1 W ashin ee L aw R evie w gton a nd L | Issue 4 Volume 50 Article 5 Fall 9-1-1993 f The S hareholde r W ealth In D efense O orm: A R epl y T o P rofes sor Gr een Maximi zation N n M . Bainbr idge Stephe s and additional works at: cholarlycommon s.law.wlu.edu/w lulr https://s Follow thi Part of the Busine ss Organizations Law Common s Recomme nded Citation In Defense Of The Shareholder Wealth Maximization Norm: A Reply To idge, Stephen M. Bainbr , 50 W ee . & L ash cholarlycommon Professor Green ttps://s ev L. R s.law.wlu.edu/ . 1423 (1993), h wlulr/v ss4/5 ol50/i ashin gton and L s brought to you for f ree and ope n access by the W This Article i ee Law Review at Washin gton & L ee University Schoo l of L aw ashin ee University Scholarly C ized editor of W ee Law Review by an author gton & L ashin en accepted for inclusion in W s. It has be ommon gton and L . [email protected] lease contact mation, p e infor lu.edu ommon aw Scholarly C l of L Schoo s. For mor
2 WEALTH THE SHAREHOLDER OF DEFENSE IN TO PROFESSOR A REPLY NORM: MAXIMIZATION GREEN M. BAINBRIDGE* STEPHEN norm the fundamental has been long wealth maximization Shareholder stronger finds Indeed, one rarely U.S. guides corporate which decisionmakers. case of the now classic the court in by that used than judicial rhetoric v. Ford Motor Co.: Dodge for primarily on and carried organized is business corporation A are to powers the directors of The stockholders. of the the profit to be is of directors The end. discretion that be employed for not does and end, to attain that means in choice the of exercised or profits, to the reduction of in the end itself, a extend change to order in to profits stockholders of among the nondistribution to other purposes.' them devote to to by, live words posit longer no are these that Our nonetheless hosts descriptively norm is both the maximization shareholder wealth that arguing and deficient. normatively of evidence to the a Despite smattering persuaded. Frankly, I am not 2 committed to the corporate law remains of mainstream the contrary, College of of Law, University of Illinois Stephen M. Bainbridge, Professor 1994 * © helpful Orts their for Eric and Klein usual Bill thank I disclaimers the Subject to Law. comments. (Mich. 1919). 668, 684 Co., 170 v. Ford Motor N.W. Dodge 1. maximization wealth shareholder not treat directors need 2. A few suggest cases that cases these of most in Upon close examination, however, objective. normative as sole their A.2d Co. v. Barlow, 98 In Dodge. A. P. Smith Manufacturing not inconsistent are with fact corporate charitable Jersey Supreme Court validated example, the New 1953), for (N.J. 581 acknowledge corporations require that ground, "modern conditions inter alia, that the giving on communities within as members of the social well as private as responsibilities discharge and rhetorical differences between Barlow the at 586. Ultimately, however, Id. operate." which they interests are often Shareholders' import. long-run little more than symbolic have and Dodge In short-run. the in appear to be harmful that decisions, as such charitable giving, served by challenged such arguments justified the court recognized that A.2d at 586, the 98 Barlow, mere on corporate social responsibility language arguably rendering its broader contribution, dictum. on language, as so with Dodge based not much be inconsistent cases to Other appear a minority for 1968), App. 237 N.E.2d 776 example, (Ill. Wrigley, Shlensky In result. upon v. the over team's sued shareholder, Wrigley, the majority the shareholder Cubs Chicago in against decision the claimed Shlensky Field. at lights to Wrigley install famous refusal latter's night that and sport day-time a baseball was that Wrigley's by beliefs motivated was lights Field. Id. Wrigley neighborhood siirrounding effect on the a deteriorating have baseball might concerned more evidence that Wrigley was uncontested Shlensky's apparently Despite 778. at for dismissed Court Appellate the Illinois interests, shareholder with than with nonshareholder 1423
3 50:1423 [Vol. LAW REVIEW LEE AND WASHINGTON 1424 of course I mainstream refer Dodge court. By the by espoused principles are still our premier corporate and which legislature Delaware's to courts directors to put law still requires done, Delaware it As long has lawmakers. 3 Dela- in At least nonshareholders. those of ahead of interests shareholder result this Although 778-80. be Id. at granted. relief which could upon claim failure to state a close on maximization, wealth devalue to shareholder appear examination may superficial on of the application a wholly unproblematic than more nothing involves case the examination Nonshareholder Constituency Interpreting Bainbridge, See Stephen M. business judgment rule. L. Rav. 971, 978-79 (1992). PEPP. Statutes, 19 by statutes adopted slightly constituency nonshareholder that the Green Professor suggests See norm. shareholder wealth maximization indicate the of erosion states over half also the Gover- Corporate Metaphors of Stakeholders: Changing as Green, Shareholders Ronald M. these of reading Green's Professor (1993). 1411-12 REv. L. 1409, LEE & nance, 50 WAsH. he hand, reads one the On respects. contradictory and important in errs two statutes, however, by interpreted it has been recently judgment "as rule as codifying the business these statutes clearly reject the Delaware is wrong. These statutes Id. This 1412. at courts." Delaware the the On 993-94. at supra, Bainbridge, See issues. constituency nonshareholder approach to wealth shareholder the challenge" "really not do statutes assertion that the Green's other hand, make to directors are best interpreted as permitting norm They wrong. also is maximization decisions. corporate making interests when nonshareholder and between shareholder trade-offs is it these jurisdictions, In supra, at 994-95. with Bainbridge, 1412 at Green, supra, Compare norm is no longer descriptively wealth maximization shareholder argue that the to possible thus measure. to hard long-term impact is their modify the norm, the statutes But while accurate. corporate law jurisdiction, position as the preeminent unchallenged First, given Delaware's statutes on constituency leaves the nonshareholder adopt such a statute to failure Delaware's does the are too So concerned. as public corporations at insofar least law the fringes the of statutes the Second, statutes. the interpreting and case applying law of lack any meaningful corporate managers to protect legislation designed special interest be regarded as plausibly can them as treat may Courts 996. at therefore Bainbridge, See supra, hostile from takeovers. apply face to their on statutes most though context, even hostile the takeover being limited to applying cases dearth of the explain continuing partly this may fact, In decisions. corporate all states in even with norm may survive wealth maximization shareholder so, If the statutes. the constituency statutes. nonshareholder 1980s. the of battles the arose out of takeover law point this on recent The 3. Delaware Delaware the Supreme 493 A.2d 946 (Del. 1985), Petroleum Mesa Co., Corp. In Unocal v. on bid] [of impact a takeover directors consider may "the board a that of target's held Court 'constituencies' other than shareholders (i.e., creditors, customers, employees, and perhaps Forbes & MacAndrews v. at In Revlon, Inc. 955. ... generally) Id. the even community to crucial provisos two court added the however, (Del. 1986), A.2d 173 506 Holdings, Inc., which except those in situations dealing with all of general applicability, first is The Unocal. boards to target arguably allowed triggered. If Unocal duties have auctioneering the Revlon constituency nonshareholder in increase an for wealth shareholder in decrease a trade-off from management forbids expressly Revlon interpretation. that forecloses Revlon wealth, 'anything interests. Rather, expense of shareholder at the interests protecting nonshareholder better off. also make shareholders better must off make nonshareholders to do directors 506 A.2d at 182. Revlon, interests become nonshareholder duty triggers, the auctioneering Revlon once Second, benefitting whether begins, object selling the business is auction whose If an entirely irrelevant. shareholder Instead, matters. longer no shareholders also may benefit interests nonshareholder limits Id. Revlon thus sharply only concern. appropriate maximization is the board's wealth only teeth has Revlon interests. To be sure, nonshareholder ability consider to directors' the from liability rule will protect directors the business judgment given that situations, takeover in
4 1425 DEFENSE OF THE NORM 1993] ware, shareholder wealth the norm maximization remains a thus more 4 competitors. its of any than law the of state the of description accurate more A interesting question is when ask we posed whether shareholder maximization wealth continues from suffice to a normative perspective. In view, my Professor a valuable brings Green the perspective to table on this 5 question. day, At end of the the however, I remain the unpersuaded that principle shareholder of maximization wealth deficient. normatively is I his paper, As read Professor Green views the choice between share- 6 ' perspective stakeholder "multi-fiduciary the and maximization wealth holder a morally as one. neutral In words, he treats other the debate as taking 7 solely place policy the on public doubt I level. whether is correct on he score, but this question that is a perhaps best another for left day. is It principally of portions those directed his paper at or relevant to questions in settings, but other most the point remains the supposed same: directors are to put shareholder interests first. have argued Our hosts that Supreme Delaware the decision in Court's Paramount Communications, Inc., v. Inc. 571 Time 1140 at A.2d 1989), (Del. least invites one t9 rethink the shareholder norm. maximization wealth See Lyman Johnson Case & David Millon, The Beyond Time, LAW. 45 2117-20 Bus. 2105, (1990). While Johnson Millon's and argument is creative and provocative, in my view Time do little has very to with nonshareholder for concern Rather, constituencies. explained simply it is better example an as extreme court's the of deference decisionmaking to board's the authority. The Model 4. Revised Corporation Act Business public the only source is of corporation rivaling law Delaware law. Its refusal drafters' to constituency a add nonshareholder provision to has considerable the Act thus symbolic importance. See Committee The of Corp. on Laws Other Am. Ass'n, Bar the Statutes: Constituencies Potential for Confusion, Bus. 45 LAW. 2253 (1990) Revised that (arguing Business Corporation Model not Act should contain non- shareholder provision). constituency recently The approved Corporate Principles ALl of permit Governance explicitly boards take to into considerations ethical account regarded reasonably to responsible appropriate the as conduct shareholder of the firm, even if not wealth is thereby PRINcIPLEs advanced. OF CORPORATE ANALYSIS GovERNANcE: AND RECOMMENDATIONS § 2.01(b)(2) (Proposed Final Draft 1992). In discussed of cases light the 2 notes supra 3, ALI however, the and restated not has existing law, poorly but rather created a wholly and explained unwarranted departure therefrom. has 5. Thomas Shaffer modem observed pointedly that systemati- "have schools law cally-theologically!--discounted, discouraged of disapproved the and invocation of the relig- tradition as ious important, even or interesting." Thomas Shaffer, The Tension Between Law in and America the THE Tradition, Religious in WEIGHTIER MATRS OF ON LAW: THE ESSAYS RELIGION AND LAW & 315, 327 Witte (John eds., Alexander Frank 1988). It is unfortunate, as well as disappointing, Green's that Professor little paper so does to that trend. counter 6. Green, 2, at supra note A point 1419. semantic order is here. in While Professor Green the term uses "stakeholder" both refer to to nonshareholders and to shareholders having connection some with the the firm, I prefer term constituents" "nonshareholder for the latter. From my perspective, term stakeholder to use the would concede much of battle the before been joined. it has Describing a stakeholder as someone implies they that have a stake in which imply the firm, may claims on they that have that the the firm firm legally is or morally bound contrast, respect. to In constituent be as to a I means that here it use only component one is a greater of part the not carry whole, does which same connotations. the at 7. Id. 1421 discussion ("[T]his takes the place plane on of question The policy. public concerns which model of corporate governance makes most sense best all of our and serves needs in a modem business environment.").
5 WASHINGTON LEE LAW REVIEW [Vol. 50:1423 AND 1426 policy, rather of morality, of I intend to take issue. with than which with the Green Professor begins premise own do shareholders that not move should law can and concludes the this that he the corporation.' From corporate managers' fiduciary obligations. So a new toward of definition a stated, and a normative component to Green's I impute both positive component that corporate law can conclusion. The positive is away move normative norm. The wealth component from the maximization shareholder law should do so. is that corporate the normative conclusion somewhat diffidently, Although Green states his most his devoting attention of to only conclusion, premise and positive detailed analysis. This is so because a normative conclusion his merits proponent neoclassical maximization norm can the wealth shareholder of his positive conchision and concede both quite premise cheerfully Green's his conclusion. Indeed, the former are wholly without conceding normative prevailing neoclassical model of the firm. consistent the with theory visualizes contracts Nexus of not as an entity, but as the firm 9 various inputs acting together to produce goods or services. aggregate an of argument also on two other premises: (1) the shareholder-corporate 8. Green's rests are not relationship; and (2) shareholders principal-agent not is a manager relationship fiduciaries." Id. at 1413-16. I consider the latter "individuals infra notes dependent on point accompanying As to the former, neither legal text. economic theory bases the and 69-84 nor shareholder wealth upon the existence of an agency relationship between share- primacy of managers. See infra notes 9-13 and accompanying text. holders or generally Frank Easterbrook & Daniel R. Fischel, The Corporate Contract, 9. H. See Rv. 1416 (1989); Michael C. Jensen L. 89 COLUM. H. Meckling, Theory of the & William Managerial Behavior, Costs and Firm: Agency 3 Fn. EcoN. 305 Structure, J. Ownership F. Fama, Agency Problems (1976); the Theory of the Firm, 88 J. POL. ECON. Eugene and 291-93 (1980); Eugene F. Fama & Michael C. Jensen, 288, of Ownership & Control, Separation 26 L. & EcoN. 301 (1983). For a somewhat different take, see William A. Klein, The J. Business Organization: Under Constraints, 91 YALE L.J. 1521 (1982). Modern Bargaining Green's paper familiarity with nexus of contracts theory, his Although Professor indicates instead public the separation of ownership and control in based corporations. premise is upon contracts did at least in part.because nexus of he theory, as we shall see, suspect I this him places he probably does not want to go. In any case, while the separation ultimately takes ownership and of an is of life, it does not provide a meaningful basis undeniable control fact for concluding corporations. ownership rights in public have Consider that no shareholders of Parable the the seems an appropriate illustration for what was originally Talents, which as exercise in moral discourse. Recall the operative an a master entrusted assets billed facts: three servants. to then left the country. By doing so, the master created both legal and He separation control. ownership and physical Two of the servants invested of assets in the doubling uses, and were rewarded when the master returned. The third, their productive value, interest returned assets without even having earned master's however, simply the and them on was 25:14-30. (A somewhat different version of the parable, punished. Matthew taught perhaps used occasion, in Luke 19:11-27.) While on appears this parable to make a a different Christ point, its religious significance depended upon the illustration's theological validity. secular the parable was effective because its hearers understood that the departed master retained Here, entrusted ownership though the stewards had been even with control over the his rights Those of us who find the parable effective today do so because we see a property. separation of and control in a host of secular settings and because we still ownership that understand separating from ownership does not control the owner of his rights. divest
6 1427 DEFENSE THE OF NORM 19931 provide Employees Creditors provide labor. capital. debt ini- Shareholders equity tially provide risk the capital bear of subsequently and losses and monitor the performance of management. monitors the Management per- coordinates employees of formance and the activities of all the inputs. firm's simply seen The firm is as complex the a legal fiction representing set of inputs. between relationships contractual these firm is other words, In the a but rather as a treated not as thing, explicit web and or nexus of implicit contracts obligations and rights establishing among various inputs the mak- ing up the firm. one are Because shareholders simply together of by bound inputs the this ownership of voluntary web agreements, meaningful concept is not a nexus in of owns contracts Someone theory. no one input, each but owns Professor totality. the thus correct is Green quite when he that asserts 1 0 "shareholders are not property owners." Green Professor he is equally correct when asserts that shareholders moral none the have of ownership. with associated normally rights Like many proponents of nonshareholder directs much constituency rights, Green at fire Friedman's of his Milton the defense famous shareholder of wealth maximization argued norm. Friedman of directors that when a board puts ahead interests nonshareholder the shareholders, the directors of those of literally are shareholders: from stealing the enterprise, free In private-property a executive system, a corporate of the owners employe is an business. He has [a] direct of the his responsibility That to employers. to conduct responsibility is the business with in their accordance desires, to will generally which be as much make money as possible conforming to while the basic of rules society ... **. in accord with Insofar as his actions "social his responsibil- reduce ity" is returns to spending stockholders, he their money.' I agree that Friedman's the problem but flawed, analysis is not is that 12 Friedman is on relying Green Dickensian a metaphor, as suggests. Rather, flaw Friedman's major in the on argument is his reliance what an now is the firm. out-dated theory of the relied Friedman upon traditional public the corporation, model of under which stock ownership than any other no is different of species private this Under the corporation property. model, thing, is can be so a it own The owned. shareholders are directors the so merely corporation, stewards shareholder's the of interests. in religious economic In as life, 3 life,' serve no masters at the same one can two thus time. Directors cannot 10. Green, note supra 1416. at 2, The Social Milton 11. Friedman, Business Responsibility to Increase Its Profits, of Is N.Y. 13, 1970, § 6 (Magazine), at 32, Tnias, Sept. 33. Green, note 2, at 1409-10. 12. supra 13. "No serve two masters. Either he will hate one can and love the other, or the one be the to will one and he devoted other." Matthew 6:24 (NIV). despise the
7 50:1423 [Vol. W REVIEW LEE LA 1428 AND WASHINGTON Rather, constituencies. nonshareholder and shareholders both to loyal be their share- of interests the to prefer them requires stewards as role their masters. holder ethos, American the of part profound is a such property private Because to cor- approach our dominated long implications normative this model's when confronted down broke however, model, traditional The law. porate cor- upon the depended model old model. The contractarian the new by it required words, In other owned. being of capable thing being a poration from separate entity an the as firm treat to corporation: the to reify one theory of contracts nexus seen, however, we As have constituents. various its of ownership concept throwing the By basic proposition. this rejects squarely baggage, ethical and economic associated its with along window, the out for argument principal Friedman's eliminates also model contractarian the nonshareholders. over shareholders favoring normative The water. the bath with the baby out throw not let's But maximization wealth the shareholder displace should we that conclusion can we that conclusion positive from the follow necessarily not does norm traditional the that showing between difference a is considerable do There so. a adopt should that we and showing inadequate is model property private must directors and officers which corporate to norm decisionmaking new affir- some requires latter conclusion Surely the behavior. their conform hosts as our new directions, strike out in we to are If mative justification. so? are we doing know why we shouldn't suggest, The paper. Green's run through arguments normative principal Two society, by privilege conferred rule as a liability limited the envisions first corporate responsible demand socially can which society return for in 4 1 limited lia- treats terms, economic into translated second, The behavior. by nonshareholders harm shareholders which through mechanism bility as a s them." onto costs externalizing certain by conferred is a privilege liability that limited argument, The first and public the of in light considered when very convincing not is society, treats model of contract The nexus liability. limited of functions private form standardized a providing than little more as doing law corporate default provide to mainly law exists corporate words, other In contract. properly are the default rules So long as ordering. private that facilitate rules private agreement to reach a the need be spared will parties chosen, most bargaining to reduce thus serves law Corporate question. issue in on the people, will most does, because contract form standard a as just costs, the At costly negotiations. undertaking without default rules accept the more little is analysis of Green's This aspect at 2, 1414-15. supra note See Green, 14. as a quasi-state corporation regarded the which theory, concession the on old a variant than corporate since over half-century a It has been state. the by delegated powers actor exercising See theory seriously. the concession stripe, took economic or political of any legal theory, 74 Appraisal, Critical A Corporation: Contracts" of "Nexus The Jr., Bratton, W. William (1989). 433-36 407, REv. L. CORNELL 2, at 1415. note supra See Green, 15.
8 1429 THE NORM OF DEFENSE 1993] time, however, same rules default modified by contrary the can because be different be accommo- rules wishing can parties idiosyncratic agreement, 6 dated.' limited a privilege granted by From this not liability perspective, is shareholders rules. Refusing to hold default of one just is It society. the thus is personally precise equivalent of enforcing liable for firm debts the contract, more and nothing less. sales nothing form standard a undoubtedly Green would Professor that the contractarian argue model and creditors is not bargain over flawed because shareholders do sorts these 1 7 shareholders for public corporations, true is of This premise of issues. close negotiations all the time in place corpo- of although take these sorts misses the point. It is precisely because share- rations, but the conclusion not and over the question of limited liability holders creditors bargain do so important. is the that doctrine The default does not matter rule's much if substantive content very 8 are If the law imposes full personal liability on transaction costs low.' liability but efficient rule, shareholders shareholders, is limited the and through private bargaining. When around creditors will the contract law high, are costs transaction however, the default rule's substantive content the law imposes matters personal liability on shareholders, very much. If full deal ink, and even some blood (figuratively of at least to date), great A 16. speaking, over both the positive and normative aspects has what might be termed the been spilled of This asks to what extent corporate law is actually made up of default enabling debate. debate mandatory rules ever appropriate. and rules, are whether to introduction the Probably best Symposium, Contractual Freedom this debate is 89 COLuM. L. Rav. 1395 in Corporate Law, is essentially position pragmatic (1989). My an positive perspective, corporate From one. a chock full of rules that purport to be codes are in mandatory, are often subject to but fact a evasion. I believe that mandatory rules are sometimes justifiable, normative From perspective, relatively only Indeed, given the advantages associated with default rules, but few in contexts. rule. ought required before we impose a mandatory be In my view, case to a fairly compelling justifiable only if a default rule mandatory allow the contracting parties rules usually are would externalities outsiders or if one of the on parties is demonstrably negative impose to contracting itself through bargaining. Whether fiduciary unable qualify for treatment as to protect duties is, a question beyond the scope of this paper. mandatory rules fortunately, do supra at 1413 ("At what point 2, shareholders and managers Green, note 17. Cf. into a relationship in which one party promises ever perform specified services freely enter to for in return payment contracts This to the consideration?"). of objection or other nexus shows which model, several places in Green's up is premised on a flawed notion of in paper, relationships. apparently would apply the term contract only to situations _contractual Green actual in which an in bargained-for consideration. This negotiations agreement result reflecting is interpretation "voluntary recently observed, narrow. commercial too As Ribstein Larry those provided by the default. terms of the arrangements, Commercial Code such as Uniform form provisions, realistically must be characterized as contractual. and standard indenture definition clearly under this broader contractual Corporate arrangements are contract." of Ribstein, The Mandatory Nature of Larry ALl Code, 61 GEo. WASH. E. the REv. L. 984, 990 (1993). that the substance of a default rule assertion not matter if transaction costs 18. The does of course is nothing more than a relatively are application of the Coase zero straight-forward The cite is Ronald H. Coase, The Problem of obligatory Cost, 3 J. L. & Theorem. Social 1 (1960). ECON.
9 [Vol. 50:1423 LAW REVIEW LEE AND WASHINGTON 1430 parties by definition must the efficient outcome, the is limited liability but bargaining costs to contrac- and, unnecessary worse yet, incur substantial high, when transaction costs are very legal rule. the override Indeed, tually live to the parties forcing impractical, is wholly the rule bargaining around inefficient rule. an with corporation's public between a bargaining that should be apparent It transaction high in a prohibitively place creditors takes shareholders its and contracting private to cannot on we depend this In cost setting. setting, a substitute must function as rules Instead, legal outcomes. efficient achieve getting whom is critical the party for it that for private bargaining. Thus a perform must we effect, In identified. value be highest has its way the over bargain the ques- the "If could costlessly parties experiment: thought apparent Green's Professor adopt?" would rule Despite they tion, which public and tort creditors of likely that both contract seems it misgivings, limited liability. a of rule would agree to corporations practical enforce- not insurmountable, a costly, if face would Creditors debts. corporate for liable to hold shareholders sought if problem they ment shareholders action a all with class as case the tried if creditor Even a practically but possible theoretically is which class, defendant a treated as individual numerous bring still have to would the likely creditor difficult, liable, severally and shareholders are jointly If its to judgment. suits collect letting and this problem by suing a few shareholders solve the creditor could fellow shareholders, contribution from their worry about obtaining them 9 still require multiple suits.' typically would claims substantial but pro- creditors better off by limited liability makes More importantly, a Under brought. be may claims against their which pockets deeper viding sharehold- become would be willing to few people liability, personal of rule 20 by highly- conducted be businesses would large-scale world, such In a ers. problem of further contract creditors face the personal regime, 19. Under liability a personally liable, are shareholders If individual of shareholders. creditworthiness the monitoring the portion of least some repay to at ability of each shareholder on the will rely creditors of all and monitor the creditworthiness would obliged to assess be Such debt. creditors even firms, for costly or, more some capital would make borrowing shareholders, which Mas- in early nineteenth century Hovenkamp that reports Herbert Interestingly, impossible. share- wealthy with of full personal liability, corporations rule a which followed sachusetts, had with poor shareholders debt financing, while those obtaining had difficulty little holders LAW: AMERICAN 1836-1937 HOVENKAMP, ENTERPRISE AND See difficulty. HERBERT considerable (1991). 50 arising claims to subject is estate entire personal whose One most that suspects people 20. business minimum, that how know at the bare to of want, would business a of the conduct out voice in want to have a proportionate and, more would likely, also being was conducted a being of way, the whole point Either conducted. be to was the business deciding how portfolio investors holding a diverse want to be passive Shareholders defeated. shareholder is to resources the neither the time nor shareholders have diversified Fully stocks. of many of their business or the solvency a particular corporation's of actively the monitor conduct whether know to want because shareholders would relevant latter (the being shareholders fellow to shareholders share of any loss). To require their to bear shareholders are able their fellow doing firm large in a sense, less management because makes even in actively firm participate
10 1431 DEFENSE OF THE 19931 NORM firms leveraged having a very amount small of equity capital and very a large of amount debt. secured The tort mass that plaintiffs Professor concern 2 Green, would particular, in ' very difficult have a time satisfying claims their such against firm." encouraging By a equity investment, liability the limited doctrine actually thus makes for easier it creditors all compensated. be to providing By rule the parties that the would they if choose could bargain, society facilitates private ordering. be To sure, benefits this share- 23 holders, but also it the benefits firm's other constituencies. Because society benefits as Professor Green's description well,24 as liability of limited a 2 5 "'social subsidy' in the form of an unpaid insurance policy" is incorrect. Limited liability is less a subsidy social a than social contract supported by consideration. Green Professor probably would that object version this of the limited story liability not does for account point: second his namely, that the doctrine shareholders allows to externalize costs various nonshareholder onto 26 constituencies and society at large. This objection, however, to fails the consider of variety mechanisms by the law which reduce can negative externalities created by corporate conduct. Forcing shareholders to inter- nalize costs those imposing by personal liability one is General option. laws welfare designed to corporate deter through conduct criminal and civil sanctions imposed the on its corporation, and directors, officers senior its are another. In run, long the latter the option probably is more efficient. would so in chaos. result FRANK See H. EASTERBROOK & DANIEL FisCHEL, R. THE ECONOMnC STRuctnuE CoRPaoATE OF 41-42 LAW (1991). 21. e.g., See, supra Green, note at 2, 1414-15. overview an For 22. mass of tort claims in insolvency proceedings, 3 DAvm see G. EpsEmN ET AL., BANtrupTcy § 11-8 (1992). point not The is liability that limited never imposes on mass costs tort but plaintiffs, those only that claimants nevertheless, are, better as a off class rule a under limited of liability of than one liability. full personal case, In any the corporation's a incentives managers to insure have firm the further protect tort creditors, even under of a limited rule liability. EASTERBROOK See & FISCHEL, note 20, supra 52-53. at After 23. reviewing the historical evidence, Hovenkamp concluded "limited that liability on the whole corporate made better creditors than [rather] off off." worse supra HOvENKAMP, 19, 55. at note Society 24. benefits in a variety of ways from limited particular, In liability. society benefits from an expanded pie economic private whenever are parties able maximize to the gains from transacting. available Indeed, the flowing gains from limited liability are enormous. There is a widely shared view that limited essential liability is the to attract amount enormous of investment necessary capital industrial for corporations arise to flourish. and e.g., See, HOvENKAmP, 19, 54 at note supra liability ("limited clearly encouraged flow the capital of enterprise"). new into By allowing the modern public corporation develop, to limited liability was in measure large the responsible for development of our modern economic system. 25. Green, supra note Hovenkamp 1415. 2, at points limited that out is properly liability regarded as only subsidy a if transfer[s] "it effectively wealth class one of from people to another." :KAmp, Hov supra 19, at note the 54. Based on historical concludes record, he that hard is "[i]t to such a make showing about limited Id. liability." Green, Cf. 26. note supra at ("Thanks 1415 2, limited to shareholders liability, remain immune to some the of of costs misjudgment or misconduct their by corporate agents.").
11 1432" WASHINGTON LEE LAW REVIEW [Vol. 50:1423 AND social The legal costs of rules include only not costs the impose they upon the parties, also the but costs the system legal in incurs enforcing those rules. have we As the seen, former option entails substantial enforcement costs both for creditors and, as a result, for the judicial system. In case, any while is it obvious that Professor Green pained is deeply by the corporate costs conduct can impose on nonshareholder constituencies, the alternatives he offers are poor substitutes shareholder for wealth max- imization. Although the metaphors proposes he substitutes as for the share- holder wealth maximization are norm not clearly out, spelled seems Green to suggest two different models for restructuring corporate managers' fi- duciary obligations. Under the first model, managers have would "multi- fiduciary" obligations shareholders to both and nonshareholder constitu- 27 ents. Under the second managers model, would permitted be to pursue 2 1 preferences. ethical own their Does really Green believe that either of these models would have 29 prevented the Bhopal tragedy? Consider the "multi-fiduciary stakeholder perspective." Green asserts that Union Carbide's knew managers about the at risks the Bhopal facility, concedes but that the were "slight" risks and 3 0 that "major were outlays" required make to the plant safe. Therefore, Green correctly concludes that decision the not to make the necessary repairs was a sensible business decision the from shareholder wealth maximization 3 perspective. But Green 1 ignores the very possibility real the that decision a was also sensible one the from perspective of the plant's workers and the local community. managers Unless are be held to strictly liable for that decisions harm some nonshareholder constituency, hindsight used cannot be when measuring their compliance their with multi-fiduciary responsibility. Rather, their com- pliance be must measured by what they knew or should known have at the decision time the was Union made. Carbide management that knew the plant was losing money that and there little was chance the plant could be 3 2 turned around. those Under circumstances, their realistic only choices were to close the plant forego to or maintenance. Given those options, and knowing the risks that were slight, management both and, more important, the workers plant's the and surrounding community probably would have thought foregoing to repairs a be gamble taking worth if it meant preserving the jobs and local economy. id. 27. See 1411. at 28. Id. at 1410. 29. is A word order perhaps in with respect to Professor Green's of the Bhopal use and disaster examples. similar view, In my grossly he overstates the magnitude of the negative externalities created by corporate by conduct focusing on instances that achieved prominence precisely they because extraordinary. were Green, 30. supra note 1420. I at 2, arguendo assume the Bhopal facts be as to stated by Professor Green. 31. Id. 32. See id.
12 1433 NORM THE DEFENSE OF 1993] choice: keep insist that there is a third Green likely Professor would and plant necessary maintenance. This is consistent the undertake open the eggs of that lay golden geese for the shareholders view as apparent his with constituencies: benefit of nonshareholder only a small today, of In cases most [shareholders] commit portion firm. With diversified their wealth to any one portfolios, their a firm is relatively low. in some in risk overall investing Indeed, elsewhere in their portfolio shareholders a result may even profit as by of the firms whose stock they own. of reverses suffered one by not policies or directions taken the do like Furthermore, if they have invested, they are free at a firm time to in which they any 3 3 market. public active very a in stock their sell taking the argument to In logical extreme, it is acceptable other words, its out entire shareholder value of a particular firm because only to wipe the 34 shareholders' be lost. of (But what happens if all portfolio part the will prescription?) firms follow Green's To the see consider this: would most problem with Green's analysis, invest willing retirement investors be to their if corporate in savings stock law? If not, why not? Probably because most investors his approach became not do regard corporate stock as a charitable donation their in investment 35 nonishareholder benefit made constituencies. to Their investment in cor- bring them a rate of return commensurate with porate stock must risks the If it does not, they will taking. stock in favor of other they are divest at least, monitor investments more closely. In either case, or, management cost equity capital will rise. Ironically, Professor Green's the of approach will to detriment of nonshareholder constituencies, ultimately thus redound with the need for infusions of equity capital are the because firms greatest same very the that produce most of size and firms small medium our growth. economic model precluded Yet, from disregarding even if Green's managers wealth shareholder be troubling. His would gives concerns, it still model to reallocate wealth directors a license nonshareholder from shareholders to 1414. 33. Id. at other at ... a moral commitment to ("Sometimes stakeholders See id. 34. 1421 may to exhaust the resources of the company require a willingness ... ). 35. object that some, perhaps many, investors have Professor might Green investment words, maximization. In other wealth wealth maximization objectives than other narrow is too because it fails to account for the variety of nonwealth factors that must be incorporated a goal a into analysis. The point is well taken, as evidenced by the popularity purely even utilitarian responsible does funds, but it socially not justify creating a multi- of so-called investment wealth should with the assumption that begin maximization is a obligation: fiduciary Analysis of the utility function for virtually all investors. Once we move significant this part beyond goal, probability is very high that the shareholders' nonwealth concerns will vary common the nonwealth a diverse shareholder community, the and components of the In large considerably. function are thus likely to collective Shareholder wealth maximization therefore utility wash. not the lowest common denominator, just the only common denominator. becomes but
13 1434 WASHINGTON LEE LAW REVIEW [Vol. 50:1423 AND As such, strikes squarely at the heart constituencies. it law. corporate of maximization wealth The shareholder long-standing on norm premised is allocation gain nonshareholder constituencies rules, under which are paid to whatever is first, over but shareholders are entitled left the of all after formers' contrast, claims model gives nonshare- are satisfied. In Green's holder constituencies the apple. As we shall see, however, second bite at a protect their adequately can nonshareholder constituencies claims through 3 6 the contracting and political a processes. bite both This makes second 7 and unnecessary wholly old saying: "God helps undeserved.1 is an There themselves." So those who help Employees, too com- law. the does local nonshareholder munities, and other wards are constituencies not of the they If fail court. why should the law give to a protect themselves, them at the apple? bite second accordance in with managers to act which allows other Green's model, ethical preferences, prove their own would constraint equally an ineffective the on on One who relies is management's which Green costs concerned. with corporations from externalizing sense moral prevent to relies costs certain thin reed upon Again, consider the Bhopal a very indeed. disaster. Under business judgment rule almost certainly would have insulated law, current the Carbide's Union from liability if they had directors undertake chosen to 38 repairs. Yet, they did not do so. Given that the necessary Union Carbide's board had unrestricted almost their own pursue precepts to freedom ethical under existing law, Green's model have led to a different why would 3 9 outcome? 36. infra See and text. 74-82 accompanying notes 37. Assuming those who enter into voluntary competitive with markets, relationships the firm should be viewed as having done on the understanding that they are making so trade- offs and certain risks. them unbargained-for ex post protection when accepting Giving those materialize risks a windfall. thus them gives See 38. that 976-80 (noting leading cases 2, reveal shareholder supra Bainbridge, at note challenges usually fail because of business judgment rule). If to operational decisions Union Carbide subject nonshareholder constituency statute, was a to be would even directors its further See insulated at 997-1002 (using examples from liability. id. that nonshareholder to show insulate from statutes constituency directors connection with decisions). liability in operational unless Carbide's that Union 39. Consider unusually au- decisionmaking structure was of decisionmakers number a thoritarian, have had to approve the decision to likely would repairs on Bhopal effect the these is that all of unlikely decisionmakers highly It plant. would ethical perspectives bring identical and to table. Even those the share the same concerns who and values may not concerns that agree particular decision best advances their a Some goals. consensus therefore has to be reached. Given the socialization sort of of and modem training shareholder maximization is the norm U.S. wealth corporate managers, prevail likely most to consensus-building any in Green himself acknowledges, this process. dominates As metaphor legal business both and 1410. fiduciary See Green, supra note about at duties. To thinking 2, sure, Green states that be metaphor is flawed, Green, supra the 2, at 1413, but changing note the is easier metaphor than done. Green's whole approach strikes one as an said Indeed, what Harold example of as the pointless describes of expecting people to Demsetz exercise differently than behave they actually See Harold Demsetz, Information and Efficiency, 12 do. L. 6 EcoN. 1, J. (1969). & based be To policy must be effective, on how people behave, public
14 DEFENSE THE OF NORM 1993] the absence Despite any of compelling affirmative justification for replacing shareholder the wealth maximization norm with either the of models Professor Green nonetheless it proposes, seems appropriate to outline 4° what I as regard the arguments two major against doing so. The first might be termed the "two problem. masters" second The termed be might the problem "managerial of sin." As Green acknowledges, management occasionally faces situations in it which is impossible advance to shareholder interests to and protect 4 simultaneously nonshareholders 1 harm. from interests whose Yet, should management pursue when shareholder and nonshareholder interests are in irreconcilable conflict? Green's answer principal seems to manage- that be should ment make trade-offs shareholder between nonshareholder and in- terests, balancing the harms and benefits or more less equitably, although is he prepared clearly permit to management eliminate to shareholder value 42 interests. nonshareholder protect to necessary when completely His not approach directly leads only to the managerial problem, sin but a raises also host practical of collectively issues making up the two masters problem. happens What there is when a conflict between shareholders and nonshareholders and also between various nonshareholder constituencies? Suppose, for example, that management considering is closing down an obsolete plant. will closing The harm the workers plant's the local and community, but will benefit shareholders, creditors, employees at a more modern which to plant work previously the performed at the old plant is how not wish they behave. we A clarifying in order here. point is of purposes For proposed Green's analyzing model, I have assumed that management's decisions are driven solely by ethical concerns. fact, In however, management's decisions are least as likely at be driven by self-interest to as by ethical concerns. (I claim do not that management alwtys pursues self-interest own its nor that it always rationally. acts claim only I that with so does it considerable frequency.) we As shall management's see, self-interest often will coincide extent to a greater nonshareholder with than interests of those with shareholders. As it however, out, turns that an argument is against-rather an than argument for-Professor Green's approach. infra 64-68 See notes and accompanying text. 40. Both problems, and "two masters" "managerial are sin," well documented the in literature, but that is part Despite of my point. the rather tone apocalyptic of some of the papers presented conference, at this have we before. been here sunspots Just as come cycles, in the corporate too so does social responsibility In debate. we had the 1930s, Berle-Dodd the In the 1950s, debate. and others Berle the revisited issue, by cases prompted In Barlow. like was the there 1970s, fracas a major over social corporate responsibility. Finally, today we the have nonshareholder constituency statutes. The twenty-year spacing is particularly inter- esting, is about because that span life the of generation. one academic other words, In the present debate not being is any driven by crisis corporate in law. just a is It perennial problem on which new each generation of law corporate feels obliged scholars its to stamp. put Herewith my spin. 41. Green, supra at 1420-21. note 2, cases, of most In course, taking nonshareholder interests into account in the shareholders' is long-run interest. the cases If Green Professor is concerned are rare, about I believe them as be, his to solution risks permitting tail to wag the dog. the 42. Id. at 1421.
15 1436 LEE LAW REVIEW [Vol. 50:1423 AND WASHINGTON Assume that the and plant. transferred, the modem communities around groups' expense. By what cannot latter at the former gain groups except 3 4 decision? the make management should standard Green, problems are overstated: these to According find themselves pulled sorts various of [F]iduciaries commonly In all these instances, professionals ... duties competing between and working they can expected both developing are to do the best by Why priorities. defensible and within of a framework reasonable the be asked to do managers senior and corporate cannot directors 44 same? done. than said As them is more easily asks Green what of thing, For one can proposition that no one matter, serve two masters the theological a 45 proposition, two thousand simultaneously old. is As a secular at least years us who find the theological of is even older. Indeed, those it certainly part precisely because we recognize its in do proposition persuasive so experience. secular validity from our personal have I examples about which Green's of one To take Professor "lawyer for the situation"" is at best uncomfortable the being experience, Brandeis, untenable. Consider the example of Louis infrequently and not this a thorough examination of Brandeis' profes- term. After coined who Frank concluded: John sional conduct, of the Brandeis [T]he from study greatest caution to be gained A lawyer is constantly a never is, be "counsel for record situation." to urged somehow he is frequently conflicts which confronted with I have never attempted this without wishing I had to work try out. clients it. Particularly when old I attempting have up and given not, to solve at the extreme pressure may feel most counsel are odds, unsuccessful costly, is their time-consuming, problems for them. It a 47 usually results in disaffecting both sides. which mistake, lawyers of idea more favorably toward the disposed authorities who Even are easy, that role "is not that may fail, and will situation acknowledge the for recrimination in wake."" its often bring what standard should use when faced with management trying 43. determine When to Green's two models distinction nonshareholder between constituencies, the conflicts between law the management concludes, under creates, standard whatever Suppose-that becomes critical. the duty it to close requires plant. Management's ethical consensus, its "multi-fiduciary" that than weight the that its decision causes must be given greater that is harms however, the obligation management its pursue: its own ethical preferences or Which course benefits. should from the decision? who would those to benefit at 2, note 1418. supra 44. Green, See 45. 13. supra note supra Green, 2, at 1418. 46. note 683, Rav. L. 708 The Ethics of Louis D. Brandeis, 17 STA. Frank, P. John 47. Legal (1965). OF W. WLiAm HODES, Tan LAW LAWYERING C. HAZARD, 48. & 1 GEOFFREY JR. 1993). at 513 (2d 2.2:103, 1990 & Supp. § ed.
16 THE NORM OF DEFENSE 1993] Green fails offer us a solution for this problem. Instead, Professor to expresses confidence those of us in the legal profession he simply that will to outlines of a multi-fiduciary" duty after "years of be "develop able the 49 painstaking legal profession's poor expe- the legal reasoning." Based on sanguine. situation," I am less for the rience with "lawyers if proves Even it standards under which possible to- develop meaningful 50 be might a multi-fiduciary duty enforced, that seems it however, likely operate mostly by virtue of those standards would hindsight, and thus the critical ability to determine ex ante whether their deprive of managers interest the The conflict of demands. rules with behavior comports law's profession again provide a useful analogy. Despite many governing the legal these rules are still viewed as inadequate, vague, and years of refinement, 5 predictability of which certainty and stuff are inconsistent; hardly the 52 despite the central importance of those virtues made. corporate in Yet, supra 2, Green, at 1419. 49. note some extent, Green's multi-fiduciary model poses problems similar to 50. To Professor nonshareholder constituency that those the statutes managers permit to both because raise, make nonshareholder trade-offs between shareholder and proposed elsewhere interests. I have which courts can review director actions taken pursuant to nonshareholder a model by My See note 2, at 997-1023. supra interpretation of the statutes. constituency Bainbridge, statutes, however, was based on certain aspects of the statutes nonshareholder constituency significantly from Professor Green's model. The nonshareholder constituency statutes that differ permit do disregard shareholder interests, whereas Green's model apparently managers not to constituency text notes 33-34. Under the nonshareholder supra statutes, does. See accompanying no have managers to nonshareholders, and nonshareholders have fiduciary standing duties no challenge to management true neither rules may be these under Green's whereas of decisions, infra model. See have Finally, nonshareholder constituency statutes the no impact on 62. note business the rule, whereas Green's models may contemplate restricting or eliminating judgment it. infra note See These differences the task of developing coherent standards under 62. make model which applied significantly more complex than that under the nonshare- can Green's be constituency statutes. holder interpretation of the nonshareholder case, statutes was not In any my constituency assumption that the statutes were a good premised To the contrary, on the idea. I explicitly soundness as a matter of the law policy. See Bainbridge, questioned statutes' corporate supra at 1013, 1023-24. 1 am note even more convinced than ever that the statutes 2, now a are bad as they of the same flaws many Professor Green's "multi-fiduciary" because share idea, the statutes were on the books in over half of the states model. were Because and to unlikely a any soon, my interpretation was put forth be time way of making the best of a repealed as situation: if we must have the statutes, at least we can interpret them bad ways in that their harmful Why should we start down that rather unattractive road by fninimize effects. of Green's when we have the option directions staying the course? Professor adopting new Marc I. Steinberg & Timothy U. Sharpe, Attorney Conflicts of Interest: The 51. See a Coherent Framework, 66 NOTRE DAME L. REV. 1, 2 (1990); see also RESTATEMENT Need for c, Tn GovaRmG LAWYERS § 201 cmt. LAw reporter's note (Tentative Draft No. (TmRD) OF 1991) 4, that carefully articulate the proper conflict of interest standard are rare"). ("cases See Nancy J. Moore, Conflicts of Interest in the Simultaneous Representation of generally Controversy, Clients: Solution to the Current Confusion and Proposed 61 TEx. L. Multiple A 211 (1982). R V. Cf. Joel C. Dobris, Ethical Problems for 52. upon Trust Terminations: Conflicts Lawyers of 38 U. MIAMI L. R . 1, 51 Interest, ("When (1983) a person is unhappy about an irrevocable
17 1438 WASHINGTON LEE AND LAW REVIEW [Vol. 50:1423 53 5 4 law, this the is principal model wishes Professor Green us. upon foist to The is problem just not unpredictability. or uncertainty Ultimately, Professor are models Green's flawed fundamentally their because of failure either of of managerial sin. Under account adequately for the to problem Professor Green's models, management could its pursue freely self- own interest by playing shareholders off against nonshareholders. When man- agement's interests with coincide of those shareholders, management could decision its justify saying that by shareholder interests in prevailed this instance, and vice-versa. closing plant The decision described again above useful proves a example. Recall and that shareholders some nonshareholder constituents will benefit is if the plant other but closed, nonshareholder constituents will lose. If management's tied compensation is size, firm to we to it resist expect can down-sizing the firm. plant likely The will stay open, with the decision being reference justified by the impact to of a on closing plant's the workers community. and local the In contrast, if management's is compensation profitability, linked to firm plant the will likely close, with the decision by being justified concern management's for firm's the creditors, shareholders, and other benefitted constituencies. we come to Now the matter. the crux of Green's If Professor models are treated as a serious reform, proposal for two paradigms they by which implemented be might suggest themselves. Under the of the more limited two, a change in the prevailing norm leaves the rest corporate law of largely intact. more expansive The the two of fundamental a envisions reshaping corporate of law. limited the I take paradigm quite seriously. Although doubt I that will reject Delaware wealth the shareholder norm maximization in the near future, the limited paradigm has arguably already come effect into in those states with nonshareholder constituency statutes. Those statutes limit the shareholder by allowing wealth norm the board to make trade-offs between and shareholder interests, nonshareholder but they work changes no direct 55 on other corporate law doctrines. The more expansive paradigm, however, hard to is take very seriously. are Specifically, states to going not repeal judgment business the in favor rule of another approach duty to fiduciary 6 5 soon. time any Assuming the business judgment rule remain in place will regardless of norm which upon, the we settle be analysis expanded must to include the financial that he has arrangement the participation entered into with who lawyer a of also represents another is interested person who transaction, in the there certainty no or is predictability for the lawyer."). e.g., Harff 53. See, 324 A.2d Kerkorian, v. 215, 220 (Del. Ch. 1974) is ("It obviously important the Delaware that have corporate law stability and predictability."). Green, supra note 2, 54. See at 1419. 55. See supra note 2; see also Bainbridge, note 2, at supra 990-94. 56. only nonshareholder The constituency statutes to explicitly state the standard of review thereunder applicable the specified judgment business See Bainbridge, rule. note supra 2, at 994.
18 1439 DEFENSE THE NORM OF -19931 context in legal norm chosen the will which operate. situations, most In coincide." The tough and interests nonshareholder shareholder constituency in are interests diverge. One suspects that, course, of cases, which the those directors and officers norm, wealth shareholder the despite maximization into account even in these often take nonshareholder constituency interests surprising cases. no one other than the This is not particularly because seriously expects managers to leave economics or law occasional professor their at home. Nor is it particularly problematic ethical and moral concerns perspective the business judgment rule will insulate from a legal because regard the shareholder wealth conse- without directors from liability to decision in the vast majority of cases." quences of the board's Professor Green reasonably ask what happened to At this point, might and "managerial the "two masters" sin" are these If problems. problems rejecting his approach, how do I explain the valid reasons for freedom the gives directors to consider nonshareholder interests? judgment business rule Green's models, to Contrary Professor share- to accountability management goal of the legal regime from which the business holder a is welfare central 5 9 That treats preservation of man- however, regime, judgment rule arises. 0 6 goal. discretion agement While both accountability an equally important as at 57. See id. to justify 999-1000. shareholder wealth maximization tempting is It the grounds norm on the tide lifts all boats. In many cases this will be true. that a rising fixed a the corporation that is both on and prior to have claim Nonshareholder constituencies shareholders. So long as general welfare laws prohibit the corporation from that of the on imposing constituencies, the shareholder wealth maximization negative externalities those the these to In some cases, however, constituencies rising tide argument redounds norm benefit. because is fails to take into account the question of risk. Pursuing inapplicable it shareholder often requires one to make a decision that increases the firm's wealth maximization risk, which disadvantages increased rate of return usually nonshareholder The constituencies. associated in not benefit nonshareholders, because their claim is with risk increase does fixed, whereas increase corporation's riskiness makes it less likely that simultaneous nonshareholder the the in satisfied. be will claims that 2, at 998 (noting See cases in which business judgment 58. supra note Balnbridge, shield operational decisions from judicial review are so rare as rule amount to does not to than little more aberrations). note See 59. 2. supra Corporate Bainbridge, Directors 60. the ALI Independent Gover- M. Stephen See and GEO. WASH. L. REv. 1034, 1073-74 nance which drew on Michael P. Project, 61 (1993), Models Corporate Governance, Dooley, Two of 461 LAw. which in turn drew Bus. 47 (1992), NTH J. ARRow, Tim Lwsrrs oF ORGANIZATION upon K Dooley premises justifi- (1974). his the business rule on the shareholder cation of judgment Dooley, maximization wealth norm. work, Arrow, is not so limited. According to at authoritative however, 466. supra, Arrow's "the giving i.e., decisionmaking, of allocation orders, having and tell taking of someone what do, is an essential part of the mechanism by to organizations someone else which supra, at 63. Authority-based ARRow, function." arise whenever decisionmaking structures organization's members differing interests and access to information. See id. at 68- the have processes further that the benefits of authority-based out cannot be obtained Arrow points 70. are empowered to review the decisionmaker's choices: "If every decision of if is outsiders A be by B, then all we have really is a reviewed in the locus of authority from A to B to shift
19 1440 WASHINGTON LEE AND LAW REVIEW [Vol. 50:1423 discretion and are goals, important are also they ultimately irreconcilable. One inevitably reaches point a which additional at accountability can be 6 only had by management limiting discretion. The 1 judgment business rule reflects thus a policy decision to accept the risks encompassed two by the and masters managerial problems sin to in capture order the benefits flowing from broad managerial discretion. Management's freedom to consider non- shareholder interests an merely is by-product incidental that of determina- tion. essential The differences regime between a shareholder premised on maximization wealth a and regime Green's on premised models now should apparent. A be would latter the to shift increase the underlying costs the managerial sin and masters two problems create, without corresponding any gains shareholders for on benefit the of equation. side the Of course, so 2 long adhere to we as the limited paradigm, replacing the shareholder wealth maximization Professor norm with nevertheless Green's models might have a more psychological of legal a than Despite impact. greater the costs at Id. ... 78. Arrow's of course, model, describes aptly the publicly-held corporation. Bainbridge, supra, business 1056. at The follows rule judgment thus from a fortiori the corporation's decisionmaking structure because it prevents usurping from courts the authority. board's Dooley, 469-70. supra, at Interestingly, however, if we make the plausible the assumption that description would remain following even a apt models, Green's to shift corporations public an authority-based have will decisionmaking regardless of structure the decisions norm by which As are made. policy a the result, justification for preserving management discretion is independent choice between of the norms. competing the that the limited (Note paradigm is by a sound thus supported as argument, policy well political realities.) by as said that, however, Having aspect of one Arrow's model quite important is assessing in debate. Decisionmakers the present in hierarchial structures may their use in authority irre- sponsible ways. at supra, ARRow, In particular, 73-76. the literature cost agency shows that decisionmakers shirk their may responsibilities variety a in of ways that benefit at themselves the of the expense members. other organization's Bainbridge, See supra, Dooley, 1057; at supra, 469. This at tension described in results the text between the in the competing virtues and accountability. of discretion model Arrow's contemplates that cases in accountability some require will concerns limits on decisionmaker's the ARROW, authority. at supra, 77-79. Hence the various business to exceptions the Dooley, rule. judgment supra, at 476. In cases covered by those shareholder exceptions, the maximization wealth is norm preferable provides it because a surer of source management accountability. notes See infra 64-68. 61. See note supra Dooley, at 470 (arguing 60, business judgment that rule is intended to protect board). authority of approach 62. Green's the embrace seems to expansive our of more two paradigms. He apparently favors imposing "on managers directors and significant multiplicity a of but competing potentially and holding obligations" for "them accountable obli- fulfilling" those Green, gations. at 1418. note supra 2, models become so, If his problematic even more because they or eliminate would reduce benefits managerial the of discretion. This another point at is which the between distinction models becomes Green's critical. Under multi-fiduciary his model, constituencies nonshareholder would presumably the have right suit to management bring when breaches allegedly duty to its fiduciary that group. In contrast, the model under in which management simply freed is to own ethical its pursue preferences, nonshareholders presumably would have standing because not model that does seem not to any formal fiduciary envision running duties to those constituencies.
20 1441 19931 DEFENSE OF THE NORM associated the business judgment rule would continue with models, Green's insulate to discretion from management cases. most in The review judicial effects psychological however, of switch, should a not be downplayed. As seen, shareholder the have we maximization norm is central wealth to 3 management's socialization. the norm Accordingly, provides a forceful where reminder of the the if director's loyalty lies. business Even judgment its renders rule rhetoric largely unenforceable, the shareholder max- wealth imization norm goad. By removing is ever present an psychological the constraint the maximization shareholder that wealth and provides norm the simultaneously exacerbating approach managerial sin problem, Green's encourage managers to is less likely to of interests the collective the pursue firm's various to encourage constituents than it is management to pursue their self-interest. own between the existing The difference critical models, and regime Green's when however, emerges cases to turn in we those which the business rule judgment does In this not apply with full force. two the context, and managerial masters problems sin not only justify the share- retaining holder wealth maximization but also norm, giving it for teeth.6 Suppose, hypothetical example, that our takeover a corporation receives a from bid bidder with a history The rejects plants. board of closing obsolete the bid, citing the bidder's history. problems practical the of All above discussed important, present. an are More while the for threatened honest concern workers the directors' may have motivated might too so decision, a concern own positions and for their corporate Indeed, perquisites. managers are more suffer losses as likely much to takeovers result other a than of are 5 nonshareholder constituencies. Accordingly, difficult to it is at all not imagine a target using as interests board nonshareholder more nothing than negotiating device a from extract to side payments the bidder. Under the judgment law, business current rule would not protect the decision directors' show that it unless they could also share- benefitted the holders." the Indeed, emergence would wholly of control auction a preclude the board considering impact the from the firm's decision their of on 6 7 Because nonshareholder constituencies. permit Professor models Green's managers off constituency play to one against another, however, ac- the See supra note 39 (arguing 63. socialization and training of that given modem corporate manager, maximization wealth most norm shareholder is in to likely any prevail consensus building process). reject view that I the 64. legitimate target to play management has no role takeover in contests. fights or proxy I To incumbent management the contrary, believe properly has discretionary substantial authority for control. But even is in contests this for question a My another here day. point only the shareholder wealth maximization is that norm should used to and guide, be of exercise evaluate, management's its decisionmaking authority, however it may be. or broad narrow Bainbridge, supra note 65. at 1009-12 See 2, inherent between interests (discussing tension managers target of and target shareholders). 66. Id. at 982. 67. Id. at 983.
21 1442 WASHINGTON AND LEE LAW [Vol. REVIEW 50:1423 6 8 current law provided by countability Thus, lost. completely be would Green's less is model to likely transfer wealth shareholders from non- to shareholder constituencies, he as apparently envisions, to is it than transfer wealth both shareholders from nonshareholders and to managers. The justification Professor for Green's becomes models more even tenuous one when recognizes that shareholders vulnerable are more this to sort of misconduct management than are nonshareholder constituencies. Professor asks: Green it "Can really that said be employees (or local communities dependent or are suppliers) really able to better 'negotiate' the 6 9 of terms their relationship to the corporation than are shareholders?" presumably While he intended be a purely this to rhetorical question, in fact it has an answer answer the and is an affirmative one. Shareholders meaningful have no in voice corporate decisionmaking. As a legal matter, have shareholders no essentially corporate power initiate to action and, moreover, entitled are vote to on a very only few corporate 70 actions. Rather, formal decisionmaking power resides mainly the in board 7 directors. of matter, As a ' practical the course, of sheer mechanics of collective undertaking thousands by action of shareholders preclude them from meaningfully affecting decisions. management shareholders In effect, have but a single mechanism which by can they "negotiate" with management: withholding capital. If shareholder interests inadequately are they protected, refuse to invest. can The nexus of contracts model, demonstrates however, equity that one is capital but inputs the of a firm that needs to succeed. Nonshareholder corporate constituencies can "negotiate" thus management with in precisely same the fashion as do by shareholders: withholding their the inputs. firm If employee disregards interests, will it difficulty greater have finding Similarly, workers. if the disregards firm creditor interests, will have it greater attracting difficulty debt financing, and so on. of 68. The problem management playing off shareholders nonshareholders against is pronounced especially Professor when to turn we second Green's because model, a system management allowing to pursue its own seems ethical preferences any to defy notion of accountability. 69. Green, note supra 1418. 2, at 70. Under the Delaware Code, shareholder voting rights are essentially the to limited election of directors and the charter approval of amendments, by-law or of sales mergers, substantially the corporation's all of assets, voluntary and dissolutions. As matter, a formal the only election of directors and the amendment of the do not require by-laws board approval before shareholder action is DEL. possible. CODE See §§ ANN. tit. 8, 211 (1991). In 109, practice, the of course, even absent directors, election of a proxy contest, is predetermined by the nominating existing board year's the following board. To sure, 71. be one of the few issues shareholders on which is input have the selection directors. of As a practical matter, however, corporate the system voting shareholder and usually apathy render this combine to formality. meaningless a phenomenon This may be changing somewhat as institutional investors become more active with respect to corporate governance matters. am doubtful, I however, that institutional activism investor will have more than marginal effects. See Stephen Bainbridge, Redirecting M. Takeover State at Proxy Laws Contests, 1992 L. REv. Wis. 1071, 1088-90.
22 1443 THE NORM OF DEFENSE 19931 fact, withholding In often may more effective tool be inputs one's a it constituencies shareholders. Some firms is nonshareholder for than for groups equity the management investments. seeking If go without years for firms these in the shareholders have little shareholder disregard interests, out at recourse other than to sell prices lack that will reflect management's 72 few contrast, of firms can In concern wealth. shareholder for for survive of new employees and new debt financing. long without regular infusions management result, can prosper for long while ignoring As a few groups 73 interests. nonshareholder any variety of other mechanisms case, have In nonshareholders a management decisions that shareholders influence which with to available 7 4 5 7 One lack. mechanism shareholders, em- negotiations. Unlike is contract employers collectively. individually and with ployees regularly bargain both Even communities sometimes bargain with creditors. do So local existing offering prospective tax abatements and other induce- or employers, firms for in could ments which return they about extract should and promises constituencies enter firm's that nonshareholder the Those conduct. voluntary relationships protect themselves by adjusting with the corporation thus can account for the externalities imposed upon them contract price to negative 6 7 firm. the by values ability to 72. shareholder be is constrained by To sure, management's disregard legal and market forces. a we have seen, however, Professor Green's models variety of As weaken forces. Indeed, Professor Green's models only make sense if they are might well those weaken intended to shareholder from ignoring that wealth. the prevent management forces 73. In addition, indirectly mis- from management often nonshareholders are protected conduct, because those likely management's be aligned with are of nonshare- interests more to constituencies holder those of the shareholders. Salaried managers hold what than with amounts a claim on the corporation's assets and earnings, which is not too dissimilar from the to fixed other nonshareholder Moreover, much of corporate managers' wealth claims of constituencies. in undiversified human capital. These factors tend to make tied is up firm-specific them more ensuring survival than with taking risks with would maximize that firm's concerned the shareholder wealth. of mainly to voluntary constituencies herein the The applies 74. analysis although firm, point is not wholly inapt with respect to involuntary constituencies. In the political process corporate law an exceptionally blunt instrument with which to protect involuntary any case, is contract, constituencies, for that matter). Tort, well, and voluntary 'as constituencies (and well as a host of general welfare laws, provide property with a panoply of law, as them protections. Jonathan R. Macey, An Economic generally of the Various Rationales 75. See Analysis Shareholders the Exclusive Beneficiaries of Corporate Fiduciary Duties, 21 STETsoN for Making REV. 23 Granted, the extent of negotiations between the corporation and nonshare- L. (1991). likely to widely. In many cases, such as hiring shop floor employees, the only holders is vary a take standard it offer. But so what? Is a be form contract any negotiation will it-or-leave it-or-leave contract because it is offered on a take a it basis? If the market is of less just party making a take it-or-leave it competitive, a set price and other terms that will offer must long sales absence of particularized negotiations. As the as the firm must to lead despite from nonshareholder constituencies in competitive markets, the firm similarly attract inputs to offer those constituencies terms that compensate them for the risks they bear. will have from be shareholders can protect themselves sure, management misconduct in a 76. To
23 1444 WASHINGTON LEE AND LAW REVIEW [Vol. 50:1423 more important consideration is the ability many an Perhaps even nonshareholder constituencies to have protect themselves through polit- the process. ical Public theory choice that teaches Well-defined groups interest are benefit to able themselves the at expense larger, of defined loosely groups by extracting legal rules from lawmakers that appear to be general laws welfare in fact redound but mainly the interest to advantage. group's Absent few self-appointed a spokesmen, most whom of are gadflies either promoting or some service they shareholders-especially sell, individuals- no have political meaningful voice. contrast, In many nonshareholder con- stituencies are represented cohesive, by politically powerful interest groups. political Consider the enormous unions, wielded power by who purportedly represent interests the employees, of a group whose interests Professor 77 Green obviously cares deeply about. Unions played a major role in passing 78 state anti-takeover laws. Those laws had a significant part off in killing 7 9 hostile takeovers. the From shareholders' perspective, helped the unions 80 kill goose the laid that golden the the From egg. perspective, union's however, hostile takeovers inflicting were considerable workers. harm on The unions were probably wrong on that score,"' but the point is that the unions their used political power to transfer wealth from shareholders to 2 s constituencies. nonshareholder In Professor sum, Green's unnecessary models are because nonshare- holder constituencies have adequate mechanisms protect themselves to from 8 3 negative the externalities created by management misconduct. be To sure, similar fashion. have As we seen, shareholders refuse to can invest contract the unless price the risks reflects to which they exposed. are The that is trouble is a one-time this mechanism. the Once shareholders have purchased the stock, company's pricing the mechanism ceases to The function. twin problems uncertainty of and bounded rationality mean that shareholders fully cannot possible anticipate all future changes in management Accordingly, behavior. the pricing process cannot fully shareholders protect from changes midstream in managerial that behavior the increase to they risks which are exposed. contrast, the In and firm many of its nonshareholder constituencies engage in repeat transactions, which constitu- allows those encies changes to demand contract in the the price for round next that them compensate for midstream changes managerial in behavior. 77. For example, another consider the political power of local communities, so which is great Congress that to forced was the Base create Closing Commission in order to resolve the political prevented gridlock that it from closing obsolete bases., military 78. Bainbridge, supra note 2, 1009 at n.154. 79. Bainbridge, 71, note supra at 1068-88. The 80. is overwhelming evidence shareholders that substantial reap gains from takeovers. See supra Bainbridge, note 2, at 1009-10. 81. 1008-09. at Id. See Roberta 82. Guide Romano, A Takeovers: to Evidence, Theory, Regulation, and 9 ON REG. J. YALE 172-73 (1992) 119, (discussing studies of nonshareholder constituency statutes). course, Of in long the run, corporate benefited managers the most from anti-takeover state laws. is precisely this But irony the of sort inherent the in managerial sin problem. The 83. same mechanisms nonshareholder protect that constituences managerial from misconduct, of also enable course, nonshareholder constituencies protect to themselves from negative the externalities created when faithful corporate managers make based on decisions solely on interests. shareholder such, As these mechanisms only affirm not the positive case
24 1445 THE NORM OF DEFENSE 19931 process is perfect, but each standing the the political contracting neither nor probably alone nonshareholder constituencies provides with meaningful more would protections than More combined. models Green's both of to the more are shareholders point, than management vulnerable to misconduct constituencies, nonshareholder are because shareholders lack meaningful access protective the of many to of which nonshareholder mechanisms 4 . themselves avail may constituencies Professor Green acknowledges some these but blithely concerns, of dismisses "[tlaken individually and them: collectively, do arguments these not constitute convincing a very justification of principal-agent, fiduciary the 5 In model."" contrast, compelling I as regard a them set of reasons for the retaining shareholder norm. wealth maximization it saying Granted, make not does it not a road that so, but is that runs both ways? arguments In case, the any the wealth of favor in shareholder maxi- mization norm reflect and realistic view a more pragmatic of human nature. As Michael out: "Any order has Novak pointed social to intends that endure certain must be on a based beings human about realism and, ' therefore, a theory of sin on with it." 86 and Here a praxis for dealing the "sin" in question is that of self-interest. No informed corporate lawyer can doubt that the corporate directors very real risk some use will officers and nonshareholder for a cloak taken to interests as actions their advance own interests. 7 In fact, have as I elsewhere,8 argued all corporate many too U.S. managers are interests. nonshareholder about hypocritical Many of the same managers who vigorously in state of nonshareholder lobbied legislators favor constituency statutes, equally in opposing were vigorous plant closing laws protection other and worker statutes. Many of the same managers who bewailed jobs after successful the lost were corporate silent takeovers, about the for shareholder retaining wealth effectively they norm, maximization undercut also the arguments against Indeed, this reason, for the norm. concern Professor many of the costs that categorized properly even not are Green as "is defined negative externalities. An externality or that the voluntary as a cost benefit more imposes or or confers actions people of one on party third a their consent." ROBERT or parties without ULEN, COOTER AND & THaOsS LAW Because 45 EcoNomxcs voluntary (1988). through nonshareholder constituencies are compensated contracting and political processes the imposes for them, costs the corporation upon those not true externalities. are costs The processes political and contracting the will force corporation to internalize Not of course, but the them. perfectly, question the then becomes whether closing the gap of benefits costs of doing so. As justify have the we Professor seen, Green's models unlikely the gap and, in any case, would to are close at so do considerable only cost. was point 84. A related Act's drafters, who made by the Model point "the that out reallocation a function for of directors wealth is which especially and one are not suited beyond pale their perceived general from mandate of the of wealth allocations society. Such (which balancing of essentially interests a the various would be) are of constituencies political decisions." Corp. Laws Committee The on Bar note supra Am. 4, at of Ass'n, the 2270. Such therefore should reallocations as a result of political, not corporate, take place processes. Green, note 2, at 1418. 85. supra NovAc, A THEOLOGY MICHAEL TOWARD 86. CORPORATION 22 (1981). OF THE Bainbridge, supra See 87. note 2, at 1012.
25 1446 WASHINGTON LEE AND REVIEW LAW [Vol. 50:1423 of jobs tactics. Ironically, much of management because the lost defensive the anecdotal evidence on harm the nonshareholders to caused by takeovers relates employees to fired defensive after restructurings used by incumbent 8 managers to defeat a hostile bid. This is not to say all that actions taken on behalf of nonshareholder constituencies self-interest. motivated are by The key point, however, that is all such actions involve potential a conflict of interest. This is even true if managers the honestly believe are they acting in faith. good As Chancellor Allen pointed has "human out, nature may incline even one acting in subjective good faith to rationalize as right which that is merely personally 9 beneficial." Professor Green has simply to failed us offer praxis a for dealing with this problem. Nor does seem it that likely is one in offing. the Absent such a praxis, however, the shareholder wealth maximization norm 9 remains far more the attractive choice. 0 In closing, seems it appropriate again to note my that of critique Professor Green's paper unfolded has wholly public on a policy In plane. thinking the about moral aspect the of debate, however, I struck was a by question Professor Green poses his in book, The Ethical Manager, which I paraphrase How here: would I about feel living in world a governed by the 9 moral implicit rules in shareholder the maximization wealth Frankly, ' norm? answer my is: "pretty good." In fact, that is precisely the which world in we live. For many the years, rule basic shareholder that interests come first 92 governed has public corporations. That rule has helped an produce econ- omy is dominated that by public corporations, which in turn has produced 93 highest the standard living of of any society in history the world. the of id. See 88. 89. City Assoc. Capital v. Interco 551 Inc., A.2d 787, 796 Ch.) (Del. (emphasis deleted), dismissed, appeal 556 A.2d 1070 (Del. 1988). There 90. was great a deal at talk of the conference about burdens proof. of Shifting the burden of proof the to other side useful is a trick, debating Chuck but, as Yablon pointed out, a of burden proof litigation a is concept has very that little to academic do with discourse. related A point needs be made, to however. burden the While of proof a fiction is in context, this the burden effecting of legal is change Because not. shareholder wealth maximi- a zation is more accurate description reality legal of is than multi-fiduciary the approach, advocates of the unavoidably latter bear the burden of effecting a change. As matter, practical I dubious am that they be able will accomplish to goal. that Most state governments bend over backwards protect to management prerogatives, point a vividly illustrated by the takeover statute phenomenon. the Even nonshareholder constituency statutes more have to with do preserving management discretion than with protecting nonshareholder interests. was This probably motivation the for Bill suggestion Bratton's the at conference change that takes place at the level. federal Unfortunately for reformers, would-be federal help is unlikely be to forthcoming. The lacks SEC authority over governance, corporate while Congress repeatedly has proven incapable of serious corporate governance reform. generally See Stephen M. Bainbridge, The Short Resurrection and Life of SEC Rule 19c-4, 69 WASH. U.L.Q. 565 (1991). 91. See RONALD M. GREEN, THE ETaICAL MANAGER 243 (forthcoming 1994) (draft materials by cited permission). 92. See supra 2-3 and notes accompanying text. 93. In address an delivered in 1934, Justice, Mr. Chief now Justice, Stone declared
26 1447 DEFENSE THE NORM OF 19931 should it be bad. all Nor cannot be success of record that with system A made has Green than Professor showing much stronger a without replaced here. "the the loyalty was, in effect, principle precept as old that fiduciary of undivided that 'a man cannot serve two masters.' More than as Holy Writ, a century ago hospitable reception to that principle and the common equity a gave not law was man giving it recognition. No thinking to can believe that slow in follow economy an a business foundation can long endure without built to that upon loyalty principle." on to say that "The separation of ownership from management, the He went the development so as to vest in small groups control of corporate of structure make numbers small and uninformed investors, of imperative a of resources great active devotion to that principle if the modem world of fresh is to and business its function." perform proper Beran, F. N.Y.S.2d 2, 5 (N.Y. App. Div. 1944) (quoting Harlan v. Stone, The 49 Bayer RiEv. of Bar, 48 HAv. L. the 1, 8-9 (1934)). Influence Public
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