Aneil Kovvali is an Associate Professor of Law at the Indiana University Maurer School of Law, and Joshua Macey is an Associate Professor of Law at Yale Law School. This post is based on their recent article forthcoming in the Texas Law Review.
The view that corporations should be run for the financial benefit of shareholders is based on two related assumptions. The first is that shareholders hold the residual claim on the firm’s assets. Residual claimants are entitled to whatever value is left after the firm has met its legal and contractual obligations to creditors, suppliers, and employees. If a firm develops a useful product, shareholder profits increase. If an investment does not work out, shareholders are the first to incur a loss. Shareholders therefore have a financial interest in pursuing projects that will efficiently meet people’s demand for goods and services.
The second assumption is that market and regulatory mechanisms are capable of causing the firm’s revenues and costs to reflect the interests of non-shareholder constituents. Stakeholders who do not own shares have numerous ways to express their preferences. Consumers select products that appeal to them. Employees pick jobs based on pay, flexibility, or location. The government can tax or ban harmful activities. These market, contractual, and regulatory interventions create financial incentives for shareholders and managers to account for non-shareholder interests such as protecting the environment and worker welfare.
