The Business Roundtable, made up of CEOs of some of the largest U.S. companies, released a statement on August 19th on the purpose of a corporation that has garnered a lot of media coverage and pushback. The statement highlights the role of business in fostering an economy that supports “a life of meaning and dignity” for Americans and emphasizes a “fundamental commitment to all of our stakeholders” in addition to serving an individual company’s “own corporate purpose.”
Heralded by the media as a groundbreaking shift, this simple statement has made a splash. But without an understanding of the history and context of the shareholder primacy theory or the Business Roundtable’s prior statements it may appear unremarkable on its face. Talking about valuing customers, investing in employees, dealing fairly and ethically with suppliers, supporting the communities in which they work, and generating long-term value for shareholders, it highlights corporate values that many already expect companies to hold.
University of Chicago Law School Professor Eric Posner proclaimed “Milton Friedman Was Wrong” in The Atlantic on August 22nd (a proclamation notable for its messenger as much as its message given that he is a professor at the school that developed the Friedman line of thinking). He places the statement in the broader context of the current discussion around corporate governance and responsibility, highlighting how out of step the Roundtable’s prior statements had become. Posner also compellingly argues that there is no such thing as quixotic corporate action that replaces the necessity of government regulation: although corporations that more carefully balance the needs of all their stakeholders are likely to be better corporate actors and more beneficial to society, “[t]he only proven way to stop corporations from polluting, defrauding, and monopolizing is to punish them through the law.”
As Posner points out, the concept of maximizing shareholder value began to dominate corporate governance relatively recently, born of agency theory by the likes of Milton Friedman in the 1970s. But this change in corporate thought was not reflective of any change in the law. Harvard Business School Professors Joseph L. Bower and Lynn S. Paine explain in a 2017 article in Harvard Business Review that while corporate boards owe fiduciary duties to shareholders their duty is also to the company itself, of which shareholders are but one important constituency. Shareholders don’t directly own the company, they own shares and the rights and privileges attached to those shares (such as the right to vote on the board). The directors they elect and the management those directors hire are fiduciaries for the company and the shareholder, not exclusive agents of the shareholders.
Management and directors may make independent judgments about what is in the best interest of the company even if it is at odds with the desires of a particular set of shareholders—so say the business judgment rule and courts asked to consider such shareholder concerns.[1] Governance approaches and incentives have shifted over the years to place more power in the hands of shareholders and align director and manager incentives with those of shareholders (often focused on shorter-term returns over longer-term considerations); a change resulting from shifting shareholder attitudes, shareholder relationships with companies, and business theory.[2] A prolonged and serious shift back to a more balanced philosophy on corporate governance could result in realigning incentives to reflect that shift.
More investors are recognizing that operating a company with only shareholder value maximization in mind can be at odds with the long-term health and growth of the company, and can result in decisions that provide short-term returns but also hobble the company’s ability to compete in the long run. Professors George Serafeim (HBS) and Claudine Gartenberg (Wharton) have found that companies who foster a sense of purpose throughout their company, rather than an exclusively shareholder profit maximization-focused approach, ultimately outperform those who don’t. Profs. Bower and Paine instead argue for a company-centered model of governance that doesn’t ignore the need for healthy shareholder returns, but rebalances skewed incentives resulting from the business community buy-in to the agency theory/shareholder primacy. As the Business Roundtable statement demonstrates, this new direction is gaining traction, particularly in light of calls for companies to more directly address concerns around issues such as climate change.
When President Trump’s asserted that companies must “strive to maximize shareholder return, consistent with the long-term growth of a company” (in Section 5 of his energy infrastructure executive order), he set two contradictory goals. A management approach “consistent with long-term growth” would balance the focus on short-term shareholder return maximization with longer-term considerations such as preparing for and responding to a changing climate, the transitional risks that accompany that change (such as a new fuel mix or carbon pricing), and the physical risks likely to be felt. But, as we have seen since the 1970s, a corporate governance approach focused on maximizing shareholder return generally prioritizes short-term return over such long-term considerations.
While there are many ideas about regulating a more balanced approach to corporate management being debated,[3] there is currently nothing preventing public companies from more meaningfully responding to the needs of employees, customers, communities they work in, long-term investors and other stakeholders, even when it negatively impacts short-term returns. Better corporate governance does not replace the need for the guiding hand of effective environmental and climate regulation based on the scientific analysis of environmental and health outcomes. However, major companies taking a more balanced approach to corporate governance can help improve outcomes. On issues like the impact of climate change, we are even beginning to see an alignment of interests among shareholders concerned with long-term return and other stakeholders. The Business Roundtable statement does not change the law, but the law has never foreclosed consideration of non-shareholder stakeholders in management and board decisions.
[1] The business judgment rule is a corporate law concept that presumes corporate directors and managers act in good faith and does not question their decisions if they reasonably believed they acted in the best interests of the corporation.
[2] “In other words, 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.” Lynn Stout, Corporations Don’t Have to Maximize Profits, New York Times (Opinion) (April 16, 2015).
[3] For example, Professor Sarah Light of Wharton proposes the adoption of an “environmental priority principle” in state corporate law that would modify the existing business judgment rule to require consideration of specific environmental benefits, among other ideas. Sarah E. Light, The Law of the Corporation as Environmental Law, 71 Stanford L. Rev. 137 (2019), https://www.stanfordlawreview.org/print/article/the-law-of-the-corporation-as-environmental-law/. Sen. Elizabeth Warren has also proposed a bill (the Accountable Capitalism Act) to require that public companies consider the interests of stakeholders other than shareholders in their management decisions.