We are living in a particularly polarized era, and corporate governance is no exception.  The divisions have threatened to spill over to Delaware, the preferred jurisdiction for incorporation in the United States, with several high-profile cases calling the state’s neutrality into question. Commenters have argued that Delaware has taken a newly politicized approach that threatens to splinter the corporate governance universe, driving corporations to other states that are more reliable (or that follow different corporations’ preferred politics).

In a new article, I argue that, in some ways, the critics are correct: Delaware law is on a path toward politicization, but – ironically – this development is traceable to the inherent contradictions in shareholder primacy, a doctrine created in part to remove political considerations from business management.

Ever since the rise of the great corporations at the end of the 19^th century, our legal system has been preoccupied with the problem of how to justify the exercise of so much power by a small group of corporate chieftains.  In general, we have settled on shareholder primacy, the principle that managers should maximize profits for the benefit of the equity holders, as the preferred constraint on the exercise of managerial power. Under shareholder primacy, non-shareholder constituencies (such as consumers and employees) are believed to be protected through contracts and external regulation, both of which extract a price for antisocial behavior.  In this manner, shareholder primacy ensures that contested political choices about how corporate surplus should be distributed are left to the democratic process and the invisible hand of a market that reflects popular sentiment.  Shareholder primacy, in other words, is championed as the only system that offers a meaningful, societally determined limit on the exercise of managerial discretion.

Slotting neatly into this system is the state of Delaware, which is home to only 0.3 percent of America’s population but exerts outsized influence over the country’s corporate law and, consequently, the principles that guide the allocation of trillions of dollars of capital.  Delaware’s legitimacy to serve this inescapably political function rests, ironically, on its fierce commitment to keeping political concerns out of its law.  Delaware is able to position itself as apolitical because shareholder primacy itself is treated as apolitical. Just as shareholder primacy is supposed to take corporations out of the business of making social policy, enforcing shareholder primacy keeps Delaware out of the business of making social policy, which allows Delaware to stay above the partisan fray.

That said, for shareholder primacy to serve its legitimating function, it must visibly operate along two dimensions: Procedurally, it must be seen to constrain corporate managers, and substantively, these constraints must be perceived to produce pro-social outcomes.  Corporate governance must, in other words, perform pro-socially – which of course requires that the social concerns that shareholder primacy excised now be imported back into the system.  The paradox is one that has come under increasing pressure.

The Tesla Trap

The first purported virtue of shareholder primacy is that it meaningfully constrains the behavior of corporate managers.  These constraints are theoretically enforced through a variety of “good” corporate governance measures, such as independent directors and single-class boards.  As it turns out, however, the evidence that these measures contribute to higher shareholder returns is so ambiguous^[1] that some have argued that they are not intended to benefit shareholders at all.  Instead, these provisions are intended to legitimate the exercise of corporate power in the eyes of society as a whole.^[2]  The “good governance” requirements civilize firms by cloaking their decision-making with a veneer of professionalism.

That possibility was surfaced in a series of Delaware decisions where the procedural requirements of good governance were seemingly disconnected from actual outcomes for shareholders, such as Tornetta v. Musk[3] (striking Elon Musk’s $56 billion pay package at Tesla), West Palm Beach Firefighters’ Pension Fund v. Moelis[4] (nullifying a shareholder agreement at Moelis & Co.), and a line of precedent holding that social ties between directors may impair independence.  These decisions unwittingly revealed the performative nature of corporate governance by placing minor guardrails on the exercise of individual control over massive resources despite few indicators that shareholders needed or wanted such protections.

Collectively, the cases read as political because they attacked practices that had become popular within Silicon Valley startups, which operated out of public view and apparently saw little need to design their governance structures with an eye toward appealing to public sensibilities.  Once these firms started to become public, however – and the extraordinary wealth and political and social influence wielded by this sector of the economy became more visible – their governance practices collided with the performative constraints of shareholder primacy.  These decisions – especially Tornetta – operated as displays that corporate managerial power was being curtailed within a framework of shareholder primacy.  But the jarringly poor fit between the rulings’ shareholder-protective rationale, and the actual outcomes shareholders had experienced, only laid bare the ceremonial nature of “shareholder primacist” procedure.

The Stewardship Solution

If the first premise of shareholder primacy is that it offers meaningful constraints on corporate managers, the second is that, in a properly functioning system, those constraints channel corporate behavior in a pro-social direction. That creates a curious dilemma for proponents of shareholder primacy because its logic requires them to continually equate societal interests with shareholder interests, all of which has culminated in the push toward, and controversy surrounding, environmental, social, governance (“ESG”) investing.

Though its meaning has become confused in the popular conversation, in the financial community, ESG refers to an investment strategy that posits pro-social corporate behavior is ultimately more profitable for investors.  In that form, ESG can be understood as gesture of profound faith in shareholder primacy’s viability.  After all, if shareholder primacy is operating as expected, profit-seeking investors should go further and make “pro-sociality” the actual investment thesis.  And, because most investors are institutions, with fiduciary obligations toward their natural-person beneficiaries, the logic of shareholder primacy necessitates that the regulatory apparatus surrounding these institutions begin to encourage or even require that they demand pro-social behavior from their portfolio firms.

The issue has now escalated into regulatory warfare, as Democrats and Republicans ping pong over what conduct is pro-social and therefore profitable, drawing investors (and, correlatively, corporate boards) into the precise political thicket that shareholder primacy was meant to avoid.  And there is no obvious escape from the trap, because, ultimately, under shareholder primacy, profitability is treated as proof of market preferences, and market preferences are taken as a kind of popular vote. Profitability, in other words, becomes a proxy for the mainstream of America.  And, especially in highly polarized times, a claim to represent the mainstream enjoys an enormous amount of political currency.

The Caremark Conundrum

Corporations are authorized only to engage in “lawful” activity, meaning, state corporate law itself conditions the grant of a charter on legal compliance.  Corporate law’s internal prohibition on illegality is another legitimating principle; it is one of the visible ways that the corporate law system can publicly communicate its pro-sociality.  As a result, shareholders may bring derivative actions against corporate directors for damages and expenses incident to intentional lawbreaking, even if that lawbreaking was undertaken for the purpose of increasing profits.  But that only turns state corporate courts – and Delaware courts in particular – into a secondary regulator for the United States. There is no possibility that Delaware can adopt such a regulatory function while avoiding the appearance of taking a political – and partisan – bent, which once again undermines the justification for shareholder primacy in the first instance, as well as Delaware’s role in the system.

Conclusion

The open question is how long profit-maximizing corporations will tolerate incurring real expenses as the price of public acceptance. If they reincorporate out of Delaware, as they currently threaten to do, the pitchforks – via more robust federal regulation, if nothing else – may in fact reveal themselves. Or, more unsettlingly, corporate managers may reach the rational calculation that they have amassed enough political influence and power to no longer need legitimizing symbols to maintain their dominance after all.

ENDNOTES

[1] E.g., Michael Klausner, Fact and Fiction in Corporate Law and Governance, 65 Stan. L. Rev. 1325, 1358 (2013); Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 Yale L.J. 1521 (2005); Yakov Amihud, Markus Schmid & Steven Davidoff Solomon, Settling the Staggered Board Debate, 166 U. Pa. L. Rev. 1475 (2018).  Some scholars have called into question the metrics prior research has used even to assess the value of corporate governance innovations.  See, e.g., See Jens Frankenreiter, Cathy Hwang, Yaron Nili, & Eric Talley, Cleaning Corporate Governance, 170 U. Pa. L. Rev. 1 (2021); Marcel Kahan & Emiliano Catan, Corporate Governance and Firm Value, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5127297; Robert Bartlett & Frank Partnoy, The Misuse of Tobin’s Q, 73 Vand. L. Rev. 353 (2020).

[2] Marcel Kahan & Edward Rock, Symbolic Corporate Governance Politics, 94 B.U. L. Rev. 1997, 2034 (2014).

[3] 310 A.3d 430 (Del. Ch. 2024).

[4] 311 A.3d 809 (Del. Ch. 2024).

This post comes to us from Ann M. Lipton, the Michael M. Fleishman Professor in Business Law and Entrepreneurship at Tulane University Law School and The Murphy Institute.  It is based on her recent article, “The Legitimation of Shareholder Primacy,” forthcoming in the Journal of Corporation Law and available here.