The Corrosion Critique of Benefit Corporations

Brett McDonnell is the Dorsey & Whitney Chair in Law at the University of Minnesota Law School. This post is based on his recent paper, and is part of the Delaware law series; links to other posts in the series are available here.

Benefit corporation statutes have emerged as the leading new statutory alternative to enable and encourage social enterprises, businesses which seek both to generate financial returns for their investors while also pursuing social missions. Some persons who strongly support social enterprises have criticized benefit corporation statutes, arguing that they create a mistaken impression that companies organized under ordinary corporation statutes cannot consider the interests of non-shareholder stakeholders except insofar as doing so benefits shareholders in the long run. This corrosive effect on the understanding of most corporations may impede the adoption of socially responsible behavior. I call this common criticism of benefit corporation statutes the “corrosion critique.”

In order to understand and evaluate the corrosion critique, it helps to start by distinguishing three conceptions of the legal purpose of corporations and whose interests officers and directors should consider. The shareholder-only conception maintains that directors and officers must ultimately base their decisions only on what they think will lead to the highest risk-adjusted returns for their shareholders in the long run. They can consider the interests of other stakeholders, such as creditors, employees, customers, and local communities, but only to the extent that doing so will help shareholders in the long-run. The stakeholder-optional conception allows directors and officers to consider the interests of other stakeholders without having to tie that consideration to an ultimate benefit to shareholders. The stakeholder-mandatory conception requires directors and officers to consider the interests of a variety of stakeholders, independent of their effect on shareholders.

How do these three conceptions line up with current corporate law? Delaware has adopted the shareholder-only conception, as seen in the Revlon and eBay cases. States with constituency statutes have adopted the stakeholder-optional conception. Benefit corporation statutes adopt the stakeholder-mandatory conception. One can argue whether Delaware has truly adopted the shareholder-only conception and constituency states have adopted the stakeholder-optional conception, but this is pretty clearly right. The full paper on which this post is based analyzes Delaware and constituency statutes in detail.

To evaluate the corrosion critique, we also need to distinguish two justifications of benefit corporation statutes. The enabling justification asserts that corporate law constrains the ability of directors and officers to consider the interests of stakeholders other than shareholders because it imposes the shareholder-only conception of corporate purpose. The branding justification asserts that benefit corporations help companies attract investors, customers, and employees by giving them a way to credibly commit to considering the interests of other stakeholders through adopting the stakeholder-mandatory conception.

Having established these categorizations, we can render a mixed verdict as to the validity of the corrosion critique. The critique does not apply to the branding justification. That justification requires adopting a stakeholder-mandatory approach to achieve the commitment needed for branding purposes, and no ordinary corporate statute currently takes such an approach. So the branding justification creates no false implications about corporate law.

For the enabling justification, the critique is mostly valid in states with corporate constituency statutes. Such states have adopted the stakeholder-optional conception for ordinary corporations, so it is thus false to imply (as the enabling justification does) that ordinary corporations are constrained in considering the interests of various stakeholders. The corrosion critique does not, however, apply in Delaware and probably other non-constituency statute states, which have adopted the shareholder-only conception for ordinary corporations. In Delaware, the implication that companies are constrained in considering stakeholder interests is correct. They must ultimately tie those interests to increased shareholder value. They have great discretion to argue that helping stakeholders will ultimately help shareholders, given the business judgment rule. Thus, most companies have plenty of room to engage in socially responsible behavior without fear of losing a fiduciary duty lawsuit. However, truly committed social enterprises which are willing to openly sacrifice profit to protect other stakeholders do have something to fear in Delaware. Just ask the founders of Craigslist how they fared in eBay.

The analysis suggests why there is much confusion around corporate purpose and duty and the corrosion critique of benefit corporation statutes. There are two differing justifications of the new statutes, and the old statutes adopt differing (and disputed) conceptions of corporate purpose. So the corrosion critique is true in some senses and states but not others.

What is to be done? I suggest that advocates of benefit corporations should stop using the enabling justification, which is subject to the corrosion critique in over half of all states (those with constituency statutes), and which justification is weak on other grounds as well. Focusing on the branding justification will direct transactional lawyers and businesses to the right reason for considering becoming a benefit corporation: Do you have shareholders or others who are willing to become involved with your company, but only if they believe you are truly committed to a dual purpose? Focusing on the branding justification will also focus policymakers and scholars on the right question to ask in evaluating the usefulness of benefit corporation statutes: Do the statutes truly help social enterprises make a credible commitment to pursuing dual purposes?

The complete paper is available for download here.

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