The Tide is Turning – The Change from Shareholder Approach to Stakeholder Approach in Light of The Business Roundtable’s 2019 Statement on the ‘Purpose of a Corporation’

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Posted on:Jul 6,2021


Ever since Edward Freeman’s seminal work in 1984 the “Stakeholder Theory: Strategic Management: A Stakeholder Approach” a shift from the earlier shareholder-based rules can be observed in corporate governance recommendations. Yet much of the focus remained on shareholders, especially when it came to whose interests should the corporation serve, as evidenced by the multitude of corporate governance rules and recommendations. The viability of status quo has been questioned by scholars due to the externalities produced by corporate activity, including the contribution towards climate change or the economic destabilisation of the lower-middle class in Western societies. In light of the aforementioned the Business Roundtable in 2019 redefined the purpose of the corporation to “promote ‘an economy that serves all Americans’”. The aim of the paper is to explore the changes in purposes of the corporation, from the ramifications of the hallmark case ‘Dodge v Ford Motor Company’ in which the Michigan Supreme Court held that the company must be operated in the interest to the shareholders up to the Business Roundtable’s 2019 statement.

Keywords: corporate governance, sustainability, shareholders, stakeholders

I. Introduction

The importance of corporate governance cannot be understated; as modern corporations have impacted society to a great degree. The literature of corporate governance itself spans from the minutiae of determining the proper ratio of fixed to variable remuneration to broad concepts such as whose interests shall be taken into account during the management of the company. The scientific consensus can be divided into two major camps: the first, who are propounding the primacy of the shareholder’s interests and the second, who believe that there are other groups whose interests should be taken into account. Edward Freeman in his book titled “Stakeholder Theory: Strategic Management: A Stakeholder Approach” called these groups (employees, creditors, local communities etc.) as stakeholders, since these groups have a stake in the proper functioning of the corporation.

This paper aims at taking a look behind the factors which could have influenced the Business Roundtable to embark on a shift from the strictly shareholder oriented approach to the stakeholder oriented approach. Firstly, a quick overview on the rules of corporate governance is intended to be given, in light of which the role and the importance of Business Roundtable’s Statement on the Purpose of the Corporation can be understood. Then a summary is intended to be given on the role of modern corporations, during which the literature on the different approaches shall be examined including some key cases that shaped corporate governance. Most of this paper will be dealing with Delaware law, due to the fact, that Delaware seems to be default choice for most US listed corporations to incorporate. This phenomenon itself has its own literature on the so-called “Delaware effect”. Lastly, the Business Roundtable’s Statement on the Purpose of the Corporation will be examined briefly.

II. What is corporate governance?

The definition of corporate governance can be manifold; this section aims at giving some of the more relevant ones. Corporate governance has its roots in American corporate practice, which markedly influenced its character. However, due to factors such as globalisation, corporate scandals etc. corporate governance became a widely studied subject in other areas of the world, whether for attracting more investment (such as in the case of emerging markets) or to increase the activity of capital markets on well-established markets, such as in continental Europe.

The OECD defines corporate governance is that “corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” According to the definition by András Kecskés, corporate governance is “the adequate governance system of companies which covers the relations between management, the owners, the employees, and other concerned persons, which is based on the lawful, ethical, reasonable, efficient and socially useful solutions for profit-oriented operations, and which is regulated by statutory provisions and the self-regulating mechanisms of the market and the business sphere”. It can be deduced from both definitions that corporate governance rules are aimed at ensuring that corporations would always be managed in view of the long-term interest of shareholders and stakeholders.

Table 1.: Examples of sources of corporate governance

Legal Extra-legal
Binding Corporate law
Capital markets law
Contract law
Non-binding EU recommendations Codes of best practice*
Gentlemen’s agreements
Business practice

Source: own compilation

The non-binding nature of codes of best practices need some explanation. Generally, the codes themselves are not binding the same way as laws, such as corporate law provisions. However, these codes may be made mandatory for listing a stock corporation on a particular stock exchange, which then gives these codes a binding character. Yet, their binding nature can be undermined by the “comply or explain” rule, which gives an opportunity for a listed corporation to differ from a prescribed rule. However, should a corporation make a decision to not adopt one of the rules outlined in the applicable corporate governance code, an appropriate explanation must be given about why it is not applying the rule, and what other measures have that corporation taken that is comparable. This aims at creating a flexible framework that is both suitable for the corporation’s needs while also maintaining the integrity of the principle that is behind the rule not observed “to the letter”.

III. The role of the modern corporation

In determining the proper corporate governance structures, the purpose of a corporation must be taken into account. Contemporary corporation codes provide broad opportunities; a corporation can be made for any legal business purposes. The articles of association set out the scope of a company i.e. what sort of activities it wishes to pursue, however, purpose cannot be conflated with scope. Purpose itself is a broader concept, that defines what the corporate form is suitable for. Due to the specialities in the development of corporate governance, the literature reviewed will focus on mostly Anglo-American matters, and Delaware law.

1. Corporate purpose in American law

The rise of the modern corporation, which was first comprehensively examined by Adolf Berle and Gardiner Means in their pioneering work “The Modern Corporation and Private Property”, completely changed the nature of our economy. Organisational efficiency that was unseen before could be achieved by the modern corporation. The emergence of the professional management introduced a whole new set of problems, such as agency cost, conflict of interests, etc. Legislators, courts, and scholars were trying to find solutions for the aforementioned problems to protect the interests of investors and to maintain the public’s trust.

Dalia Mitchell identified three distinct eras in how the courts in the USA treated the purpose of the company, reflecting on the challenges of the time. The first era spanned from the 1900s to the 1930s. This was the time when the modern corporations emerged, which made governments and scholars wary, due to the unprecedented scale of their power and wealth concentration. One such way to curb their power was the ultra vires doctrine, which was aimed at limiting the purpose of the corporation to business matters. However, Mitchell argues that in this era progressive scholars were trying to emphasise the “social and political” role of corporations, thus the corporate power exercised “in trust for the community”. The Steinway v. Steinway & Sons decision in 1896 showed that courts were willing to set aside the ultra vires doctrine and allow charitable contribution if it directly benefitted the corporation. Due to the social pressures of the time, however, courts were more willing to allow charitable contributions, as long as the management reasonably could show a link between the contribution and the interests of the company. However, the Dodge v Ford Motor Company decision showed that corporations owed duties to their shareholders. The facts of the case could be summed up as following: Henry Ford in 1916 announced that it would no longer pay special dividends as the corporation wished to invest the money in a new plant “to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes.” The Ford Motor Company also announced they would further reduce the price of the successful Model T. The Dodge Brothers, holders of special shares successfully petitioned for an injunction to order the corporation to pay special dividends and to prevent Ford from further decreasing the price of their automobiles. The Supreme Court of Michigan reviewed the decision and partially allowed Ford’s appeal. While supreme court declared that it is within the powers of the corporation to set their prices on automobiles – as per the business judgement rule, which protects the independence of the management’s decision-making – the corporation itself could not justify withholding earnings based on humanitarian causes. The court itself stated that “a business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes”. This decision has been viewed as the nucleus of the shareholder-primacy viewpoint, that has become so dominant since the 1970s. An interesting exception must be noted to the mainstream viewpoint, however, as Lynn Stout argues that the Dodge case is a weak example case on corporate purpose: the facts mainly dealt with protecting minority shareholders from an oppressive majority.

The second era spanned from the 1940s to the 1970s. This was the era when corporations became an “American institution”, which happened due to their role in the war effort and the post-war economic boom which also allowed for an unprecedented increase in living standards for the population in general. Corporations were also important in fighting the Cold War, that is why, according to Mitchell, managerialism arose. Courts were more willing to give more leeway for management to make decisions even if it went against the wishes of shareholders. Thus the scope of the business judgement rule became wider. An example from the era was the Shlensky v Wrigley decision from 1968, when a group of shareholders brought a derivative claim against the management of Wrigley Field. The shareholders sought damages on the ground that by not fitting floodlights on the field, they were suffering losses from lost potential income that could have been realised from selling more broadcasting rights of baseball matches played in night-time. However, the court refused to rule against the management, citing that the question at hand was a matter of business. Interestingly, the reason behind not installing the lights was that the management felt concerned about property prices nearby the stadium. By the end of this era, however, due to the rapid changes in American society, the economic downturn and the increased consciousness about the ills brought upon the environment by the corporate activity would have seemingly resulted in a corporate purpose more sensitive towards the problems of society. Yet, in the third era spanning from 1970s brought shareholder interests into the forefront. This era witnessed the beginning of the downward spiral of the “traditional” American corporations and the emergence of corporate raiders and the increases in the frequency of hostile takeovers, which was threatening the stock markets, a symbol of American economic power, and towards the American corporations in general.

2. Shareholder primacy

According to Mitchell, the concept of shareholder primacy was an attempt by Delaware courts to curb takeover activities. The idea of shareholder value was to enable to management to take appropriate defence measures against takeovers under the pretext of delivering the best value for the shareholders. Yet, shareholder primacy has not been a new concept. In an Anglo-American context it can be traced back to the fact that corporations had been acting as conduits for raising capital from the general public. Shareholder primacy can be traced back to Adolf Berle’s works in the 1930s. The agency problem he outlined served as the basis for many of the theories on shareholder primacy. Thus, managers, acting as agents, had to govern the company in the interest of the shareholders, their principals. However, the exclusiveness of shareholder interest only began to come to the forefront in the 1970s. Milton Friedman in 1970 stated that the only social responsibility of a business was to increase its profit for the shareholders.
The theories on shareholder-oriented approach is not homogeneous. Many different viewpoints can be identified, ranging from the ones simply stating the primacy of shareholder interests (while not excluding the interest of other groups) to approaches that exclusively put shareholder interests into the focus of the management. Professor Gilson went as far as setting the share price value as the only concern for management.

3. Stakeholder approach

Concurrently with the emerging hostile takeover activities in 1970s and 1980s, R. Edward Freeman published his book on management as a response to the changes in the perception of the firm. Due to the changes in society, Freeman argued that the classical approach to management, which only focused on the inside processes – such as getting a product to the market or to deal with employees – was no longer sufficient, as in reality the firm also interacted with outsiders, such as the government or special interest groups. In his book he aimed at outlining a management system which was able to respond to the challenges presented to the firms. He identified 11 different stakeholders: governments, local community organisations, owners, consumer advocates, customers, competitors, media, employees, special interest groups, environmentalists and suppliers. The term “stakeholder” came from previous researches conducted by Stanford University in 1963, and it was meant to denote these groups had an interest in operations of a firm, directly or indirectly. Stakeholder theory, however is much older than that, as Merrick Dodd’s work in 1932 already argued for a more stakeholder-oriented approach for management, as a reaction to the effects of the Great Depression on the American society.
The stakeholder concept gained traction later on, while also attracting criticism. For example, Jensen argued that by adding multiple objectives to the management, the firm loses focus, thus makes it more susceptible to the whims of the management. Elaine Sternberg even went as far as deeming the stakeholder concept to be wholly incompatible with corporate governance and business. The infinite number of stakeholders makes it hard to identify whose interest should be accounted for, making it impossible to manage a corporation. Also she noted that accountability is virtually non-existent as there is no clear set of criteria on which performance is judged on.

The stakeholder approach became favoured by international organisations, NGOs, and certain European governments. In Estonia for example, takeover regulations prescribe a stakeholder approach for the management. Countries such as Germany and France consider the corporation as a stakeholder, as the management has to act in the best interest of the corporation they manage. While there have been attempts at reframing the nature of Delaware’s corporate law as not being strictly pro-shareholder only, Yosifon gives contrary evidence, according to him Delaware has never moved away from the shareholder primacy viewpoint.

IV. Importance of the Business Roundtable’s 2019 Statement on the Purpose of the Corporation

The Business Roundtable, established in 1972, is a non-profit organisation that consists of the CEOs of the largest publicly traded stock corporations in the United States (Apple, Amazon, General Motors, Boeing etc.). The organisation itself had an important role in promoting corporate governance within its membership, as evidenced by the corporate governance principles. Since 1997 the Business Roundtable expressly defined the purpose of the corporation to serve the shareholders. This approach itself aligned well with the corporate law of Delaware, where the law itself requires the corporate management to solely observe shareholder interests during decision-making. In 2019 the Business Roundtable released their new “Statement on the Purpose of the Corporation” which could be seen as a drastic departure from the previous years’ statements. The new statement highlighted that members of the Business Roundtable shall be committed to all their stakeholders, including customers, employees, suppliers, communities, while also maintaining their commitments toward the long-term value for shareholders.

What sort of ramifications does the Business Roundtable’s statement hold? It can be argued that corporations this way may try to give themselves more room to engage in other activities that are not strictly related to their core business. Corporations seem to be tackling social issues, ranging from CSR initiatives to make business decisions that also serve as a statement on political issues. Meanwhile Delaware law – which is the applicable law to most of the signatories, as they are registered in Delaware – still prescribes shareholder primacy. Thus it can also be argued that corporations of the Business Roundtable are attempting to increase their room for manoeuvre when it comes to business activities.

V. Conclusion

The largest business corporations in the United States seemed to have acknowledged that they not only owe duties to their shareholders but also to their stakeholders. Many of the signatory corporations had to endure intense press scrutiny in the past 5 years. Amazon for its tenuous labour relations, Boeing for its ill-fated 737 MAX jetliners or General Motors for closing down factories in the USA, these actions have all generated negative press attention. If one also considers how some of the signatories are part of the fossil-fuel industry, we can see an attempt at responding to changes in societal attitude. As the statement has been made quite recently, one can hope that the declared shift from the strict shareholder-oriented approach will be more than a publicity stunt and the signatory corporations will take it seriously.


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Barnabás Ferencz
assistant lecturer
University of Pécs, Faculty of Law