In 1932, Adolf Berle and Gardiner Means introduced the then-radical thesis that corporations are accountable not only to their stockholders, but also to other “stakeholders” such as customers, employees, suppliers and the communities in which they do business. Stakeholders other than stockholders are sometimes called “other constituencies.” Academics debated that thesis for forty years. In 1970, the founder of the Chicago School of Economics, Milton Friedman, wrote a famous essay arguing that the sole purpose of a corporation is to make money for its stockholders. Friedman’s opinion settled the matter for some, but for others the debate raged on in universities, boardrooms, courtrooms and legislatures.
In August of this year, the Business Roundtable released a one-page “Statement on the Purpose of a Corporation,” avowing a shared “fundamental commitment to all stakeholders,” including not only stockholders but also all of the other constituents mentioned above: “Each of our stakeholders is essential. We commit to deliver value to all of them.” Nearly every Business Roundtable member signed that Statement, which changed the Business Roundtable’s earlier statement (issued in 1997) that “[t]he paramount duty of management and of boards of directors is to the corporation’s stockholders.”
While some may see this change as long-overdue, others may react to the Business Roundtable’s new “stakeholder” model with skepticism and question the timing of the decision to change the earlier statement ahead of the 2020 elections in which corporate governance has been raised as an issue.
We are often asked what the new “stakeholder” model portends for decision-making in the boardroom. Answering that question, we join other leading US law firms in asserting that the legal standards and business practices stated below have earned their place in the boardroom and should be observed by prudent corporate directors:
- Long-Term Increase in Value Is the Primary Goal. As a matter of law, the primary purpose of a corporation is to increase its long-term (not short-term) enterprise value and is not, in ordinary circumstances, to maximize returns of and on capital provided by stockholders. The board of directors of a corporation has a fiduciary duty to the corporation and its stockholders to use the board’s business judgment to promote the corporation’s long-term increase in value.
- State Law Is Controlling. In addition to stockholders, the other constituents of a corporation typically include the groups mentioned above, as well as creditors of the corporation. The composition of the stakeholder group is determined as a matter of law by the business corporation law of the state in which the corporation is incorporated.
- “Other Constituency” Statutes Vary in Scope. While Delaware case law may limit the ability of a board of directors to consider interests of non-stockholders when taking certain corporate actions, the Business Roundtable Statement is not inconsistent with the law already in effect in more than half of the states, including Florida, Illinois, Indiana, Massachusetts, New Jersey, New York, Virginia, and Wisconsin, all of which have adopted “other constituency” statutes.States began adopting these statutes in the 1980s in response to hostile takeover activity.The statutes vary in scope, but generally allow boards of directors to consider interests in addition to the interests of stockholders when exercising their fiduciary duties in corporate decision-making.The additional interests typically include expected effects on customers, employees, suppliers, communities and creditors, local and national economies, long-term and short-term interests of the corporation, and other factors considered relevant by the board.
- Business Judgment Rule Should Insulate Careful, Loyal Decisions. The board of a corporation organized in an “other constituency” state may exercise its business judgment to allocate corporate resources to the other constituencies acknowledged by that state if and to the extent that it believes, in the exercise of its business judgment, that doing so will contribute to the long-term value of the corporation. Even if organized in a state without an “other constituency” statute such as Delaware, a board that fulfills its fiduciary duties of care and loyalty in making a business judgment to allocate resources to other constituencies should be protected from liability by the business judgment rule.
- Board May Weigh Corporate Reputation, Employee Welfare, Other “Soft” Factors. In determining whether to allocate resources, and how much to allocate, to other constituencies, a board of directors may properly consider factors such as the corporation’s reputation, the potential for positive or negative legislative or regulatory developments, and employee morale and welfare, in addition to other factors that could affect the long-term value of the corporation.
- “Benefit Corporations” Must Consider Other Constituents. Some companies have chosen to incorporate as “benefit corporations” since the first enabling law was enacted by Maryland in 2010. The directors of benefit corporations are required by state law to consider stakeholders other than stockholders. Well-known benefit corporations include Kickstarter, Plum Organics, Patagonia, Laureate Education and Altschool. More than half of all states now permit this choice, including California, Colorado, Delaware, Florida, Illinois, Massachusetts, New York, Texas, Virginia and Washington, DC. See https://benefitcorp.net/policymakers/state-by-state-status.
We do not read the Business Roundtable Statement as a commitment to value other constituencies more highly than stockholders, but rather as a commitment to consider the interests of other constituencies alongside the interests of stockholders. That would not require a change of law in ordinary circumstances in “other constituency” states or in other states as a general matter when the board is properly exercising its business judgment. There are extraordinary circumstances such as a sale of control of the corporation in which, under the laws of certain states, the interests of stockholders trump the interests of other constituencies. We do not read the Business Roundtable Statement as aspiring to change those results. In any particular situation, to the extent that the interests of stockholders align with the interests of other constituencies, the correct board decision would seem clear.
We surmise that the current debate may well result in a more challenging role for boards of directors, which could be charged with balancing the oft-competing interests between stockholders and other constituencies (and, for that matter, the oft-competing interests among the other constituencies). To bear that responsibility, boards will need greater resources and a broad perspective. As can be seen from the proliferation of other constituency statutes and benefit corporation statutes across the United States, state corporation law has been proven flexible enough to accommodate a new balance along these lines.
We invite your questions and comments.