Four score and twelve years ago, Adolf Berle and Merrick Dodd debated the fundamental role of corporations within society. We have engaged in that debate ever since. In a nation conceived in liberty and dedicated to the proposition that all persons are created equal, how should we expect corporations to treat the different stakeholder groups (employees, customers, suppliers, local communities, etc.) whose interests their operations deeply affect?
Now we are engaged in a war over corporate purpose and governance that at times seems to test whether our polarized nation, or at least our patience, can long endure. Stephen Bainbridge’s distinction between the ends and means of corporate governance provides a map for the great battlefields of that war.
The battle over purpose contests the proper ends of corporate governance. The traditional American position is that corporate boards should focus only on shareholder wealth maximation, with a growing minority arguing instead that boards should care directly about other stakeholders, too. The means of corporate governance concerns who should be empowered within corporations.
Bainbridge himself advocates strong boards pursuing shareholder wealth maximization, while Margaret Blair and Lynn Stout agree on empowering boards while requiring them to mediate among the interests of the various stakeholders. Lucian Bebchuk agrees with Bainbridge on the end of shareholder wealth but wants to see shareholders be able to hold boards accountable for pursuing that end. But what of those who agree with Bebchuk as to the means of corporate governance – boards need to be held more accountable – but agree with Blair and Stout as to the ends of corporate governance – boards should balance various stakeholder interests? In a new article, I join scholars like Matt Bodie and Grant Hayden in arguing that a focus on stakeholders as to the ends suggests empowering stakeholders as to the means. If governance is for the stakeholders, it should be by the stakeholders as well.
As for who is actually governed, the core theory of the firm developed by scholars like Ronald Coase, Oliver Williamson, and Oliver Hart suggests that it is primarily employees. An economic firm is a zone of discretionary authority in which the firm’s managers can direct employees what to do with the firm’s assets. Shareholders are secondarily subject to managerial discretion, as they provide financial capital which managers can deploy with limited contractual restrictions on their ability to determinine the financial return for shareholders. Creditors, suppliers, and customers have rights and duties defined usually by contracts or discrete transactions.
In the debate over the ends of governance—who governance is for—advocates of shareholder wealth maximization make several arguments:
- A clear metric makes managers more accountable;
- Maximizing profits will maximize social welfare, given certain assumptions;
- Other areas, such as employment or consumer protection law, protect other stakeholders; and
- Shareholders are residual claimants, who need protection and whose interests align with profit maximizing and hence social welfare.
But stakeholder advocates have better arguments in response:
- Even shareholder wealth maximization is not a clear-cut tool in practice;
- Given omnipresent externalities, maximizing profits will not come close to maximizing social welfare;
- Other areas of law often work poorly, while corporate governance provides a more flexible way to balance competing interests; and
- Employees are also residual claimants.
If governance is for the benefit of stakeholders, should it also be by stakeholders? Blair and Stout, the leading stakeholder theorists, say no, advocating for strong boards to mediate among stakeholders. But the mechanisms for ensuring boards do that are weak, suggesting we should empower stakeholders further. Governance by stakeholders would bring a variety of benefits:
- Some stakeholders, especially employees, can bring much useful information to bear;
- Some stakeholders, especially employees, have incentive to use that information to help their companies do a better job;
- Empowering employees can reduce supervision costs; and
- Empowered stakeholders will feel greater loyalty to a company.
Notably, these arguments for stakeholder empowerment mostly involve employees. This suggests that of all stakeholders, they should gain the most power, as my article argues. But the case for stakeholder governance must also consider potential costs. Most significant are the costs of decision-making, as various stakeholders can have conflicting interests. For instance, though paying employees well may improve their performance, beyond some point higher wages will mean higher costs for customers or lower profits for shareholders. Determining how many stakeholder interests to include, and how to structure stakeholder empowerment, must take those costs into account.
Large companies already engage their stakeholders in many ways, including through formal meetings, surveys, social media, employee resource groups, and stakeholder councils. Some companies still have unions for at least some employees. There are pockets of cooperatives in the U.S., and employee board representation in other countries, notably Germany. But for most major U.S. companies, stakeholder engagement falls far short of empowering any stakeholders to participate directly in corporate decisions.
Employees have the strongest case for empowerment, which could take the form of board representation, works councils, or more union representation. Other stakeholders could be given less power. Customers, suppliers, and environmentalists could be placed on stakeholder councils. These could at first be advisory, and then be given some limited authority, including the ability to nominate directors. Through reforms such as these, we can ensure that governance of the stakeholders, by the stakeholders, and for the stakeholders shall flourish on the earth.
This post comes to us from Professor Brett McDonnell, the Dorsey & Whitney Chair at the University of Minnesota Law School. It is based on his recent article, “Stakeholder Governance as Governance by Stakeholders,” available here.