The age-old debate over the purpose of for-profit corporations has reignited, with two rival theories on offer: shareholder primacy and stakeholder parity. The first posits that the primary purpose of corporations is to maximize shareholder value, while the second urges the equal interests of all other constituents, especially employees, customers, and communities.
While the debate can seem complex and polarizing, the reality for corporate directors is simple and subtle: directors’ legal duties run to shareholders, but directors may promote the interests of others when those are rationally related to shareholder interests. If prevailing debate sometimes suggests a stark choice between shareholders and other stakeholders, the reality is that their interests are more aligned than it may seem and directors continue to operate accordingly.
Corporate law has long required directors to act in the best interests of the corporation and its shareholders. In practice, this duty sometimes translated into a mandate to maximize shareholder value—at all costs. But while some businesspeople may follow that practice, most recognize that promoting shareholder interests invariably entails protecting the interests of others, such as employees and customers. Corporate law accommodates this reality by giving directors wide latitude in exercising their business judgment. Rather than such an impractical mandate that directors maximize shareholder value, courts say they must act in the best interests of the corporation and its shareholders.
The flexibility in this framework entices advocates of non-shareholder interests to argue that directors owe a duty not only to the corporation and its shareholders but also to its employees, customers, and other constituents or “stakeholders.” Although this is certainly not the law, stakeholder advocates urge a norm in which directors no longer prioritize shareholder value but feel an obligation to such other constituents as well. Yet if it would be impracticable for judges to enforce a rule of shareholder value maximization, it would be more difficult to formulate a workable legal rule requiring directors to optimize across such contending interests.
Corporate law’s flexibility thus facilitates long-running debate over corporate purpose, which recur throughout modern corporate law history. The tenor of today’s version of this debate reflects shifts in political, physical, social, and economic conditions. These include:
- declining trust in government has increased demand for non-governmental organizations, including corporations, to protect stakeholder interests.
- rising concern about climate change has led activists to focus on corporations as a critical locus for reform.
- powerful social movements, including #MeToo and Black Lives Matter, have increased pressure throughout society, including on corporations, to redress gender and racial grievances.
- powerful institutional asset managers lean towards stakeholder capitalism because their index fund business model means they cannot compete on price or returns.
These and related shifts are behind the extraordinary success of the movement for environmental, social and governance (ESG) priorities in public companies and their investors. That success is self-reinforcing, as it makes more people aware of pressing concerns such as governmental efficacy, climate change, and diversity. Corporate norms evolve accordingly, as index fund managers publish their expectations, employees and other constituents assert themselves, and federal regulators add disclosure requirements
These forces shape boardroom discussions and implicate two established duties that induce board attention. First, most corporate decisions have multiple important effects on various constituencies and boards are dutybound to be informed about these. Second, corporations must maintain systems of internal control to promote compliance with law and company policy, and boards are dutybound to assure their effectiveness.
Yet despite such changes in boardroom practice, corporate law remains the same. For one, directors are elected by a corporation’s shareholders, not by other stakeholders, and can be sued for breach of duty by shareholders, but not by others. Directors, not shareholders, are charged with overseeing corporate policy and strategy. And, as noted, directors may take the interests of other constituents into consideration, and invariably do so, but are not obliged to. Their duty is to the corporation and its shareholders.
The purpose of the for-profit corporation therefore remains to make a profit, achieved through employing people, serving customers, and protecting associated communities. Exactly how a particular corporation pursues this purpose is ultimately the question for each board’s business judgment. Under this formulation, boards of for-profit corporations need not maximize shareholder profit, but nor may they put other interests on par with the shareholder interest.
Amid recurrent debates over corporate purpose, boards often face political and social pressures to promote different priorities of various constituents or stakeholders. Today’s pressures may seem particularly intense. But directors, especially those new to board service, do well to remember these venerable business and legal principles.
Please feel free to contact Lawrence Cunningham, Special Counsel at Mayer Brown, to discuss further.
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