Wednesday, September 3, 2008
Among non-experts, conventional wisdom holds that corporate law requires boards of directors to maximize shareholder wealth. This common but mistaken belief is almost invariably supported by reference to the Michigan Supreme Court's 1919 opinion in Dodge v. Ford Motor Co.
This Essay argues that Dodge v. Ford is bad law, at least when cited for the proposition that maximizing shareholder wealth is the proper corporate purpose. As a positive matter, U.S. corporate law does not and never has imposed a legal obligation on directors to maximize shareholder wealth. From a normative perspective, options theory, team production theory, the problem of external costs, and differences in shareholder interests all suggest why a rule of shareholder wealth maximization would be bad policy and lead to inefficient results.
Courts accordingly treat Dodge v. Ford as a dead letter. (In the past three decades the Delaware courts have cited the case only once, and then on controlling shareholders' duties to minority shareholders). Nevertheless, legal scholars continue to teach and cite it. This Essay suggests that Dodge v. Ford has achieved a privileged position in the legal canon not because it accurately captures the law - it does not - or because it provides good normative guidance - it does not - but because it serves professors' need for a simple answer to the question, What do corporations do? Simplicity is not a virtue when it leads to misunderstanding, however. Law professors should mend their collective ways, and stop teaching Dodge v. Ford as anything more than an example of how courts can go astray.
Professor Stout, I throw down the gauntlet. Why would I stop teaching such a fun case just because it states a legal rule that courts do not follow? Not only should we teach this case, we should write poetry about it. The case actually makes two very different and important points. One is that "judges are not business experts" and therefore if Henry Ford (left) wants to build up the corporate coffers so that he can invest in a new plant, that's his lookout and the Dodge Brothers can't squawk about it. I don't think Professor Stout objects to that portion of the opinion.
The other point is that the court will not permit Ford to treat Ford Motor Co. as a "semi-eleemosynary institution." He is not free to use the corporation's surplus to benefit humankind through lowered prices on Ford cars. He has to look after his shareholders first. Professor Stout objects to some language in the opinion -- that the purpose of corporations is to maximize shareholder wealth. I think the case really stands only for the more limited proposition that a corporation cannot simply decide that its investors have gotten as much return on their investment as they're entitled to and refuse on that basis to issue a special dividend. I doubt that the case is used to inculcate students into the view that the sole purpose of corporations is shareholder wealth maximization, since it is always taught in conjunction with other cases (e.g., Barlow and Wrigley), that clearly show that courts consider things other than shareholder wealth maximization to be legitimate corporate purposes.
I have developed my own view of this case in an article on the business judgment rule, which is not available electronically but can be found in 81 Tulane L. Rev. 829 (2007). Basically, I think Ford went off on his charitable urges because he did not want to reveal his true reason for preventing the Dodge Brothers from getting the $1 million in special dividends that they were after. It would not have been good for Ford Motor Co. if Ford had revealed his fear of competition. So Ford came up with a different justification for his decision and his language -- and his contempt for his shareholders -- was so extreme that the court balked. But I digress, here's the Limerick:
Dodge v. Ford Motor Co.
Reinvesting to build a new plant,
Ford went on a common-man rant
And stiffed his investors.
The boss who sequesters
His profits will have to recant.