Of all the social and economic challenges to the current state of Delaware corporate law, perhaps the most potentially revolutionary is the shift in attitudes about the very purpose of corporations. Delaware corporate law holds as a core precept that the corporation’s goal is to maximize shareholder value. Corporations’ freedom to serve the goals of other corporate constituencies (such as employees, customers, or the communities in which the companies operate) or to serve broader goals such as protecting the environment or aiding the poor is constrained by the requirement that any such efforts be primarily aimed at improving the bottom line for the benefit of the companies’ shareholders. With its recent authorization of public benefit corporations (“PBCs”), Delaware has now made it possible for entrepreneurs to change this shareholder primacy rule by choosing a business entity form that is required to pursue the social good as well as profits.
Not all observers agree that traditional Delaware corporations must exclusively pursue profits. Progressive corporate legal scholars such as Margaret Blair and Lynn Stout have long asserted that corporate boards must balance the interests of different corporate constituencies, which sometimes means sacrificing profits to assist workers, lenders, or communities. And the Delaware courts themselves have not always been clear on this point. Nevertheless, today, it seems reasonably clear that Delaware corporate law requires boards of directors to attempt to maximize shareholder profits, at least as a default rule.
Entrepreneurs who want to pursue social goals to the exclusion of profits may form non-profit corporations. But only in 2013 did Delaware provide a ready-made option for entrepreneurs who wanted to create an entity that balanced traditional profit-seeking with the pursuit of other social goals.
In the states’ competition for corporate registrations and their associated franchise taxes, Delaware is the clear winner. Whether the competition has resulted in a race to the bottom or a race to the top for corporate law, Delaware has found a formula that has attracted a clear majority of the major corporations in the U.S. Delaware law is the gold standard.
The benefit corporation form, in contrast, has often received poor reviews from corporate law experts. Commentators have argued that the new freedom to pursue other goals will exacerbate agency costs by interfering with the ability of the market for corporate control to police boards and executives. And the very idea that balancing the needs of other constituencies such as workers is a worthy goal is highly controversial. All of which prompts the question: why mess with success? Why risk Delaware’s sterling reputation with the corporate bar and the directorate class by endorsing this untested and controversial new form of business organization?
I interviewed two of the principal players involved in the benefit corporation legislation and examined public statements made by the Delaware governor’s office. These sources revealed that Delaware was primarily trying to induce social entrepreneurs to register their companies in the state.
For the PBC legislation to attract social entrepreneurs, the law must fulfill their needs. My interviews with 25 social entrepreneurs from around the country revealed that their needs were multi-textured. Some entrepreneurs wanted liability protection that would enable them to choose to trade off profits for the social good when they so desired, especially in the context of a sale of the company (“Protect”). Others had pecuniary goals at least partially in mind, hoping that their social mission would help to attract and retain customers, employees, or investors (“Brand”). The majority’s overarching ambition, though, was idealistic in nature. These social entrepreneurs wanted a legal form that expressed their values and hopefully inspired other entrepreneurs and investors to imitate their prosocial business strategies (“Express”).
The PBC statute does permit social entrepreneurs to achieve the Protect goal; the default rules alone, however, may prove inadequate. The statute does only a mediocre job of effecting the Brand and Express goals, but private ordering has the potential to improve matters.
Delaware’s PBC statute states that directors must balance shareholder wealth maximization against the interests of other corporate constituencies. Directors can fulfill their duty to balance the interests of the various corporate constituencies and the specific public benefit elected by informing themselves, remaining disinterested in each decision, and avoiding decisions that “no person of ordinary, sound judgment would approve.”
This standard resembles that of the business judgment rule in the requirements to be informed and disinterested, but seems more stringent in its substantive component. While the business judgment rule requires only that informed and disinterested directors who are acting in good faith avoid wasting corporate assets and making irrational decisions, the PBC statute seems to impose liability for decisions that are merely unreasonable.
Delaware’s PBC statute grants directors permission to pursue other goals at the expense of profit, seemingly fulfilling the Protect goal. But at the same time, the PBC statute has potentially expanded directors’ liability – rather than limiting it – by not only granting permission but also imposing a duty to consider these other interests.
Unlike the Protect and Express motives, which are primarily rooted in an altruistic desire to help society, the Brand motive seeks pecuniary gain by leveraging the company’s social mission to achieve better results with employees, customers, and investors. For social entrepreneurs to benefit in this way by choosing a PBC, the various target audiences must care enough about the company’s PBC status to be willing to sacrifice other benefits to work there (in the case of employees), pay a premium price for the product or service (in the case of customers), or sacrifice some expected return or believe that their return will be higher because of the company’s PBC status (in the case of investors). In addition, PBC status must send a reliable signal to those audiences that a company is managed in a prosocial manner.
PBCs are far too new to have generated meaningfully useful data on these questions. There is some cause to think, however, that significant numbers of employees, customers, and investors may feel strongly enough about a company’s prosocial behavior to be willing to pay more (or be paid less). Even assuming this market is significant, PBC status will only help entrepreneurs reach that market if it sends a reliable signal of a company’s prosocial behavior. Unfortunately, the Delaware statute does not do a particularly good job of boosting a PBC’s credibility.
The statute attempts to lend credibility to prosocial claims by (a) mandating that every PBC adopt a specific public benefit it will pursue; (b) requiring PBC boards of directors to pursue the company’s public benefit and balance the company’s other needs – such as profit – against the need to effectuate its prosocial goals and the interests of others materially affected by the corporation’s activities; (c) permitting shareholders to sue directors who fail in their balancing duties; and (d) imposing certain disclosure requirements related to the company’s social purpose.
Merely stating a public purpose achieves nothing in itself. The purpose is only meaningful to the extent the company achieves it, or at least tries to do so. The balancing mandate is quite weak. In all likelihood, directors can fulfill their balancing duty by informing themselves, remaining disinterested, and avoiding unreasonable decisions. Moreover, even if directors fail in their duties, they are unlikely to suffer liability. Only shareholders have standing to sue to enforce the balancing duty, and in closely held PBCs, the shareholders are likely to be the same people as the directors. Finally, the disclosure provisions only require PBCs to provide a report on the company’s prosocial activities to its shareholders. In the typical case of a closely held PBC, where the shareholders exercise meaningful (if not total) control over the board, the disclosure is unlikely to contain information that the shareholders do not already possess. Also, there is no enforcement mechanism built into Delaware’s statute to force directors to obey their disclosure duties.
My interviews with social entrepreneurs indicated that, for many of them, the expressive function was the most important reason they chose to incorporate as a benefit corporation. If Delaware is to attract social entrepreneurs to PBCs, then the statute must satisfy this need.
The name of the entity may itself aid in this regard. The name serves as an advertisement that the company aims to be about something more than making a profit for its shareholders. The balancing duty may also be helpful in this regard. Conducting conversations about how a business decision will affect the company’s various constituencies and taking those constituencies’ concerns seriously will permit the founders to articulate their values regularly. The benefit report will provide a vehicle to express these values to a potentially broader audience.
In some ways, then, the PBC statute seems targeted at the Express goal. But the statute is still quite limited. Founders who want their companies to express their values will presumably be most satisfied with an entity form that clearly advertises the company’s prosocial ethos. If PBCs can too easily be used by those who want to present the appearance of creating a public benefit without the reality (greenwash), as seems true based on the analysis above, then the use of the form will remain suboptimal.
Private Ordering Solutions
Although the PBC statute does not adequately fulfill entrepreneurs’ goals, many of its flaws can be remedied with private ordering. Any additional risk of liability can be eliminated with a provision in the certificate of incorporation, though this will conflict with the Express and Brand goals. Founders who find the PBC’s prosocial signal too weak can enhance the disclosure requirement with charter provisions that require the board to make the report available to the public or to measure the company’s conduct against a third-party standard such as B Lab’s B Impact Assessment. Finally, they can seek outside certification, such as that provided by B Lab, that goes beyond the rather sparse requirements imposed by the PBC statute. By taking some of these steps, founders can better express the values that will suffuse their business.
This post comes to us from Professor Michael B. Dorff, Downer Chair of Corporate Law at Southwestern Law School. It is based on his recent article, “Why Public Benefit Corporations?,” available here.