is an inference that the Director Defendants failed to respond. The confluence of events during 2018, including the revelations about the Global Chief People Officer, led to action. Throughout 2019, the Director Defendants engaged with the problem of sexual harassment and misconduct at the Company. They worked with Company management on a response that included (i) hiring outside consultants, (ii) revising the Company’s policies, (iii)implementing new training programs, (iv) providing new levels of support to franchisees, and (v) taking other steps to establish a renewed commitment to a safe and respectful workplace.

Given that response, it is not possible to draw a pleading-stage inference that the Director Defendants acted in bad faith. The pled facts do not support a reasonably conceivable claim against them for breach of the duty of oversight.

Good.

On a personal note, I was flattered that VC Laster cited some of my work in the course of his opinion:

Activist Hedge Funds versus Social Justice Warrior CEOs

In the preceding post, I noted how even prominent social justice warrior CEO like Marc Benioff is embracing shareholder capitalism during the present economic turmoil. Why is he doing so? At least in part, according to the WSJ, because he's facing pressure from activist hedge funds:

At least five activist investors have taken positions in the company, including Elliott Management Corp. and Starboard Value LP. They are pressuring Mr. Benioff to change the way he runs things. In a presentation last year, Starboard said Salesforce wasn’t doing enough to increase profits.

This would not surprise readers of my book The Profit Motive, in which I discuss the role hedge funds like Elliott and Starboard have played in checking ESG impulses by CEOs. I used Etsy as a case study of the phenomenon:

The Etsy story in fact stands as a paradigmatic example of the increasing pressure public companies face from activist hedge funds to improve share price performance. ...

In one sense, activist hedge funds are akin to traditional value investors. They seek to identify target companies that they believe to be undervalued by the market. Unlike traditional value investors, activist funds are willing to be much more involved “hands on” investors. Although some activists seek value-enhancing changes through negotiation, the subcategory with which we are mainly concerned tend to be highly confrontational.  In either case, however, the standard hedge fund compensation 2-and-20 rule—i.e., an annual management fee of two percent of assets under management and a performance fee of 20% of returns above a specified benchmark—encourages managers of these funds to have a laser-like focus on the stock price of the companies in which they invest. ...

Although activist investors formerly concentrated on low hanging fruit, which typically consisted of poorly managed small firms, they are increasingly willing to take on even the largest companies.  Not surprisingly, the CFOs of about half of the companies surveyed by Deloitte reported their firm “made at least one major business decision specifically in response to shareholder activism,” with share repurchases being the most common.  In many cases, such decisions have had distinctly negative effects on stakeholders.

As Marc Benioff is now finding out.

As longtime readers know, I am deeply skeptical of shareholder activism. In a book chapter, Preserving Director Primacy by Managing Shareholder Interventions, in Research Handbook on Shareholder Power 231 (Edward Elgar Publishing; Jennifer G. Hill & Randall S. Thomas eds. 2015), I argued that:

... not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.

I explained that:

As potential activists, hedge funds have several advantages. First, hedge funds are not subject to the sort of conflicts of interest that discourage activism by mutual funds and other financial institutions with relationships with corporate management. Second, hedge funds are not subject to the regulatory limitations applicable to mutual funds on the size of the stake they hold in portfolio companies. Hedge funds thus can take larger positions in portfolio companies than traditional mutual and pension funds, allowing them to capture a larger share of any gains. Third, because hedge fund compensation structures award them a percentage of any games earned by the fund, hedge fund managers have a higher incentive than those of mutual or pension funds to pursue activities that raise the value of their stake even if other investors are able to free ride on their efforts. (Effross 2013, 268) Finally, the free rider problem is further mitigated when multiple hedge funds band together in so-called wolf packs to target a specific company, sharing the costs and gains of activism.

...

Turning to the merits of the growing incidence of hedge fund activism, [Robin] Greenwood argues that “hedge funds may be up to the task of monitoring management—a number of recent academic papers have found that hedge funds generate returns of over 5 percent on announcement of their involvement, suggesting that investors believe these funds will increase the value of the firms they target.” (Greenwood 2007)

A recent study by Lucian Bebchuk, Alon Brav, and Wei Jiang of 2000 activist hedge fund interventions between 1994 and 2007 found “no evidence that interventions are followed by declines in operating performance in the long term; to the contrary, activist interventions are followed by improved operating performance during the five-year period following these interventions.” (Bebchuk et al. 2013) A contemporaneous literature review by Bebchuk concludes that shareholder interventions on the aggregate are  “beneficial for companies and their shareholders both in the short term and the long term.”

I go on to express doubts about cases in which hedge fund managers advocate specific business decisions, while expressing less skepticism about cases--like the interventions at Salesforce and Etsy--that operate at a high level of generality and seek to hold directors accountable for focusing on interests other than those of shareholders.

Salesforce's Mark Benioff Morphs from Social Justice Warrior to Gordon Gekko

In my book The Profit Motive, I talked about Salesforce CEO Marc Benioff:

A 2017 Slate essay claimed that “Fortune 500 companies today are socially liberal, especially on areas surrounding diversity, gay rights, and immigration; they are unabashedly in favor of free trade and globalization, express concern about climate change, and embrace renewable energy.” Robert Miller similarly concludes “that, at the current time, a sizeable majority of individuals in the socio-economic class from which public company directors, partners at elite law firms, senior officers at institutional investors and proxy advisory firms, politicians, and academics are drawn overwhelming favors one particular political agenda—i.e., the largely progressive political agenda that emphasizes issues such as climate change, environmental concerns, racial and gender diversity, systematic racism, and so on.” Salesforce.com CEO Marc Benioff, to cite but a single prominent example, energetically promotes social responsibility and woke activism. ...

Even true social justice warrior CEOs like Marc Benioff abandon their stakeholder capitalism commitments when push comes to shove. ... To cite but a single high profile example, the Wall Street Journal reported on August 29, 2020, while the pandemic was still raging, that one day after “Salesforce.com Inc. posted record quarterly sales, the business-software company notified its 54,000-person workforce that 1,000 would lose their jobs later this year.”  As John Stoll opined in the Journal, Salesforce CEO and Business Roundtable 2019 statement signatory Marc “Benioff called the company’s strong earnings a victory for stakeholder capitalism.” Benioff claimed to have done “a great job” for both shareholders and stakeholders. One might reasonable ask, however, as Stoll did, “how does the billionaire founder justify this claim when shortly after that interview Salesforce notified staff of plans for around 1,000 layoffs? This despite Mr. Benioff’s no-layoff pledge in March on Twitter and the challenge to other CEOs to follow his lead.”  One might add to that inquiry a question about how Benioff would justify telling Salesforce employees that in a few months down the road 2% of them would be fired, leaving them to twist slowly in the wind for months while worrying whether they would be among those who get fired.

Benioff's morph from social justice warrior to shareholder capitalist continues according to today's WSJ:

Through the sky’s-the-limit boom years, Marc Benioff, the co-founder and chief executive of Salesforce Inc., told employees they were bound together like family. In today’s leaner times, he is laying off thousands of them.

Why? Because, as Benioff now acknowledges, "ultimately, the success of the business has to be paramount.” 

“Layoffs are always hard,” Mr. Benioff said, but the Salesforce culture of family bonds only goes as far as business allows. “You can continue to keep a company going with excess employees, but it’s not healthy for the company,” he said.

Salesforce has struggled recently and its executives admitted--until they got scared off by their employees--that the firm's embrace of corporate social responsibility was part of the problem:

Salesforce executives ... said “wellness culture overpowered high performance culture during the pandemic” to explain the company’s recent headwinds. After employees complained on Slack—“Most disturbing and tone deaf is this sad excuse,” one post said—the line was changed.

It seems like Benioff is not alone:

Silicon Valley companies for years sold workers on the idea that they operate as communities with shared values and where people come first. Highflying firms could easily afford such amenities as on-site dry cleaners, workout classes and free food. 

Management is now cracking down.

As I predicted.

Senator Schumer's Misconceptions and Misrepresentations about ESG Investing

In today's WSJ, Senator Chuck Schumer argues that "Republicans Ought to Be All for ESG." There's a lot of misinformation in it. He claims, for example, that:

America’s most successful asset managers and financial institutions have used ESG factors to minimize risk and maximize their clients’ returns.

True, sort of. A lot of investment managers do use ESG. But not successfully. In my book The Profit Motive I review the data on ESG investing and point out that:

If socially responsible firms are superior performers, one should see evidence that investment portfolios weighted towards such firms outperform the market on a risk-adjusted basis. Yet, there is little evidence that socially responsible investment funds outperform relevant market indices. ... In general, there is no evidence that SRI investment funds—standing alone—improve portfolio company performance on environmental or social metrics, probably because such funds prefer investing in firms that already score high on those metrics. ... A 2021 literature review of over 1,100 peer-reviewed studies and 27 published meta-analyses determined that the risk-adjusted financial performance of ESG investing was indistinguishable from that of conventional investing.

He then claims:

Investors and asset managers increasingly recognize that maximizing returns requires looking at the full range of risks to any investment—including the financial risks presented by increasingly volatile natural disasters, aging populations and other threats that the public doesn’t normally associate with financial modeling.

It's interesting timing for that claim, because on Monday in the WSJ we learned that Vanguard CEO Tim Buckley was backing his massive fund family away from ESG:

“Our research indicates that ESG investing does not have any advantage over broad-based investing,” Mr. Buckley said in a recent interview with the Financial Times. Matching word to deed, his comments came after he had withdrawn his firm from the $59 trillion Net Zero Asset Managers initiative, an organization that is part of the $150 trillion United Nations-affiliated Glasgow Financial Alliance for Net Zero. Both alliances are committed to restricting their investments over time to companies that are compliant with the Paris Agreement’s objective of net-zero greenhouse gas emissions by 2050. Mr. Buckley claims the financial world, swept up in climate-change fervor, can’t make such commitments without reneging on its fiduciary duties.

Next Schumer turns to the recent Department of Labor ERISA rule allowing investment managers to freely invest their client's money in ESG:

Nothing in the Labor Department rule imposes a mandate. It simply states that if fiduciaries wish to consider ESG factors—and if their methods are shown to be prudent—they are free to do so. Nothing more, nothing less.

The present rule gives investment managers an option.

But what if the investment manager's client don't want their money going down the ESG sinkhole? Presumably Schumer would say "change investments," but not all of us have that choice. As I discussed in an earlier post, the University of California unilaterally shifted my retirement money into portfolios that track ESG indices. Nobody asked my permission and I don't have any choice in the matter.