The Quest for Legitimacy in Corporate Law

The waves of politics, culture, and identity are crashing over corporate headquarters. Disney’s recent criticism of Florida’s “Don’t Say Gay” law resulted in the company losing its tax status with the state following a political backlash. Tech giants like Amazon, Google, and Microsoft, have been repeatedly rocked by employee walkouts. Corporations’ social choices are attracting criticism from a wide variety of stakeholders across the ideological spectrum. Progressives denounce corporate initiatives as mere facades aimed to deflect from the lack of desired social, political, and economic progress, illustrated by their familiar “greenwashing” critique of corporate actions on climate change. Meanwhile, conservatives bemoan companies’ newfound enthusiasm for social causes as out-of-bounds for a profit-making entity and castigate managers as mouthpieces of “woke” elites who are imposing their values on an unwilling public.

Rather than simply rebuking corporate choices, these attacks are increasingly focusing on managers’ competence to decide controversial social issues, questioning their accountability and representativeness, and portraying managers’ motivations as suspicious and biased. Critics left and right are united in their perceptions that managers wield seemingly arbitrary powers over their subordinates, control vast economic resources, and influence our wider society in untold ways through political lobbying. Should corporate managers possess such authority to spearhead broad societal change?

This question may sound bewildering to corporate governance specialists, but it is easily recognizable to experts on administrative agencies as a challenge on the legitimacy of managerial authority. It echoes doubts long raised against policymaking by administrative agencies: lack of democratic authorization, concerns about overpowerful rule-setters, unease at the delegation of important policy choices to unaccountable and unrepresentative officials, and opaqueness of decision-making processes. To contend with these fears, administrative law has honed a toolbox of institutional design and policy mechanisms to bolster the legitimacy of agency decision-making by offering substantive and procedural justifications for the exercise of authority. These processes, such as the development of notice-and-comment procedures, increased disclosure and transparency requirements, and agency emphasis on developing policy through predictable rulemaking procedures rather than other ad hoc mechanisms, provide the foundation of why agencies hold such important powers in our democratic society.

We argue that corporate law should borrow from this toolbox for agencies to adjust corporate governance methods in a way that helps justify corporations’ socially impactful choices. Our paper, titled The Quest for Legitimacy in Corporate Law, explores how corporate governance can be recalibrated to emulate administrative agency processes to bolster the legitimacy of managerial decisions when managers make decisions on important and controversial social, political, and economic issues. We begin with widely used legitimating devices employed by administrative agencies, such as notice-and-comment, disclosure and transparency, independent monitoring mechanisms, scientific and technocratic expertise, standardizing policymaking, and securing enforcement. We then identify these tools’ corporate law equivalent and explore how it could produce similar legitimating effects.

We believe that adopting these interventions from administrative law can help corporations better navigate current challenges because they justify corporate actions not only on legal grounds, but also on sociological and moral ones. Sociological factors explore whether a decision is accepted by key stakeholders and the wider public, while moral criteria analyze whether a decision is seen as “the right thing to do.”. Corporate managers adopting deliberative values previously embraced by agencies, such as participation, transparency, expertise, standardization, and accountability, can help corporations both gain respect for their choices even from those stakeholders whose personal views are not aligned with the firm, as well as improve the quality of managerial decision-making itself. Public law scholars have long recognized that relying on legal legitimacy, and ignoring sociological and moral criteria, risks raising challenges over authority. If corporate law means helping managerial choices regain social endorsement and moral affirmation, we argue, it must reorient its governance tools toward these two goals. This is our main project in this paper. The table below summarizes our argument.

We then use our proposed template as a benchmark for assessing managers’ responses to recent societal challenges. Corporations have faced multiple economy-wide legitimacy-related challenges over the past decade due to their involvement in controversial social and political issues. These challenges include liberal stakeholders questioning corporate commitments to climate change, renewed pushes for gender diversity in the workplace after #MeToo scandals, and managerial responses to racial justice reform after the tragic death of George Floyd and other minorities at the hands of the police. We find that when companies use legitimating devices such as stakeholder participation, expert consultation, increased transparency, and standardization, they are more likely to gain initial broad acceptance from stakeholders for their decisions. On the other hand, when managers seek to respond to social challenges without regard for this template, they imperil the legitimacy of their decision-making and risk triggering reactions such as employee walkouts and consumer boycotts. To regain their legitimacy, managers often alter governance structures to align them with measures in our proposed template.

We then show how high the stakes for management can become when they systematically disregard this template even though their business impinges on core social values. From news that Facebook conducted psychological research on users without their consent and the Cambridge Analytica Scandal, to the possibility that the platform incited genocide in Myanmar, Facebook has suffered one of the worst legitimacy failures of any company in recent memory. Judging the harm to the company as substantial, its executives embraced a radical corporate governance proposal—the creation of an independent oversight board to make decisions on censorship issues—to improve their legitimacy among stakeholders. We argue in this paper that ex ante governance reforms taken from administrative policymaking to ensure the legitimacy of managerial decision-making would have been a much better managerial response to ensure stakeholder support when firms enter complex and controversial social issues.

The complete paper is available for download here.