Individually or collectively, corporate leaders are promising stakeholders to improve corporate practices on a range of issues. In a new article, I argue that they can demonstrate their commitment to stakeholders by designing contracts differently.

We are already attentive to the ways that stakeholders are harmed by the contracts they enter into directly with corporations.  This awareness has raised concerns over contracting practices and bargaining power, information asymmetries, and informed consent.  In my article, I focus on contracts to which stakeholders are not parties, and how those contracts can nonetheless harm stakeholders as third parties.[1]  For example, contracts between a corporation and its suppliers can create labor, safety, and health risks for individuals who work for the supplier or subcontractor.[2]  While they did not sign the supply contract, the rights of those individuals may be compromised by terms in the supply contract relating to price, volume, and other matters.[3]  This stakeholder vulnerability that arises from third-party status  is different than the vulnerability that arises between two parties in a direct contractual relationship when one party may be able to exercise greater power than the other.

The situation of contractual third parties alerts us to five dimensions of inequality that place stakeholders at unique risk of harm from corporate conduct: notice, choice, risk management, legal remedies, and exchange benefits.  These forms of inequality originate from the key problem of incentives.  As third parties, stakeholders are not at the bargaining table when the terms of the contract are negotiated and drafted. Those at the bargaining table – in this case, corporate actors – have little incentive to consider the interests of stakeholders.[4]  The result is that contracts often neglect the interests of a range of stakeholders who are at risk of harm once the contract is performed.[5]  To supply the critical but absent incentive, I propose that corporate actors, as contracting parties, must take into account the interests of stakeholders when performance of the contract creates a risk of physical harm to them.

This “contractual stakeholderism” addresses many concerns raised in the recent stakeholder debate.  It offers a way to implement stakeholderism by proposing a contractual solution for stakeholder harms that originate within contract design.  By recommending a mandatory duty to contract, this proposal creates an incentive to protect stakeholders that is otherwise absent. It addresses the risk of corporate inauthenticity by making a corporation’s commitment to stakeholderism verifiable; if corporate leaders mean what they say, then they should demonstrate that commitment in their corporation’s contracts. It also addresses the risk of impracticality by helping to identify the action that corporate actors should take: contract design.  

Finally, my article proposes shifting the normative foundation of stakeholderism from receipt of benefits to prevention of harms.  While not exclusively, many arguments in favor of stakeholderism emphasize the benefits – to a corporation, specifically, or society, generally – that result from stakeholder protection. But it is not always true that what is good for the stakeholder is good for the shareholder.  When their interests conflict, the benefits-based approach will inevitably lead to giving the shareholder priority over the stakeholder.  That is why I advocate for a harms-based approach that focuses on the risks that a corporation’s activities create for stakeholders.  That approach does not depend on the benefits that stakeholder protection brings to a corporation or society but the dangers that its absence may impose on stakeholders who never consented to the risk of those dangers.  This distinction is important because the harms-based approach may protect stakeholders that a benefits approach would not by applying to a wider range of corporate activity and protecting a broader range of stakeholders.

ENDNOTES

[1]  See, e.g., Aditi Bagchi, Other People’s Contracts, 32 Yale J. Reg. 211, 212 (2015); Dave Hoffman & Eric Lampmann, Hushing Contracts, 97 Wash. U. L. Rev. 165, 199 (2019); Andrew Johnston, Governing Externalities: The Potential of Reflexive Corporate Social Responsibility (Univ. of Cambridge Ctr. for Bus. Rsch., Working Paper No. 436, 2012); Cathy Hwang & David Hoffman, The Social Cost of Contract, Columbia L. Rev. (forthcoming 2020).

[2] See Mark Anner, Squeezing workers’ rights in global supply chains: Purchasing practices in the Bangladesh garment export sector in comparative perspective, 27:2 Rev. of Int’l Pol. Economy 1, 6-8 (2019).

[3] Kishanthi Parella, Protecting Third Parties in Contracts (September 22, 2020). American Business Law Journal (Summer 2021 forthcoming), available at SSRN: https://ssrn.com/abstract=3697273

[4] Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita, For Whom Corporate Leaders Bargain, Southern California Law Review, Volume 93, 2021 , available at SSRN: https://ssrn.com/abstract=3677155 or http://dx.doi.org/10.2139/ssrn.3677155

[5] Id. at 34.

This post comes to us from Professor Kish Parella at Washington and Lee University School of Law. It is based on her recent paper, “Contractual Stakeholderism,” available here.