The Roundtable’s Stakeholderism Rhetoric is Empty, Thankfully

Jesse Fried is the Dane Professor of Law at Harvard Law School. This post was authored by Professor Fried.

This summer, the Business Roundtable released an updated “Statement on the Purpose of the Corporation” that disavows the Roundtable’s longstanding endorsement of shareholder primacy—the notion that corporations should principally serve shareholders.

The Statement changes precisely nothing. But that’s a good thing. Firms and the broader economy would suffer if CEOs could unilaterally disempower shareholders.

The Statement was signed by 181 CEOs, including Apple’s Tim Cook and JPMorgan’s Jamie Dimon, who committed “to lead their companies for the benefit of all stakeholders—customers, employees, suppliers, communities, and shareholders.” The CEOs appeared to be demoting their own shareholders, forcing them to compete with various other stakeholders for managers’ affections.

But every CEO who signed the Statement serves at the pleasure of their firm’s directors. These directors, in turn, are elected—and can be replaced—by shareholders. Furthermore, both directors and executives can be held liable for breach of fiduciary duty if they explicitly prioritize other stakeholders over shareholders. Although CEOs have substantial power, they cannot deviate too far from shareholders’ preferences. Thus investors, not the CEO, have the ultimate say over how, including for whom, the corporation is run.

To be sure, investors may want CEOs to consider broader stakeholder interests. Doing so may benefit shareholders indirectly by increasing profits in the long run. Or investors may be willing to sacrifice some financial return to benefit society. If shareholders approve, a CEO is free to take steps that benefit other stakeholders at shareholders’ expense. But shareholders will still have the last word.

This allocation of power did not happen by accident. Shareholder-favoring arrangements were negotiated when these businesses were younger and needed outside capital: each large publicly-traded firm once started as a small firm that sought funds to grow. Investors supplied financing to this small firm, hoping to profit. Since most early ventures fail, investors rely on gains from successful firms to offset the gambles that generate losses. But investors worry that managers of successful firms may be reluctant to return excess capital to investors, preferring instead to engage in empire-building. So, investors usually insist on arrangements that give them the power to compel firms to return excess capital. These arrangements typically—but not always—include director-removal rights and shareholder-oriented fiduciary duties.

Firms selling shares on U.S. stock exchanges may give public investors much weaker rights, and sometimes do. A firm can eliminate shareholder-focused fiduciary duties by structuring itself, for example, as a limited partnership or as a benefit corporation. A firm can also eliminate public shareholders’ director-removal rights by giving others control over the board. Consider Facebook, which uses dual-class stock to give founder Mark Zuckerberg control. Or consider Alibaba, whose articles of association give a group of employees the right to nominate a majority of the board. Capital-raising firms are free to use variants of existing legal structures to allocate board seats to employees, creditors, or other non-shareholder constituents. But capital providers almost always bargain for shareholder primacy in exchange for their funds.

The shareholder-primacy system works, both for individual firms and the economy as a whole. When large public firms cannot profitably deploy assets, directors sell off poorly-managed divisions and distribute unneeded cash because of their fear of removal by investors. Annual net payouts from public firms to shareholders now total around $400 billion. The cash freed up from mature firms can be invested in younger non-listed firms, which absorb more than $400 billion annually from VC and PE firms alone.

These non-listed firms get less attention than public firms, but they are just as important to the economy: they account for more than 50% of nonresidential fixed investment and employ almost 70% of U.S. workers. And, historically, private firms, funded by venture-capital and private-equity funds, have generated tremendous innovation and job growth.

At the end of 2018, public firms sat on $5 trillion in cash, even after engaging in record levels of investment that year. Some of these funds, if distributed to shareholders, could be recycled and used to support hiring and investment by non-listed firms.

If the Business Roundtable CEOs could unilaterally demote shareholders, our economy would suffer. Much of this $5 trillion in cash would be trapped inside public firms, because managers prefer to play with more assets rather than with less. Resources would be poorly invested. As payouts from public companies declined, cash-hungry unlisted firms would have less access to capital.

And even if an investor had capital to invest in a small firm, she might think twice before doing so. If the firm fails or goes sideways, she loses. If the firm succeeds and goes public, she still might not win: the CEO could decide to use its assets principally to serve other stakeholders, with capital return to shareholders a mere afterthought.

Fortunately, however, the CEOs of the Business Roundtable cannot undo the legal arrangements that investors negotiated before supplying capital. CEOs may consider other stakeholders’ interests, as Tim Cook and Jamie Dimon pledged to do. But only as long as their investors let them. That was the original bargain, and the vitality of our economy depends on it being respected.

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One Comment

  1. Vivian Ford
    Posted Friday, November 22, 2019 at 3:42 pm | Permalink

    I agree with the sentiment, particularly the reality of no change. However, the imprecision here such as “preferring to engage in empire building” is very disappointing, there’s something of the naif in the writing of this Professor and clearly no commercial experience. Lots of theory, so he has a good imagination.

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