Shareholder Primacy Isn’t the Best of All Possible Worlds

In a recent opinion piece in the Financial Times[1], Harvard Law School Professor Jesse Fried makes a strong case that the Business Roundtable’s CEOs statement, in which they committed to “lead their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders,” by itself will not affect how CEOs run their companies. This is surely correct. But he overstates his case by treating the current “shareholder primacy” system of corporate governance as both the historical norm and the ideal system.

Fried bases his argument for shareholder primacy on the binding contractual nature of corporate charters and the ability of shareholders to (eventually) replace directors that do not uphold shareholder interests. In doing so, he gives short shrift to the impact of state corporate laws and judicial decisions construing director duties, particularly those of the State of Delaware, where most large U.S. corporations are based. Only a few decades ago, directors’ duties, even in Delaware, were far more broadly construed to allow consideration of employee and community interests as well as those of shareholders. It took Milton Friedman’s 1970s-era polemics and a new theory developed by academic students of the agency problem inherent in corporate management structures to convince Delaware courts and lawmakers to change historical practice and make shareholder primacy the sole guide for director actions.

As a long-time business executive and corporate lawyer who has spent untold hours in corporate board meetings, I can attest that the fear of personal legal liability is the most powerful motivator when boards are presented with decisions that affect the interests of both shareholders and broader constituencies. So long as directors feel that they face personal liability under state corporate law if they consider the interests of employees or local communities when voting on proposals for mass layoffs, plant closures, or offshoring of operations and jobs, they will inevitably elect not to do so.

Moving beyond legalities, Fried misses the entire point of the debate when he asserts that the “shareholder primacy system” has worked well both for corporations and the economy as a whole and that therefore it should not be questioned. I am not aware of any actual, as opposed to theoretical, demonstration of the macroeconomic benefits of the shareholder primacy system asserted by Fried.  What evidence there is, from declining real GDP growth rates in recent decades to the 2008 financial crash, cast real doubt on those benefits.

But one has only to look at the rapid growth of income and wealth inequality in the U.S., the allocation of almost all worker productivity gains to capital holders, and the havoc created in the lives of working and middle-class corporate employees by shareholder-focused management to see that aggregate economic measures are not the criteria we should be using to analyze this issue. Something is wrong with this version of U.S. shareholder capitalism if it primarily benefits rent-seekers at the top of the distribution of wealth.

To be sure, the massive transfer of wealth away from corporate workers and communities to stock-motivated managers and equity holders since the 1970s cannot be laid entirely at the feet of shareholder-biased corporate governance. Tax policy, stock-based management incentives (based on the same agency theories), multinational location arbitrage, reduced investment in public infrastructure, and other factors have played major, and perhaps dominant, roles.  But that is no reason to mimic Dr. Pangloss and conclude with Fried that “[t]hat’s the way it is and that’s the way it should be” when it comes to corporate governance. The negative consequences of the current system for both democratic political structures and global market capitalism are evident to all.

What changed once can change again. Like so many ideas that came out of the Chicago School, shareholder primacy theory has had its chance and been found wanting. It is time for a fresh approach.


[1] “Shareholders always come first and that’s a good thing,” The Financial Times, October 8, 2019.

This post comes to us from Todd H. Baker, a senior fellow at the Richman Center for Business, Law and Public Policy at Columbia Business School and Columbia Law School.