The Costs of Weakening Shareholder Primacy: Evidence from a U.S. Quasi-Natural Experiment

Should corporate governance be about maximizing shareholder wealth or balancing the interests of a wider set of stakeholders? This debate has become one of the central themes in corporate governance. Under the doctrine of shareholder primacy, directors and officers owe their fiduciary duties primarily to shareholders, with the objective of maximizing shareholder value. Shareholders enforce this objective through various disciplining mechanisms, including capital markets, the threat of takeovers, and the ability to pursue legal remedies. By contrast, stakeholder theory suggests that corporate fiduciaries should consider the interests of employees, customers, suppliers, and communities. 

There is much debate concerning the implications of weakening shareholder primacy and embracing stakeholder theory. However, empirical work on these issues is hindered by the difficulty of finding clean experiments that make it possible to identify the effects of weakening shareholder primacy. In our paper, we examine the implications of a 2017 change in corporate law in Nevada. This law change provides a quasi-natural experiment to assess the impact of weakening shareholder rights on governance, stakeholders, and firm outcomes.

Corporate law in the United States is determined at the state level. Most public corporations are incorporated in Delaware, where the courts and statutes are explicit that the fiduciary duty of directors runs to shareholders. Nevada is the distant second most popular state of incorporation, sometimes dubbed the “Delaware of the West.” Nevada law has long been more protective of insiders, but until 2017, Nevada courts still looked to Delaware precedents in practice. The effect was that, despite statutory differences, shareholder primacy was still a guiding principle. This changed dramatically with the passage of Senate Bill No. 203 in 2017, which made it crystal clear that the doctrine of shareholder primacy does not apply in Nevada and that directors and officers are protected against shareholder litigation. From that moment, Nevada firms operated under a meaningfully different regime from those incorporated elsewhere.

The strength of this setting is that it isolates the effect of weakening shareholder protection without confounding changes in the US economy or institutions. If market mechanisms were sufficient to discipline managers on their own, this legal shift should have had little or no effect. If, however, legal protections are crucial even in the presence of strong markets, then the Nevada reform should have measurable and adverse consequences for shareholders. However, since such a change allows officers and directors to take decisions that benefit stakeholders, it might be positive for stakeholders. 

Our analysis shows that governance quality in Nevada firms deteriorated significantly after the law. The entrenchment index worsened, boards became less independent, and director attendance declined. If the intention was to give insiders the freedom to act in the interests of stakeholders, one might expect improvements in environmental and social outcomes. In reality, both environmental and social performance declined, indicating that the additional discretion was not used to promote stakeholder welfare.

We also find that the financial reporting quality suffered. Auditors increased their concerns about companies’ financial reporting and Nevada firms became more likely to receive SEC comment letters pointing to deficiencies in their disclosures. Executive pay practices moved in a way that is more consistent with managerial entrenchment: the excess compensation of CEOs increased while the pay-performance sensitivity of their contracts declined. In other words, managers received more money while being held less accountable for firm performance.

Institutional investors, often considered crucial monitors of governance, also appeared to retreat. After the passage of the law, institutional ownership in Nevada firms fell. The frequency of securities lawsuits also declined, which is consistent with the law’s effect of weakening shareholder litigation rights. Taken together, these patterns suggest a broad erosion of accountability mechanisms.

The capital markets recognized this deterioration quickly and penalized firms accordingly. On the effective date of the law, Nevada firms experienced negative abnormal stock returns. Over the following two years, these firms underperformed relative to peers incorporated elsewhere. Measures of firm value, such as Tobin’s q, dropped significantly, especially in firms where governance declines were most pronounced. Credit markets responded too: the cost of debt rose for Nevada firms, reflecting higher perceived risk. These results show that markets did not view the shift as benign; instead, they priced in the costs of weakened shareholder primacy.

Investment behavior also changed in troubling ways. After the law, Nevada firms became more acquisitive, reduced asset sales, and pursued deals that the market greeted with skepticism. At the same time, R&D activities became less efficient and capital expenditures became less responsive to Tobin’s q, a sign of declining capital allocation efficiency. 

Taken together, the evidence paints a sobering picture. Firms did not adopt stronger internal governance to compensate for the weakening of shareholder rights. They did not shift toward stakeholder-friendly policies. Instead, insiders used their greater freedom to entrench themselves, extract higher pay, weaken reporting quality, and pursue inefficient investments. Both shareholders and stakeholders were worse off as a result.

The Nevada experiment therefore offers a clear lesson for the ongoing governance debate. It demonstrates that legal protections for shareholders matter deeply, even in a setting with strong capital markets and active institutional investors. Markets alone were not sufficient to discipline insiders once the law shifted. More strikingly, the reform did not deliver benefits to stakeholders even though it gave discretion to officers and directors to take decisions that would benefit them. Despite claims that relaxing shareholder primacy would empower firms to act in the interests of employees, communities, or the environment, Nevada firms’ environmental and social performance actually deteriorated.

In conclusion, weakening shareholder primacy without introducing credible accountability mechanisms carries real costs. The Nevada case shows that loosening the legal guardrails of shareholder oversight does not lead to more stakeholder-friendly governance. It leads instead to weaker accountability, poorer capital allocation, and lower firm value. For policymakers, the message is clear: if the goal is to broaden corporate purpose, it must be done in a way that strengthens, rather than undermines, mechanisms of accountability. Otherwise, reforms risk repeating the Nevada experience, where shareholder primacy was weakened and all parties, shareholders and stakeholders alike, were left worse off.

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Benjamin Bennett is an Assistant Professor of Finance, Neeley School of Business, Texas Christian University.
René M. Stulz is the Reese Chair in Banking and Monetary Economics, Fisher College of Business, The Ohio State University, NBER and an ECGI Fellow and Research Member.
Zexi Wang is an Associate Professor of Finance, Lancaster University Management School.

This blog is based on the paper What are the Costs of Weakening Shareholder Primacy? Evidence from a U.S. Quasi-Natural Experiment presented at The First Annual Corporate Governance Academic Forum at the University of Toronto. Visit the event page to explore more conference-related blogs. 

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