United States: The Purposes Of A Corporation And The Role Of The Board

Monday's Business Roundtable Statement on the Purpose of a Corporation is significant, mostly because it opens the door for more discussion of the idea of "corporate purpose". While there are many ways that conversation could go, there are good reasons to believe the discussion will lead to a shift in corporate governance towards more authority and responsibility for corporate boards. Specifically, boards will be expected to lead on corporate social responsibility issues.

Andrew Ross Sorkin sums up the background nicely in his article in Tuesday's New York Times1, including his summation that "for whatever progress may have been made Monday, it is hardly clear the debate is over." There are two issues, in particular, touched on by Sorkin that deserve quick supplementation.

First, a reason that Milton Friedman would say in 1970 that "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," and that the Business Roundtable would say in 2019 that companies "share a fundamental commitment to all of our stakeholders," is that in Friedman's time we had a functioning federal government (think Great Society programs of the mid-1960's, the National Environmental Policy Act of 1970 and the Employee Retirement Income Security Act of 1974), and today we have a dysfunctional federal government2. If you are optimistic that our political governance will improve markedly in the short term, then you should expect the corporate purpose debate to cool off soon. Friedman, by the way, was very explicit about the premise underlying his view of corporate social responsibility; namely, that corporate social responsibility involves the diversion of corporations for the performance of political functions: "[the corporate executive] is in effect imposing taxes, on the one hand, and deciding how the tax proceeds shall be spent, on the other. . . . The doctrine of 'social responsibility' involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources to alternative uses."

Second, the Council of Institutional Investors ("CII"), in responding negatively to the Business Roundtable's Statement, is relying on an argument that bends to the pressure of close inspection. On the one hand, CII could not credibly take a position against corporate social responsibility, insofar as its members have been very vocal supporters of that idea, in an active way. For example, for the third year in a row in 2019 environmental and social proposals were a majority of all shareholder proposals filed under Rule 14a-8. On the other hand, CII's membership is threatened by a return to the era of corporate managerialism, in which corporate executives had discretion to determine corporate policy with relatively little consultation with shareholders or oversight by boards. CII tried to thread the needle by strongly linking corporate social responsibility to long-term shareholder value, while kind of preserving the idea of shareholder primacy: "To achieve long-term shareholder value, it is critical to respect stakeholders, but also to have clear accountability to company owners." Echoing Friedman, CII argues that to the extent that social responsibility cannot be linked to stock price performance, the corporate responsibility issues are in the sphere of government, not business: "It is government, not companies, that should shoulder the responsibility of defining and addressing societal objectives with limited or no connection to long-term shareholder value." The principal problem with that thread-the-needle solution is that the link between long-term shareholder value and corporate social responsibility may not be strong enough, at least at this time, to fill the current vacuum.

Where are we headed? A stakeholder perspective, as contemplated by the Business Roundtable's Statement, does not necessarily involve any legally binding obligation. What the CEOs "commit" to in the Business Roundtable's Statement is almost certainly not legally enforceable under a contract theory. As for corporate fiduciary law, CII is probably right when it argues that "accountability to everyone means accountability to no one." Proposals have been made for creating a framework for legal responsibility in a world of stakeholder-focused governance. One such proposal would have each corporation have a statement of its corporate purpose included in its by-laws, with board fiduciary responsibility to justify their decisions in light of their statements of corporate purpose, to the satisfaction of the courts.3

A more likely landing point for the current debate is a strengthening of the role of directors, on whose shoulders can be placed responsibility for balancing shareholder interests with social interests. To bear that responsibility, the resources and commitment of boards would be increased.4 The result could perhaps retain the idea of shareholder primacy, but with increased attention to stakeholder perspectives – and, specifically, social and environmental issues – accompanied by disclosure related to those issues, as well as a heightened standard for board attention to the risks of inaction.5 The corporate law of Delaware, and likely most other states, could accommodate a new balance along those lines without any fundamental change to the law, because of the deference accorded to directors by the business judgment rule. Thus, directors would be encouraged to give heightened attention to stakeholder interests and would be protected under a traditional business judgment rule analysis from second guessing by the courts. Plaintiffs challenging corporate social responsibility efforts would have to plead facts showing that a corporate decision being challenged was not undertaken because of the potential benefit to shareholders that results from the intangible value of the corporation acting as a good corporate citizen. The board would be well positioned to assume that role as representatives of shareholders, who can be voted out by them, and not as corporate managers with the same types of entrenchment risks and incentives that Friedman's shareholder primacy theory was designed to address.


1 Andrew Ross Sorkin, "How Shareholder Democracy Failed the People (at https://www.nytimes.com/2019/08/20/business/dealbook/business-roundtable-corporate-responsibility.html?action=click&module=Top%20Stories&pgtype=Homepage).

2 We do not use the term "dysfunctional" as an aspersion on any political party or philosophy, but rather to describe a generalized inability of elected officials of all philosophies to engage in consistent dialogue and compromise that leads to the passage of thoughtful legislation designed to address the many existing issues faced by the country.

3 Colin Mayer, "Prosperity – Better Business Makes the Greater Good" (Oxford University Press, 2018).

4 As contemplated by Ronald J. Gilson & Jeffrey N. Gordon in their recent article entitled "Board 3.0 – An Introduction," Business Lawyer, Vol. 74, p. 351, 2019.

5 As contemplated by our recent notes entitled "Caremark and Reputational Risk Through #MeToo Glasses" (at https://www.clearymawatch.com/2018/05/caremark-reputational-risk-metoo-glasses/) and "Not So Sweet: Delaware Supreme Court Revives Caremark Claim, Provides Guidance On Directors' Oversight Duties" (at https://www.clearymawatch.com/2019/06/not-so-sweet-delaware-supreme-court-revives-caremark-claim-provides-guidance-on-directors-oversight-duties/).

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