The Perils of Reforming Corporate Law to Favor Stakeholders

In corporate governance circles, the clash between the different philosophies of shareholder primacy and stakeholderism rages on. In a recent article in the Columbia Law Review, Professor Aneil Kovvali challenged what he calls the “stark choice hypothesis,” which suggests that pursuing stakeholder interests could hinder government reforms, forcing a choice between internal corporate governance reforms and external regulations. Because we criticized stakeholderism on these grounds in a couple of our prior articles, he places our work in the “stark choice” camp.

In a recent piece, we respond to Professor Kovvali’s critiques.

First, we clarify our stance on shareholder primacy vs. stakeholder reform by emphasizing that we neither champion the former nor oppose firms’ initiatives to improve non-shareholder constituencies. Our critique to stakeholderism is directed at a corporate law reform that would formally expand director fiduciary duties towards stakeholderism.

In our view, stakeholderism would result in prioritization of internal reform, cherry picking the contents of such a reform, and jeopardizing more meaningful external reforms. We argue that prioritizing stakeholderism over external reforms might exhaust the reformer’s efforts. Stakeholderist corporate law reforms may lead to cherry picking only those reforms that do not offend Corporate America. Worse, such reforms would likely put in jeopardy any more meaningful reforms.

While Kovvali offers examples of so-called dual-track reforms (internal and external), we question their effectiveness. An example of internal reforms is constituency statutes, which are famously insufficient in protecting weaker constituencies. As for external reforms, all the ones he mentions have been adopted by states, whereas meaningful reforms should be federal so that they protect all Americans uniformly and avoid well-known race to the bottom issues.

Kovvali emphasizes that an internal, stakeholderist reform is more realistic, but that is its only appeal. The risk is that many policymakers might do merely what is easy: support a realistic but wholly inadequate reform just to show their constituents that they are doing something. In addition, we challenge the idea that stakeholderism may be conducive to future external reform. A more realistic scenario is a top-down imposition of stakeholderism as a legal requirement that leads executives positioning themselves as the only “true experts” in stakeholder interests. This in turn might hinder external reforms that could benefit stakeholders. In this regard, a stakeholderist corporate law reform would imply enhanced lobbying risk, something that Kovvali downplays. Considering the lobbying records of large corporations against organized labor, granting corporations a fiduciary duty toward stakeholders may further empower executives to lobby against reforms benefiting weaker constituencies such as workers.

In conclusion, while Professor Kovvali conducts an impassioned defense of stakeholder governance against what he labels as the “stark choice” critique, we rebut his arguments, with the concession that on one point he is correct: internal reform is easier to achieve than external reform. However, we reject the implication that because internal reform may be more feasible, we should just give up and accept it. Internal reform will never accomplish what stakeholder champions have been seeking to achieve with labor, environmental, antitrust, and tax reforms. If politics precludes external regulation, there is nonetheless no basis to believe internal reform is an equally effective way to protect weaker constituencies. It’s not enough to say accept internal reform now so that, if it is successful, boards and legislators will be more open to more effective external reforms later.

This post comes to us from professors Matteo Gatti and Chrystin Ondersma at Rutgers Law School. It is based on their recent article, “The Perils of a Stakeholderist Corporate Law Reform: A Reply to Professor Kovvali,” available here.