Sustainability and Corporate Governance in Latin America

Many legal and finance scholars have rightly emphasized that Milton Friedman’s statement about the purpose of a corporation has been widely misinterpreted. As Luigi Zingales mentioned in an article criticizing the popular statement issued by the Business Roundtable in 2019, even Friedman would agree that companies need to deliver value to customers, invest in employees, deal fairly and ethically with suppliers, and support communities. Otherwise, they will be unable to attract consumers and talented workers, and therefore they might be unable to maximize shareholder value. Moreover, Friedman made clear that companies should focus on maximizing profits within the limits of the law. Therefore, as the law is supposed to prevent undesirable practices such as pollution, collusion, corruption, discrimination, or violation of human rights, companies can maximize shareholder value without creating any type of externalities that can undermine the promotion of sustainability and long-term growth.

A variety of legal and institutional factors undermine Friedman’s views to achieve a socially optimal outcome by exclusively focusing on maximizing shareholder value.

For this view to be socially optimal, however, the law should effectively prevent undesirable business practices. In other words, companies should operate without creating any type of negative externalities, and the law should prevent all forms of market failures potentially allowing firms to enrich themselves at the expense of other stakeholders. Unfortunately, this is not the case. Due to a variety of factors, including corruption, regulatory capture, lack of expertise, and divergences in the types of business practices that should be prohibited or discouraged, the law does not – and cannot possibly – capture the whole spectrum of business practices ideally unwanted from corporations. Furthermore, even if all these practices were prohibited, the law might not be properly enforced, especially in countries with weak institutions. As a result, companies might not be deterred from committing undesirable business practices. Therefore, a variety of legal and institutional factors undermine Friedman’s views to achieve a socially optimal outcome by exclusively focusing on maximizing shareholder value.

Jurisdictions around the world have adopted different strategies to promote sustainability and responsible capitalism.

Yet, that does not mean that regulators should necessarily intervene. They should do so only if the solution eventually adopted provides a more desirable outcome for society. While most authors agree that something needs to be done to promote responsible capitalism, it is not clear whether the answer should be provided by corporate law. Advocates of corporate law solutions include Martin Lipton and Lynn Stout. According to these authors, corporate directors should take into account the interests of customers, employees and communities. Therefore, part of the solution to fix capitalism includes the empowerment of directors. On the other side of the spectrum, however, Lucian Bebchuk and Roberto Tallarita have argued that requiring corporate directors to serve the interests of a variety of stakeholders is an inadequate and substantially counterproductive approach to address stakeholder concerns. By making corporate leaders less accountable and more insulated from shareholder oversight, these authors argue that the empowerment of directors would increase slack and hurt performance, reducing the economic pie available to shareholders and stakeholders.

Jurisdictions around the world have adopted different strategies to promote sustainability and responsible capitalism. For instance, various Asian countries require corporate directors to take into account the interests of employees, customers and communities. Therefore, by expanding the scope of directors’ duties, they favor the empowerment of directors. In the United States, the SEC has recently adopted new disclosure obligations on climate-related risks. This solution, supported by the academic literature, seeks to tackle climate change while providing investors with additional information that can also be relevant for the assessment and monitoring of their investments. The European Union has adopted various initiatives to promote responsible capitalism, including the enactment of the Non-Financial Reporting Directive and the recent approval of the Proposed Directive on Corporate Sustainability Due Diligence that, among other aspects, expands the scope of directors duties. Namely, when fulfilling their duty to act in the best interest of the company, the Proposed Directive requires directors to take into account the human rights, climate change and environmental consequences of their decisions. Other responses adopted in the European Union to promote sustainable growth while enhancing the competitiveness of capital markets have included various controversial policies such as the abolition of quarterly reporting obligations for listed companies, as well as the implementation of loyalty shares in various European countries, such as France, Italy, Belgium and more recently Spain.

When it comes to directors’ duties, most Latin American countries require corporate directors to act in the best interest of the corporation.

Within this range of responses, where does Latin America stand? When it comes to directors’ duties, most Latin American countries require corporate directors to act in the best interest of the corporation. Despite the controversies surrounding the concept and beneficiaries of a corporation, this provision has generally been interpreted as a mandate to act in the best interest of the shareholders as a whole – at least while the company is solvent. In any case, nothing prevents the shareholders from electing directors, or promoting certain actions, that can advance socially desirable goals provided that this strategy is aligned with the interest of the corporation. Therefore, responsible capitalism can be achieved through the involvement of shareholders, consistent with the type of investor-led model of sustainable corporate governance advocated by several authors such as Wolf-Georg Ringe, and promoted by various institutional investors and hedge fund activists.

Nonetheless, the imposition of directors’ duties towards stakeholders can also be found in some jurisdictions in Latin America. For example, the Brazilian Companies Act requires directors and officers to act in the best interest of the company, “including the requirements of the public at large and of the social role of the corporation.” Moreover, controlling shareholders have duties and responsibilities towards “the other shareholders of the corporation, those who work for the corporation and the community in which [the company] operates”.

Many countries in Latin America, including Colombia, Peru, Ecuador and more recently Uruguay, have enacted legislation to recognize the so-called collective interest and benefit corporations

Additionally, many countries in Latin America, including Colombia, Peru, Ecuador and more recently Uruguay, have enacted legislation to recognize the so-called collective interest and benefit corporations, and other jurisdictions in the region – such as Argentina and Chile – are moving in the same direction. In these companies, inspired by the benefit (“B”) corporation existing in other jurisdictions around the world, corporate directors are required to serve a variety of stakeholders. Yet, since the shareholders ultimately decide whether a company becomes a collective interest and benefit corporation, this strategy to promote responsible capitalism can also be understood as a form of an investor-led mechanism to promote sustainable corporate governance.

Despite the shareholder-oriented corporate governance model that, with a few exceptions, prevails in Latin America, the regulatory framework for businesses in most Latin American countries includes many stakeholder-oriented provisions. For example, most corporate laws in Latin America include strong creditor-oriented provisions, including the need to capitalize or liquidate the firm if, due to the existence of losses, the company’s legal capital falls below a proportion of the company’s net assets. In various Latin American jurisdictions, such as Mexico and Ecuador, the insolvency legislation not only provides employees with the priority in the ranking of claims that exists in many jurisdictions around the world, but it also exempts employees from the moratorium protecting debtors from the initiation of legal actions by the creditors. More controversially, especially in countries with weak institutional environments, foreign investors seeking to start a business in Cuba need to obtain, among other aspects, the approval of a public agency assessing the environmental impact of the business.

Given the market and institutional features existing in Latin America, an investor-led model of responsible capitalism will probably be more desirable.

The promotion of sustainable growth is a goal probably shared by most authors and regulators. However, divergent opinions arise when deciding the optimal strategy to achieve this goal as well as the role eventually played by corporate law and governance. To effectively address this question, an aspect often omitted in the academic and policy debate is the particular market and institutional features of a country. For instance, in jurisdictions where controllers enjoy high private benefits of control, as is the case in many Latin American countries such as Brazil, Argentina, Colombia, Venezuela and Mexico, empowering directors and controlling shareholders to focus on a wider scope of stakeholder oriented objectives – rather than a narrower focus on maximizing shareholder value – can exacerbate the already high risk of opportunism of controllers vis-à-vis outside investors existing in these jurisdictions. 

Therefore, ironically, well intentioned initiatives seeking to promote responsible capitalism could end up doing more harm than good for the advancement of sustainability and long-term growth. Additionally, in countries with weak institutions and high levels of corruption, as is the case in most Latin American countries except for Uruguay, Chile and Costa Rica, citizens might be rationally skeptical about the ability of public authorities to effectively solve societal problems through the enactment and enforcement of laws. Therefore, given the market and institutional features existing in Latin America, an investor-led model of responsible capitalism will probably be more desirable. Yet, some legislative responses will also be needed. In some cases, these legal responses will support investor-led initiatives contributing to sustainable capitalism, such as those facilitating class actions, derivative suits (non-existing in many Latin American countries) and disclosure on societal issues potentially relevant to investors (e.g. climate change, gender equality, and political spending). In other situations, a legislative response will be needed to address some fundamental problems existing in most Latin American countries, such as inequality, corruption, and the lack of diversity in many forms, including gender, race, and socio-economic background.

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Aurelio Gurrea-Martinez is an Assistant Professor of Law at Singapore Management University, head of the Singapore Global Restructuring Initiative, and director of the Ibero-American Institute for Law and Finance.

This article is from the special issue of the ECGI Blog on Corporate Governance in Latin America including articles from Marta Viegas & Francisco Reyes Villamizar. 

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