The reason why it is important to phase out for profit corporations is the perceived belief that, within them, directors have a legal duty to maximise profits for shareholders above all else. This rule is sometimes known as ‘shareholder primacy’ or the duty to ‘maximise shareholder value’.
One corporate lawyer, gone over to the other side, elaborates:
“Corporate law thus casts ethical and social concerns as irrelevant, or as stumbling blocks to the corporation’s fundamental mandate. That’s the effect the law has inside the corporation. Outside the corporation the effect is more devastating. It is the law that leads corporations to actively disregard harm to all interests other than those of shareholders. When toxic chemicals are spilled, forests destroyed, employees left in poverty, or communities devastated through plant shutdowns, corporations view these as unimportant side effects outside their area of concern. But when the company’s stock price dips, that’s a disaster.“1 (Hinkley C)
Strangely enough, the duty to maximise shareholder value does not explicitly appear in company incorporation documents which normally simply instruct directors to “exercise their powers and discharge their duties with a view to the interests of the corporation and of the shareholders.” It is the law, particularly in the USA, that has built up around these vague statements through previous decisions of the courts which have led to the creation of this perceived duty.
The classic case occurred in America in 1919 when the Dodge brothers, who owned 10% of Ford, sued Henry Ford, the majority shareholder and director. Henry Ford had wanted to reduce prices and increase wages instead of paying dividends. The Michigan court ruled in favour of the brothers saying: “it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others.”2
Since then there have been thousands of cases around the world including some with contradictory or more nuanced conclusions, but the majority opinion still appears to be that a duty exists to maximise shareholder value.
(a) The position in the USA
In 2012, the distinguished professor of corporate and business law at Cornell Law School published a book called “The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.”3 In it, she pointed to some of the court decisions at variance with Dodge v Ford and argued that: “it is activist hedge funds and modern executive compensation practices — not corporate law — that drive so many of today’s public companies to myopically focus on short-term earnings; cut back on investment and innovation; mistreat their employees, customers and communities; and indulge in reckless, irresponsible and environmentally destructive behaviors.“
However, it would appear that some different US corporate law professors line up on the other side, even if they agree that the duty itself is pernicious. Professor Yosifon at Santa Clara University and Professor Benbridge at UCLA, for example, both appeared in the New York Times in 2015 and 2016 respectively, arguing that a duty under US law still exists to maximise shareholder value.4
Matters are further complicated by the fact that each State will have a slightly different legal framework. It is therefore fair to say that, at best, the position is unclear. It is this lack of clarity which has acted as a spur to the B Corporation movement particularly to seek to change the incorporation documents to specifically deny shareholder primacy (For more information on B Corps see this article).
(b) The position in the UK
On the surface, the position appears different in the UK. The Companies Act 2006 passed by Tony Blair’s Labour government at s 172(i) stated:
” A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to –
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.”
However, a formal UK government review of business decision making in 2012 reported on a study undertaken on behalf of the Association of Chartered Certified Accountants by Professor Collison. He reported that the corporate executives in his study seemed to interpret the law as imposing a requirement to maximise the share price in the short term. The review went on to say: “It seems unlikely that Professor Collison’s respondents did not know what the law was: these responses may therefore illustrate their state of mind rather than their understanding of the law. The TUC commented that “what directors’ duties require of directors in reality is almost irrelevant if this is how directors interpret their duties”, and went on to suggest that s172 should be reformulated so that the directors were required to promote the long-term success of the company.”5
(c) The position elsewhere
It is likely that what can generously be described as a ‘lack of clarity’ around the duty to maximise shareholder value exists around the world in a similar way but with some variations. It is well known, for example, that German corporations above a certain size require worker representation on their boards, which is designed to have some mitigating effect for some stakeholder groups. However, in a 2003 book called “The Company”, the authors (rather prematurely perhaps) describe the idea that companies should be responsible to a wider group of stakeholders than just shareholders “is in gradual retreat in its strongholds of Japan and continental Europe.”6
A duty to damage other interests?
Where externalising costs onto other stakeholders does benefit shareholder value then it is hard not to interpret a duty to maximise value as carrying with it a concurrent duty to damage humans and their communities. Not all decisions that benefit shareholder value will necessarily create such damage, but where it does, a duty to cause damage could be said to exist.
Big investors typically have deep pockets. This means that the potentially high costs of legal action, or the threat of legal action, to protect financial interests may not be a significant barrier. The lack of legal certainty in this area must create a temptation for financially-driven shareholders to consider this type of action extremely regularly.
We cannot know this because boardroom minutes will not normally find their way into the public domain. But looking at the actual damage which corporations routinely create, it is not difficult to infer that such discussions are common. This goes to the heart of why corporations have become dangerous to external interests and why, in their current form, a phase-out of for-profit corporations will become a logical campaign goal for human communities everywhere.
1How Corporate Law Inhibits Social Responsibility A Corporate Attorney Proposes a ‘Code for Corporate Citizenship’ in State Law by Robert C. Hinkley January 19, 2002 http://www.commondreams.org/views02/0119-04.htm
3 Lynn Stout: The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.” Berrell-Koehler 2012
4 www.nytimes.com/roomfordebate/2015/04/16/what-are-corporations-obligations-to-shareholders/its-law-but-it-shouldnt-be. http://www.nytimes.com/roomfordebate/2015/04/16/what-are-corporations-obligations-to-shareholders/a-duty-to-shareholder-value
5 THE KAY REVIEW OF UK EQUITY MARKETS AND LONG-TERM DECISION MAKING Interim Report FEBRUARY 2012
6 The Company: A Short History of a Revolutionary Idea by Adrian Wooldridge and John Micklethwait 2003 Wiedenfeld & Nicolson