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E-MailRobert G. Eccles is Visiting Professor of Management Practice at Oxford University Said Business School, and a Senior Advisor to the Boston Consulting Group; Leo E. Strine, Jr., the former Chief Justice of the Delaware Supreme Court, is the Austin Wakeman Scott Lecturer in Law and Senior Fellow at the Harvard Law School Program on Corporate Governance, as well as Of Counsel at Wachtell, Lipton, Rosen & Katz; and Timothy Youmans is Lead-North America, EOS at Federated Hermes. This post is based on their article published in the Harvard Business Review. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here), and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).
When leading money managers embrace the need for corporations to be socially responsible and the Business Roundtable (BRT) declares that the purpose of a corporation is “to create value for all stakeholders,” it is safe to say that purpose has gone mainstream in the corporate narrative. A consensus is emerging that society and diversified investors are best served by companies that focus on sustainable value creation and respect the legitimate interests of all stakeholders, not just stockholders. But how can these high ideals be put into practice? That corporate employees and host communities have borne the brunt of the economic effects of the current pandemic only underscores the deepening sense that our corporate governance system’s empowerment of the stock market has undermined the fairness of our economy.
If companies and institutional investors are serious about responsible, sustainable wealth creation in a manner fair to all corporate stakeholders, then they must match high-minded rhetoric about purpose with accountability. This will require a new governance form that makes a company’s obligations to fulfill its purpose enforceable.
For such a governance form to be effective, however, it must require two conditions to be met. First, companies must be clear about what their purpose is. Every company’s board of directors should publish a stakeholder-inclusive “Statement of Purpose,” which defines the positive contribution to society the company will make, and the steps it will take to eliminate its negative impact on society. The board chair or lead independent director and the governance committee should take the lead in drafting it. It must be unique, and not be so generic it applies to all industry competitors. (The Swedish private equity firm EQT exemplifies this in the “Statement of Purpose” published in its 2019 Annual Report [p.111.])
The second step is for companies to adopt integrated reporting that allow investors and other stakeholders to evaluate the company’s success in achieving its purpose. For instance, Philip Morris International (PMI) recently issued a statement of purpose (pp. 3-5 in its 2020 Proxy Statement) to phase out cigarettes and replace them with reduced risk products. But this eyebrow-raising example will make even the optimistic among us ask: How will we know that PMI and other companies are living up to these promises?
The good news is that metrics exist that enable the public to hold corporations accountable for meeting their stated Purpose. Frameworks for companies to report their performance on material ESG issues such as on environmental responsibility and fair treatment of workers, in a way that is integrated efficiently with their financial accounting disclosures, are gaining acceptance. Corporations are adopting the Global Reporting Initiative (GRI) standards, the Sustainability Accounting Standards Board (SASB) standards, and the recommendations of the Taskforce on Climate-related Financial Disclosures (TFCD), accelerating the movement toward full integrated reporting.
But even with the widespread adoption of statements of purpose and the increased use of integrated reporting frameworks to communicate companies’ progress toward enacting business purpose, a crucial, final step remains: making a company’s commitment to its purpose enforceable. Here, a new form of governance is required.
In a majority of American states today, the law explicitly allows corporate directors to give weight to the interests of stakeholders but, in reality, this rarely happens. The reason is simple. In none of those states do corporate boards have a “shall” duty to act with fair regard to workers, the environment, and the community. At best, corporate boards and managers who answer only to one constituency—the stockholders—“may” give weight to other stakeholders so long as they can do so and satisfy a stock market hungry for immediate returns. In the leading jurisdiction, Delaware, management may treat other stakeholders well so long as there are rational relating benefits to stockholders. But, under the famous Revlon case, (Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)), all that matters in a sale of the corporation is what buyer will pay the highest price, and stakeholder concerns go out the window.
As a practical matter, therefore, virtually all American public corporations are governed by rules that provide power only to stockholders, and none to other stakeholders. Given the sharply increased power of institutional investors and the decline in worker leverage in recent decades, it should not be surprising that American workers have seen their historical share of the gains from increased corporate profitability drop sharply. Nor should it be surprising that many corporations have sought stock market-pleasing profits through unethical and risky behavior resulting in consumer and environmental harm.
So how to resolve this legal impasse? A recent innovation offers a sensible answer. Before the current attention to corporate purpose, a movement centered on corporate purpose existed that went beyond rhetoric to develop a form of business entity—the benefit corporation—that puts legal force behind the idea that a business should have a positive purpose, commit to do no harm, seek sustainable wealth creation, and treat all its stakeholders with equal respect.
Under Delaware’s leading statute allowing corporations to adopt that model, benefit corporations must have a statement of purpose, and act with due regard to society, the environment, and all corporate stakeholders. Even in a sale of the company, directors must protect the interests of the workers, consumers, and communities of the corporation, and cannot sell to a callous buyer just because it offers the highest price. Not only that, the statute allows stockholders—such as socially responsible investment funds and universal investors like index funds—to sue to make the company honor its purpose and duty to stakeholders.
The model is conservative in that it does not give other stakeholders enforcement rights but depends on the existence of stockholders who give real weight to social responsibility and respect for other stakeholders. And the model preserves the strong protections against managerial self-dealing essential to all stakeholders. But by modifying the Revlon rule, imposing a “shall” duty toward stakeholders, and enabling stockholder suits to enforce the company’s mandatory duties, the model gives genuine meaning to purpose. Likewise, by requiring that public benefit corporations adopt metrics to measure their performance against their Statement of Purpose and report their results, the statute creates the information flow essential to accountability. Thus, the Delaware benefit corporation model incorporates our first two steps and takes the critical third step of making the corporation’s duty to fulfill its Statement of Purpose, and respect stakeholders and society, binding.
The current pandemic’s negative effect for corporate stakeholders like workers, creditors, and company communities underscores the value of the Delaware benefit corporation model. The CARES Act’s short-term limits on stock buybacks, dividends, and executive compensation for companies getting federal funding support are understandable attempts to address the symptoms of the problem. The underlying problem will be even better addressed by durable reforms requiring large companies receiving government subsidies convert to benefit corporation status. This would put us on the path toward a much fairer and less risky economic system that respects the fundamental value of the workers and communities, both critical to the capitalist system and that focuses on environmentally responsible, sustainable growth.
Just one thing has to happen to make the benefit corporation model the dominant form of corporate governance in U.S. capital markets: the Business Roundtable and mainstream institutional investors must rally behind it. If the Business Roundtable supports conversion of their public companies to this model, their mere “trust us, we care” words will become those of accountable leaders who embrace an enforceable obligation to others. But, corporate leaders cannot succeed unless institutional investors, such as BlackRock, Fidelity, State Street, and Vanguard and organizations like the Council of Institutional Investors, also walk their talk on corporate purpose and on the value of stakeholders like workers. These and other large investors have demonstrated that their voting clout can move the market. If they support public companies in converting to benefit corporation status, our corporate governance system can change for the better—fast.
The question, therefore, is not whether there is a sensible way to make purpose meaningful, it is whether the powerful players that dominate American corporate governance will come together to make it happen.
