What is the purpose of the corporation in society? Whose interests are corporate managers supposed to advance? How can corporate law and governance best promote social welfare? For the past 50 years, most scholars and business leaders would have answered these questions the same way – corporations should maximize shareholder wealth. But over the past decade, this view has come under pressure from stakeholder governance proponents who argue for direct consideration of the corporation’s other corporate constituents. Meanwhile, defenders of the classic view maintain that this wave of pushback is politically motivated, misguided, and inconsistent with lessons learned over the past half century.
In a new article, I argue that these positions could be right or wrong, depending on the circumstances. More specifically, I argue that the welfare-enhancing purpose for corporations and their management depends on external economic conditions, which both these positions assume away. Shareholder primacy is likely to be welfare-enhancing in a world where the government regulates corporate externalities, ensures competitive markets, and reduces inequality. Once these assumptions are relaxed, however, the case for stakeholder governance improves.
I support this theoretical insight with a historical analysis of two corporate purpose “moments” of flux, or periods where the public and academic perception of corporate purpose swung from one pole to the other. This has only occurred twice in the past 100 years – after the great stock market crash of 1929 and following a period of economic stagflation in the 1970s – which makes it particularly interesting to study why these shifts took place when they did. My analysis suggests that extreme changes in external economic conditions set the stage for different theories of corporate purpose to thrive and influence the path of law in the U.S.
The stock market crash of 1929, which followed a period of rising inequality and increased corporate concentration, prompted a shift away from a shareholder-oriented vision that prioritized profit-maximizing above all else toward a model that directed management to serve as trustees for all of the corporation’s constituencies. In the wake of the crash, the public was keenly aware of the harm created by large corporations with substantial market power as well as the problems that came from unequal corporate rent distribution and a lack of countervailing government regulation. That environment laid the foundation for stakeholder governance to capture the public consciousness and alter the path of law.
This “management trustee” view persisted for over 50 years, until the pendulum swung back to a shareholderist view in the 1980s. Laying the foundation for this return was a period of slow corporate growth and high inflation, as well as low inequality. Not only that, before President Ronald Reagan’s election in 1980, many people believed that corporate activities were unduly subject to government constraints. In this environment, the view that corporations should pursue shareholder value – a position that had been deemed a loser only a few years earlier – took hold of a population gripped with concern about managerial agency costs, slow corporate growth, and burdensome regulation. These ideas laid the foundation for a return to shareholderism that has shaped the path of corporate law and governance ever since.
As this brief introduction suggests, shifts in the dominant view of corporate purpose in the U.S. have been precipitated by changes in external economic conditions, which rendered certain intellectual arguments more appealing than others. Specifically, arguments for stakeholderism won the day when proponents could point to evidence of rampant corporate externalities and the government’s inability to address them; by contrast, calls for shareholderism gained momentum in the face of slow corporate growth and profitability.
Are purpose shifts the product solely of unprincipled political and social forces, or could there be a deeper logic supporting a dynamic concept of purpose? My article offers a theoretical account in support of the latter proposition. Simply put, the failure of government to respond to corporate concentration, corporate externalities, and societal inequality not only increases public appetite for stakeholder governance, but may also render it welfare enhancing, in a second-best sense.
Consider a hypothetical widget factory that pollutes as part of its production process. Assume that the private costs of manufacturing widgets are less than the social costs of environmental harm. As such, the factory produces more widgets than is socially beneficial. For various reasons, the government does not regulate pollution adequately and the factory is allowed to continue its inefficient production. How to respond to this problem? Of course, asking the factory’s managers to consider and mitigate pollution creates well-known inefficiencies and is unlikely to be as effective as a regulatory mandate. But if regulatory reform is not available, or the costs of securing it are very high, an “inefficient” corporate governance rule may become the best way to create social welfare.
This observation builds on scholarship in other fields – namely tax law – that demonstrate that inefficient legal rules can be rendered efficient when the enactment of the better rule is not possible or very costly. My analysis also relates to a rich literature in comparative corporate law, which has observed that differing institutional environments across jurisdictions may affect the optimality of various corporate governance arrangements. My article applies these broad insights to the corporate purpose debate that is once again gripping the U.S. and suggests that a dynamic concept of purpose that accounts for external economic conditions could be preferable to a static one.
Interestingly, my historical analysis reflects this logic to some degree: It appears that the cultural pressure on management to benefit either shareholders or society shifts in response to extreme changes in externality regulation, corporate concentration, and inequality. This pressure provides a foundation for certain intellectual ideas about the corporation’s role in society to rise in prominence, capturing the public imagination until external conditions change again. Again, it is not the persuasiveness of the arguments but the conditions of the time that lead to their eventual acceptance – and potentially their desirability.
Nonetheless, my historical analysis departs from this economic logic in important ways. For example, by the time each purpose shift took hold, the justification for it had waned, in part because the regulatory environment had begun to change as well. For example, in the 1970s, dissatisfaction with government regulation brought about a presidential administration committed to deregulation and a purpose shift toward shareholder primacy. This example therefore counters contentions that the embrace of stakeholder governance will undermine regulatory change. Instead, as both of my historical examples reveal, purpose shift and regulatory change appear to occur in tandem.
Despite this mismatch between history and theory, the observation that external factors can change the welfare-creating orientation for corporate governance is an important counterweight to scholarship and advocacy that maintain that a return to past principles is necessarily inefficient, or that there is one right answer to the question of the proper role for corporations in society. Instead, the greater the departure from a first-best world, the stronger the rationale for a broader concept of purpose. At bottom, I hope that my central claim – that external economic conditions could affect welfare-enhancing orientation for corporate governance – will add nuance to this important debate that has had a dramatic impact on the path of corporate law and governance for decades.
 Cf. Bruce Ackerman, We The People (Harv. University Press 2013) (coining the term “constitutional moment” which occurs when institutions undergo or require profound change, usually in response to public and cultural pressure).
This post comes to us from Professor Dorothy S. Lund at Columbia Law School. It is based on her recent article, “Toward a Dynamic View of Corporate Purpose,” available here.