The Neoclassical View of Corporate Fiduciary Duty Law

Zachary J. Gubler is Marie Selig Professor of Law at the Arizona State University Sandra Day O’Connor College of Law. This post is based on his article forthcoming in the University of Chicago Law Review.

There’s an old and venerable way of talking about corporate fiduciary duties that maintains that they are owed to the corporate entity itself. Sometimes this way of talking about fiduciary duties is embraced by advocates of stakeholder value maximization in support of their position, with their sparring partners on the shareholder-value side of the continuum brushing that formulation aside as an outmoded way of thinking. But what if both camps are wrong? In other words, what does it actually mean to owe duties to the corporate entity? In a recent article, I develop an answer to that question that is different from saying that duties are owed merely to shareholders or to stakeholders. The argument is that the point of saying that fiduciary duties are owed to the corporate entity is to fix those duties on the one thing that is essential about that entity, which is to say, the permanent equity capital. If fiduciary duties are to be understood in light of the permanent nature of the equity capital, then a maximization norm won’t have anything to do with any impermanent flesh and blood shareholder but with a hypothetical permanent investor. And saying that duties are owed to some hypothetical permanent holder of the equity capital is definitely not to endorse a stakeholder value maximization norm. But it’s also not the same thing as saying that those duties are owed to shareholders, who, at least in a public corporation, come and go and whose interests are therefore focused on the relative short term.

This view of corporate fiduciary duties, what I call the “neoclassical view,” does a better job than alternatives at explaining certain features of corporate law that, on other interpretations, seem mysterious at best. A permanent equity maximization norm can explain, for example, how cases like Dodge v. Ford, holding that directors must maximize the value to shareholders, can coexist with cases like Goodwin v. Agassiz, which holds that insider trading does not constitute fraudulent nondisclosure at common law because fiduciary duties don’t run to individual shareholders. A shareholder maximization norm might be able to explain Dodge, but it can’t very well explain Goodwin. And a stakeholder maximization norm might make sense of Goodwin, but it fumbles in explaining Dodge. Under the neoclassical view, maximizing equity value is central to the board’s objective function, but that doesn’t mean that one owes duties to any particular shareholder. And thus, under the neoclassical view, we can explain the results in both cases – an equity maximization norm in Dodge but no fraud-based insider trading liability in Goodwin.

This neoclassical view of corporate fiduciary duties goes hand in hand with a particular model of the corporation, what I call the “perpetual entity model.” This model of the corporation is appealing because it does a good job explaining why corporate decision-making power is allocated as it is, in favor of boards. The reason? Because they are less likely than shareholders to engage in short-term thinking. At the same time, it explains why shareholders aren’t shut out of the decision-making process entirely. Under this model, the corporation is a vehicle for extremely long-term capital allocation, in fact longer-term than anything that could be expected of the typical public company shareholder. Thus, while the current shareholders’ views on a given matter, for example a merger, are not completely irrelevant to the board’s extremely long-term planning, they are also not unimpeachable and should probably be approached with a healthy bit of skepticism. For this reason, the corporate voting system under this model looks less like an ironclad way of making group decisions and more like an optional tool for gathering information that may or may not be helpful to the real decision-maker, which is the board. More generally, market signals are an important guide to the long-term capital allocation embedded within corporate fiduciary duties, but the board also needs the discretion to toss the guidebook aside in circumstances where it might lead them astray.

The neoclassical view of corporate fiduciary duties, and the associated perpetual entity model of the corporation, gives rise to several observations, some more controversial than others. Starting with the more controversial, this view of corporate fiduciary duties implies that corporate law does not simply facilitate contracting between relatively short-term-focused shareholders and boards. Rather, it calls on boards to do something more—to transcend the short- term interests of shareholders, and sometimes to even resist them defiantly, in order to invest for the extremely long term with all of the private and public benefits (and, yes, costs) that such a long-term focus entails. Thus, the corporation under this view is not a creature of contract. Rather, it reflects an explicit policy decision that long-term thinking as to capital allocation is privately and socially valuable and needs to be encouraged. This of course does not mean that such thinking is costless. It most certainly is not, as recent scholarship has reminded us. But at least with many types of businesses, this policy decision suggests, the benefits outweigh those costs.

Perhaps less controversially, viewing corporate fiduciary duties in light of the corporation’s permanent capital highlights what, arguably, most differentiates the corporation from alternative entities, including the limited liability company and the partnership: its permanent entity status. It also differentiates the corporation from the business trust, which some have argued is the most obvious substitute for the corporate form, at least historically. Thus, this account offers a possible explanation as to why the corporation evolved to predominate over these alternatives.

Ultimately, the article seeks to demonstrate how deeply embedded a long-term capital allocation outlook is in the structure of corporate fiduciary duties; how this outlook distinguishes the corporation from other business entities; and how it is essential to understanding how corporations are governed and the shape of corporate law itself.

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