Historically, how a corporation invests and pursues its goals has been recognized as within the discretion of the board of directors. The business judgment rule insulates directors from liability for exercising that discretion by restricting second-guessing from shareholders absent a showing of fraud, illegality, or self-dealing. In other words, a business decision that doesn’t turn out well shouldn’t be questioned as long as the directors acted in good faith.
In recent years, though, the business judgment rule seems to have been eroded by forces from both the political right and the political left. Those leaning right assert that the obligation to maximize shareholder wealth means that corporations cannot act to benefit employees, communities, or the environment unless that action is linked directly to increasing shareholder wealth. Left-leaning critics of corporations agree with the premise that corporations are required to act callously and without regard to the needs of non-shareholder constituencies, but argue that this “rule” should be changed to require that corporations act in a more socially responsible way..
Many leading commentators, including former Delaware Supreme Court Chief Justice Leo Strine, have argued, though, that directors are limited in making decisions because they must seek, in good faith, to maximize shareholder wealth. Although I agree that the general role of a board of directors is to maximize shareholder wealth, the discretion to determine what it means to maximize wealth should be solely up to the directors, assuming they act in good faith, and not the shareholders or the court. This is the concept of “director primacy.”
We place the power with the board of directors because individual shareholders may have widely varying views about what they want out of their investment. Some shareholders may want the company to pursue investments that can support a long-term retirement strategy. Others may seek regular dividends, and some may seek a rapid rise in stock price so they can make a quick sale and profit. Directors must balance all of those goals. If their job is to look at shareholder maximization overall, they can’t serve every individual shareholder at any given time.
I argue that the board of directors is in charge of the corporation, and it should have broad latitude in how it chooses to proceed, absent some form of self-dealing. That is not a particularly unusual proposition, but I go a bit further than many others on how broad that discretion should be. I believe the business judgment is an abstention doctrine, meaning that courts will not second guess the choices of the board of directors unless someone can show bad faith or other fraud or self-dealing.
That is, when it comes to boards of directors, we should assume that they have positive intent and that their decisions were made in the best interest of the corporation, absent express evidence to the contrary. Doing so will, I argue, allow corporations (via their boards of directors) the appropriate latitude to seek quick profits, substantial growth, or long-term stability to maximize community benefit. All of these goals can be seen as maximizing shareholder value in different ways. In fact, I believe that we would see more stability and community benefit, as well as higher profits, if we were to make clear that directors are free to pursue nearly any goal for their business, as long as they act in good faith.
Using the model from the Edward R. Murrow radio show, “This I Believe,” I created the following to help put into context how this works for director primacy and the business judgment rule:
I believe in the theory of Director Primacy. I believe in the Business Judgment Rule as an abstention doctrine, and I believe that Corporate Social Responsibility is a choice, not a mandate. I believe in long-term planning over short-term profits, but I believe that directors get to choose either one to be the focus of their companies. I believe that directors can choose to pursue profit through corporate philanthropy and good works in the community or through mergers and acquisitions with a plan to slash worker benefits and sell-off a business in pieces. I believe that a corporation can make religious-based decisions — such as closing on Sundays — and that a corporation can make worker-based decisions — such as providing top-quality health care and parental leave — but I believe that, to get the benefit of the business judgment rule, both such decisions must be rooted in the directors’ judgment that such decisions will maximize the value of the business for shareholders. I believe that directors, and not shareholders or judges, should make decisions about how a company should pursue profit and stability. I believe that public companies should be able to plan like private companies, and I believe the decision to expand or change a business model is the decision of the directors and only the directors. I believe that respect for directors’ business judgment allows for coexistence of companies of multiple views — from CVS Caremark and craigslist to Walmart and Hobby Lobby — without necessarily violating any shareholder-wealth maximing norms. Finally, I believe that the exercise of business judgment should not be run through a liberal or conservative filter, because liberal and conservative business leaders have both been responsible for massive long-term wealth creation. This, I believe.
This post comes to us from Joshua Fershée, dean and professor of Law at Creighton University School of Law. It is based on his recent article, “This, I Believe: A New Look at Corporate Purpose, Director Primacy and the Business Judgment Rule,” available here.