Saturday, December 29, 2018

Strine and Wealth Maximization: Cracks in the Wall?

Chief Justice Leo Strine of the Delaware Supreme Court just posted a fascinating article/speech to SSRN, which was apparently delivered to the Institute for Corporate Governance & Finance in November.

The subject of the speech is the fiduciary obligation that mutual funds owe fund beneficiaries when voting their shares, and in particular, the funds’ failure – in Strine’s view – to adequately police portfolio companies’ political spending.

The general thesis is that investors in mutual funds benefit most when the economy does well by generating long-term, sustainable jobs, and he lauds the current trend of mutual funds’ willingness to second-guess corporate managers and vote for measures that promote long-term sustainability, including their increasing willingness to back shareholder-sponsored proposals on ESG measures.  As he puts it:

[I]nstitutional investors are not just getting involved in boardroom battles.  … [S]ome prominent mutual funds have now expressed the view that their portfolio companies should act with sufficient regard for the law and general social responsibility. That is, in the area of corporate social responsibility, the largest institutional investors seem to be evolving in a positive direction.

He laments, however, that funds’ willingness to buck management appears to stop when it comes to political spending:

In the key area of corporate political spending, the Big 4 have opted for a policy of total deference to management….  [T]he Big 4 generally will not even vote to require corporations to disclose what they spend on politics, leaving the Big 4 and others largely blind to what is going on… [T]o be fair, State Street has done far better, supporting a majority of these proposals over the years….

In his view, political spending indicates that the corporation is seeking to profit by short-term regulatory arbitrage rather than by long-term investment in better products and services that will pay off more over time:

If a business has to try to make money by influencing the political process, that suggests that its prospects for growth by developing improved products and services are not strong. Instead, the business apparently has to seek special favors to gain access to subsidies or government  contracts, not on the basis of the merits alone, but by currying favor…

He calls upon mutual funds to vote in favor of transparency regarding political spending, and even in favor of supermajority shareholder approval of political spending. 

So, this intrigues me for several reasons.

First, there is currently a fierce political battle being waged over the value of ESG proposals and whether mutual funds should vote in favor of them.  As I previously mentioned, this was a topic of discussion during the SEC’s recent proxy roundtable, and Phil Gramm in particular spoke emphatically against such proposals.  (He has also written, with Mike Solon, an op-ed against them).  Main Street Investors is, despite the name, a corporate group that has also been lobbying against such proposals and against mutual funds’ increasing tendency to support them.  Thus, it is surprising to see the Chief Justice stake out such a firm position in favor of ESG proposals.

But that’s not all.

The usual argument in favor of these proposals is that they are in fact long-term wealth maximizing, as Strine acknowledges.  But he also goes further and suggests that mutual funds should favor these proposals – and restrictions on political spending – even if they are not wealth maximizing in the corporate sense, out of respect for fund beneficiaries’ presumed shared interest in the safety of their jobs and the health of the environment.  As he puts it:

Worker Investors derive most of their income and most of their ability to accumulate wealth, from their status as laborers, not as capitalists. ….Unless American public companies generate well-paying jobs for Worker Investors to hold, Worker Investors will not prosper and be economically secure….

[F]or diversified investors any increased profitability by particular corporations that results from externalities is suffered by them both as Worker Investors and as human citizens who pay taxes, breathe air, and have values not synonymous with lucre.

The colder economic term externalities can be put in the more human terms of dirtier water and air, workers who suffer death or harm at an unsafe workplace, employees whose health care needs to be covered by the government or a spouse’s more responsible employer, or defrauded or injured consumers. All of them are costs that Worker Investors bear as taxpayers, human victims, and as diversified investors.  In other words, Worker Investors are not in on the swindle that results when an industry, think big tobacco, is able to make profits by shifting its costs of harm to others….

This is an extraordinary claim.  He is placing workers’ shared desire for certain basic living standards on par with the hypothetical shared desire of all investors to maximize returns, and claiming that mutual funds have a duty to advance those interests.

Now, he’s not the first to make this argument (Other examples here and here).  But I didn’t expect to hear it from Strine, and I have so many questions.

First, there is the issue of the factual basis for the argument.  Some of those workers presumably are employed with big tobacco, or big oil, or coal, or any of the other industries where the desire for good jobs (or even the desire for affordable transportation) and environmental sustainability conflict.  Shall we gloss over these distinctions (in the same way we do regarding the somewhat fictionalized concept of wealth maximization)?

Second, assuming he is correct, why is this a duty imposed on mutual funds and not the corporations directly?  Strine has been a vocal champion of directors’ duties of wealth maximization; is he saying that mutual funds should be voting for policies that directors’ own duties prohibit them from advancing?  I mean, obviously, the business judgment rule would prevent any kind of judicial second-guessing one way or another, but if we can talk theoretically about what mutual funds’ fiduciary duties require we can do the same for corporate directors.

Now, Strine (with co-author Nicholas Walter) has written before that if corporate political spending cannot constitutionally be constrained by regulation after Citizens United, then that suggests the shareholder wealth maximization norm must give way to a stakeholder theory of corporate obligation. (An argument that has also been made by others, including David Yosifon).  Previously, though, I took him to mean that Citizens United should be overruled; should we now take him to be inching toward a reformed view of corporate law? 

I obviously do not know whether anything more will come of this, but I look forward to future developments.

Ann Lipton | Permalink


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