Thursday, March 19, 2015
This I Believe: On Corporate Purpose and the Business Judgment Rule
Prof. Bainbridge yesterday posted about The Modern Corporation Statement on Company Law. The statement has ten fundamental rules, of which number ten is:
Contrary to widespread belief, corporate directors generally are not under a legal obligation to maximise profits for their shareholders. This is reflected in the acceptance in nearly all jurisdictions of some version of the business judgment rule, under which disinterested and informed directors have the discretion to act in what they believe to be in the best long term interests of the company as a separate entity, even if this does not entail seeking to maximise short-term shareholder value. Where directors pursue the latter goal, it is usually a product not of legal obligation, but of the pressures imposed on them by financial markets, activist shareholders, the threat of a hostile takeover and/or stock-based compensation schemes.
Prof. Bainbridge is with Delaware Chief Justice Strine in that profit maximization is the only role (or at least only filter) for board members. As he asserts, “The relationship between the shareholder wealth maximization norm and the business judgment rule, . . . explains why the business judgment rule is consistent with the director's "legal obligation to maximise profits for their shareholders."
Chief Justice Strine has noted that the eBay decision, which I have written about a lot, says that "the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders." I think this is right, but I remain convinced that absent self-dealing or a “pet project,” directors get to decide that what is in the shareholders' best interests.
I have been criticized in some sectors for being too pro-business for my views on corporate governance, veil piercing law, and energy policy. In contrast, I have also been said to be a “leftist commentator,” in some contexts, and I have been cited by none other than Chief Justice Strine as supporting a “liberal” view of corporate norms for my views on the freedom of director choice.
When it comes to the Business Judgment Rule, I think it might be just that I believe in a more hands-off view of director primacy more than many of both my “liberal” and “conservative” colleagues. Frankly, I don’t get too exercised by many of the corporate decisions that seem to agitate one side or the other. I thought I’d try to reconcile my views on this in a short statement. I decided to use the model from This I Believe, based on the 1950s Edward R. Murrow radio show. (Using the Crash Davis model I started with was a lot less family friendly.) Here’s what I came up with [Author's note, I have since fixed a typo that was noted by Prof. Bainbridge]:
I believe in the theory of Director Primacy. I believe in the Business Judgment Rule as an abstention doctrine, and I believe that Corporate Social Responsibility is choice, not a mandate. I believe in long-term planning over short-term profits, but I believe that directors get to choose either one to be the focus of their companies. I believe that directors can choose to pursue profit through corporate philanthropy and good works in the community or through mergers and acquisitions with a plan to slash worker benefits and sell-off a business in pieces. I believe that a corporation can make religious-based decisions—such as closing on Sundays—and that a corporation can make worker-based decisions—such as providing top-quality health care and parental leave—but I believe both such bases for decisions must be rooted in the directors’ judgment such decisions will maximize the value of the business for shareholders for the decision to get the benefit of business judgment rule protection. I believe that directors, and not shareholders or judges, should make decisions about how a company should pursue profit and stability. I believe that public companies should be able to plan like private companies, and I believe the decision to expand or change a business model is the decision of the directors and only the directors. I believe that respect for directors’ business judgment allows for coexistence of companies of multiple views—from CVS Caremark and craigslist to Wal-Mart and Hobby Lobby—without necessarily violating any shareholder wealth maximization norms. Finally, I believe that the exercise of business judgment should not be run through a liberal or conservative filter because liberal and conservative business leaders have both been responsible for massive long-term wealth creation. This, I believe.
Nice post. Think you and I are very close on this as well.
I'd like one clarification, however. You write, "I believe that directors can choose to PURSUE PROFIT through corporate philanthropy and good works in the community." (emphasis added).
Do you believe that directors of a Delaware corporation could properly direct the corporation to engage in philanthropy and good works without a profit motive?
Explained further, do you think the directors at CVS could safely say that they stopped selling tobacco products for the community benefits --- even though they all believed it would hurt the corporation's share price in both the short term and the long term?
Posted by: Haskell Murray | Mar 19, 2015 4:48:15 PM
Thanks for the comments. Haskell, I think that a Delaware corporation does need to pursue profit through their community decision making, as I read eBay ands similar cases. I posted about CVS a while back -- http://lawprofessors.typepad.com/business_law/2014/02/cvs-more-evidence-courts-are-creeping-into-the-boardroom.html -- and I think Delaware courts are moving to say no your question of whether directors of a Delaware corporation could properly direct the corporation to engage in philanthropy and good works without a profit motive. At least, not in any significant way.
I don't believe this is the right choice, but I believe it is the law of Delaware. This is why the role of the benefit corporation is Delaware is one of the few places it has value. Unfortunately, I think this disregard of director primacy is risky for all companies, and not just those with community-minded focus, because eventually I think it could allow shareholders and courts to question any decision that can defer profit or delay monetization of certain initiatives.
Posted by: Joshua Fershee | Mar 20, 2015 9:49:58 AM
I agree with that response, though I know that there are professors who disagree.
However, it is unlikely that we will ever see that issue addressed with publicly traded companies, because I doubt a majority of the board would ever admit to ignoring shareholder value. They would simply frame it in long-term shareholder value terms, which the court would rightly respect.
We might, however, see more cases in the closely-held corporation context, where one or two individuals have effective control and are bold enough to admit their social, non-profit based, motives (as in Dodge and eBay). However, even those cases are likely to be rare, and will likely use the long-term value explanation.
Posted by: Haskell Murray | Mar 20, 2015 11:06:48 AM
" I believe that public companies should be able to plan like private companies, " Amen, amen and amen. Now if only the securities markets will get out of the way to let companies do just that.
Posted by: Jena Martin | Mar 23, 2015 1:02:42 PM
If you are being criticized by people on both sides of this important issue, you're probably in close to the right place! Thanks for sharing this statement of belief. Our views are very close, although perhaps not fully aligned. Hard to say without inquiring more into your use of terms in places . . . . But this is a useful, worthy effort.
Posted by: joanheminway | Mar 19, 2015 4:03:12 PM