Sunday, December 20, 2020
“T” is for Transformative (Corporate Governance)
In my first post on the "Study on Directors' Duties and Sustainable Corporate Governance" ("Study on Directors' Duties") prepared by Ernst & Young for the European Commission, I said that corporate boards are free to apply a purposive approach to profit generation. I added that:
[a]pplying 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.
This week, I focus on corporate governance’s enabling power. Therefore, “T” is for transformative corporate governance. Market-led developments can and do precede and inspire legal rules. Corporate governance rules are not an exception in this regard. To illustrate these rules’ transformative potential, I dwell on the ongoing debate around stakeholder capitalism.
First question. What is stakeholder capitalism? In a recent debate with Lucian Bebchuk about the topic, Alex Edmans explained that “stakeholder capitalism seeks to create shareholder welfare only through creating stakeholder welfare.” The definition suggests that the way to create value for both shareholders and stakeholders alike is by increasing the size of the pie.
In his book, Strategic Management: A Stakeholder Approach, R. Edward Freeman defines “stakeholder” as “any group or individual who can affect or is affected by the achievement of the organisation’s objectives.” (1984: p. 46). The Study on Directors’ Duties is concerned with the negative impact of corporate short-termism on stakeholders such as the environment, the society, the economy, and the extent to which corporate short-termism may impair the protection of human rights and the attainment of the sustainable development goals (SDGs). I am not going to discuss whether there is a causal link between short-termism and sustainability. In my previous post, I say that we need to take a step back to determine short-termism and whether it is as harmful as it sounds. Instead, I am interested in finding an answer to the following question. Has stakeholder capitalism practical value?
Edmans points out that “in a world of uncertainty, stakeholder capitalism is practically more useful.” It is more challenging to put a tag on various things in a world of uncertainty, and the market misvalues intangibles. Therefore, in this context, stakeholder capitalism would be a better decisional tool that improves shareholder value and profitability and shareholders' welfare.
Still, how do we measure CEO’s and directors’ accountability toward shareholders and the corporation for the choices they make? Can CEOs and directors be blamed for not caring about social causes? Is stakeholder capitalism, or as Lucian Bebchuk calls it “stakeholderism,” the right way to force managers to make the right decisions for the shareholders and the corporation?
While Edmans stays firmly behind stakeholder capitalism because he considers it has practical value in increasing shareholder wealth while increasing shareholders’ welfare, Bebchuk maintains that “stakeholderism” is “illusory” and costly both for shareholders and stakeholders. Clearly, they disagree.
However, both Edmans and Bebchuk agree on this – we need a normative framework that goes beyond private ordering and prevents companies from subjecting stakeholders to externalities such as climate change, inequality, poverty, and other adverse economic effects.
Corporate managers respond to incentives such as executive compensation, financial reporting, and shareholders' ownership. The challenge is to understand what type of corporate governance rules are more likely to nudge CEOs and managers to value other interests than shareholder wealth maximization. Would a set of principles suffice, or do we need a regulatory framework?
Freeman's definition of a stakeholder is telling because it allows us to think of corporations and governments as stakeholders for sustainable development. I am also inspired by the distinction that Yves Fassin makes in his article The Stakeholder Model Refined, between stakeholders (e.g., consumers), stakewatchers (e.g., non-governmental organizations) and stakekeepers (e.g., regulators). I suggest that the way to ensure stakeholder capitalism’s practical value is to create corporate governance rules based on appropriate standards. The SDGs afford the propriety of those standards.
Within this regulatory setting, corporate governance will fulfill its transformative potential by enabling, for example, the representation and protection of stakeholders, the representation of “stakewatchers” through the attribution of voting and veto rights and nomination to the management board (similar to German co-determination by which stakeholders like employees are appointed to the supervisory board). Corporate governance will show its transformative potential by enabling the expansion of directors' fiduciary duties to include the protection of stakeholders’ interests, accountability of corporate managers, consultation rights, and additional disclosure requirements.
The authors Onyeka K. Osuji and Ugochi C. Amajuoyi contributed an interesting piece, titled Sustainable Consumption, Consumer Protection and Sustainable Development: Unbundling Institutional Septet for Developing Economies to the book Corporate Social Responsibility in Developing and Emerging Markets: Institutions, Actors and Sustainable Development. The book was edited by Onyeka K. Osuji, Franklin N. Ngwu, and Dima Jamali. The piece addresses the stakeholder model from the emerging economies perspective. It goes to show how interconnected we are.
Joan, thank you so much for your comment! Changing the Delaware-centric shareholder wealth maximization norm as it stands is a challenge. Still, it is not impossible, especially if shareholders are nudging CEOs and managers to do it.
In my last post, Should We Call it Moral Money?: Ownership Matters and Commitment Too, I say that firm ownership and investor commitment matter because higher owner commitment is associated with a stronger sense of corporate purpose, that is, a stronger sense that the goal for the corporation is beyond wealth maximization.
I like it when you say that “responsible corporate managers respond to their perception of the legal rules within which they must operate. I assume in this regard that we are talking about public company boards and that they are well advised (legally, accounting-wise, and financially).” I agree. This is why business operations must fully integrate corporate purpose for it to be effective. In this sense, shareholders’ ownership with a long-term perspective and a governance structure that incorporates corporate purpose in the decision-making process is critical.
If there is a shift in the corporate culture that drives regulatory changes, lawyers will respond to that and advise accordingly. If there are regulatory changes that drive a shift in the corporate culture, lawyers will respond to that too.
Posted by: Lécia Vicente | Dec 29, 2020 7:59:22 AM
Thanks so much for this thoughtful response. I am with you.
I also want to note for your reference in this regard the work of GWU Law Professor Larry Cunningham on quality shareholders as part of the Quality Shareholder Initiative (https://www.law.gwu.edu/c-leaf-initiatives), of which I am a fellow. I believe it will resonate with you. Larry's work in this area stems from his in-depth projects studying Warren Buffet and Berkshire Hathaway Inc.
I appreciate the engaging posts!
Posted by: joanheminway | Dec 29, 2020 5:14:47 PM
Thank you for the pointers. Professor Larry Cunningham’s work resonates with me.
Shareholders can influence the corporation in different ways. Their commitment to the corporation affects stakeholders and the way directors exercise their fiduciary duties.
I am currently developing scholarship at the intersection of contract law and corporations. I look at corporate ownership through the principle of substance over form to create a mechanism that allows us to define the corporations’ ownership structure with more precision.
I find that such a mechanism is relevant for accountability purposes, especially when the presence of the relational element is significant and the shareholders are not committed.
This is a conversation I want to keep on having! Thanks, again.
Posted by: Lécia Vicente | Dec 29, 2020 8:15:21 PM
I've loved these posts! Great reading for me as I prepare to be on the AALS panel next week on these issues. The discussion will be much richer because of your contribution and the commentary between you and Joan.
Posted by: Marcia Narine Weldon | Dec 31, 2020 10:22:16 AM
Marcia, thank you for your comments! I am attending AALS too.
There is one particular aspect of the discussion that has captured my attention as well: co-determination. Appointing workers to boards is often seen as a good mechanism to implement stakeholder capitalism. However, I understand that data on this is mixed. Here is a review of the academic research on the value of workers on boards (http://alexedmans.com/wp-content/uploads/2019/02/Workers-on-Boards.pdf). It would be great to expand the conversation and discuss the evidence regarding workers' real impact on boards of directors. Thank you again.
Posted by: Lécia Vicente | Jan 1, 2021 9:45:06 AM
So much information and so many ideas in this post, Lécia! Let me highlight one that deserves further attention, from my standpoint:
"Corporate managers respond to incentives such as executive compensation, financial reporting, and shareholders' ownership. The challenge is to understand what type of corporate governance rules are more likely to nudge CEOs and managers to value other interests than shareholder wealth maximization. Would a set of principles suffice, or do we need a regulatory framework?"
You respond with the idea that regulation is key, noting structural and substantive law changes--a tall order!
I am of the view that responsible corporate managers respond to their perception of the legal rules within which they must operate. I assume in this regard that we are talking about public company boards and that they are well advised (legally, accounting-wise, and financially). With that in mind, I have a question for you. What prospect do we have to actually change the Delaware-centric shareholder wealth maximization norm as it currently seems to operate? That would be, imv, the lynchpin to change--especially since I do not see a lot of the structural changes as possible (but I may be unduly pessimistic on that point, and you can tell me so). Many boards are advised (wrongly, imv) that they must increase shareholder wealth in every decision they make. I suspect that in most cases, although I may be wrong, the advisors (whether legal or other) do not also advise that the board should engage in a robust stakeholder analysis before acting in the interest of shareholders.
Your additional thoughts are welcomed.
Posted by: joanheminway | Dec 21, 2020 8:04:44 AM