Corporate Governance as Privately-Ordered Public Policy: A Proposal

Lynn Stout is Distinguished Professor of Corporate and Business Law and Director of the Clarke Program on Corporations and Society at Cornell Law School. Sergio Gramitto is a Post-Doctoral Associate, Adjunct Professor, and Assistant Director of the Clarke Program on Corporations and Society at Cornell Law School. This post is based on their recent paperRelated research from the Program on Corporate Governance includes Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here), and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

In this paper, we show how our society can use corporate governance shifts to address, if not entirely resolve, a number of currently pressing social and economic problems. These problems include: rising income inequality; demographic disparities in wealth and equity ownership; increasing poverty and income insecurity; a need for greater innovation and investment in solving problems like disease and climate change; the “externalization” of many costs of corporate activity onto third parties such as customers, employees, creditors, and the broader society; the corrosive influence of corporate money in politics; and discontent and loss of trust in the capitalist system among a large and growing segment of the population.

We demonstrate how, to a very significant extent, these problems can be traced to the way shares in business corporations are currently owned, traded, and voted. We also offer a plausible plan for shifting the structure of share ownership, trading, and voting to create a more democratic and sustainable capitalism that allows business corporations to better serve humanity. Our proposal, which envisions developing a new form of institutional shareholder, does not rely either on market forces or government interventions. Rather, it relies on voluntary cooperation and the private ordering of free individuals using modern information technologies. It operates to reduce inequalities not only in wealth and income, but also in influence over business corporations.

Our proposal has the following basic elements:

  1. Upon reaching the age of 18, all U.S. citizens receive a share in a collective portfolio of securities; in essence, a collective mutual fund (the Universal Fund or Fund). As in a typical mutual fund, the Universal Fund’s shareholders (Universal Shareholders or Shareholders) periodically receive a proportionate share of all dividends and interest payments paid to the Fund portfolio (Portfolio). Ideally, the Portfolio would include equity securities from a wide variety of corporations, both public and private. Universal Shareholders would not be allowed to sell, hypothecate, or bequeath their Fund shares (Shares). Upon his or her death, each Shareholder’s Share would revert to the Universal Fund itself.
  2. Initially, the Universal Fund would acquire securities primarily from donations by high net-worth individuals and companies, e.g. during public offerings. We explain why both have strong incentive to make such donations. For example, Bill Gates’ and Warren Buffett’s recently-organized Giving Pledge has attracted signatures from 154 billionaires in 16 countries; each signatory has pledged to give away at least half of their wealth. Moreover, it has been estimated that from 2007 to 2061, U.S. estates worth $60 trillion will change hands.
  3. The Universal Fund will be administered by administrators (Administrators) who are passive functionaries compensated only by a fixed fee. This fee should be quite low because, just as in an indexed mutual fund today, Administrators would not be given discretion to select securities to buy or sell. They would merely maintain a list of Shareholders; periodically distribute proportionate dividends to Shareholders; and vote the shares in the Universal Portfolio in accordance with instructions provided either by the Shareholders or by proxy services selected by the Shareholders. In other words (and in contrast to the typical mutual fund today), Universal Shareholders receive not only a proportionate economic right to returns generated by the Portfolio, but also a proportionate political right to determine how the underlying securities in the Portfolio are voted in corporate elections. As a practical matter, rational apathy will discourage most Shareholders from providing Administrators with individual voting instructions. However, Shareholders can be incentivized to select an appropriate proxy advisor by making receipt of Share dividends contingent on such a selection, and by having the Fund rather than the Shareholder pay the advisors’ fee.

Adopting our proposal accordingly would not only provide an ongoing income stream for all Shareholders; it would also create a new, powerful institutional investor (the Universal Fund). Securities in the Fund would be voted in accordance with the preferences of Shareholders, who of necessity are diversified, long-term investors with significant interests as employees, customers, taxpayers, and organisms that live in the environment. We show how providing income to and empowering Shareholders this way would reduce inequality and disparities in wealth and equity ownership; increase economic security; spur corporate innovation and investment; reduce corporate externalities; and provide a variety of “soft” social benefits such as greater civic engagement, reduced social tensions, and improved trust in and support for the capitalist system.

We then address possible objections. These include the objections that donations to the Fund might be unlikely; that Administrators might impose agency costs; that reduced trading in the shares of the securities in the Portfolio would erode market efficiency; that it would be too difficult for Shareholders to provide Administrators with voting instructions; and that Universal Shareholders might have irrational or antisocial share voting preferences. We present arguments why these critiques either do not apply or can be addressed.

We conclude that implementing our proposal is practicable. Doing so would provide a number of significant social benefits and is unlikely to present any dangers. Practical challenges exist, but can be overcome. The primary obstacles to implementation may be psychological. These include the widely-held and often-unconscious beliefs that (1) social problems can be remedied only through uncoordinated market forces or state coercion; (2) that human beings are purely selfish actors concerned only with amassing financial wealth; and (3) that anything that has not been done in the past, cannot work in the in the future. We show how these beliefs are erroneous and conclude that our proposal offers a hopeful path to a better future.

The complete paper is available for download here.

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