There are many sources of information about corporate operations, but one of the most critical is the disclosure required by the federal securities laws. Whenever a company seeks to raise capital through the public sale of securities, the U.S. Securities and Exchange Commission (“SEC”) requires that it file a detailed description of its business and financial condition, periodically updated with new information about its profits, revenues, assets, and general business activities. Regulators, competitors, employees, journalists, and members of the community have all grown to depend on securities disclosures to provide a working portrait of the country’s economic life. Yet securities disclosures are not targeted toward the community at large; they are intended for investors alone, and when investors do not require disclosure, the general public is kept in the dark. As a result, corporate transparency is a function of the needs of the investing class. In a recent article, I argue for the creation of a system of mandatory corporate disclosure aimed at non-investor audiences such as workers, consumers, and members of local communities.
One of the great challenges of corporate law has been to develop regulatory systems that enable the productive use of the form while ensuring that corporate wealth and power is channeled in a prosocial direction. Under the current regime, the structure of the corporation provides managers with strong incentives to maximize profits, even at the expense of other groups with which the corporation interacts. Shareholders vote for directors – which permits them to oust those who do not pursue their interests with sufficient vigor – and corporate pay packages reward managers for maximizing shareholder wealth. At the same time, managers also have incentives to consider non-shareholder constituencies. Environmental law, antitrust law, consumer protection law, antidiscrimination law, labor law, and the like all force managers to account for the impact of corporate activity on society as a whole. These laws may penalize managers directly for lack of compliance, but more commonly, penalties are imposed on corporations themselves, threatening to cut into corporate profits and ultimately diminish shareholder wealth. Managers are thereby given an incentive to accommodate non-shareholder constituencies as part of their general mandate to act on shareholders’ behalf.
Yet legal rules are necessarily imperfect. Not every instance of corporate lawbreaking can be the subject of an enforcement action, and it is not practical to outlaw all unethical corporate activity. In this state of affairs, markets, both economic and social, fill the gaps. In order to earn profits, corporations not only have to produce goods and services that attract customers, but they also must generate enough reputational capital to maintain relationships with suppliers, employees, and other critical stakeholders. Corporations that develop poor reputations – for creating harmful products, for mistreating their workforce, for overcharging clients – will find it more difficult to operate. Journalists will spotlight their behavior; consumers will avoid them; investors and other suppliers of capital will flee; and competitors will challenge their position. Regardless of whether managers are expected – via fiduciary duties or otherwise – to maximize shareholder wealth, an effective system of “soft” corporate discipline ensures that the pursuit of shareholder wealth is aligned with the well-being of the broader society in which the corporation operates.
The catch is that these markets for corporate responsibility require a baseline level of transparency. Public disclosures by corporations can expose antisocial practices (which may then be the subject of protest), permit employees to compare working conditions and wage data, and allow competitors to identify monopoly rents and opportunities for innovation. Transparency also makes legal systems more effective: Firms known to have adopted unsavory business practices may attract scrutiny from regulators, inspiring more precise legal prohibitions or simply a greater enforcement effort. Corporate secrecy, by contrast, permits antisocial practices to thrive. Yet under our current regulatory regime, only companies that choose to sell their securities to the public are subject to generalized disclosure obligations – and even then, only as to matters that are material to an investor audience.
America’s peculiar system of tying generalized corporate disclosure requirements exclusively to public investment is the result of a series of historical compromises. Both in the Progressive Era, and again during the 1970s, activists, scholars, and politicians sought to enact corporate disclosure schemes in order to make businesses more accountable to society at large. Each time, these efforts were redirected towards investor audiences, in the expectation that investors could serve as a proxy for the broader society.
It is now evident that the compromise carried with it the seeds of its own destruction. Both Congress and the SEC have concluded that the giant institutional investors who dominate contemporary markets require fewer regulatory protections, and they have concomitantly made it easier for issuers to raise capital without becoming subject to mandatory disclosure requirements. The result is that modern businesses can grow to enormous proportions while shielding the details of their operations from public scrutiny. Meanwhile, the fact that corporations have generalized disclosure obligations only to investor audiences helps make investors, rather than other constituencies, the central object of corporate concern. Even if the public demands information about firms’ environmental impact, their treatment of workers, their political activity, and their use of customer data, corporations are under no obligation to provide it absent a showing of relevance to an investor audience. Investors can then use their informational advantage to influence business decisions, while other stakeholders are left weakened and unprotected. The result is new demands for corporate accountability to non-investor constituencies.
I therefore recommend that we explicitly acknowledge the importance of disclosure for these stakeholder audiences and design a regulatory regime geared to their interests. The assumption – stated or unstated – that all public disclosure must necessarily run through the securities laws has distorted the discourse for decades. There has been little, if any, discussion of the informational needs of the general public, while advocates for myriad causes overburden the SEC with a flood of requests for disclosure of information relevant to their own idiosyncratic interests. A requirement that large corporations operate with a certain baseline level of public transparency would help align shareholder and stakeholder interests, free the SEC to focus on the needs of investors alone, and ensure a level informational playing field between “public” and “private” companies, thus encouraging more companies to conduct public offerings in the first place.
This post comes to us from Associate Professor Ann M. Lipton at Tulane Law School. It is based on her recent article, “Not Everything is About Investors: The Case for Mandatory Stakeholder Disclosure,” available here.