Ever since Adam Smith described the efficiency of markets in an age where freedom and property rights were coming to be seen as key elements of the good society, capitalism has honored the concept that capital return at individual enterprises is a good heuristic for their social return. In a complex and interdependent global economy, however, that concept is being challenged, as many question whether the costs of unfettered profit seeking outweigh its benefits. This has led some to challenge the utility of the shareholder primacy doctrine, and others to challenge the utility of capitalism itself. This article argues that benefit corporation law represents an important opportunity to establish a better set of ground rules for capitalism that would preserve the capital allocation function of markets while addressing the negative social and environmental impacts that have become associated with capitalism.
In 2010, jurisdictions in the United States and beyond began to adopt benefit corporation statutes as a new option for corporations to choose a form of internal governance that rejects shareholder primacy.1 The benefit corporation statutes have undergone significant changes in the first decade of their existence. The motivation behind the original legislation was concern with the orientation of corporations, primarily around creating returns for their shareholders, leaving other stakeholder interests secondary. In this article I argue that if the purpose of this rejection is to encourage corporate conduct that is more socially and environmentally responsible, then eliminating shareholder primacy will leave a significant gap in the law unless it is replaced with principles that will lead to such conduct. In addition, eliminating shareholder primacy without replacing it with other principles that lead to coherent choices would discourage equity investment that is not accompanied by strict governance controls. Early iterations of the statute did not explicitly provide such principles, but newer versions are beginning to sketch out principles that: (1) will satisfy shareholders that their capital is being allocated in a manner that protects their interests as investors and (2) will address the social and environmental costs that are ignored in the oversimplified market model of capitalism reflected in shareholder primacy. I first address the four major forms of benefit corporation legislation that have been adopted and then trace the progression of these forms from the simple rejection of shareholder primacy to the creation of replacement principles. I then discuss the origin of shareholder primacy as: (1) a mechanism to protect investors from untrustworthy agents and (2) the instantiation of an orthodox market model of the economy. I show that for the same reasons that the market model of economics does not address dangerous externalities and inequalities, shareholder primacy leads corporations to externalize costs and ignore or exacerbate inequality. This makes corporate law, combined with shareholder control of corporations, a source of significant negative social and environmental impact.
I posit that some of the newer benefit corporation statutory language, and especially that of the recently adopted British Columbia version, is beginning to include principles that require companies to address inequalities and external costs and to recognize the need to do so in conjunction with others to mitigate the effects of a competitive market. This new language does more than eliminate shareholder primacy: it opens the door to express principles that investors, companies, and stakeholders can use to establish ex ante expectations for corporate conduct when stakeholder concerns and shareholder returns come into conflict. Finally, after reviewing the language adopted to date, a new set of director obligations for benefit corporations is suggested. These obligations recognize that profits that come from exploiting common resources or vulnerable populations should be rejected and that companies must also contribute their fair share toward common resources through tax payments and other means. At the same time, these obligations recognize that once these collective action thresholds are met, it is appropriate for companies to optimize profits to take advantage of the ability of free markets to allocate resources efficiently.
Although I focus on the language in benefit corporation statutes (which are purely optional), the need for collective action on many social and environmental concerns might suggest that it is necessary for all corporations to act in accordance with principles suggested here, rather than just those that make an affirmative choice to become benefit corporations. That question and the issues considered throughout this article interrogate the gap between the need for collective action and the inability of governments and NGOs to organize it and ask whether that gap can be filled, in whole or in part, by restructuring relations among firms, investors, and society. From that perspective, it would be necessary for all corporations to internally operate in this manner or to have their owners and controllers insist that they do. This latter concept is the subject of a companion paper.2
Moreover, even if all companies and investors were to adopt the principles of a fully realized benefit corporation statute, such principles will not solve social and environmental problems any more than shareholder primacy can solve the problem of how to make profits. This article only suggests a shift in principles; the hard work of applying those principles will have to be done by asset owners, asset managers, regulators, and companies. In a world of shareholder primacy, we have established complex accounting structures, stock-based compensation schemes, an investor protection regime, and recognized trade-offs among risk, anticipated cash flows, tax implications, and other matters that comprise financial value. If we change the vision of success for business, we will have to build parallel concepts that allow for monitoring, incentivizing, and influencing managers to reject the type of profits that sap the strength of our social and environmental systems while continuing to pursue those profits that result from the creation of authentic value.
In 2010, Maryland adopted a statute authorizing benefit corporations, which was quickly followed by other states around the United States. The initial efforts at drafting and advocating for benefit corporation laws were undertaken by B Lab, a nonprofit entity based in Pennsylvania.3 B Lab focuses on creating infrastructure for profit-based businesses to operate with positive social and environmental impact.4 B Lab believes that corporation law and capital markets created a barrier to such responsible behavior by requiring companies to prioritize profit over impact and, in particular, precluding corporations from sacrificing shareholder value to benefit other stakeholders.
Scholars and others have disputed whether corporate law truly requires such a prioritization, either in the United States or outside it.5 Sometimes it is argued that the law is unclear and that the creation of a separate benefit corporation statute will, by negative implication, reinforce the idea that shareholder primacy does exist for any corporation that does not choose to become a benefit corporation.6 I have argued that the law in Delaware has clearly come down in favor of shareholder primacy.7 Of course, some jurisdictions in the United States have fully or partially adopted constituency statutes opting out of this regime.8
Other jurisdictions clearly allow or even require directors to consider the interests of stakeholders, but it is often unclear whether this consideration must ultimately redound to the benefit of shareholders.9 Indeed, in some jurisdictions, this latter concept—sometimes called “enlightened shareholder value”—has been specifically incorporated into statute.10 Even in those jurisdictions where the legal test allows stakeholder interests to overcome shareholder interests, there is no guidepost as to how such decisions are to be made, and it seems that companies often default to shareholder primacy, of the enlightened sort or otherwise.11
Arguments around the existence of shareholder primacy continue to be made, refuted, and made again.12 The point that bears emphasis is that benefit corporation legislation presents a valuable opportunity even if shareholder primacy is not the legal rule. Even where it is true that corporate law does not currently grant shareholders primacy, there is little guidance as to how directors should prioritize among all possible stakeholders, and the evolving benefit corporation statutes can offer such guidance. This development addresses the great concern of those who favor shareholder primacy—that without the North Star of shareholder value, corporate management will simply be able to do whatever it desires and justify it as necessary to help one class of relevant interests or another.13
In addition to addressing the agency question, principles to replace shareholder primacy are necessary to place the corporation within a coherent economic model, which a simple admonition to “protect stakeholder interests” fails to do. Simply designating managers as philosopher-kings and expecting an allocation of capital that is both efficient and fair seems like a risky proposal.
Regardless of the scholarly debate over the existence of shareholder primacy, dozens of jurisdictions have adopted corporate forms that expressly reject the concept.14 The statutes vary, especially in their articulation of what guiding principles will replace primacy. In this Part, I analyze the text of the original version, the Model Benefit Corporation Legislation (“MBCL”), and then compare each significant aspect to the approach taken in the other statutes.
The MBCL was commissioned by B Lab and drafted by a prominent Philadelphia law firm; it has been adopted in some form in about thirty-three states.15 The Delaware statute (the “Delaware Act”), which has significant differences from the MBCL and is followed to some degree in three additional states,16 is influential owing to the heavy use of Delaware as a forum for companies intending to raise outside capital.17 The first statute outside of the United States was adopted in Italy, which was followed by the first South American version in Colombia. The next important model to look at is the recently proposed Chapter 18 of the Model Business Corporation Act (the “MBCA Model”). The MBCA is a model corporation statute maintained by the Corporate Laws Committee of the American Bar Association Business Law Section and is followed to some degree in thirty-four states and the District of Columbia (but not Delaware).18 The MBCA Model varies from both the Delaware Act and the MBCL and reflects the experience of its drafters in working with each of those versions.19 Finally, we review the benefit company provisions from British Columbia (the “British Columbia Act”), the first Commonwealth jurisdiction to adopt a benefit corporation statute.
As we will see, the newest example—the British Columbia Act adopted in May 2019 and effective June 30, 202020—goes beyond the prior models by establishing principles (but not rules) for the board to follow in accounting for competing concerns of stakeholders and shareholders. It thereby illustrates the real promise of benefit governance: to establish principles that can protect stakeholders while still encouraging investment and preserving the logic and advantages of a market economy and maintaining the attractiveness of equity as an investment.21 Of course, these are principles only, which create categorical priorities: producing profits from real value creation but not from exploiting vulnerable populations or common resources. Managers will still need to exercise discretion to make those distinctions, shareholders will have to decide what common resources matter to them, and, in some instances, courts will have to decide when management is abusing its discretion or interfering with shareholder voice regarding the application of these new principles. More concretely, asset owners may decide that they do not want profits that come from degrading the environment or violating human rights. I do not wish to understate the challenge of defining those parameters and monitoring and incentivizing conduct around them. The question raised by benefit corporation law is whether we want to move in a new direction.
The rest of this part is devoted to a detailed discussion of how the various new models of benefit corporation law replace (or fail to replace) shareholder primacy as a guiding principle. A reader more interested in the concepts could at this point skip directly to Part III.
The MBCL is structured as an overlay of the standard business corporation statute, so that all the rules applicable to other corporations continue to apply, except where the statute expressly provides for a departure.23 It authorizes both new formations of benefit corporations and conversions of conventional corporations to benefit corporations by charter amendment.24 Exit through charter amendment is also permitted.25 Conversion or exit requires a two-thirds vote of each series or class entitled to vote on the action.26
Section 201 establishes a broad corporate purpose beyond creating value for shareholders; it requires that all benefit corporations create “general public benefit” and that the articles of incorporation may also set forth a “specific public benefit.”27 The former is defined as
[a] material positive impact on society and the environment, taken as a whole, from the business and operations of a benefit corporation assessed taking into account the impacts of the benefit corporation as reported against a third-party standard.28
The statute defines the optional specific benefit with a nonexclusive list of positive impacts.29 In addition to these alterations in corporate purpose, the MBCL also directly addresses the obligations of directors,30 requiring the board to address the effects of actions upon a set of stakeholders and interests.31
This text requires that directors “consider” interests beyond those of the shareholders. For corporations in jurisdictions with constituency statutes, clause (2) adds that directors may consider the interests listed in that provision.32 This adds little if anything to Section 301. Clause (3) expressly rejects shareholder primacy by eliminating any requirement that directors give priority to any one factor listed in clauses (1) and (2).33 Without this paragraph, clause (1), which only requires consideration of the various stakeholders, would not explicitly eliminate any preexisting rule that directors prioritize shareholder interests. A board charged with primarily promoting the interests of shareholders could also be charged with considering all stakeholders in so doing—as noted earlier, this is the approach of enlightened shareholder value taken in the United Kingdom Companies Act.34 However, by expressly disclaiming any such priority, the MBCL creates a regime wherein shareholders’ interests do not have a legally privileged position in the boardroom.
Although the MBCL provides for expanded obligations of the corporation and directors with respect to nonshareholder interests, it is drafted to limit available relief to enforce those expansions. The statute provides that: (1) neither the directors nor the corporation shall have monetary liability for failure to create the contemplated public benefits or, in the case of directors, for noninterested actions in considering the various stakeholders listed in accordance with Section 301(a),35 (2) the directors do not have separate duties to stakeholders,36 (3) the business judgment rule shall apply to an action brought against directors under the expanded consideration regime,37 and (4) any claim for violation of the requirements of the statute must be brought either directly by the corporation or derivatively by shareholders of at least 2 percent of the shares of a class or series of stock.38 Despite these limitations, however, the protections of the business judgment rule are not extended to actions against the company itself for failure to achieve its benefit purpose. This essentially means that the 2 percent shareholders may seek injunctive relief against a corporation for failing to pursue public benefit, and the court will not apply the lenient business judgment rule.39
The MBCL also includes an annual disclosure obligation, requiring the corporation to adopt a comprehensive standard developed by an independent third party for reporting overall social and environmental performance.40 This is the same standard by which the company’s achievement of “material public benefit” is measured. The report need not be verified but must be made publicly available.41
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Although there are other details to the MBCL, the foregoing provisions establish the framework that differentiates benefit corporations from conventional corporations. By comparing these original benefit corporation provisions to those that followed, we can begin to establish a deeper view of how a benefit corporation statute might toggle between: (1) the mere rejection of shareholder primacy and (2) the creation of coherent principles to replace it, and how the statute’s details might be adjusted to reflect the difference. This comparison can also set the stage for thinking about principles that could be applied more broadly to global equity markets to create an economic system that is both sustainable and just.
In 2013, the Delaware Act was adopted.42 It created a new model of the benefit corporation, which it called a public benefit corporation or PBC. In 2015 and 2020, the Delaware Act was amended,43 and the following description reflects those changes. The PBC has been the benefit corporation model of choice for companies raising outside equity.44
In contrast to the MBCL, the Delaware Act does not begin with an expansion of purpose or performance standard; instead, it begins with a statement of intent:
A “public benefit corporation” is a for-profit corporation organized under and subject to the requirement of this chapter that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner.45
The reference to “public benefit” in this preamble is not parallel to the general public benefit language in the MBCL. As discussed in the following, “public benefit” in the Delaware Act represents a specific purpose that a corporation must adopt alongside the obligation to account more generally for all its impacts.46 That more general idea of benefit is captured in the preamble in the phrase “responsible and sustainable manner,” but it describes a mode of operation, in contrast to the MBCL general benefit concept, which lays a foundation for positive impact.
At a structural level, the Delaware Act operates like the MBCL by creating an opt-in regime that overlays the corporate statute.47 Although opting in incorporates a general commitment to sustainability and responsibility, the Delaware Act also requires the corporation to select a particular public benefit, which contemplates a positive effect on a category of stakeholders.48 Unlike the MBCL, it does not require a supermajority vote of shareholders to opt into or out of the benefit provisions. Notably, the initial version of the Delaware Act required a 90 percent vote of each class or series entitled to vote in order to become a PBC, and the 2015 amendments lowered that requirement to a two-thirds vote of the outstanding voting shares; there was also a two-thirds vote to exit PBC status, which was in place from 2013–2020.49 The 2020 amendments eliminated the remaining high votes and also eliminated appraisal rights for shareholders in transactions that converted conventional corporations to PBCs, which had been included in the original legislation and limited in the 2015 amendments through a market out for public companies.50
Turning to the substantive provision that alters directors’ obligations, the Delaware Act operates by imposing on directors a duty to address three sets of interests: (1) those of the shareholders,51 (2) those of anyone affected by the corporation’s operations, and (3) the specific public benefits identified in the certificate of incorporation.52
Although the corporation is required to include the public benefit “within its statement of business or purpose,” the only enforcement mechanism in the statute is the opportunity for shareholders to challenge the board’s satisfaction of the balancing obligation set out in Section 365(a). In contrast to the MBCL, there is no separate “benefit enforcement proceeding” against the company itself for not meeting its purpose or a defined level of performance. Moreover, the Delaware Act does not have an overall impact test whose satisfaction could be contested in such a proceeding. In contrast, the MBCL calls for benefit corporations to achieve—or at least pursue—“material positive impact,” which appears to establish an objective test. This contrast will be discussed in the following.
The Delaware Act establishes limits on the permissible lawsuits that are similar to limits against lawsuits included in the MBCL. In contrast to the MBCL, the Delaware Act expressly preserves the business judgment rule for all lawsuits such that broad discretion for independent directors is fully preserved.53 The certificate of incorporation may include a provision that protects directors from monetary liability for failing to balance the three types of interests properly.54 In addition, the Delaware Act states that directors do not have duties to beneficiaries of the balancing obligation (other than shareholders),55 thus precluding suits by nonshareholders and limiting the right of shareholders to bring derivative suits to holders of 2 percent (or, in the case of public companies, shares with a value of at least two million dollars).56
As to transparency, the requirements of the Delaware Act are much more lenient that those of the MBCL. There is no requirement to report against a third-party standard or to make the report public, and the report only has to be created on a two-year (rather than annual) cycle.57 The company has great flexibility, and it is simply required to report to shareholders the board objectives and standards for achieving general and specific public benefits and to assess the corporation’s success in achieving them.58
Following the adoption of the MBCL and Delaware Act in multiple U.S. jurisdictions, interest increased outside the United States, and in 2016, Italy became the first country to adopt a version of benefit corporation law (in contrast to the state-by-state process that takes place under the U.S. federal system).59 The creation of a società benefit is similar to creation of a benefit corporation under the U.S. statutes: inclusion of a provision in the constitutional documents that require board and shareholder approval for already existing companies. It also has a preamble reminiscent of Delaware’s, declaring that the purpose of the law is to promote corporations that “operate in a responsible, sustainable and transparent manner.”60 In its approach to modifying fiduciary duty, the law is similar to Delaware’s. Directors must “consider” (1) the interests of shareholders, (2) the pursuit of “common benefit objectives,” which is essentially a mandatorily chosen specific benefit, and (3) the broad group of “individuals, communities, territories and the environment, cultural and social heritage, entities and associations, as well as other stakeholders.”61 On the other hand, the term consider may be weaker than Delaware’s mandate to balance.
Although the fiduciary aspect reads much like the Delaware statute, the Italian version follows the MBCL by requiring an annual report against a third-party standard. However, it departs from both models in not limiting remedies—there is no provision that preserves or creates director discretion, limits stakeholder lawsuits, or limits liability.
In 2018, Colombia followed, adopting a statute that authorized the creation of sociedades de Beneficio e Interés Colectivo (BIC corporations).62 A BIC corporation is required to “not only pursue the benefit and interests of its shareholders but also of the environment and the community.”63 The statute goes on to state that BIC corporations “shall include in their corporate purpose clause any general public benefit activities they intend to pursue.”64 “General public benefit activity” is not defined. Opting into the statute requires a majority vote of its shareholders.65 In exercising its authority, directors must “consider the benefit of the corporation, its owners or shareholders while pursuing the general public benefit set forth in its corporate bylaws.”66 In some sense, this structure is more reminiscent of the MBCL because the strongest benefit obligation appears to fall on the corporation itself (to pursue the interests of the environment and the community), in contrast to directors’ obligation to consider elements that do not appear to include those broad interests.
The company must release an annual report that uses a third-party standard. Unlike the U.S. versions, a state regulator may create a list of acceptable third-party standards, and the state also has the power to revoke BIC status for noncompliance.67 Unlike any other example, the Colombian statute creates fifteen highly particular requirements that a BIC corporation must meet involving issues such as diversity, wages, local sourcing, and greenhouse gas emissions.68 It is unclear whether these standards must be met by every BIC.69 Like the Italian statute, the Colombian version is silent on director discretion and liability, as well as the right of stakeholders to bring lawsuits under the new provisions. However, generally directors in Colombia may be subject to liability for gross negligence; the business judgment rule has been applied in at least one case involving a conventional corporation, but it is not a widespread doctrine, and the case does not constitute a precedent that must be followed in other cases.70 Because the BIC status is granted through a bylaw provision, only shareholders (and not stakeholders) may bring claims against the directors or company under the provisions.71
In April 2019, the Corporate Laws Committee of the American Bar Association Business Law Section voted to recommend adoption of the MBCA Model.72 Following the rules for amending the MBCA, the MBCA Model was published for comment in The Business Lawyer,73 republished with a change eliminating appraisal rights,74 and is expected to be approved.
Like the other two U.S. models, the MBCA Model allows corporations to opt in by amending the articles of incorporation, a constitutional document that requires approval by directors and shareholders.75 In addition, a two-thirds shareholder vote is required for actions that create or unwind a benefit corporation. The MBCA Model does not support appraisal rights in such transactions.76
Like the Delaware Act, the expanded obligations of the MBCA Model run exclusively through a modification of fiduciary duties—not through limiting corporate purpose. This is done through two director mandates:
As can be seen, the precatory “responsible and sustainable” of the Delaware Act appears in the MBCA Model in an operative provision; the term is defined as follows:
“Responsible and sustainable manner” means a manner that:
Together, these provisions require directors to pursue positive value creation as a whole and to consider the interests of stakeholders separately from those of shareholders. Part IV argues that this text clarifies, in a way that neither the MBCL nor the Delaware Act does, that the requirement to address stakeholder interests encompasses the need to consider a corporation’s impact on common resources. In other words, the MBCA Model takes a significant step toward affirmative principles that would replace shareholder primacy.
Lawsuits are limited to injunctive claims by 5 percent shareholders.79 The business judgment rule is preserved.80 In addition, the MBCA Model follows the Delaware Act by authorizing a limitation on liability in the articles of incorporation that has the effect of eliminating liability for disinterested breaches of the stakeholder provisions.81
The MBCA Model disclosure regime is a mix of the MBCL and the Delaware Act. As is the case with the MBCL, the report must be annual and public (in contrast to the Delaware Act, which only requires a report once every two years and which need only go to shareholders). The mandatory content of the report, however, is quite close to the Delaware Act model, requiring a description of the objectives and standards the company has decided upon, as well as an assessment under them. No third-party standard is required.
On May 15, 2019, British Columbia became the first Canadian jurisdiction, and indeed the first Commonwealth jurisdiction, to adopt a benefit corporation alternative.82 Like the other statutes, the benefit company83 provisions can be opted into through an amendment to the corporate articles, which requires the vote of both directors and shareholders. The same shareholder vote—two-thirds—is required as in U.S. jurisdictions, although in British Columbia, that is just the standard amendment vote, whereas in most U.S. jurisdictions, the vote required for amendments generally is only a bare majority.84 Appraisal rights are granted whenever a corporation becomes or ceases to be a benefit corporation.85
The British Columbia Act, like the Delaware Act, requires a specific benefit objective. Like both the Delaware Act and the MBCA Model, it operates through defining fiduciary obligations, rather than expanding corporate purpose. It also follows the MBCA Model in making use of a defined term: “responsible and sustainable.” The directors have the following obligations:
A director or officer of a benefit company, when exercising the powers and performing the functions of a director or officer of the company, must
Finally, the now-critical phrase “responsible and sustainable” receives the following definition:
“responsible and sustainable manner,” in relation to the conduct of a benefit company’s business, means a manner of conducting the business that
Like the Delaware Act, and unlike the MBCL and MBCA Model, there is no requirement to meet or pursue a material public benefit—only ongoing standards for considering nonshareholder interests. In establishing those standards, the British Columbia Act goes furthest toward establishing those stakeholder values that are intended to reflect the ongoing responsibility of corporations as institutions embedded in a complex social and ecological fabric. The directors must consider the well-being of those affected by their decisions and attempt to use only a fair share of limited resources. These concepts go well beyond the weak consideration. As discussed further in Part IV, they also point the way for equity markets to fill in specific gaps that market forces do not address—the costs of externalities and inequality.
With that in mind, it must be remembered that this statute still maintains the rule that these new obligations are to be enforced only by shareholders and only through injunctive proceedings. In this, the British Columbia legislature followed the lead of the U.S. models.88 The good faith nature of the new obligations preserves the Canadian version of the business judgment rule.89
This standard should be mentioned although it has not been adopted by any jurisdiction or organization. In July 2020, a report on corporate governance commissioned by the European Commission Directorate-General for Justice and Consumers was finalized and made public.90 Although the report did not make specific recommendations, it did analyze twenty-one different alternatives, and the alternative that received the most favorable treatment was an EU-wide directive requiring each member state to implement the following mandatory standard of fiduciary duty for directors of all corporations:
As noted earlier, the origin story of the benefit corporation begins with an NGO establishing a certification regime for companies that purported to act responsibly with respect to social and environmental impact. It did not want to certify companies that would privilege shareholders over other stakeholders because such a privilege would inevitably erode their positive impact.92 However, the corporate law of many jurisdictions (including Delaware) required directors to favor shareholder interests,93 and even where shareholder primacy was not a strict rule, it was often the easiest route for directors to take because shareholders generally hold the ultimate power over who comprises the board and, thus, the management of the corporation.94 They conceived of the benefit corporation as a remedy for this circumstance.
But why was shareholder primacy so influential in the first place? The case for shareholder primacy often begins with the need to address the “agency problem”—the concern that disparate shareholders in a complex modern economy do not have the capacity to directly manage their assets, so that management is left to a professional class of managers. The concern, classically articulated by Adolph Berle in a 1931 law review article,95 is that these managers will tend to use those assets to benefit themselves, rather than the shareholders, and that imposing a fiduciary duty to shareholders, and only shareholders, would create a clear and enforceable rule, making such defection less likely. In addition, it is posited that if managers are not held to a standard that requires them to satisfy a single, unified stakeholder group, they will be unable to efficiently allocate assets because trying to serve multiple masters would require a juggling of incommensurate interests.96
Whether one accepts this reasoning completely or not, it certainly makes sense that directors, who have great discretion in managing the assets of other people, ought to have guiding principles. Common stock investors are in an awkward position: they give up control of their capital with no promise of a specific return and take the risk of being first in line to lose their investment if the firm fails. Their reward for this is the residual—whatever is left after everyone else involved in the enterprise is paid. The size of that residual is based on two factors: first, the overall return of the enterprise (the pie), and second, the allocation of that return among shareholders and other stakeholders (the slice).97
Without a rule ensuring that the average residual returns will justify the risks and uncertainties of their position, capital providers will be reluctant to surrender control of equity investments. Retreating from a position that the return to residual risk bearers is the primary concern of managers may leave capital providers in an untenable provision—being asked to surrender control of their capital to managers who have no obligation to provide a return to them: this may ultimately (and ironically) increase the cost of first risk capital that has been so advantageous to the economy.98 Indeed, it may stifle the flow or divert it to closely held enterprises where investors can firmly maintain control, perhaps actually resulting in reduced stakeholder welfare.99 For this reason, the admirable goal of B Lab in creating the benefit corporation—eliminating shareholder primacy—only does half the job. A benefit corporation statute must also create replacement principles that adequately address the agency problem and promise a predictable methodology for determining the return that accrues to first-loss residual equity.
However, in designing these principles, drafters should keep in mind the reason that the simple rule of shareholder primacy is itself inadequate: it drives behaviors that threaten environmental and social systems. When shareholder return is prioritized without any regard for other stakeholders, inefficiency and unfairness result. The quest must be for rules or principles that distinguish between shareholder returns based on socially productive behavior and those based on behavior we wish to discourage.
The continuing evolution of the statutory language outlined in Part II suggests that drafters are wrestling with these issues instinctively, even if they have not fully articulated the concerns. The need for principles to replace shareholder primacy echoes in the recurring questions: does a statute require or allow consideration of stakeholder interests? Is this consideration for the sake of the stakeholders themselves, or is it merely an instrumentality, ultimately in service of the interests of either the shareholders or the corporation? And, if the latter, what exactly are the interests of an imaginary entity? Does a requirement to consider interests even amount to an obligation because, after consideration, those interests might be dismissed, no matter how apparently important? Does an obligation to balance or take into account those interests have greater content by requiring directors to factor such interests into their decisions? Do directors have complete discretion as to which stakeholders to prioritize?
To answer these questions, laws and norms should: (1) provide principles for allocation and stewardship decisions and (2) drive corporate behaviors that respect the needs of the environment and society. With respect to the latter, it will be critical to address collective action concerns, where a change in overall corporate behavior is required. The climate crisis and the need to reduce carbon emissions rapidly is an example of this phenomenon, as is the need for corporations to cease looking for profits by avoiding their fair share of the tax burden.
Returning to the statutes with these questions in mind, we can review their workings with an eye toward the need to create predictable but responsible investment opportunities for shareholders by establishing a coherent set of expectations as to how stakeholder interests must be accounted for before profit is pursued—a model that replaces the simple but problematic rule of shareholder primacy.
The MBCL obligates directors to consider the effect of corporate action on: (1) a list of stakeholders (including shareholders), (2) the corporation itself, and (3) the ability to accomplish its benefit purposes (which include generating a material positive impact on society and the environment, taken as a whole). The word consider (“to think about carefully”)100 does not necessarily imply that the elements to be considered must actually affect a decision.101 Because the statute does not clearly require the directors to factor any particular interest into their final decision, it appears that a board could still engage in decision making that prioritizes shareholders without violating its benefit corporation obligations; alternatively, non-shareholder interests might be considered and factored in but only in a manner that benefited the shareholders.102 For example, a board might consider the interests of customers to the extent that satisfied customers improve the shareholders’ financial returns but not for the sake of the customers themselves.
This is not to say that the duties of directors as contemplated by the MBCL do not represent a significant change from mandatory shareholder primacy: the statute expressly states that a corporation “need not prioritize” any particular listed factor, eliminating any mandate that shareholder interests prevail or that stakeholder interests may only be considered to the extent they affect shareholder interests. In other words, at a minimum, Section 301 drops mandatory shareholder primacy and gives directors broad permission to de-emphasize shareholder interests. But the elimination of that rule leaves a void: what should directors do when actions that benefit shareholders harm one or more stakeholders? How is the pie to be sliced?
The corporate obligation to create a material public benefit only partially answers this question. The MBCL is unique among the schemes discussed here in placing a separate substantive obligation on the corporation itself: the corporation can be sued for failing to pursue or fulfill its purpose of creating general public benefit (or a specific benefit if one has been established). This unique right to pursue a benefit proceeding allows a shareholder to bring a claim that a company’s decisions are not calculated to create a positive impact on society and the environment. This standard, with its reference to “as a whole,” implies a netting function.103 It establishes a foundation requiring that, all in all, a corporation must strive to leave the world better than it found it by having more positive than negative social and environmental impact.
But if this public benefit requirement is the only valid stakeholder interest claim, the statute establishes a substantive safe harbor, rather than a full change in orientation from shareholder to stakeholder. If the obligation to consider leaves directors free (but not mandated) to make individual decisions that ultimately favor shareholder interests, then as long as the company is making the world a better place (environmentally and socially) overall—in other words, as long as the company provides a minimum material level of benefit—it could make individual decisions that are socially and environmentally harmful.
For example, a pharmaceutical company selling an antibiotic at a reasonable price that saves hundreds of thousands of lives a year might decide to improve its bottom line by disposing of waste legally in a country with poor environmental controls, claiming that very few lives would be put at risk from its small contribution to the problem. Note that this analysis is not dependent on the level of pecuniary advantage conferred by the disposal method—the savings might be slight.104
This issue might also arise in an end-stage transaction such as a merger. Imagine a sale of that same company and that the highest bidder was a private equity fund that had plans to shut down research into several early-stage products that had potential to save many lives. Imagine this was to satisfy anticipated debt covenants in the funds to be borrowed to acquire the company. The continued sale of the company’s active products would satisfy the material positive benefit test, so that the directors would have no obligation to account for the cost to potential patients of the sale that would end research into the new products.
These are extreme examples, meant to illustrate a point, rather than being intended as a discussion likely to take place in the boardroom of an actual benefit corporation.105 The point is that the net positive construct does not provide a rubric for decision making once the general benefit test is satisfied and, thus, does not realize the full potential of benefit governance to create a more sustainable economy or address the agency issue in a novel manner. Moreover, the net positive test is of questionable utility: there are multiple dimensions of impact, all of which must be addressed to create an economy that preserves all necessary environmental and social resources. Accordingly, all environmental and social impacts are not commensurate—we cannot simply cash in some equality for more carbon sequestration.106 This multidimensional aspect of sustainability suggests the need for principles that reach beyond a net positive or negative calculation of impact “as a whole.”107
As a result of this single overall impact test, the MBCL does not include principles to address the collective action concerns triggered by most social and environmental issues. For example, humanity must marshal scarce common pool resources, whether environmental ones such as carbon-carrying capacity or economic concerns such as tolerance for risk in the financial system. Similarly, there are public goods to which all concerned should contribute, whether through the payment of taxes or otherwise. Finally, collective action is necessary to address structural inequalities that lead to injustice. For these issues, factoring in stakeholder interests is a matter of ensuring an entity is consuming or contributing its fair share, which does not easily translate into positive or negative environmental impacts that can be added or subtracted from other impacts.108 Of course, the MBCL would enable directors who wanted to use only a fair share of resources to do so by eliminating shareholder primacy. The argument here is that benefit corporation law has the potential not only to permit but to mandate such conduct or, at least, principles that imbue such conduct.
Indeed, any simple materiality test may fail to address these concerns. A medium-sized industrial concern may claim that its carbon footprint alone is too small to have a material effect on the climate. Similarly, the tax bill of any single corporation will not be material to overall government revenues. But if the goal of benefit governance is to create a business climate where companies consider maintenance of a sustainable environment and society as part of their mandate, there would have to be a principle that utilizes “if everyone acted this way” thinking. This seems especially true as to stakeholders that are largely external to the corporation in contrast to internal stakeholders, such as workers and customers, whose relationship with the corporation is such that its effects on them are likely to be material. The potential significance of this distinction is discussed in Part IV.
As described in the preceding section, the MBCL rejects shareholder primacy but replaces it with principles that may not, on their own, provide comprehensive principles to be applied to all decisions or establish a fiduciary obligation that drives toward sustainability with coherent principles. The design of the Delaware Act arguably moves closer to such principles. First, recall that the Delaware Act does not create a floor purpose that must be met; instead, it operates solely through directors’ fiduciary duties, not through regulation of the corporation or its output. Those duties require directors to balance the interests of shareholders with the interests of others affected by the corporation’s conduct (and the company’s specific benefit). The definition of the word balance is “to bring into harmony or proportion,”109 which does appear to be an actual substantive principle associated with the directors’ new obligation, in contrast to the more procedural consider requirement of the MBCL (even if the substantive principle is admittedly fuzzy). That is, considering important negative stakeholder impacts but then simply dismissing them as factors in decision making would arguably not be enough to “harmonize” those interests. The undefined and precatory use of the term “responsible and sustainable” in Section 362 further reinforces this substantive reading, though without providing much content. Both the Italian and Colombian versions have similar “always on” constructs.
Consider again the examples from above—the decision to dispose of waste in a dangerous fashion that creates a human rights or environmental concern or to sell to a buyer who will shut down research and further assume the financial gain would have been quite small. As described earlier, under the MBCL, the company could meet the consideration test if the board minutes reflected due deliberation but then failed to factor in the lives potentially improved and saved by a more responsible waste disposal method or by continuing the research (so long as the corporation’s total net impact continued to be positive). In contrast, under the Delaware Act standard, there would be at least some room to argue that the dismissal reflected an imbalance—that a decision to play a role in an ongoing environmental disaster or abandon important research for a small financial gain was out of balance and neither sustainable nor responsible.
This is not to say that shareholders could or would be likely to frequently make such challenges—assuming the board decisions were disinterested, the hurdle for showing irrational balancing would be high under the business judgment rule.110 Nevertheless, the difference in the type of test—substantive rather than procedural—is conceptually important, even if the business judgment rule creates a form of procedural protection around it. Normatively, it changes the nature of corporate decision making by insisting that the interests of affected stakeholders matter whenever decisions are made. If a company ignores human rights violations in its supply chain, it is no defense under the Delaware Act to point to all the other good it did. The overall net creation of positive good is not a defense against a failure to put in some level of effort to act responsibly and sustainably and to balance shareholder and stakeholder interests in individual cases.111
This distinction highlights why some form of benefit corporation alternative is useful even in jurisdictions that do not have legally mandated shareholder primacy. There still may be a gap between the obligations we might want to govern corporate behavior and those that exist in jurisdictions that merely permit directors to account for stakeholder interests. That said, the Delaware test does not seem to answer the harder questions posed by the lack of a replacement standard: although it mandates accounting for stakeholder interests in all circumstances (rather than when the board decides to do so), it does not provide any guidance for making decisions that require choosing among stakeholder interests—at least not beyond the undefined term responsible and sustainable. Nor does it attempt to directly address the problems of collective action: its employment of a materiality standard arguably still leaves a gap for critical policy concerns that require all participants to restrain their use of common resources.112
Thus, as with the MBCL, the Delaware Act does not replace the guidance of primacy with a full framework that drives corporations to create sustainable profits.
Upon initial inspection, the MBCA Model appears to be designed in the same way as the MBCL; there is an obligation to create a net positive effect for stakeholders overall but only a requirement to “consider” their interests in any decision, leaving open the possibility of dismissing critical stakeholder concerns once they are acknowledged. However, viewed in their full context, the stakeholder obligations appear more comprehensive. First, the MBCA Model makes more progress toward addressing collective action concerns by acknowledging that materiality should reflect the nature of the corporation and not just the effect vis-à-vis the stakeholders themselves; “responsible and sustainable” is defined as pursuing effects that are material taking into consideration the corporation’s size and the nature of its business.113 The Official Comment links this definition to the collective action concern over scarce resources:
Such operations and decisions have the potential to affect, positively or negatively, critical resources, such as environmental capacities and social stability. The requirement that directors pursue, through the business of the corporation, creation of a positive effect on “society and the environment, taken as a whole” should be viewed in the context of the individual corporation and its ability to create a positive effect that is material considering its size and the nature of its business. It does not require the benefit corporation to create such an effect by itself. For many benefit corporations, pursuit of a positive effect may involve conduct that, in combination with similar conduct by others, can be expected to have a positive effect on society and the environment, taken as a whole.114
Thus, the MBCA Model appears to require that directors consider their use of common resources. This seems difficult to net: using one’s fair share when one’s individual contribution might not have a material effect is not a concept that can be subject to a netting analysis. One’s fair share of carbon, water, and tax burdens is largely incommensurable precisely because the concept of equitably bearing a shared burden does not reduce to dollars or lives or a similar measuring rod to compare with or exchange for the fair sharing of other burdens.
It is also important to note that the MBCA Model’s definition of “responsible and sustainable” expressly rejects the idea of enlightened shareholder value by requiring that the interests of stakeholders be considered as “separate” interests from those of shareholders. Thus, even outside the creation of material positive effect overall, there is an explicit requirement that directors consider the interests of shareholders as standalone concerns. It seems unlikely that the drafters would have included this specific requirement, along with the consideration of common burden sharing, and then expected that directors would ignore those concerns once the corporation had rendered a net positive overall impact.115
The British Columbia Act is clearer; there is no room to read the statute as requiring a minimum compliance level of net positivity only. As with the Delaware Act, there is no requirement of overall positive effect in the statute. Instead, directors are required to act in a responsible and sustainable manner each time they exercise their authority. Such action is required not only when considering the fair share issues discussed in the next part but also by “tak[ing] into account the well-being of persons affected by the operations of the benefit company.”116 This verb phrase implies more than the mulling over that consideration might allow; instead, stakeholder well-being must enter the board calculus.
Most significantly, however, the British Columbia Act statute goes further and makes the collective action principle explicit by requiring directors to act with a view toward conducting business in a responsible and sustainable manner and defining that manner as not only accounting for the well-being of persons affected by corporate operations but also endeavoring to “use a fair and proportionate share of available environmental, social and economic resources and capacities.”117 This is an extraordinary step and the clearest attempt to replace shareholder primacy with an affirmative record that recognizes the limitations of free markets to create sustainable value, a principle that is absent from—and in some respects opposed to—standard market economics. For the first time in corporate law, a statute fully places the corporation into the context in which it is embedded, insisting that it is responsible for its fair share of preserving the critical systems upon which it relies.118 Although one might object that the statute fails to provide answers to any of the difficult trade-offs that a stakeholder-oriented corporation must make, the same is true of conventional corporate law: it sets a direction (shareholder value) but does not provide answers as to the many trade-offs that must be made to get there. Yet conventional corporate law has been stunningly successful in creating value for shareholders.
Thus, there are great gaps to be filled in—how do we calculate an enterprise’s proportionate share, and just how much of the common resource can be used? Turning to an earlier hypothetical, how could the pharmaceutical company decide whether to spend the money to safely dispose of its waste products? Although the British Columbia Act does not supply a metric by which to answer that question, it does create a coherent framework for establishing rules of the road that will. If there is a consensus that businesses should adhere to an established chemical disposition framework to preserve our global commons, then the company can do so without considering trade-offs because the choice has been made through a leveling of the playing field. Similarly, if there is a consensus that companies should work toward a planet that does not heat up by more than 1.5 degrees Celsius, protocols for calculating fair shares of carbon emission can be calculated, and if there is consensus that certain labor practices are inconsistent with worker well-being, then rules and norms precluding such practices can be followed. The law gives companies a framework to forgo certain otherwise profitable behaviors considering their effects on stakeholders once they determine that other companies are playing by the same rules. Common shareholders can expect returns that optimize their returns within those boundaries—at least if that is what they seek through corporate democracy; shareholders can always choose an even lower return through the exercise of their proxies. Thus, the statute does more than eliminate shareholder primacy: it creates an express set of principles that investors, companies, and stakeholders can use to establish ex ante expectations for corporate conduct when stakeholder concerns and shareholder returns come into conflict.119
The EC Study Standard has a number of interesting characteristics: it includes a list of stakeholders reminiscent of the MBCL but uses the stronger Delaware Act term “balance” in instructing directors how to weigh those interests. This first part also appears to go beyond enlightened shareholder value by clarifying that balancing those additional interests—including of the environment and society at large—is in the interests of the corporation itself. However, there could be concern that tying the stakeholder interests to company interests must cabin the balancing to items involve continuing value of the company. Otherwise, the provision would suggest some sort of “pan-corporatism,” in which each corporation is manifest in all of society and the environment.
In contrast, the second part of the standard seems to provide assurance that directors must concern themselves with impacts fully outside “the interests of the company” with its separate mandate to “[i]dentify and mitigate sustainability risks and impacts, both internal and external, connected to the company’s operations and value chain.” This independent duty to mitigate social and environmental risks, including those external to the corporation, that are connected to its operations and value chain makes it clear that a company must consider its impact on others, even if those impacts have no effect on the corporate interests themselves, however broadly or narrowly defined.
As with the British Columbia Act, this would break new ground if adopted because it would establish that corporations cannot simply externalize costs without making attempts to mitigate them. Indeed, adoption of this provision as a directive would be especially meaningful because it would apply to all EU corporations, not just those who opt in. The standard does, however, appear to fall short of the standard set forth in the British Columbia statute by failing to establish a specific bar as to the level of mitigation necessary, that is, to use only a “fair and proportionate amount” of scarce resources.
The foregoing discussion has been focused on the provisions of the benefit corporation models that address the expanded obligations of the corporation and its directors. It has not been focused on enforcement mechanisms, separate disclosure requirements, or opt-in mechanisms. This is not because those provisions are not significant but because this article is primarily intended to explore the why of benefit governance through examination of the differing principles that each statutory scheme established for the directors, rather than focusing on the how of ensuring that the principles are followed. (As discussed later in Part IV, the why suggests that the answer to how may lie not just in enforcement mechanisms at the corporate level but in expanding benefit governance to the fiduciaries that control investment portfolios.)
Nevertheless, before turning to how corporations with a benefit purpose can fit into a new model of ownership, I want to address these items relating to enforcement to the extent they are relevant to the purpose of redefining corporate governance.120
First, three of the four North American models preserve the business judgment rule—the idea that courts will give directors broad discretion in making business decisions. The MBCL preserves this rule for suits against directors but not for suits directly against the company. The other three North American statutes leave the deferential standard of review for disinterested directors untouched. In addition to the judicial standard, it should be noted that the MBCL requires the use of a third-party standard to measure general public benefit.
The wisdom of retaining (or limiting) director discretion under benefit governance, either through a stricter standard of judicial review or the requirement of a third-party substantive standard, may be a function of the new regime’s purpose. If the purpose of benefit governance is simply to eliminate shareholder primacy, a new regime eliminates the North Star of shareholder primacy without replacing it with an overall guiding principle as to how to utilize the greater discretion afforded to directors. In that case, the agency problem could become a serious concern because directors would be freer to make decisions that suit their own purposes by citing whatever stakeholder interest might align with those purposes. This would leave shareholders with a residual equity position but no principle to guide the stewardship of underlying assets and thus little reason to risk their capital in the first place—or perhaps, more reason to insist on strict governance controls. Thus, if the introduction of benefit governance consists of the mere negation of primacy, the introduction of greater checks on directors, such as the MBCL introduction of a third-party standard and the greater judicial oversight role in a benefit proceeding, might well be necessary.
In contrast, if benefit governance replaces the principle of shareholder primacy with new principles, such as a mandate to protect common resources and to ensure fair allocation of gains, then the need to alter the judicial standard of review is less clear. The principles under which directors make decisions are changed, but there is a new guiding principle, and the need for directors to be able to engage in risk-taking and entrepreneurship without fear of liability or second guessing would appear to remain intact. Moreover, to the extent that the new guiding principles of benefit governance do require oversight, the role of the courts can be the same as it is under conventional corporate law for the same reasons.121
In conventional corporate law, a significant oversight role is generally filled by shareholders through the exercise (or threat of exercise) of the franchise, inspection rights, and the right to bring derivative suits. Thus, as with conventional corporations, the best mode of enforcement of the principles of a comprehensive benefit governance regime such as the British Columbia Act may be shareholder rights.122 It may be argued, however, that shareholders should not be the only constituency to play this role in the new entity because they are no longer the sole beneficiaries of director duties. By analogy to conventional corporations, should some or all these rights be granted to stakeholders (as well as shareholders) in a benefit governance regime? The statutes to date uniformly reject this idea. The practical reasoning behind this difference is a concern that giving all stakeholders the right to enforce obligations might lead to litigation that puts the board in the middle of unending disputes.
More importantly, shareholders may be well positioned to represent the interests of the most stakeholders because shareholders are generally broadly diversified and at least somewhat representative of citizens more generally.123 These factors mean that shareholders care about the external costs that a company imposes on society and should thus be encouraged to prevent companies from taking actions that do more harm than good in the world, even if profitable.124 In one recent proposal for policy changes to encourage more responsible capitalism, three types of harm to third parties were noted that diversified shareholders might seek to limit: harm to other companies in their portfolios, harm to their own lived experience, and harm to other people who crossed clear ethical boundaries.125
Both the Delaware Act and the British Columbia Act require that benefit corporations adopt a specific purpose in addition to the general public benefit purpose. The origin of the specific benefit idea is somewhat obscure, but it appears there has been a view that because a mandatory general benefit is so amorphous, it is necessary to name a specific public benefit to provide some counterweight to the strong pull of shareholder primacy.126 The need for such a counterweight may be reduced if the new principles to replace shareholder primacy are clearly articulated and become better understood generally.
Of the models examined, all but the Delaware Act and the MBCA Model require a third-party standard. The need for a substantive third-party standard can be compared to the need for the precise and complex financial accounting that has developed to inform investors with respect to the financial condition of corporations. Just as conventional corporate fiduciary duties cannot be effective without common yardsticks, benefit corporation duties create a need for clear and verifiable standards.
If an effective system of sustainable corporate governance must impose a principle that companies use only their fair share of a resource, then it must set a goal and methodology for establishing that share. For example, with respect to carbon emissions, there must be a goal in terms of total atmospheric load and something akin to an allocation or credit system. Similarly, if inequality is to be addressed through a living wage requirement and verification of working conditions throughout the supply chain, there must be an agreed-upon standard for living wages and verification. These concepts require systems of accounting just as do the ideas behind profit and loss statements and balance sheets.
This does not mean, however, that a benefit corporation statute is the ideal location for such standards; just as conventional corporate law does not establish accounting standards, benefit corporation law may best leave the creation of monitoring standards to regulators and standard-setting organizations. This process could be led by shareholders who, through their broad shareholdings and other forms of participation in the economy, internalize many corporate externalities.127
Each new regime establishes a reporting requirement. The MBCL and British Columbia Act mandate annual public reporting against a third-party standard, the MBCA Model requires an annual public report but based on criteria established by the corporation, and the Delaware Act requires only a report to shareholders every two years and does not require use of a third-party standard. To the extent they are viewed as burdensome, such standards may have the effect of discouraging the use of the structures altogether by public companies already subject to demanding disclosure regimes.128
If the goal of corporate governance shifts away from shareholder primacy, it seems inevitable that a shift in disclosure must follow. Whether the goal is like that of the MBCL, to ensure a material positive benefit on the environment and society, or like that of the British Columbia Act, to impose collective action principles, it seems there will be little opportunity to enforce those new goals if the disclosure regime does not move away from a focus on financial return. On the other hand, imposition of this requirement through a separate disclosure regime in the new benefit corporation statutes, rather than through the modification of existing regimes, may, as a practical matter, not be an optimal solution.129
As with third-party standards, it may make the most sense to follow conventional corporate law and allow a disclosure regime to develop outside the corporate law itself, as has happened in the United States, where disclosure is largely governed by a unified federal system.
Finally, all the statutes require board and shareholder action to opt into the new regime and, with the exception of Colombia and, as of 2020, Delaware, add additional hurdles by either requiring an unusually high shareholder vote, granting appraisal rights to shareholders, or both. If benefit governance is simply an option for a different way of doing business for those who want to deprioritize shareholder return, rather than a tool for systemic change, such optionality and hurdles make sense—if shareholders have made their investments based on a system that rewards them with maximized residual returns, then it may make sense to give them opportunities to object through voting and dissenting. This is consistent with a “materiality” benefit corporation regime that involves company-by-company decision making as to social and environmental impacts.
On the other hand, if, as I argue, the concept of benefit governance can (and should) be used more broadly to address collective action issues that society struggles to cope with, the opt-in formula may act as a barrier—how can corporations address collective action issues if only some are programmed to do so, while others continue to be programmed to exploit the commons and perpetuate unfairness if those practices lead to the highest financial return on their equity? The EU Study, in discussing the idea of a mandatory, European-wide regime, cites the creation of a more level playing field in creating greater economic impact. Indeed, others have suggested that making the expanded obligations of benefit corporation directors applicable to all companies—or at least all large corporations—might be a way to directly create a new type of economy.130 This question—of whether the logic of benefit governance as it is evolving should be universally mandated—is critical.
As the prior two parts demonstrate, every benefit corporation model to date makes it clear that directors are not bound by the doctrine of shareholder primacy, but some go further, establishing affirmative principles that mandate that directors factor in stakeholder concerns at every step or requiring that directors factor in a corporation’s fair share of scarce common resources. Which of these versions is right depends on what problem the benefit corporation concept is meant to address, which in turns depends on why one might be troubled by shareholder primacy in the first place.
There is, of course, a great deal of literature on the question of shareholder primacy.131 As noted at the beginning of Part III, discussions of shareholder primacy often begin with a focus on its ability to counter the agency problem of managers with control over investor assets.132 Subsequent developments in finance and economics have reinforced the focus that this model brings to individual company performance. First, there was the rise of modern portfolio theory, which leads professional investment managers to include significant amounts of equity securities in their portfolios and to diversify broadly those portfolios across markets. This allows investors to acquire riskier securities to increase return, while diversifying away from the idiosyncratic risk of those securities. The second development was the shift to institutional investors under professional management. Clients of these managers measure success by comparing their returns to the returns of similarly risky portfolios, with any deviation labeled alpha. The capital markets are now dominated by a search for positive alpha, that is, beating the return of similarly risky investments or investment portfolios. As a result of these developments, the investing community focuses its efforts on beating the market (or matching it with low-cost index strategies) rather than elevating the value of the market itself.133 That means that the markets reward companies for financial performance that beats their peers.
Although agency theory, modern portfolio theory, and institutional investing have contributed to the rise of shareholder primacy, the element that most strongly supports it is the broad acceptance of markets as the superior method for allocating resources, best exemplified by Milton Friedman’s declaration in the title of a New York Times Magazine essay, “The Social Responsibility of Business Is to Increase Its Profits.”134 This idea—that markets work better than other methods of allocating resources and that they work best when left to their own devices—is responsible for the continuing strength of shareholder primacy in today’s capital markets. As discussed in the following, this belief in the superiority of Adam Smith’s invisible hand135 ignores the many assumptions that go into its formalization as the First Fundamental Theorem of Welfare Economics.136 Orthodox economics centers on this proof that voluntary exchanges create value and lead to equilibriums that are optimal—at least in the sense that no one can be made materially better off without making someone else worse off.
Shareholder primacy takes this idea and applies it to the corporation twice. First, the welfare of shareholders is treated as the primary concern among a group of internal stakeholders (investors, employees, managers, customers, and others who enter into voluntary economic relationships with the corporation). Within this nexus,137 primacy focuses on the position of the shareholder as a residual claimant—the party within the corporate nexus that gets what is left over after employees, suppliers, and other internal stakeholders are paid and goods and services are produced and sold. Other internal stakeholders (the theory goes) can establish contract terms (and litigate to enforce contractual and other rights) to optimize their own welfare—employees and managers can bargain for their labor, and suppliers and customers can bargain on cost and quality and even bring tort claims. But shareholders, who get whatever is left over (and only what is left over), will be uniquely motivated to arrange those sets of relationships most efficiently: they have an incentive to find situations where, after bargaining with all the internal stakeholders, the most value is likely to be left over on a risk-adjusted basis. So, it is argued, by the magic of the invisible hand, the self-interest of shareholders will allocate and steward capital to create the greatest surplus, providing opportunities for all internal stakeholders to engage in value-maximizing transactions.
Moreover, by creating the greatest surplus for the shareholders (representing real wealth), this application of shareholder primacy creates more capital to be invested by those shareholders, which will create more opportunities for all other internal stakeholders to engage in more voluntary exchanges of labor, goods, and services. The case for shareholder primacy asserts that if the board were to look after stakeholders other than shareholders—for example, give employees more than necessary to optimize profit—they would be interfering with the invisible hand’s magic: by paying more than an efficient wage, they would be limiting the opportunity set of voluntary economic exchanges, crippling the invisible hand. Thus, even though the surplus payment of an employee might redound to her individual benefit, the efficiency of the economy overall will be reduced, because she would have performed the same work for less, and that differential could have been invested to create another opportunity somewhere else in the economy.
But as applied in today’s markets, shareholder primacy involves a double move: not only does it promote the interests of shareholders over internal stakeholders, it does so over external stakeholders as well—those who are affected by the corporation’s action, even though they have no legal relationship with it. Thus, directors engaging in shareholder primacy would look to maximize return to shareholders without regard to the effects of the corporation’s operations on citizens who do not have contracts with it or legal recourse under tort laws or otherwise.138 Thus, a company might use water resources in a region that leads to difficulties for residents of an area in which their manufacturing takes place, leading to higher costs or even lack of sanitary conditions. If the company has no legal liability139 for this situation, then shareholder primacy would dictate that it ignores those costs to residents.140 As will be discussed in the following, this “application” of market economics occurs entirely outside of any market—distinct from the application of shareholder primacy to internal stakeholders, there are no voluntary exchanges occurring with these external stakeholders, so that the justification that markets are efficient even if imperfect provides no basis for applying shareholder primacy to external stakeholders.141
Of course, the forgoing descriptions are oversimplified. And, even to the extent they adequately describe economic theory, they leave out important assumptions and critiques. What I want to suggest here is that what we often think of as problems created by shareholder primacy are problems inherent in orthodox market economics (or in applying such principles where they make no sense), which are exacerbated by pushing them through a corporate form with limited liability that attempts to maximize residual value for shareholders.142
To start with the most obvious point, this simplified version of the invisible hand ignores externalities. If I have excess gasoline and you have an empty tank, we may both be financially better off by engaging in a voluntary exchange. But if the exchange now allows you to put the gasoline into your tank and burn it, other people who were not parties to that exchange will be affected by the emissions from the tank. Orthodox economics acknowledges this,143 but it perhaps could be characterized by viewing those externalities as flies in the ointment, so that while neoclassical economics acknowledges that government must step in to regulate negative externalities, it also asserts that government should use a light touch to preserve as many voluntary exchanges—and thus as active an invisible hand—as possible.144
Another acknowledged failing of the invisible hand is that its output in terms of fairness is only as good as its input.145 Thus, although (in theory) markets provide all participants with the opportunity to improve their positions without anyone incurring a loss in status, it does not guarantee any move toward a more equal distribution if the initial allocation of value was unequal—and it may even lead to a more unequal distribution, even if no one ends up worse off in absolute terms.146 Moreover, there is significant empirical support for the idea that inequality restricts economic growth.147
There are other imperfections in the invisible hand. One is the well-known concern with bounded rationality. People simply are not particularly adept at making rational voluntary exchanges, so relying on such exchanges to improve everyone’s overall welfare may not always work, even if the problems of externalities and equity are addressed.148 Relatedly, preferences (and awareness of opportunities for exchange) change over time. Finally, the equilibriums predicted by the invisible hand may be unstable, whether due to consumer rejection of equilibrium solutions149 or social instability from growing inequality.
Many criticisms of shareholder primacy are of applying unfettered free market economics to both internal and external corporate relationships without acknowledging its core limitations. The most glaring mismatch of market economics to shareholder primacy relates to the second of the two moves: shareholder primacy over parties that have no legal relationship with the corporation. When a critic says that shareholder primacy leads companies to pollute to maximize profits, they are pointing out that the corporation is not taking certain costs into account when it makes voluntary exchanges with employees, customers, and suppliers because many of those affected by the pollution are neither part of the corporate nexus of contracts who have bargained with or otherwise have legal relationships with the corporation. This might be better characterized as corporate primacy, putting the interests of all those who are within the corporate nexus over those who are not—it has nothing to do with internal corporate governance. Imagine a general partnership engaged in the same business, where a group of individuals was able to use its own capital and do all the work itself within a corporate system requiring unanimous consensus. This internal governance system would not involve any concerns over shareholder primacy because decisions would simply be made by unanimous worker and owner consent. Yet if those workers and owners were the rational value maximizers of Smithian theory, they would still choose to pollute if the diffuse negative effect of their emissions was outweighed by the direct value received as workers and owners. This result—creating economic costs that are unaccounted for in decision making—is a failure of markets, not governance.150
Many of the problems of collective action discussed in Part III fall into this category of external costs. Individual firms may financially benefit by using resources that are limited, assuming others do not overuse that resource. But if they restrain themselves, and others do not and the resource is overused, they also do worse than if they had participated in the overuse. This prisoner’s dilemma lies behind several problems that involve the preservation of common pool resources—free goods that anyone can use but whose overall availability is limited. The obverse problem occurs with public goods, which are costly to create but freely accessible and which can be used without depletion (like public safety). Here, the rational, value-maximizing firm will seek to contribute as little as possible to their maintenance, knowing it can free ride on others’ contributions. So rational firms deplete common pool resources and do not contribute to public goods, leaving us without either in a world of value maximizers, even though they themselves would be better off if they and others did restrain themselves and contribute.
Thus, a manufacturer may contract with a power supplier to purchase electricity at a low price, in part by using fuel that has a large carbon footprint. While the manufacturer and supplier gain in keeping with the invisible hand, the rest of the world suffers as the climate crisis accelerates.151 Employment arrangements that supply little security or training may also weigh on society generally, which must provide a safety net. When corporations do not account for such costs, the value of the goods and services they provide may not equal the cost of the negative externalities they impose, and, as a result, the apparent benefit of corporate activity may be chimerical. Thus, corporate primacy (facilitated by shareholder primacy) may result in economic activity that should not be occurring from an overall perspective.
These dilemmas can only be solved by finding methods to assure corporations that if they restrain themselves, other firms will do the same, and that if they do not, they will be punished. But the key point for this discussion is that this flaw in shareholder primacy is simply an artifact of the inadequacy of a pure market solution.
But what of internal stakeholders, such as the customers and employees who enter voluntary exchanges with the company? Because all these stakeholders are at the table, does that mean that we can rely on market forces?
It is clear from the Fundamental Theorem that one cannot rely on the market to deliver a fair result when the starting positions of the parties are unequal. For example, if the workforce is hungry and has no power or better options, it will work for wages that offend our sense of morality because for the workers, eating is better than starving: the trade of work for low wages is Pareto optimal. Another illustration of this point would be the recent bidding war among cities for Amazon’s second headquarters.152 The cities involved believed it was in their best interest to attract jobs and so offered tax breaks and other incentives. But these incentives could well mean that the shareholders (who benefit from the increased residual owing to unpaid tax) were not paying a fair share toward the public goods they benefited from, leaving others to pick up the slack (or meaning the cities in question offered less than the optimal amount of public goods); in a market economy where there is a constant competition for capital, for margin, and for talent, it is difficult for corporations that have sufficient power to reduce their taxes to resist doing so, leading to a negative feedback loop, whereby companies compete to lower their taxes, leaving them without the public goods that would benefit them and their shareholders over the long run.
In other words, applying the logic of the market (through the operation of shareholder primacy) without constraint ignores the ability of voluntary bargainers with a strong hand to exploit weakly positioned counterparties. (Of course, creating a corporate form that allows the aggregation of huge amounts of capital from disaggregated investors who then benefit from state-granted perpetual life and limited liability is a contributor to the uneven distribution of power in place when the internal corporate bargains are struck.)
These power differentials among internal stakeholders involve more a question of gainsharing than of actual value of production.153 Conflicts among workers, customers, and owners may have more to do with who gets the best bargain among a number of possibilities where both sides gain. If a corporation chooses to increase profits to shareholders by reducing wages, it only reduces the wages to a point at which workers still determine they are better off working than not. Thus, from the point of view of the internal stakeholders, the transactions that occur are less likely to be economically counterproductive owing to negative externalities. Nevertheless, they may (1) offend our sense of fairness (recall that one aspect of the invisible hand theory is that it does not remedy initially unfair allocations of resources) and (2) indirectly create negative externalities by creating societal conditions that, when aggregated, impose a cost on large communities.154 For example, a corporation may pay a wage that is sufficient for meager subsistence, thus making workers better off than if unemployed. Yet by keeping wages low and training minimal (to increase shareholder return), the company may be contributing to a society with an unprepared workforce that will erode economic growth over time.155
Of course, external costs and fairness are not the only issues that stand between a market-based economy and an ideal allocation of resources. Two issues that have been much discussed are information asymmetry—the fact that not all parties have the same level or quality of information—and bounded rationality—the fact that even bargainers who are fully informed and possess adequate bargaining power may not make the decision that will be best for them, viewed by themselves in retrospect.156 Unlike the first two gaps examined, these are not inherent in the theory itself but rather reflections of the fact the assumptions that underlay the theory are never fully realized. That said, a value-maximizing corporation may actively exploit these limitations, creating the externality of an inefficient economy to increase profits.157
If shareholder primacy is a blind application of the invisible hand to relations among a corporation, its shareholders, and its internal and external stakeholders, and if benefit corporation law is a search for a replacement principle that preserves the beneficial aspects of market economics, is there a way that those principles can attempt to bolster knowledge and rationality?
To an extent, these flaws are addressed through application of the first two principles—accounting for externalities and fairness. When companies or shareholders knowingly take advantage of either superior knowledge or human failings in interactions with internal stakeholders, they are encouraging consumption of resources in a manner that is less than optimal. Consider Facebook determining how to keep users affixed to their screens and revealing personal data. This involves the manipulation of human frailty and exploitation of the consumer.158 But it also generates huge external costs in wasted time and loss of privacy, as well as concentration of power through data possession (which itself enables further manipulation of a boundedly rational consuming public).
Accordingly, benefit governance principles that seek to limit negative externalities and generate greater fairness will suggest an effort to reduce the costs of information asymmetry and bounded rationality. But there may be more specific aspects. Certainly, a commitment to disclosure regarding social and environmental impacts will address informational gulfs that cloud decision making for both internal and external stakeholders. Practices that specifically target information deficits, such as click-through licenses with one-sided arbitration clauses, might be an example to be addressed through the fairness principle.
To date, much of the discussion around benefit corporation law has been focused on the need to reject shareholder primacy. The discussion in Part IV indicates that: (1) such rejection is critical to enhancing the operations of corporations so that they do not blindly apply an invisible hand model where it does not work and (2) that there are specific failings of that model that can be addressed with principles that replace shareholder primacy. Without such principles there is a risk that directors will either simply continue to follow a primacy model because of investor pressure or follow no real principle, meaning that assets are applied neither to favor the investors nor to enhance economic efficiency.
Such principles should also address the agency problem, if applied universally. The rejection of profits earned through negative externalities would establish a level and sustainable playing field upon which companies can compete for margin, talent, and capital. Similarly, if universal principles of fairness are applied (elimination of modern slavery, payment of living wages, etc.), minimum standards of gain sharing will be relatively uniform, again creating a level playing field for market-based competition and preservation of the benefits of residual risk-bearing.
The provisions in the British Columbia Act come closest to establishing such principles of any of the models adopted to date. The following definition of the obligations of a benefit corporation director are intended to further refine those provisions in light of the considerations discussed in this article:
Uniform Definition of Benefit Corporation Director Obligation
A director of a benefit corporation, when exercising the powers and performing the functions of a director of the corporation, must act in a responsible and sustainable manner. For the purposes of this obligation, a “responsible and sustainable manner” shall mean a manner that endeavors to:
Jurisdictions around the world are adopting legislation that allows companies to reject shareholder primacy. But the problems created by corporations putting shareholders first is just one example of the problems created by applying market mechanisms in our economy without accounting for limitations of that mechanism. To address that gap, shareholder primacy should be replaced with principles that require corporations to reject profits derived from creating negative externalities or exploiting vulnerable populations. With such principles in place, implementing rules will be developed, allowing corporations to sustainably compete on a level playing field.
However, because these market failures represent breakdowns within the system of competition, corporations operating in competitive markets will be unable to simply adopt benefit corporation law and develop implementing rules on their own without a mechanism for collective action. The most likely mechanism for such action at this historic moment would be concerted shareholder action, which is the subject of a companion paper.159