Corporate Purpose and Stakeholder Fairness Through the Lens of Behavioral Economics: Legal Implications

“ESG” (the acronym for “Environmental, Social and Governance”) is a term that either inspires a transformative feeling of hope or a cynical roll of the eyes. For some, ESG, and similar concepts including “stakeholder governance” or “stakeholder capitalism”, is merely an “illusory promise” that will ultimately harm stakeholder groups rather than help safeguard their interests – this view is expressed in the recent articles written by Bebchuk and Tallarita (here and here) and Bebchuk, Kastiel and Tallarita. According to the “shareholder supremacy” side of the debate, the proper venue for safeguarding stakeholder interests is in specific non-corporate law fields of regulation such as labor, environmental protection and tax law. To others, such as R. Edward Freeman, Colin Mayer and Alex Edmans, the corporate enterprise requires attention to nonfinancial considerations as well due to the fact that corporations serve a greater purpose in society beyond shareholder profit maximization. Broadly utilizing the insight of the “framing effect” from behavioral economics, this conflict can be contextualized as disagreement over the proper framing of corporate purpose regarding the appropriate balance between shareholder profits and stakeholder interests. This longstanding debate is here to stay and has even received a “booster”, if we may use this word in our context, over the last two years, in the form of increased activity implementing the stakeholder approach through the supervision of ESG-related financial, reputational and legal risks. Society, it seems, is gradually seeking answers to larger questions of corporate purpose because of the perceived role corporations have in shaping the future of capitalism, the future of human rights, and even the future of humanity and the planet. These trends, like islands, are slowly but surely merging to form a continent, manifesting in a novel framing corporate purpose.

In addition to drastically increasing ESG-related investments, corporate actors (including shareholders, other stakeholder groups, directors, officers, institutional and retail investors, professional organizations, judges and regulators) have been making efforts to turn ideological statements into practical initiatives, emerging one after another at a dizzying pace. What explains the paradigm shift in values in the business and financial sectors embodied by the rising interest in ESG? Why are there so many attempts to enable companies to measure and report on ESG matters consistently and comparably? What explains the legal evolution in directors’ oversight duties? The scholarship on this matter currently lacks a comprehensive framework that satisfactorily explains the increased management, financial and legal scrutiny on corporate behavior, or why corporations choose to fall in line through voluntary documents such as ethical codes of conduct, commitments to make ESG disclosures and statements such as that of the Business Roundtable from 2019. As is natural for changes that are perceived as paradigmatic and still in progress, there is not necessarily any consensus on such changes’ meaning.

My recent study, Corporate Purpose and Stakeholder Fairness Through the Lens of Behavioral Economics: Legal Implications, aims to bridge the gap between the vision of stakeholder capitalism, as manifested today in ESG risks and opportunities, and the shareholder-focused history of corporate law. In the article, I claim that the current reality of regulators around the world, international organizations, institutional investors and corporations themselves investing time, money and efforts on increasing transparency towards stakeholder groups reflects the ubiquity of the fairness concept. The framing effect, together with the fairness concept, might explain the “buzzword status” of terms such as ESG and corporate social responsibility and indicate the root of the deeper change in the perception of corporate mission critical purpose.

The main thesis of the article is that the new view of corporate purpose, and stakeholder capitalism that derives from it, is closely related to the concept of fairness. The article hypothesizes that certain foundational concepts developed in the realm of behavioral economics, rather than traditional economic theory with the assumption of rationality and wealth maximization that underlies it, can help describe and justify the transformative and newfound prominence of the stakeholder approach and the rejuvenated discourse around the legal framing of corporate purpose. Paradoxically, even though behavioral economics has achieved a place of honor in the academic literature, including in the legal world, and despite the fact that the social responsibility of the business sector revolves around issues that are at the core of behavioral economics research, the connection between the two has yet to be discussed.

The proliferation of declarative and practical ESG initiatives demonstrate powerfully how critical the idea of fairness is in human decision-making, in a manner that supports the findings of behavioral economics and which contradicts several basic assumptions of neoclassical economics. While the traditional neo-classical economy is still a dominant theory of corporate law, it seems that the time has come to re-examine the corporate institution and corporate law from a fresh angle based on the alternative economic paradigm presented by behavioral economists, rather than the paradigm presented by neoclassical economics. The two economic approaches – traditional and behavioral – differ in their assumptions and conclusions, especially regarding the purpose of business corporations and the impact of fairness on corporations’ relationships with various stakeholder groups. Key insights from behavioral economics can empirically contextualize the legal regulation of stakeholders and corporate purpose. These insights explain why a culture of trust and fairness encourages reciprocity and cooperation more effectively than the previously dominant view of the corporation and its unwavering preference for shareholder interests. Behaving fairly is not “irrational,” in the broad sense of the term, since according to the findings of behavioral economists, incorporating fairness is an important part of corporate decision-making by improving relationships with customers, employees and creditors, as well as with potential institutional investors, regulators and the courts. In this sense, the framework of intrinsic fair thinking is a potential tool for corporate actors to take measures that function as a “vaccine” or “preventive medicine” against negative legal, reputational and financial consequences from unfair actions. Furthermore, and as explored in the article, the basic doctrines of corporate law itself impose increasing obligations towards stakeholders, and a descriptive evolutionary review of these legal mechanisms (such as separate legal personality, piercing the corporate veil and directors’ oversight duties) provide the foundation for a developing broader conception of corporate purpose that incorporates fairness towards stakeholders within corporate law, rather than in external specific legislation (such as environmental protection, labor law and class actions).

The article concludes with the normative idea that the need to cope with the fairness bias, as emphasized by behavioral economics research, provides a solid foundation for legally implementing considerations of fairness into the modern corporation’s DNA by reframing the underlying approach towards the primary legislation which regulates business sector activities. Unlike the claim made by Bebchuk and Tallarita and others, who call to stakeholder protection outside corporate law, my article claims that the legal implementation of the fairness-based approach, which is the core of the stakeholder approach, ought to be substantiated within corporate law, thereby directly becoming an integral and legally binding part of the discretion exercised by corporate directors and officers. As implied in the arguments made by Edmans and Mayer, and as a natural consequence of the fall of the “will theory” in modern contract law and the related weakening of the “nexus of contracts” conception of the corporation as the traditional safeguards against corporate externalities, framing the idea of fairness within the function of any given corporation’s legal purpose, is best suited for guiding routine corporate decision-making towards trust and cooperation with the corporation’s relevant stakeholders.

The legal reframing of corporate purpose as one that intrinsically incorporates fairly considering stakeholder interests alongside profit-maximizing interests brings forth the expressive function of the law in integrating desired social and business norms based on an alternative culture of fairness and trust into one of the most crucial economic (and social) institutions of our time. Finally, this new framing gives rise to a broader and more holistic view of the corporation that maintains the profitable objectives which characterize corporate activity, while enriching the picture painted within that framework in order to help unify the business and financial discourse with the legal discourse regarding the purpose of the modern corporation.

The complete paper is available for download here.