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In the latest installment of the Salzburg Questions for Corporate Governance, John Cannon, partner at Shearman & Sterling LLP, reflects on discussions from the latest Salzburg Global Corporate Governance Forum program entitled Accountable to Whom? Restating the Purpose of a Corporation
This article is part of the Salzburg Questions for Corporate Governance series by the Salzburg Global Corporate Governance Forum
Recently, participants in the latest Salzburg Global Corporate Governance Forum program entitled Accountable to Whom? Restating the Purpose of a Corporation, addressed the contemporary debate over the proper purpose(s) of businesses conducted in the corporate form.
Professor Ed Rock of New York University School of Law, the Reporter (i.e., chief author) for the American Law Institute’s Project for a Restatement of the Law of Corporate Governance, led the program. Participants from multiple jurisdictions and perspectives, including corporate executives and directors, institutional investors, lawyers, academics, and experts on sustainability and other ESG matters, also contributed to a lively discussion.
The starting point for the conversation was the most recent version of Section 2.01 of the draft Restatement, “The Objective of a Corporation,” a text intended to articulate what the law now is in the United States rather than what it should be.
Then, through consideration of hypotheticals highlighting the potentially conflicting interests of shareholders and other stakeholders, the participants explored how corporate directors should or could make difficult decisions resolving those conflicts and how those decisions reflect a view of the purpose of the corporation. In this post, I consider some insights on the debate that I gleaned from the discussion.
One might think there would be little controversy about the content of current US law, which most people believe requires corporations to operate for the benefit of shareholders (1). After all, only shareholders elect directors, and only they, in most instances, may sue directors and officers for breaches of duty. Nonetheless, a vocal group in the US (with allies in the UK and elsewhere) argues that existing corporation law, properly understood, allows - or even requires - corporations to manage their affairs for the benefit of multiple stakeholders. These stakeholders include employees, lenders, customers, suppliers, and communities.
Prominent advocates for a stakeholder corporate governance model include the renowned corporate lawyer Martin Lipton. Lipton believes that Milton Friedman’s iconic 1970 essay, “The Social Responsibility of Business is to Increase its Profits,” ushered in an overly shareholder-centric and laissez-faire vision of capitalism. He and his allies further argue that (contrary to the current draft of Section 2.01 of the proposed Restatement) shareholder primacy is not legally mandated and has led to excessive short-termism and inadequate corporate concern for other constituencies and the broader interests of society.
Like many participants in our program, I am skeptical about this stakeholder model as an accurate explanation of the meaning of existing US corporation law. I also worry that the CEOs who signed The Business Roundtable’s “Statement on the Purpose of a Corporation” may only be paying lip service to stakeholder concerns. Still, I am sympathetic both to the desire to change our legal regime to be more protective of non-shareholder interests and to the instrumentalist view that consideration of non-shareholder interests often is to the long-term benefit of shareholders. This last point is key. In an increasingly interconnected world in which corporate reputation has become ever more important, valuable, and fragile, the shareholders of corporations that ignore important stakeholder interests and societal issues are likely to be the losers.
As participants in our program noted, Germany (with its “co-determination” model requiring board membership for employee representatives) and other jurisdictions already impose explicit legal accountability of corporate leaders to employees, local political units, and other non-shareholder groups. Yet other jurisdictions regulate corporate conduct and externalities more extensively than in the US, even if they do not necessarily modify the obligations of directors and officers to shareholders. One participant from Asia observed that we are mistaken if we believe that the rules we apply to the regulation of capitalism are immutable, like the laws of physics. From this perspective, corporations are artificial legal constructs required to have a social purpose and be regulated to ensure that they serve that purpose.
The distinction between laws that regulate the external conduct of business by corporations (e.g., environmental regulations, taxes, employee protections, and sustainability mandates) and those that purport to alter the internal governance of corporations (e.g., German co-determination and US Senator Elizabeth Warren’s proposed Accountable Capitalism Act) is a useful one. It also suggests different approaches that jurisdictions may adopt in seeking to make corporations more socially responsible.
Interestingly, rather than advocating for the Accountable Capitalism Act or some other statutory imposition of a governance model with true accountability to stakeholders, Lipton and his allies (including the World Economic Forum) are promoting a “New Paradigm.” This approach envisions neither extensive regulation of corporate externalities nor intrusive prescriptive rules about board composition and accountability. Instead, this ostensibly new model proposes voluntary cooperation among corporate managements, directors, large institutional investors, local governments, public pension plans, employees, and ESG advocates. They are encouraged to manage corporations in a socially responsible manner for the long-term benefit of corporations and all their stakeholders. To the extent that this movement advocates legislative or regulatory change at all, it is principally to make shareholder activism more difficult.
The New Paradigm, and stakeholder governance more generally, have come under criticism from prominent academics in law and finance who question the legal basis for stakeholder governance, the sincerity of corporate leaders pledging allegiance to the model, and the social utility of abandoning shareholder primacy (2). However, the critique of this model of stakeholder governance that resonates the most for me is that by allowing corporate decision-makers to consider and act in the interest of multiple divergent stakeholders without having enforceable legal obligations to those stakeholders, this may mean in practice that those leaders will be accountable to no one.
Finally, I believe that many corporations, whether through action or inaction and whether intentionally or not, have contributed to profound societal problems, including income inequality, racial and gender-based injustices, and climate change. It seems doubtful that a shift from shareholder primacy to the New Paradigm and stakeholder governance alone will be adequate to solve those problems.
(1) This is perhaps most apt as a description of the corporation law of Delaware (the state where a substantial majority of large US corporations are incorporated) applicable to for-profit corporations other than “public benefit corporations.” Note that Pennsylvania, among other states, has adopted a so-called “constituency” statute that allows directors to weigh the interests of other stakeholders, including employees and local communities, against those of shareholders.
(2) See, e.g., Lucian A. Bebchuk & Roberto Tallarita, The Illusory Promise of Stakeholder Governance, 105 Cornell L. Rev. 91 (2020).
John Cannon is a partner in the Compensation, Governance and Employment Retirement Income Security Act (ERISA) practice of Shearman & Sterling LLP and co-chair of the firm's Corporate Governance Advisory Group. He has been at the firm since 1985. He is an inaugural fellow of the American College of Governance Counsel, a member of the American Law Institute and an adviser to the American Law Institute's Restatement of the Law, Corporate Governance project. He received a J.D. from the New York University School of Law and an A.B. from Harvard College. John is a Fellow of Salzburg Global Seminar.
The Salzburg Questions for Corporate Governance is an online discussion series introduced and led by Fellows of the Salzburg Global Corporate Governance Forum. The articles and comments represent opinions of the authors and commenters, and do not necessarily represent the views of their corporations or institutions, nor of Salzburg Global Seminar. Readers are welcome to address any questions about this series to Forum Director, Charles E. Ehrlich: cehrlich@salzburgglobal.org. To receive a notification of when the next article is published, follow Salzburg Global Seminar on LinkedIn or sign up for email notifications here: www.salzburgglobal.org/go/corpgov/newsletter