The legal principle that corporate boards must focus exclusively on maximizing value for shareholders wasn’t always taken for granted. It was enshrined in a 1919 court decision involving
Ford lost, though not entirely. Minority shareholders John Francis Dodge and Horace Elgin Dodge, who were scraping together money to launch a rival automaker, sued him to stop frittering away profits and to raise dividends. In Dodge v. Ford Motor Co., the Michigan Supreme Court ordered Ford to pay an extra dividend. But it simultaneously undercut the principle of shareholder primacy by affirming what’s now known as the business judgment rule, which gives boards of directors wide latitude to decide what’s in the best interest of the corporation.
That ambiguity has never been resolved. For a century there’s been a struggle between advocates of shareholder primacy and those who say corporations should take into account other priorities, particularly
Which side is right? Well, that’s where it gets interesting. The latter-day Henry Fords are correct that companies can and should aspire to more than just pushing up their stock prices, while today’s Dodge brothers are right that managers and boards shouldn’t have free rein to do whatever they wish with a company’s money.
Managing conflict over the purpose of the corporation is difficult, but some see it as part of the art of running a company. Barnali Choudhury, a law professor at the UCL Faculty of Laws in London, compares corporate directors to the resourceful main character Truffaldino in The Servant of Two Masters, an Italian comedy written in 1746. “Like Truffaldino, corporate managers should also be able to serve both the financial interests of shareholders and the interests of non-shareholder corporate constituents through use of the ambiguity of the corporate purpose,” she wrote in a 2009 article for the University of Pennsylvania Journal of Business Law when she was at Charleston School of Law.
The Trump administration has taken a very different approach, arguing that there should be little ambiguity when it comes to the fiduciary responsibilities of the board of a corporation or the trustees of a pension fund. On Sept. 4, the Department of Labor cited the legal principle of “eye single” in justifying a proposed rule in the Federal Register: In other words, fiduciaries of a pension fund must promote the welfare of participants and beneficiaries to the exclusion of all other concerns. The eye single formulation, which has a long legal history, may trace back to none other than Jesus, who said in the Sermon on the Mount (Matthew 6:22, King James Version): “The light of the body is the eye: if therefore thine eye be single, thy whole body shall be full of light.”
These, then, are the battle lines. The century-long debate has intensified lately because the ESG movement has gotten
But the power of big holders and the proxy advisory firms that help them decide how to vote their shares rubs some people the wrong way. “A small number of unelected agents, operating largely behind closed doors, are increasingly important to the lives of millions who barely know of the existence much less the identity or inclinations of those agents,” Harvard Law School professor John Coates wrote in a 2018 paper.
The Labor Department, headed by
The SEC has gone easier on ESG than Labor has, because the fiduciary standard in the law for corporate boards is more relaxed than the one for retirement plan trustees. But in July the SEC
Perhaps the most direct assault on ESG, albeit not one involving directors’ duties to shareholders, is being mounted by the
The Trump administration does have a point that there’s a potential conflict between ESG and a board’s fiduciary duties. Some ESG advocates try to elide the conflict by arguing that doing good for the environment, society, and governance increases corporate profitability in the long run. That’s true in some cases, but ESG isn’t simply a $100 bill on the sidewalk. The profitable parts of it are already being done willingly, or at least could be done soon. The resistance, political and otherwise, is to the unprofitable parts. “You can’t get away from the idea that ESG takes away from profitability,” says
Shouldn’t shareholders be able to push companies to do whatever they want, even if it seems political? In theory, yes, says
A cynical take on ESG is that it’s a way for CEOs and boards to avoid accountability. If profits come in below expectations, they can point to some wind farm as an explanation. “As profit maximization proponents have warned, vastly broadening the discretion of corporate managers can leave management with so much discretion that neither shareholder, employee, nor consumer wealth is maximized, but instead only their own,” Choudhury wrote in her law journal article.
There are three strong lines of attack on the shareholder primacy argument, Zingales says. One is that shareholders may choose to go beyond what the government requires because the government doesn’t always do what’s right. A second is that “corporations were born as public institutions with special privileges granted by the state,” and with those privileges come responsibilities. A third is the argument from absurdity: “In principle, if you take Friedman to an extreme, I should sue a CEO who doesn’t buy off all the members of Congress.” Almost nobody believes that.
Even if it’s only about money, diversified investors care about maximizing their overall returns, so they have a financial incentive to, say, push one company to reduce greenhouse gas emissions if it would benefit other companies whose shares they own that are harmed by climate change. Big money managers such as BlackRock are in a good position to coordinate that sort of thing.
It’s not economic theory or corporate law or any lofty principle that stops CEOs and directors from pursuing ESG goals, says Judy Samuelson, founder and executive director of the Aspen Institute’s Business and Society Program. The real obstacle, she says, is far more prosaic: the way CEOs’ bonuses are based on short-term financial performance. In a book on ESG to be published in January, The Six New Rules of Business: Creating Real Value in a Changing World, Samuelson names companies that she says have done it right:
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