Stark Choices for Corporate Reform

Aneil Kovvali is the Harry A. Bigelow Teaching Fellow & Lecturer in Law at the University of Chicago Law School. This post is based on his recent paper, forthcoming in the Columbia Law Review. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders? both by Lucian Bebchuk and Roberto Tallarita; and Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

Corporate law has been wracked by a decades-long debate. A majority of academics and practitioners support shareholder primacy, the view that corporations exist solely to generate financial returns for shareholders. But an increasingly vocal minority supports stakeholder governance, the view that corporate leaders should consider the interests of a broader range of stakeholders, including workers, consumers, and members of surrounding communities. Shareholder primacy theorists have long claimed that stakeholder governance would be costly or ineffective in advancing the interests of stakeholders. But they have recently escalated their attacks by insisting that stakeholder governance rhetoric is potentially dangerous to stakeholders: eminent commentators have suggested that adopting corporate governance measures to promote stakeholder interests could “derail,” “crowd out,” “impede,” “cannibalize” or otherwise prevent governmental reforms and regulations that would do more to advance stakeholders’ interests.

The hypothesis that reformers face a stark choice between internal corporate governance reforms and external regulations plays an important role in the case against stakeholder governance. Workers and other stakeholder constituencies have plainly suffered in the past few decades. Stakeholder governance is a movement born of desperation over the plight of these constituencies, and pessimism about the likelihood of effective and helpful government intervention. The stark choice hypothesis seeks to play one concern against the other.

It is also one of the few arguments for shareholder primacy that would resonate with people focused on stakeholder interests. Critics of stakeholder governance-based reforms sometimes claim that they may be destructive because they would prevent corporate acquisitions and other transactions that would create economic value. But stakeholder governance theorists are likely to accept some loss of economic value to deliver benefits to stakeholders. Only a threat to stakeholder interests is likely to be persuasive. Similarly, critics of stakeholder governance claim that it may not deliver the intended benefits. But that concern alone is not a reason to preclude experimentation with such reforms, especially after decades in which shareholders enjoyed outsized gains and other corporate constituencies suffered deeply while external regulators did little to help. In order to explain why stakeholder governance should not be pursued, shareholder primacy theorists must explain why it would be risky to try. The stark choice hypothesis plays that necessary role in the rhetoric of shareholder primacy theorists.

Despite its enormous importance, the hypothesis that reformers face a stark choice between two exclusive strategies has not been subjected to serious critical analysis. A more careful look reveals that the hypothesis is undertheorized and difficult to square with experience. Like much of the traditional law and economics literature, the hypothesis ignores important realities about the costs of political action. There is no reason to believe that the choices are mutually exclusive: there is no clear constraint that forces a choice between the internal and external paths. There is little reason to assume that reformers are biased or naive in their expectations: reformers are often sophisticated to the point of cynicism, and are unlikely to overestimate the value of an internal reform or to trade away an achievable external reform that would be more effective. And there is no reason to believe that the choices carry fixed political costs: internal reforms could reshape the way that corporations use their formidable political capital with respect to external reforms, making external reforms more likely.

Stakeholder governance theorists have not pressed this case, perhaps because many are not eager to encourage governmental action. But once the stark choice hypothesis is identified and inverted to match reality, it becomes possible to evaluate opportunities to effect real change through internal corporate governance reforms.

Apart from filling a gap in the literature, the discussion also illuminates the somewhat confusing corporate law discourse on political process. Supporters of shareholder primacy are sometimes profoundly optimistic about how effective government can be in addressing problems, suggesting that corporate leaders can focus on shareholder profits because government officials will tend to all other issues. On other occasions they are implicitly pessimistic; the suggestion that stakeholder interests are distinct from the long term interests of shareholders often amounts to a suggestion that corporations can harm stakeholders for long periods of time without the government interfering in a way that affects profitability. Supporters of stakeholder governance are similarly torn between deep pessimism about the government’s ability to address problems and an apparently strong belief in the capacity of government regulators. A careful look at the processes for internal and external reform can throw some light on a debate that is normally characterized more by heat.

The complete paper is available for download here.

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