Reforming the US corporation
Can boards serve more than their shareholders?
In 2019, we witnessed, in a year of rocky IPOs, the success beyond all expectations of the Beyond Meat listing. The differentiator: socially conscious investors (focused, in this instance, on the environmental benefits of a shift to plant-based food) comprised the critical component of the underwriters’ IPO order book that was missing from other, less successful, flotations. Estimates put the assets under management of impact investing at more than $500 billion, dwarfing the $143 billion dedicated to activist equity strategies.
As the magnitude of funds aimed at socially beneficial businesses has grown, investors and their intermediaries (such as proxy advisory firms like ISS and Glass Lewis, independent designers of best practices for disclosure like the Sustainability Accounting Standards Board, and watchdog and rating organizations like Sustainalytics) have contributed to the proliferation of ways to measure and evaluate each corporation’s impacts on the environment, customers, workers and local communities.
Countering the focus on short-term growth
The companies in the IPO pipeline for 2020 – and indeed lots of existing publicly-traded corporations – are now considering how to harness this development to improve relations with their spectrum of stakeholders. But to achieve this objective, they will need to take innovative steps to manage two countervailing forces.
First, a slice of the market remains focused on metrics that indicate rapid, short-term growth to the exclusion of all other objectives. Up until now, companies have failed to counter this dynamic. Yes, fluffy statements by founders and CEOs about long-termism and values regularly take up space in IPO prospectuses and follow-up communications. But these well-intentioned sentiments are at risk of being overwhelmed by management’s widespread distribution of powerful data that is often incompatible with these sentiments and ironically does not even make it into the IPO prospectus: internal financial projections.
All the founders’ letters and statements of corporate values in the world are not going to alter the commitment to near-term growth at all costs that is necessary if management hands analysts and investors sets of aggressively optimistic management projections. This syndrome is especially problematic in connection with IPOs, where there is pressure to provide the best possible financial forecasts during roadshows.
All the statements of corporate values in the world are not going to alter the commitment to near-term growth at all costs that is necessary if management hands the market aggressively optimistic projections.
Are directors who think beyond shareholders in breach of their fiduciary duties?
Second, corporate law in most states provides that directors and officers must act in the best interests of the corporation and its shareholders, not other constituencies. There is a limit to how much a director can squeeze the square peg of benefiting “other constituencies” into the round hole of a duty to maximize shareholder value at every turn.
Interestingly, in advance of the Business Roundtable’s recent pronouncement that looking out for stakeholders other than shareholders is part of the corporate mission, a number of clients called to ask whether their companies’ support of the Roundtable’s position would put their directors and officers in conflict with their fiduciary duties.
The answer was an easy, “No problem.”
Because most states’ corporate law provides that directors and officers must act in the best interests of the corporation and its shareholders, the Roundtable’s statement relies on a realization that has been around for over a century: a company’s actions that benefit non-shareholder constituencies may simultaneously be in the best interests of the corporation and its stockholders. Absent this realization, all acts of corporate charity and responsibility would constitute corporate waste.
The Roundtable’s statement relies on a realization that has been around for over a century – that a company’s actions that benefit non-shareholder constituencies may simultaneously be in the best interests of the corporation and its stockholders.
But as the power of impact investing grows and the market’s measurement of corporations’ impact on “other constituencies” becomes more precise (but also more disparate), fiduciaries of corporations are at risk of being driven to make decisions that benefit “other constituencies” to an untenable extent. The answer to clients’ questions may start to become, “Actually, you may not be complying with your fiduciary duties if you take that step.”
How boards can flip the narrative
In 2020, successful IPO issuers, and even some courageous companies that are already publicly traded, will have the opportunity to take strong steps to counter these two forces. First, management can moderate the growth projections they provide to the market, especially during IPO roadshows, and be comfortable that the cost of this decision will be offset by compelling, substantive disclosure that both details the company’s public benefit and sustainability mission and is sufficient to attract a healthy layer of impact investors into the IPO order book and long-term shareholder profile.
Second, the limits of corporate law can be overcome by taking advantage of a Delaware statute that has until now been virtually ignored by publicly traded companies. It provides that a corporation may amend its charter to become a public benefit corporation (or PBC) and redefine fiduciary duties to focus on not only the interests of shareholders but also the interests of other constituencies (and, even better, of whatever public benefits the charter specifies). Moreover, this statute generously insulates directors and officers from claims for breach of duty so long as no self-dealing is involved.
Delaware legislature needs to help corporations make the shift
That said, there are a few fixes that the Delaware legislature needs to adopt urgently to permit corporations to move in this direction. For one, modifications should be made that harmonize the process of conversion to a PBC with the provisions applicable to other charter amendments – the requisite shareholder approval should be reduced from 66 and two-thirds percent to a simple majority of the outstanding shares, and the conversion to a PBC should not trigger appraisal rights. In addition, the statutory protection of fiduciaries against liability should make clear that the holding of shares by a director or officer would not, by itself, result in her being deemed to be engaged in self-dealing that negates her insulation from liability if her balancing of shareholder value, other constituencies, and the designated public benefit ends up favoring shareholder value.
Finally, when a corporation’s narrative is framed by detailed environmental and social impact disclosure and the adoption of an alternative fiduciary duty paradigm, the insulation of this narrative through structural features (such as high-vote shares for the pre-IPO stockholders and a classified board arrangement whereby only a third of the directors are up for re-election each year) becomes justifiable rather than a source of controversy. It is no longer the ability of self-centered founders to do whatever they want that is being insulated – rather it is a well-articulated and designed mission to serve a broader purpose than short-term growth.
The limits of corporate law can be overcome by taking advantage of a Delaware statute that has until now been virtually ignored by public companies.