Institutional Investing When Shareholders Are Not Supreme

Anne Tucker is Associate Professor of Law at Georgia State University College of Law. This post is based on an article that first appeared in the Harvard Business Law Review, authored by Professor Tucker, and Christopher Geczy, Jessica Jeffers and David Musto, all of the Department of Finance at the University of Pennsylvania.

Signs of the public’s appetite for alternative business forms, such as benefit corporations, [1] that blend profit with purpose include the success of get-one-give-one brands like Warby Parker, and Etsy’s recent $300 million IPO, which made it the second (and largest) B Corp to go public. The success of alternative business forms will also depend, in part, on acceptance by institutional investors, as companies would likely suffer without access to their trillions in assets under management.

The question of institutions’ attitudes toward investing in alternative business forms prompted our recent research, Institutional Investing When Shareholders Are Not Supreme. [2] We address the question by gauging institutional investors’ response to decreased pressure on public firms to maximize shareholder value caused by the passage of constituency statutes. Why constituency statutes? Constituency statutes, first passed as takeover defenses in the 1980’s, explicitly extended directors’ discretion to consider non-shareholder interests in takeover, and sometimes other, circumstances. [3] The changes imposed by constituency statutes were smaller in scope (permissive director discretion in limited circumstances) than the changes codified in benefit corporation legislation (mandatory director consideration of a broader range of circumstances), but constituency statutes were the first codification of directors’ ability to reject a potentially profit maximizing endeavor because of other, non-shareholder concerns. [4] We didn’t rely solely on the statutory language to demonstrate that constituency statutes constituted a legal change; we analyzed thirty years’ worth of case citations to conclude that the statutes, as enforced, expanded boards’ rights to serve nonshareholder interests as opposed to maintaining the status quo. [5] Constituency statutes, at the time of their initial passage, sparked a large body of corporate legal scholarship theorizing the impact (and legality) of reducing pressure to maximize shareholder value. [6] We reviewed this initial debate in our paper because it mirrors, in many respects, the rhetoric and theory evoked in today’s alternative business form debate.

In our study we limited our empirical review to high fiduciary duty institutional investors (HFDIs) including public and private pension funds, as well as endowments. HFDIs’ fiduciary duties owed to investors explicitly forbid sacrificing monetary returns in pursuit other goals. If institutional investors were incapable of reconciling their unique fiduciary duties to their investors with the limited latitude of some companies to pursue nonmonetary corporate goals, we hypothesized that we would see this effect most clearly on HFDIs. And if we saw a flight of HFDI investment in response to constituency statutes, an admittedly weaker version of profit de-maximization pressure, then we could make an informed prediction that institutional investors would have little tolerance for new alternative business forms, like benefit corporations. We measured both the number of HFDI investors (participation) and the percent of shares held by HFDIs (exposure) to test both flight of HFDIs and dilution of their holdings in constituency statute corporations.

To observe the effect of constituency statutes on institutional investment behavior, we employed a “difference-in-differences” methodology to measure the change in HFDI investment in public firms after the state of incorporation passed a constituency statute, and then contrasted that change to the change in HFDI investment in firms incorporated in states that did not pass such a statute. [7]

Our data set—which spanned over thirty years and included all 50 states—demonstrated that HFDIs did not significantly decrease their investment participation in response to the passage of constituency statutes. While we cannot rule out that constituency statutes had some effect on HFDI investment, we can rule out that these investors significantly altered investment behavior after the passage of constituency statutes, as one might expect if these institutions perceived material conflicts with their fiduciary duties. Both the timespan of our study and the size of our sample make it unlikely that any effect observed across the statutes’ passages dates would be confounded empirically by some other concurrent event.

If you care about the viability of benefit corporations and other alternative business forms, this early data may provide some insights into the tolerance and acceptance by institutional investors of these news firms. In other words, this data is cautiously optimistic about capitalization prospects of alternative business forms. The absence of a clear road block from constituency statutes is not an unqualified green light for alternative entities, importantly because constituency laws were limited in scope, permissive (not mandatory) and granted no additional enforcement rights, which may, together, tip the balance for institutional investors concerned about their fiduciary duties, reducing the pool of capital available for newly minted alternative purpose firms.

Institutional investors want to be outliers in terms of positive investment returns, not with regard to litigation risks. Widespread institutional investor acceptance of reduced pressure to maximize shareholder value may provide important feedback about how to interpret fiduciary duties owed to investors in the face of changing director duties as mandated under benefit corporation laws, or in other companies that aren’t legally organized as an alternative firm, but incorporate “other serving” interests as a part of their business model.

The full paper is available for download here.


[1] For example, corporations in 27 states can organize as Benefit Corporations, entities can form as low-profit limited liability companies or L3Cs in 8 states, and corporations in any state can voluntarily label themselves as a “B corp” after obtaining B Lab certification for meeting “rigorous standards of social and environmental performance, accountability, and transparency.”
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[2] 5 Harv. Bus. L.Rev. 73 (2015).
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[3] See id. at 138 (Appendix D: Benefit Corporation Legislation).
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[4] Common features of benefit corporation legislation include the creation of a corporate purpose outside of profit, a mandate that directors shall consider nonshareholder constituents, limited director liability for pursuit of alternative purposes, a named benefit officer or named benefit director, an annual benefit report, and a benefit enforcement proceeding. Constituency statutes, like benefit corporation statutes, focus on expanding directors’ ability to consider nonshareholder constituencies utilizing similar language, but do not build in the additional features described above.
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[5] For a full discussion of our case review and results, please see Section V (pp. 105-118) of our paper, Institutional Investing When Shareholders Are Not Supreme, 5 Harv. Bus. L.Rev. 73 (2015).
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[6] See id. at 98-105 (conducting the literature review).
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[7] For a full discussion of our data and methodology please see Section VI (pp. 118-128) of our paper, Institutional Investing When Shareholders Are Not Supreme, 5 Harv. Bus. L.Rev. 73 (2015).
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