Thursday, September 20, 2018
Evil and Shareholder Value
Matt Yglesias recently riled up the corporate law twittersphere with this tweet claiming that the shareholder value theory requires evil if evil increases shareholder value:
According to shareholder value theory, if being evil increases the discounted present value of future dividends then Google’s executives are required to be evil.— Matthew Yglesias (@mattyglesias) September 15, 2018
It’s a bad theory. https://t.co/B22fXWvkKe
The responses were swift and critical. Stephen Bainbridge led off:
Are you really that stupid? Or are you just willing to loo like an uninformed idiot to lie to your readers? https://t.co/7EOyw3b7C5 pic.twitter.com/sXU7uczPY0— Professor Bainbridge (@ProfBainbridge) September 15, 2018
Dave Hoffman also critiqued the claim.
I wish I were teaching corporations this semester so I could give this quote as a prompt for a final exam and see which of the unwary it traps.— Dave Hoffman (@HoffProf) September 15, 2018
This is not the law. https://t.co/JQEV5qAfzP
Hoffman went on to point out that directors are not obligated to seize every possible profit-maximizing opportunity:
Corporate law does not punish boards for failing to seize every dollar, outside of extremely limited merger contexts. So, given two options, you don't have to seize the one that maximizes the dividend stream in the way posited.— Dave Hoffman (@HoffProf) September 15, 2018
Even though corporate law does not force corporate boards to extract every penny in every situation, many still have concerns about how a real or perceived shareholder wealth maximization obligation prohibits corporate boards from explicitly pursuing non-shareholder interests. Haskell Murray has an interesting post on the issue. Mark Underberg also explored the issue in the context of corporate free exercise claims. As Emily Winston and others have explained, these concerns also underlie growing support for benefit corporations--for-profit entities that also explicitly pursue social goals. Leo Strine, the Chief Justice of the Delaware Supreme Court, also addressed this issue in a 2012 essay. He took the view that for-profit corporations were required to generally work to make money for shareholders and that empowering them to explicitly and purposefully advance other ends might not be wise:
A group promoting a new form of for-profit corporation, the charter of which indicates that other ends, such as philanthropic or community-aimed ends, can be put ahead of profit, reacted with hyperbole, urging corporations to leave Delaware. If, they said, you remain incorporated in Delaware, your stockholders will be able to hold you accountable for putting their interests first. You must go elsewhere, to a fictional land where you can take other people’s money, use it as you wish, and ignore the best interests of those with the only right to vote. In this fictional land, I suppose a fictional accountability mechanism will exist whereby the fiduciaries, if they are a controlling interest, will be held accountable for responsibly balancing all these interests. Of course, a very distinguished mind of the political left, Adolph Berle, believed that when corporate fiduciaries were allowed to consider all interests without legally binding constraints, they were freed of accountability to any.
Dave Hoffman seems to share this view as well.
It strikes me as largely benign that market forces temper managers' enthusiasm for goals that can't, at least vaguely, be linked to plumping the equity cushion of the firm's residual claimants! This is different from a legal command. https://t.co/eVjsJTIt7R— Dave Hoffman (@HoffProf) September 16, 2018
In any event, capital market pressures (and incentive compensation plans) may cause corporate managers to pursue profits--even in areas where shareholder profit maximization may not be good for society. After all, it's not terribly difficult to find troubling examples of corporate profit-seeking behavior. Just take a look at how corporations price insulin today. Or think about how BP aggressively drilled without working to internalize the environmental risks before the spill. This doesn't necessarily mean that the right decision is to free corporate managers from an obligation to think about shareholder interests.
Andrew Baker and Tamara Piety both make the functional point that market forces now drive managers toward shareholder wealth maximization even if they would rather balance objectives differently.
I'm with @TamaraPiety. My view is that managers want to achieve some balance of objectives (generally) which doesn't equate to strictly maximizing shareholder value. E.g. managers deal with employees more than shareholders and would rather pay more for a happier workforce.— Andrew Baker (@Andrew___Baker) September 16, 2018
Putting the precise requirements of corporate law to the side there are a lot of forces that tempt corporate managers to focus on shareholder profits in a blinkered way. These include capital market forces, incentive compensation plans, and widespread misconceptions about what corporate law actually requires. The business judgment rule does a great deal to shape behavior here and provide freedom for corporate managers to make ethical choices. Bainbridge captured it well:
But the key thing to remember is that because of the business judgment rule, the Dodge/eBay standard only has real teeth in zero sum/conflict of interest situations like Revlon. Shareholder wealth maximization strikes me as the better rule in those cases.— Professor Bainbridge (@ProfBainbridge) September 16, 2018
I'm with you. And there is some interesting research that I saw recently indicating that corporate foundations may be strong signs of managerial entrenchment and vehicles for self-dealing.
Posted by: Ben Edwards | Sep 20, 2018 7:01:00 AM
I like what Milton Friedman had to say about the objective of corporate decision-making:
In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.
I like Friedman's boundaries. They make a lot of sense to me and I would hope exclude a lot of decisions that involve doing evil.
Posted by: Bernard S. Sharfman | Sep 20, 2018 7:48:52 AM
Plus, I doubt a court of equity would compel a board of directors to commit an evil, but not criminal, act just because it would lead to great profits for the company. While I find fiduciary duties to have SWM as their objective, there must be boundaries (see Friedman's quote).
Posted by: Bernard S. Sharfman | Sep 20, 2018 8:28:31 AM
Great post, but what is “evil” in this context? If it’s a violation of existing law, then it’s obviously incorrect to say that the shareholder wealth maximization norm requires a corporation to do evil if it maximizes profit. If you don’t like some conduct that is not prohibited by law, then work to change the law to prohibit that conduct rather than provide cover to managers to spend other people’s money to pursue what they deem to be the right social cause of the day. Many of the social causes people claim can only be pursued with the abolition of shareholder primacy are actually completely consistent with shareholder primacy because they create goodwill and increase employee productivity, etc., while the calculation of optimal return is so fraught with assumptions that flexibility is the name of the game (not to mention, as is thoroughly set forth in you post, the cover provided by the business judgment rule). Meanwhile, the less obviously profitable social causes are so contested these days that it is arguably better for corporations to make as much money as possible, create gains for their shareholders (including all those with pensions invested in the company), and then allow those shareholders to use their money to support whatever causes they wish. Finally, the fact that the pursuit of profit has led to some awful results is likely easily offset by the reality that pursuit of one group’s social good has often resulted in the literal death of countless “outsiders” – not to mention the fact that human fallibility plus the limits on information gathering routinely lead to awful decisions even when the “good” goal is not particularly contested. While we can blame the pursuit of profit for a lot of ills, it also deserves a lot of credit – and the burden of proof as to some alternative better utopia driven by corporate waste of profits (which is what corporate social responsibility accurately defined ultimately is) should be on those advocating for the counter-factual.
Posted by: Stefan Padfield | Sep 20, 2018 6:42:42 AM