For someone who has long argued that a corporation is not property, that it is not owned by its shareholders, and that shareholders are not the only stakeholders to whom the board of directors owes a fiduciary duty, Palladino’s essay is a most welcome addition to the literature on corporate governance. I agree with her description of the evolution of shareholder primacy and the fallacies on which it is based. We part company, however, on the solution to the problem.
I reject legislation and regulation, fearing it would quickly lead to state corporatism and loss of our market economy. Instead, I have been urging long-term investment and growth that facilitates implicit agreement between corporations and the asset managers and asset owners who elect the directors. In a roadmap I developed for the World Economic Forum—which issued it in September 2016—I called this The New Paradigm.
The New Paradigm is premised on the idea that companies and shareholders can forge a meaningful and successful private-sector solution to attacks by financial activists and the short-termism that significantly impedes long-term economic prosperity. It is not a contract and can be unilaterally modified. The framework of The New Paradigm conceives of corporate governance as a collaboration among corporations, shareholders and other stakeholders, and it calls for a recalibration of the relationship between public corporations and their major institutional investors. This is achieved through two central concepts. First, that engagement between a company and its shareholders is understood as a dialogue, not dictates from either side. And second, that stewardship is understood as a commitment on the part of asset managers and asset owners to be accountable to the beneficial owners whose money they invest and to use their power as shareholders to foster sustainable, long-term value creation.
In this framework, if a company, its board of directors, and its CEO and management team are diligently pursuing well-conceived strategies that were developed with the participation of independent, competent, and engaged directors, and its operations are in the hands of competent executives, asset managers and asset owners will support the company and refuse to support financial activists seeking to force short-term value enhancements without regard to long-term value implications.
The Business Roundtable’s recent abandonment of shareholder primacy is a step in this direction, but it is important to note that the Council of Institutional Investors and others immediately challenged the wisdom and legality of stakeholder corporate governance. As to the wisdom, Palladino makes the case and nothing need be added. And as to legality, I would like to clarify why CII is wrong. Delaware law does not enshrine a principle of shareholder primacy or preclude a board of directors from considering the interests of other stakeholders. Nor does the law of any other state.
Although much attention has been given to the Revlon doctrine, which suggests that the board must attempt to achieve the highest value reasonably available to shareholders, that doctrine is narrowly limited to situations where the board has determined to sell control of the company and either all or a preponderant percentage of the consideration being paid is cash or the transaction will result in a controlling shareholder. Indeed, the Revlon doctrine has played an outsized role in fiduciary duty jurisprudence not because it articulates the ultimate nature and objective of the board’s fiduciary duty, but rather because most fiduciary duty litigation arises in the context of mergers or other extraordinary transactions where heightened standards of judicial review are applicable.
The fiduciary duty of the board is to promote the value of the corporation. In fulfilling that duty, directors must exercise their business judgment in considering and reconciling the interests of various stakeholders—including shareholders, employees, customers, suppliers, the environment and communities—and the attendant risks and opportunities for the corporation. The board’s ability to consider other stakeholder interests is not only uncontroversial, it is a matter of basic common sense and a fundamental component of both risk management and strategic planning.
Corporations today must navigate a host of challenges to compete and succeed in a rapidly changing environment; for example, as climate change increases weather-related risks to production facilities or real property investments, or as employee training becomes critical to navigate rapidly evolving technology platforms. A board and management team that is myopically focused on stock price and other discernable benchmarks of shareholder value—without also taking a broader, more holistic view of the corporation and its longer-term strategy, sustainability, and risk profile—is doing a disservice not only to employees, customers, and other impacted stakeholders but also to shareholders and the corporation as a whole.
The board’s role in performing this balancing function is a central premise of the corporate structure. The board is empowered to serve as the arbiter of competing considerations, whereas shareholders have relatively limited voting rights, and, in many instances, it is up to the board to decide whether a matter should be submitted for shareholder approval (for example, charter amendments and merger agreements). Moreover, in performing this balancing function, the board is protected by the business judgment rule and will not be second-guessed for embracing environmental, social, and governance (ESG) principles or other stakeholder interests in order to enhance the long-term value of the corporation. Nor is there any debate about whether the board has the legal authority to reject an activist’s demand for short-term financial engineering on the grounds that the board, in its business judgment, has determined to pursue a strategy to create sustainable long-term value.
And yet even if, as a doctrinal matter, shareholder primacy does not define the contours of the board’s fiduciary duties so as to preclude consideration of other stakeholders, the practical reality is that the board’s ability to embrace ESG principles and sustainable investment strategies depends on the support of long-term investors and asset managers. Shareholders are the only corporate stakeholders who have the right to elect directors, and in contrast to courts, they do not decline to second-guess the business judgment of boards. Furthermore, a number of changes over the last several decades—including the remarkable consolidation of economic and voting power among a relatively small number of asset managers, as well as legal and “best practice” reforms—have strengthened the ability of shareholders to influence corporate decision-making.
Under prevailing law, directors may, and often must, tackle issues that affect all stakeholders—not just shareholders. Effective resolution of these issues requires effective partnership with investors. The prospects for such a partnership are increasingly promising. Ethical investing, as the Financial Times recently observed, “has reached a tipping point.” Key institutional shareholders—including Blackrock, State Street, and Vanguard—have recognized that companies must serve broader social purposes. Survey after survey of major investors confirms that they expect companies to articulate a clear socially and economically valuable purpose, to take public stands on ethical issues, and to formulate long-term corporate policy with the risks posed by income inequality and environmental deterioration in steady view. The law empowers directors to address these new risks—and to capitalize on the attendant opportunities. An evolving shareholder landscape provides an opportunity for directors to do so with the support and counsel of major investors and asset managers. Well-advised boards will seize the opportunity as a matter of priority.
Thus, I’m in agreement with Palladino up to the point where she urges the inclusion of workers on the board of directors and the creation of a worker ownership fund. At least I view it as a step too far since I believe that endorsement of The New Paradigm will obviate the need for it and similar efforts, such as Senator Elizabeth Warren’s Accountable Capitalism Act, which would provide 40 percent worker membership on the board of directors. Nevertheless, I applaud Palladino’s contributions to the literature on corporate governance and welcome the continuing dialogue it will help to spur on these matters that are so fundamental to corporations and our society.