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Following up on Brett McDonnell, Hari Osofsky, Jacqueline Peel and Anita Foerster’s thoughtful paper and recent OBLB contribution, this post highlights a number of issues it raises for corporate theory and corporate governance....

This article was originally posted on the Oxford Business Law Blog on 6 July 2021.

The trade-off between corporate governance on the one hand, and legislation & regulation on the other hand may entail a cost-benefit analysis which surely deserves an explicit discussion

Following up on Brett McDonnell, Hari Osofsky, Jacqueline Peel and Anita Foerster’s thoughtful paper and recent OBLB contribution, this post highlights a number of issues it raises for corporate theory and corporate governance in the context of sustainability and the transition to a zero-carbon economy. The paper is extremely timely: on the day before its presentation at the OBLB conference, an activist hedge fund with an environmentalist agenda succeeded in electing three directors to Exxon Mobil’s board. Also on May 26, a Dutch court ordered Shell to reduce its emissions at a faster pace—although it was not a shareholder suit, and Shell will likely appeal the decision. The paper attempts to draw normative lessons from the interviews with representatives of US and Australian corporations, asset managers, advocacy groups, and others. 

Diverging stakeholder interests

How can policymakers ensure that environmental concerns are considered in corporate decision-making? As a first best solution, McDonnell et al would in principle like to see formalized stakeholder voice implemented in the law (although they concede it is not the most realistic option). Putting an official advocate for the environment on the board is an intriguing idea, but raises the question of how the interests of various corporate stakeholders should be reconciled. A rather narrow definition of the term ‘stakeholder’ includes only groups that have made a specific investment into the relationship with the firm, such as employees with skills that are hard to transfer to a different job. Shareholders’ status as residual claimants is usually the economic justification for their control rights. Employees may have non-transferable skills, and in some cases, they may also be tied to the firm by promises of future payments, such as non-transferable (often unfunded) pension obligations. Employees cannot typically diversify these risks, which exposes them to opportunism that could justify giving them increased voice in corporate governance such as codetermination.

Broad-based stakeholder orientation, including board-level employee representation, does not guarantee greater attentiveness to the environment or sustainability. Employees’ career prospects and income may benefit from the success of a corporation that pollutes. A good example might be pre-scandal Volkswagen, which was likely an attractive employer in part because it was very successful. Not only did it have 50% labour representation on the board, but also significant political representation from one of its shareholders, the State of Lower Saxony. While formally enshrining the role of an advocate of the environment is an attractive idea, with employee representatives and other constituency directors on the board (eg, those representing the interests of large, strategic investors) decision-making processes would become yet more complex, and control over corporations more tenuous. The advisory board model suggested by McDonnell et al as a second-best solution thus seems more practical. 

Stakeholder orientation and managerial discretion

In many stakeholder-oriented perspectives, releasing managers from rigidly pursuing shareholder interests is seen as a way of giving some weight to stakeholders. While managerial discretion facilitates the balancing of interests by managers or the board, supporters of shareholder primacy have often criticized stakeholder views for giving too much discretion to managers and releasing them from accountability to anyone. Throughout history and across countries, stakeholderism has therefore often been criticized as the friendly face of managerialism that hides its true effects and maybe its supporters’ true intentions. Walther Rathenau’s famous 1917 book ‘Vom Aktienwesen’ discussed pathologies of shareholder-decision-making that did not serve the development of either the corporation or public interests; it was subsequently critiqued as developing an idea of a metaphysical ‘business as such’ that developed a life of its own and lacked accountability. 

In an apt reframing, Bratton and Wachter have reinterpreted the Berle-Dodd debate in 1931-32 as being about management’s discretion and its role on the path out of the Great Depression: While one side (Berle) sought to constrain unaccountable management by binding it to shareholders interests, the other side (Dodd) aimed at corporate leaders rather than the government having the prime responsibility for curing the economic ills of the time. Berle’s work advising the Roosevelt administration during the New Deal and his subsequent satisfaction that corporations were properly regulated explain why he later accepted that Dodd’s position had eventually carried the debate.

Finally, Milton Friedman famously criticized exhortations that managers should be ‘socially responsible’ for permitting business leaders to arrogate decisions that would rightfully be those of shareholders, particularly in the political sphere. If stakeholder advocates were not able to get their desired results from Congress, is it legitimate to get these results from management? Following Friedman, one could argue that this is a circumvention of the democratic process.

These debates show that an important aspect of corporate law is to shape the degree and contours of managerial discretion, and that it changes the relative bargaining power of the different ‘stakeholder’ groups on the margin. Putting the responses in McDonnell et al’s interviews into the larger international context, it would be interesting to know more about how the firms in question operate. Are their ownership structures relatively dispersed or concentrated? Are most outside investors institutional or retail investors? What kind of labour relations do these firms have? Whether firms will need to be attentive to the views of institutional investors and feel under pressure to implement them will to a large degree depend on the bargaining power of each group. 

While the US and Australia are probably relatively similar in these two key respects, it is less clear whether the results can be generalized to countries with more concentrated ownership structures. Gains and losses could differ across different types of shareholders, namely by their degree of diversification and the nature and motives of the investor. Moreover, different shareholders—in different countries—will be subject to different social obligations. Pressure to conform to a particular orthodoxy dominating public debates (be it shareholder wealth maximization or environmentalism) could differ depending on the shareholder. Institutional investors appealing to millennial investors will likely be subject to very different social forces than a controlling family, eg in Italy or Korea. Like managers, institutional investors may be compelled to engage in performative conduct and push for environmentalist views even if it does not serve their portfolio interests. Employees may feel obligated to project a particular set of values to the outside world. They may have some bargaining power to push firms into (or away from) a pro-environmental position. While many investors may be willing to give up returns for a more environmentalist policy in an ESG-oriented fund, some employees could be willing to forgo income to work for a more climate-friendly firm. There are good reasons to suspect that employees will sacrifice more. A job is typically more salient for one’s identity than investment positions, and more visible within the respective social group.

Fiduciary duty and managerial discretion

McDonnell et al persuasively show that it is difficult to use fiduciary duties to enlist corporations for environmentalist causes. Despite occasional statements to the contrary (eg, EBay), a duty to maximize financial returns either does not exist or is not enforceable in a meaningful way; the business judgment rule permits broad managerial discretion in most circumstances as long as managers are not subject to a conflict of interest. In the US, the monitoring duties under Caremark are most directly relevant, which are limited to situations where a law has been violated. The Citigroup case stated that extending such duties to situations of excessive risk-taking would take courts into the dangerous territory of policing managerial decisions, which is exactly what the business judgment rule is intended to avoid.

There are other jurisdictions where the duty to monitor is construed differently, and Australia (discussed by McDonnell et al) may be among them. Another example may be the well-known IKB case of the OLG Düsseldorf in Germany, where acceptance of an excessive risk taking in a bank was considered a breach of duty because directors could not have reasonably believed (in the view of the court) that they were acting in the best interests of the company.

However, while substantive monitoring duties in the US are only weak constraints, the US is the country where shareholder litigation against actual or apparent violations of duties is most likely. In most other major corporate governance systems, representative litigation on behalf of shareholders against directors and officers is rare for well-known reasons, such as standing limitations in derivative suits (the ‘loser pays’ rule), the absence of contingency fees, and the lack of a discovery system. It may not have been an accident that the US developed the strongest shield in the form of its business judgment rule in the face of the most developed litigation culture. Consequently, it seems unlikely that fiduciary duties will become a promising mechanism for environmentalism elsewhere.

The disclosure of a firm’s lobbying activity, political donations and environmental impact could be a promising path to pursue, as corporations are increasingly compelled to work toward the goal of a zero-carbon emission economy.

Conclusion: A policy and political trade-off

The theme underlying McDonnell at al’s paper is ultimately a trade-off between corporate governance on the one hand, and legislation and regulation on the other hand. First, if we cannot force firms to work toward a zero-carbon economy because legislation and regulation will not develop this way, is it legitimate to get this result through social and economic pressure from institutional investors? Second, are fiduciary duties and shareholder activism truly the best mechanisms? If they are reshaped to accommodate environmental goals, their new form may also permit other types of activism for which they are less well-suited. Thus, the trade-off may entail a cost-benefit analysis which surely deserves an explicit discussion. As McDonnell et al point out in their thought-provoking paper, the impact of corporate disclosure is limited and often constitutes ‘greenwashing.’ Shareholder activism ultimately depends on preferences and incentives of asset managers. Litigation is typically successful only when there is a climate-related law or regulation. Maybe the disclosure of a firm’s lobbying activity, political donations and environmental impact would be a promising path to pursue as society, and public debates increasingly compel corporations to work toward the goal of a zero-carbon emission economy.

Martin Gelter is a Professor of Law at School of Law, Fordham University, New York.

This post is based on contributions to and the discussion at the 5th Annual Oxford Business Law Blog conference on ‘Business Law and the Transition to a Net Zero Carbon Economy’ which took place online on 25 to 27 May 2021. This post is forthcoming in Andreas Engert, Luca Enriques, Georg Ringe, Umakanth Varottil and Thom Wetzer (eds), Business Law and the Transition to a Net Zero Carbon Economy (CH Beck - Hart Publishing 2021) (forthcoming).


Event: Business Law and the Transition to a Net Zero Carbon Economy (25 - 27 May 2021)

Videos of the presentations are available on the ECGI website and YouTube channel.

This article features in the ECGI blog collection

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