The Case for Consumer-Oriented Corporate Governance, Accountability and Disclosure

The following post comes to us from Shlomit Azgad-Tromer of Tel Aviv University‚ÄĒBuchmann Faculty of Law.

When offering securities to the public, corporations must comply with an exclusive informational regime that allows speech only within the uniform boundaries determined by the SEC. Corporations must use a standardized method for financial audit and report, and disclose in plain and simple English any material fact of interest to a potential buyer. But when offering the public other products, corporations are entitled to speak freely to consumers as they wish, under the wide wings of the freedom of commercial speech, constrained merely by the ban on misrepresentation and fraud. Why are investors better protected than consumers? Why does our legal system choose to provide consumers of investments better information to secure their freedom of choice?

The answers lie in the limited scope of current corporate law. Consumers are not considered corporate stakeholders entitled informational accountability. Rather, consumers are a weak and voiceless party to a contractual relationship with the corporate seller. The consumer capacity is therefore restricted by the terms of the contract, determined unilaterally by the seller. Corporations offering merchandise or services to the public, in 2014, enjoy the status of small merchants in the archaic marketplace: they need to provide consumers with information only to the extent where lack thereof would render the agreement involuntary, as required under contract law. Consumers of securities, on the other hand, are labeled “investors,” and are considered prominent corporate stakeholders. Offering securities to the public entails an informational regime that includes periodic and immediate uniform disclosures including all material information in plain English, accompanied by standardized financial audit and report.

This paper calls for corporate informational accountability towards consumers, by setting positive disclosure standards on corporations offering products or services to the public. The argument is structured as follows. Part I compares consumers to investors, showing that consumers are more vulnerable in their relationship with the corporate seller than investors are, and thus are in higher need for informational accountability. This paper compares the scope of risks per purchase (or investment); the complexity of product choice versus investment allocation; and the right to exit, showing that consumers are at least as vulnerable as investors are. The consumer products market is compared to capital markets, and in particular, the role of institutional and investment advisors acting in the investment market is compared to consumer unions acting in the consumer products market, aiming to reduce information gathering costs. Comparing structural characteristics of the consumer products market to capital markets leads to the same conclusion, strengthening the result that consumers’ informational rights are under protected.

Part II analyzes the voluntary commercial speech environments for the consumer products market. The analysis portrays informational practices from three distinct sources: sellers, consumers, and third parties, in particular, consumer organizations. This second part of the paper explains why voluntary disclosures are insufficient to create a sound foundation for freedom of consumer choice, both due to market failure in consumers’ demand for information and due to a market failure in the supply of product information. Consumers have both too much and too little information: commercial speech overwhelms informational environments, but, given masses of information overload, it often becomes very costly to find factual information about the material features of the product. At the same time, often the most important and material information is completely unavailable due to insufficient incentives of all three information sources and consumers’ limited accessibility to adequate sources of information and mediums for its dissemination. Consider, for example, the following examples: the effective costs of car ownership; the chemical composition and quality of bottled water; the real savings value compared to future costs of living for pension plans. Consumers’ bounded rationality, along with consumers’ cognitive limitations, create vulnerability to the overloaded commercial speech environment and a failure in the efficient allocation of demand for product information, given limitations in consumers’ capacity to absorb and analyze overloads of information existing in the consumer products market. Sustainability reporting gives little answer to the problem of product information as it is not product specific and not directed at the consumers’ audience. Market failure is evident on both the demand and supply side of the product information market.

Part III argues for consumers’ corporate membership using organizational theories of the corporation. Given that consumer contracts are frequently not negotiable, but rather subject consumers to the rules determined unilaterally by the seller, the relationship of consumers with corporate sellers resembles organizational membership. Securities Exchange Commission v. H. J. Howey Co. [1] and United Housing Foundation Inc. v. Forman [2] create a legal distortion, because it is not the purpose of purchase we need to protect, but rather the unilateral relationship and one-sided control of all relevant information, which equally apply to consumers and investors alike.

Doctrinal foundations are discussed in Part IV. Corporate law is established as the doctrinal setting for product disclosures, offering an extension of the scope of current corporate governance and applying stakeholder theory to consumers as corporate members. The suggested corporate law accountability is compared to accountability under contracts law, arguing to the merit of the former. Three essentials for corporate disclosure accountability towards consumers are suggested, including a duty of materiality, accessibility, and succinct disclosures.

The full paper is available for download here.

Endnotes:

[1] Securities Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946).
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[2] United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975).
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