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In his 1911 inaugural address as Governor of New Jersey, Woodrow Wilson took the opportunity to remind listeners about the special nature of corporations. “A corporation exists,” he said, “not of natural right, but only by license of law, and the law, if we look at the matter in good conscience, is responsible for what it creates.”
Put another way, corporations are creatures of public permission—and they always have been. The early United States inherited the construct from the United Kingdom, where the king literally bestowed incorporation as a form of royal privilege. Corporations are special in that they are granted perpetual existence, and they protect the individuals that form them from personal liability if things go bust. They are also an extraordinary way to raise capital for businesses because they have the right to sell shares first to initial investors, and in some cases for those investors to trade their shares in a secondary market.
Today’s corporations have retained their privileges and lost their public purpose.
The legal rules binding and defining corporations have changed considerably since the nation’s founding and since Wilson’s time—corporations now have many of the same constitutional protections as human persons—but Wilson’s fundamental point bears repeating because it is still true: the privileges granted to large corporations are just that—privileges—not rights, and they are granted by the government so that corporations can accomplish public purposes that otherwise would be hard to meet. It follows then that if corporations only exist because we, the people, allow them to, we should only permit them to exist if they are responsive to our needs.
Today’s corporations have retained the privileges and lost the public purpose. They cut employee costs to as low as possible, so that workers can’t make enough to sustain their families. They outsource work so that people who used to make a fair wage and benefits as employees are forced to work as independent contractors. They use technology to invasively monitor workers. All of this, along with the attacks on unionization, keeps worker bargaining power as low as possible.
At the same time, the corporate form has created immense prosperity. Corporations take big risks and have grown in size such that the largest of them earn more revenue than many countries. The question is, for whom? And who bears their social costs?
Large corporations today are governed according to “shareholder primacy,” a philosophy that says that the ultimate purpose of the corporation is to make money as quickly as possible for shareholders. Yet there is no legitimate or legal reason for the government to let large corporations benefit only their shareholders. Indeed, it is time to change corporate law to reflect a stakeholder governance model, so that stakeholders—principally employees, though others such as customers and the public—have a voice inside corporations and a fair shot at earning some of the value they have created.
Over the years, many people have proposed “stakeholder” and “public benefit” modifications to corporate law. The B Corp movement, for example, has led the way for public benefit statutes nationwide, and legal scholars such as Kent Greenfield, Robert Hockett and Saule Omarova, and Ralph Nader have all proposed modifying and perhaps federalizing corporate law. But the leading voices challenging corporate power today tend to focus on corporate power in politics (e.g., campaign contributions), or corporate power as employers (e.g, the need for unions and minimum wage hikes), without directly calling for a change in how corporations are governed.
Making corporate governance accountable to the public again is not only our right, but our responsibility, and it would require, remarkably, just a few straightforward changes. Namely, we make the board of directors accountable to multiple stakeholders; balance representation on boards of directors by electing different kinds of stakeholder representatives, including employees; clarify the corporate purpose; and federalize incorporation for our largest corporations so that states are not striving to out-compete each other with business-friendly laws.
Using corporate governance law to create a stakeholder governance model would change the balance of power inside corporations and affirm that corporations are public creations, not market creations; in other words, we grant them the right to exist. We must reconstitute corporate law as ultimately public law: setting the terms for corporate behavior so that corporations serve—and don’t dominate—society. The following relatively simple policy proposals do not get the attention they deserve, but if we want to reverse today’s rampant inequality, we must remake the laws that govern the distribution of power inside corporations.
From the perspective of company employees—or even consumers who would like to buy better products at cheaper prices—shareholder primacy is, to put it mildly, a very odd way to run a company. At its core, the logic necessitates that all corporate decisions are made according to the effect that they will have on the share price. Boards understand themselves as ultimately accountable only to shareholders, because all other corporate stakeholders—employees, customers, taxpayers—are covered by “contracts” (never mind that most workers are at-will employees). Prioritizing shareholders means keeping costs—among them, employee wages—as low as possible, even if that will have a negative effect on the corporation’s long-run ability to grow and prosper.
Shareholders are not, in fact, the “owners” of the corporation; they are owners of the shares that the corporation has issued, and most of the time they have purchased these shares in a trade from a previous owner, not from the company itself. After an initial offering of equity by public companies, shareholders buy stock on the secondary markets—from other shareholders—meaning none of the money they spend to buy shares actually makes its way to the company. In other words, the end result of shareholder primacy is a firm run for the benefit of diversified shareholders who bought their shares on a secondary market, invest nothing directly in the company, and probably do not even know they are a shareholder. Makes sense, right?
Alternatives to ‘shareholder primacy’ are possible. Employee ownership businesses (such as Publix Super Markets) and benefit corporations (such as Patagonia) are thriving.
Meanwhile, the employees are often treated as an afterthought, and the legal theory of shareholder primacy gives management an out: executives can claim that they simply cannot raise wages because that takes away money that is due to shareholders. Corporate executives have an array of tools that work to enrich themselves and shareholders at the expense of other stakeholders. These include legal tools such as stock buybacks, fissuring, and union-busting, as well as management tools such as downsizing and using the specter of automation to hold down wages so that more wealth is available for shareholders. (Stock buybacks, which push up remaining share prices instantly without the hard work of companies actually making improvements, are currently at record-breaking highs.) These tools work because opaque rules such as fiduciary duty and board elections seem neutral; in reality, they help the wealthy gain power.
Moreover, the story corporations often tell themselves is that employees have equal bargaining power and enter freely into contracts with the company; conversely, it is the shareholders who lack a meaningful contract and are therefore due the spoils. But this, of course, is a fiction: employees do not enter into some kind of perfect contract with a firm’s management—companies have tremendous power over the hiring and working conditions of their employees. Over the last forty years, for example, companies have largely chosen not to raise wages in line with productivity, seeing workers as a cost to be controlled, rather than a source of profit in and of themselves.
Employees, in many ways, have more at stake than shareholders. They usually have one job, whereas shareholders have diversified portfolios. They invest time and effort in creating value for the company, whereas shareholders just spent money. If the company goes bankrupt, it is much harder on employees to find new jobs or deal with the sudden loss of a promised pension than it is for shareholders, who can sell shares instantaneously. As Professor of Law Kent Greenfield describes in The Failure of Corporate Law (2005), workers are in a “complicated and dependent” relationship with a corporation, and their ability to bargain for the theoretical contract depends on the social power they command.
The stakeholder model of corporate governance would redesign governance so that all stakeholders in our economy (workers, customers, and the public) have a chance to benefit as corporations create profit. It is simultaneously radical and incremental by promising to remake our economy with some straightforward legal shifts. Though there are plenty of variations, three substantive changes to corporate governance are necessary.
The first change is to disallow corporations from forming for any lawful purpose. Corporations should be required by statute to have as their purpose “creating general public benefit,” which is the language that benefit corporations such as Kickstarter and Patagonia use. Benefit corporations are companies that have chosen to be governed by a new kind of law that requires a public benefit purpose and accountability to stakeholders. Benefit corporation status is permissive—right now, corporations have to choose it. Corporate law should be changed so that all corporations—creatures of the state—must create a general public benefit. This would, at minimum, allow some ability to challenge corporate externalities that have disastrous social consequences.
State-by-state incorporation led to a race to the bottom where ultimately Delaware has come out on top: a state of 900,000 people is home to 66 percent of the Fortune 500 charters.
The second change is to mandate that employees, and perhaps other stakeholders, have elected representatives on the board to balance the interests among those making major decisions of the corporation. The third is to make the fiduciary duties of board members—their obligation to be loyal and to make decisions with the interests of the corporation, not themselves, in mind—applicable to a variety of stakeholders, not merely the shareholders who have been actively trading on the secondary markets.
In order to make these changes, we must also federalize incorporation for our largest companies. The early history of corporate chartering was by state legislatures. This new form of business was so beneficial to its incorporators that state governments wanted to retain the right to allow or disallow formation. But by 1896, New Jersey recognized the comparative advantage it could have if it attracted businesses to incorporate under its own laws and changed its statute such that companies could incorporate “for any lawful purpose.” Predictably, new corporations flocked to New Jersey.
State-by-state incorporation has meant a race to the bottom where ultimately Delaware has come out on top: a state of 800,000 people is home to 66 percent of the Fortune 500 charters. Delaware’s business-friendly incorporation laws are possible due to the “internal affairs doctrine,” which allows companies to use the state governance laws of the state where they incorporate. Corporations are allowed to form in any state, no matter where they do business, employ people, or spend money. They need not have any meaningful contact with the state where they are incorporated. Corporations cannot evade labor law, anti-discrimination law, or other state laws that govern their affairs when they are operating in a state, but incorporation law is outside this norm.
This is profoundly undemocratic. Stakeholders of corporations chartered in Delaware, such as employees or creditors, have no political voice in the creation of Delaware corporate law. This norm also keeps states from asserting their own governance standards over businesses that actually operate in their state. States will continue to compete—undercutting each other with business-friendly laws—unless we stop them. The internal affairs doctrine is not a federal or state statute and is not a matter of constitutional law. It is simply accepted practice.
The alternative is to federalize corporate law and place a stakeholder governance model at the federal level. Federalizing the right to incorporate would also recognize that large corporations sell products and employ people all over the country and all of us have a right to determine their rules of governance, including how their spoils are shared. Our large corporations are multinational in scope and operate in multiple states. A federal corporate charter for large corporations would bring corporate law into the twenty-first century and make it subject to the political will of all of us, rather than the voters of Delaware, who are fewer in number than hourly employees of Walmart.
In order to imagine a stakeholder corporate governance model, it is useful to understand that plenty of alternative business structures operate—and thrive—today. There are small-but-growing employee ownership businesses (such as Publix Super Markets, with its 190,000 employees), benefit corporations (such as Patagonia), and worker cooperative movements (such as Cooperative Home Care Associates, a 400-person home health aide cooperative in the Bronx) in pockets of the United States. These models all have stakeholder governance at their core, and their success is an antidote to the notion that businesses must maximize shareholder value in order to thrive.
A stakeholder model of governance in corporate law would allow for a real contest for power inside our companies.
Employee ownership, for example, is more common than many believe. According to the National Center on Employee Ownership, over 25 million U.S. employees participate in some kind of employee ownership program. While employee ownership can affect the procedures of the business, most employee-owned businesses are not flat consensus-decision-making cooperatives. They often have management hierarchies, just like mainstream businesses, but they differ in that employees directly participate in governance alongside other shareholders or they conduct the governance themselves by electing the board and voting on the big issues for the company. Employees share in the profits of the business just as other investors and shareholders do.
Benefit corporations in the United States take a different approach. The benefit corporation movement has acknowledged the dominant shareholder primacy model but does an end-run around it by establishing an entirely different statute that companies can opt into. The statutes have a clear statement that the purpose of the corporation is to benefit the public: benefit corporations do not exist to extract wealth from the rest of society. The responsibilities of their boards are to all stakeholders, from employees to clients to the broader public. Companies choose to incorporate as benefit corporations for a variety of reasons such as founder preference or to gain a marketing advantage to a discerning customer. This means that problematic companies like Walmart won’t choose this model, but it has been heartening to see the model quickly gain relevance across the economy. There are now roughly five thousand benefit corporations, including Kickstarter and Kleen Kanteen, and thirty-four states have benefit corporation statutes.
There are also success stories outside the United States. Nearly twenty European countries have some kind of “co-determination” philosophy, which creates legal rights for workers in big corporate decisions, in place, and Japan is well-known for its structures for worker participation and learning. Germany, however, probably offers the most instructive case study. Large German corporations such as Volkswagon are a mainstay of the economy, yet they must have workers on their board of directors and are run according to the co-determination philosophy. Moreover, large German companies also have works councils inside companies, as well as industry-level bargaining.
Contrary to what mainstream U.S. corporate legal theory might have you believe, these structures have not caused the German economy to fall apart due to paralysis because there is no one “residual claimant” who has all the power within the company. Nor is this model marginalized to pro-social businesses, as in the United States: 44 percent of German workers are employed at companies with works councils.
Stakeholder governance for the United States’s largest corporations would not be a panacea. It would not, on its own, reverse catastrophic inequality or stop executives from finding new ways to enrich themselves. And it would introduce its own complications—complications that would have to be solved mainly through court decisions. What does it actually look like, for instance, for a corporation to violate its public purpose? Who wins when a board makes a decision that prioritizes workers over shareholders, and the shareholders sue? Will company management find ways to play employees and shareholders off each other for their own personal gain?
Corporate power should not trump people power.
Remaking corporate law to a stakeholder model of governance would certainly come with such obstacles, but it would also allow for a real contest for power inside our companies. The statistics that define our inequality crisis are familiar and won’t start to reverse without a change in corporate behavior. The most important reason to change corporate law is to reaffirm the simple fact that corporations are created by public political will. Corporate power should not trump people power, and I use that word deliberately. In 2018 we recognize more than ever the dangers of corporate control over our lives and our politics. In order to emerge from the political crisis we find ourselves in today, we must invert the power dynamics that got us into this mess.
The recent Janus v. AFSCME decision highlights just how urgent the timing is. The ruling was a setback, and a meaningful one, for unionized workers. But while Janus is not the end of union power, it is a clarion call that we must structurally reduce corporate power. In the face of the judiciary’s relentless onslaught on worker bargaining power, Congress could act by fundamentally restructuring corporations to empower workers. Candidates for Congress looking to inspire working-class voters in November would do well to take up the charge.
Lenore Palladino is Assistant Professor of Economics and Public Policy at the University of Massachusetts Amherst. She is also a Fellow at the Roosevelt Institute and a Research Associate at the Political Economy Research Institute.
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