BOSTON: 9 May 2013 - In the United States, we’re experiencing a turning point in the intellectual history of how we think about corporations.  Or, we are experiencing the beginnings of this generations’ revisiting of the core questions about what corporations are, to whom they owe obligations, and how best to conceptualise them and their regulation.  This moment has been engendered because of the increasing scepticism the public is showing toward corporations and the people who manage them. The scepticism, in turn, owes its existence to the triple shocks of the Global Financial Crisis (revealing the risks to the economy of corporate mismanagement), the Deepwater Horizon oil spill (revealing the risks to the environment of corporate misdeeds), and Citizens United v The Federal Election Commission (opening up our politics to the risks of corporate seizure).

This moment might be squandered by the failure of academic analysis to break out of the conceptual dichotomy that has long dominated these debates within corporate law. On the one hand, we see the shareholder supremacists who lament the instances of managerial mismanagement and self dealing and offer a remedy of increased shareholder power. If only management were constrained by additional shareholder power to nominate directors, approve executive pay, or receive financial disclosures, then management’s incentives would better align with shareholder interests. The downside of this remedy, obviously, is that many of the risks of corporate power would increase with increased shareholder say. The problems of short-termism, environmental degradation, employee mistreatment and disempowerment, and risk externalisation would hardly be resolved with shareholder empowerment. In fact, the opposite would likely be true. This is because the interests of shareholders at best align with the interests of other stakeholders and of society as a whole only haphazardly, and at worst not at all.

On the other hand, we see the managerial and directorial apologists suggesting that the way forward is to protect managerial prerogative, so the benevolent elites will be able to resist the short-sighted urges of the marketplace and manage the firm for the benefit of its investors and indeed society as a whole. If only management would be loosened from the bothersome constraints of shareholder activism and government regulation, we would witness a burst of competitive energy that would carry us toward economic nirvana. The downside of this remedy, obviously, is that managerial prerogative is overwhelmingly used to benefit managers. Explosions in executive compensation and perquisites, the manipulation of financial reporting and disclosure, and self dealing in various guises are a more common outcome than benevolence. If the treatment for the ills of shareholder primacy is managerial empowerment, the cure may be worse than the disease.

There is a third way.  Managerial obligation could be increased, without the obligation running solely to the holders of equity. Fiduciaries of companies could be subject to meaningful constraints and obligations, enforceable by courts, without disabling their ability to use the corporate form for economic gain. The conceptual innovation of this third way — I use “innovation” though the idea is actually quite ancient — is for the fiduciary obligations of management to run to the firm as a whole, which would include an obligation to take into account the interests of all those who make material investments in the firm. Within this framework, it would continue to be a violation of fiduciary duties for management to self-deal, or act carelessly, or exercise something less than good faith judgment. It would also be a violation of their duties consistently and persistently to prioritize one stakeholder over others, or to fail to consider the interests of all stakeholders in significant corporate decisions.

The best way to conceptualise this third way — meaning the most helpful in building analogies that assist in defining their obligations — is to think of the board as a regulatory body.  Boards exercise power, delegated by and overseen by the state, to organize and officiate over a powerful institution that affects myriad stakeholders.  Like with regulatory bodies, there should be an obligation of consultation, of due diligence, of notice, and of opportunity to comment before decisions are made.  And most crucially, there is a requirement that the decision maker is fair, not beholden to any one stakeholder, and not influenced by personal or financial interest. Moreover, the substantive decisions are reviewed by courts on both substantive and procedural axes, with a significant level of deference (but less than the equivalent of the the business judgment rule).