Sunday, December 6, 2020
The post below is the first in Lécia Vicente's December series that I heralded in my post on Friday. Due to a Typepad login issue, I am posting for her today. We hope to get the issue corrected for her post for next week.
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My series of blog posts cover the recent "Study on Directors' Duties and Sustainable Corporate Governance" ("Study on Directors' Duties") prepared by Ernst & Young for the European Commission. This study promises to set the tone of the EU's policymaking in the fields of corporate law and corporate governance. The study explains that the "evidence collected over 1992-2018 period shows there is a trend for publicly listed companies within the EU to focus on short-term benefits of shareholders rather than on the long-term interests of the company." The main objective of the study is to identify the causes of this short-termism in corporate governance and determine European Union (EU) level solutions that permit the achievement of the United Nations (UN) Sustainable Development Goals (SDGs) and the objectives of the Paris Agreement.
Both the United Nations 2030 Agenda and the Paris Agreement are trendsetters, for they have elevated the discussion on sustainable development and climate change mitigation to the global level. That discussion has been captured not only by governments and international environmental institutions but also by corporations. Several questions come to mind.
What is sustainability? This one is critical considering that the global level discussion is often monotone, with the blatant disregard of countries' idiosyncrasies, the different historical contexts, regulatory frameworks, and political will to implement reforms. The UN defined sustainability as the ability of humanity "to meet the needs of the present without compromising the ability of future generations to meet their own needs."
The other question that comes to mind is: what is development? Is GDP the right benchmark, or should we be focusing on other factors? There is disagreement among economists on the merit of using GDP as a development measure. Some economists like Abhijit Banerjee & Esther Duflo say, "it makes no sense to get too emotionally involved with individual GDP numbers." Those numbers do not give us the whole picture of a country's development.
The Study on Directors' Duties maintains as a general objective the development of more sustainable corporate governance and corporate directors' accountability for the company's sustainable value creation. This general objective would be specifically implemented either through soft law (non-legislative measures) or hard law (legislative measures) that redesign the role of directors (this includes the creation of a new board position, the Chief Value Officer) and directors' fiduciary duties. This takes me to a third question.
What is the purpose of the company? In other words, what is it that directors should be prioritizing? In a recent blog post, Steve Bainbridge says
I don't "disagree with the assertion that the law does not mandate that a corporation have as its purpose shareholder wealth maximization" but only because I don't think it's useful to ask the question of "what purpose does the law mandate the corporation pursue?
[…] Purpose is always associated with the intellect. In order to have a purpose or aim, it is necessary to come to a decision; and that is the function of the intellect. But just as the corporation has neither a soul to damn nor a body to kick, the corporation has no intellect.
Bainbridge prefers "to operationalize this discussion as a question of the fiduciary duties of corporate officers and directors rather than as a corporate purpose."Defining corporate purpose implies providing answers to complex questions about the nature of the corporation. Is the purpose of the company to maximize shareholder value? Is it to promote other stakeholders' interests (e.g., employees, customers, suppliers and creditors, the economy, the community, the society, the environment, the long-term and short-term interests of the corporation) alongside shareholder value maximization? Is it to maximize shareholders' interests that include shareholder value maximization and societal and environmental considerations?
Corporate directors are in charge. They are the face of the business. In his piece published in the New York Times in 1970, Milton Friedman wrote that the managers' primary responsibility was to the corporation owners, that is, the investors. He wrote, "there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game […]." Any goodwill generated by the corporation is a by-product of its own self-interest, Friedman said. He perceived such goodwill as nothing more than "hypocritical window dressing."
However, fifty years passed, and we live in a new world – the post-Milton Friedman world. Here we are, discussing how CEOs and corporate boards should respond to climate change and the SDGs. How did we get here? The world has changed. Even Friedman does not deny how impactful the managers’ policy considerations can be. He acknowledges that the managers’ role can be political. If their role can be political, then making profit may not be the sole consideration in the managers’ minds.
Nevertheless, what does this mean for the corporation? What does it say about the relationship between managers and shareholders? Are managers no longer responding to the shareholders’ interests if the managers’ focus is on social issues? Not quite.
Let's take a contractual approach to the corporation. If we do that, we understand that optimizing shareholder value means paying attention to the new social values that claim a more inclusive economy. The better corporate officers and directors respond to new challenges and respond to those new social values, the bigger the shareholders' return will be.
Still, was Friedman completely wrong when he referred to "window dressing?" For example, companies incorporate environmental concerns into their capitalistic endeavors to appear to comply with the SDGs. This corporate attitude is referred to as "greenwashing." Fortunately, this phenomenon has been counterbalanced by the companies' commodification of sustainability products and investment in sustainability projects that are truly environmentally conscientious.
The pension system, shorter tenure of CEOs in corporate boards, executive compensation, and the rise of the sunrise industry are factors that make shareholder wealth maximization the purpose of the corporation. Still, this reality does not prevent corporate boards from applying a purposive approach to profit generation, which may lead to better corporate governance. Applying such a purposive approach will depend on moral leadership, CEOs' and corporate boards' long-term vision, clear measurement of the companies' interests and communication of those interests to shareholders, and rethinking executive compensation to encourage board members to take on other priorities than shareholder value maximization.
Corporate governance has a significant transformative role to play in this context. The question (the last one for this blog post) is the following. Is the Study on Directors' Duties that the European Commission outsourced up to the task? So far, the reactions have been poignant. The evidence that the study set forth has caused notable controversy and criticism, namely by a group of Harvard professors – Roe, Spamann, Fried & Wang -- who vehemently called attention to the study's flaws.