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The second seminar of the ECGI Spotlight Series presented a paper by Prof. Ed Rock (NYU School of Law and ECGI), “For Whom is the Corporation Managed in 2020?: The Debate over Corporate Purpose”. Following a brief introduction by the event co-hosts, Prof. Amir Licht (Interdisciplinary Center Herzliya and ECGI) and Tom Vos (KU Leuven), Prof. Rock presented his paper. He emphasised the importance recently attached to the debate over corporate purpose, referring to Larry Fink’s letter to CEOs on “a sense of purpose”, the statement by the Business Roundtable on the purpose of the corporation, Martin Lipton’s work on “the new paradigm”, Colin Mayer’s book “Prosperity”, and EY’s report for the European Commission on directors’ duties and sustainable corporate governance.

Prof. Rock’s goal with the paper was to clarify what the debate over corporate purpose is about, and to show that there are four different but intersecting debates. First, the legal debate is about what the law permits or requires, and about the best description of the corporate form as an enterprise form, as compared to other forms (such as an LLC, a benefit corporation, a general partnership or a limited partnership). The second debate is the finance debate, about how to think about the corporate form, both theoretically and empirically. The third debate is the management debate, which is about how to build successful companies. Finally, the political debate concerns the social roles and obligations of large business entities, and whether corporations can substitute for political decision-making. According to Prof. Rock, the problem with the debate over corporate purpose is that participants do not always make clear in which debate they are participating.

Prof. Rock then offered his preliminary answers to the four debates. Concerning the legal debate, he argued that in the US, “enlightened shareholder primacy” is an accurate description of the default settings of the corporate form, but that parties can alter these default settings. The restatement on corporate governance reflects the traditional view and is a more or less accurate description of the corporate form through history: directors have large flexibility to take into account the interests of other stakeholders, as long as there is a rational connection to shareholder benefits. The shareholder primacy norm mainly matters in boundary cases, such as conflicts between groups of investors, a sale of the company or in case of wholly-owned subsidiaries. He also noted, however, that this is only a US perspective and that in Germany and other countries, on the other hand, the shareholder primacy norm would not be an accurate description of the default governance system.

In the finance debate, shareholder primacy is generally accepted as an accurate description of what firms in the United States and the United Kingdom actually do. The statement by the Business Roundtable probably will not change this, according to Prof. Rock, but a change in the law might.

In the management debate, shareholder primacy is viewed as a terrible strategy, because the task of management is to get everyone to work together and build a great company, and focusing only on shareholders is unlikely to do that. There is an exception to this, according to Prof. Rock, when shareholder primacy is exactly what is needed from a management perspective, such as in private equity turnarounds. Prof. Rock argues that the statement by the Business Roundtable probably will not change how managers manage the firm, because they already do not manage the firm exclusively for the benefit of shareholders. There may be a problem with how business schools teach their students that they should maximise shareholder value at every point in time, but the law does not require managers to do that. In addition, Prof. Rock distinguishes between the business purpose, a management concept that exists in any enterprise, and the corporate objective, which is what a corporation is required to do under the law. He notes that the concept of “corporate purpose” is often used in an ambiguous way, without clearly distinguishing between these two possible meanings. He also questions whether it makes sense to entrench a business purpose in a corporation’s constitutive documents.

Finally, in the politics debate, it is clear that corporations have social responsibilities, according to Prof. Rock. What is unclear, however, is what the effect will be of moving away from shareholder primacy towards a more explicit concern for other stakeholders: it may be a winning strategy, in the sense that it may forestall intrusive mandatory regulation, or it may be a losing strategy, paving the way for such intrusive regulation.

Prof. Rock discusses how some have argued that we should change the traditional answer to the “law question” in order to change how the firm operates (“management question”), increase firms’ legitimacy (“politics question”) and avoid intrusive mandatory regulation. However, he questions whether a change in the law would indeed have such an effect, and whether not changing the law would really lead to more intrusive regulation. He also noted that the harm done by such a change in the law should be taken into account.

Prof. Rock concluded that corporate law does a few things very well: it creates a menu of enterprise forms, from which business people can choose; and the legal rule of shareholder primacy creates an accountability structure that can control agency costs. According to Prof. Rock, the danger is that if you ask corporate law to do too much, i.e. to create political legitimacy for capitalism, it may not end up doing anything at all.

In his comment on the paper, Leo Strine (former Chief Justice of the Delaware Supreme Court, Columbia Law School, Yale Law School, University of Pennsylvania, and Wachtell) stated that he agreed with Prof. Rock’s conclusion that shareholder primacy is an accurate description of the law in Delaware. However, Mr. Strine argued that the paper does not sufficiently cover the problem of gain-sharing between shareholders and workers. He cited a paper by Lawrence Summers and Anna Stansbury, which finds that the increasing inequality in the US can be traced back to a decrease in worker power and an increase in shareholder power. A second problem with increased shareholder power, according to Mr. Strine, is that businesses have been able to influence the political system with donations, undermining the regulatory protections of workers and the environment. Finally, he disagreed with scholars such as Lucian Bebchuk, who argue against stakeholder capitalism. He pointed to the fact that many countries, including in Europe, currently have some form of stakeholder capitalism, with stronger unions and works councils. According to Mr. Strine, this has led to a smaller decline in gain-sharing in those countries. He concludes that part of the solution could be to move towards a model that is only moderately driven by stockholder interests, such as the benefit corporation: this system would at least force directors to think and care about the interests of stakeholders, and put a brake on too much shareholder power.

Next, Prof. Herman Daems (Chair of the board of BNP Paribas Fortis) commented on the paper, coming from the perspective of a finance and business scholar, with extensive experience in chairing corporate boards. He agreed with Prof. Rock that corporate governance cannot be a substitute for failures by governments in public policy regarding inequality and climate change. This does not mean that corporations have no responsibilities. According to Prof. Daems, they should act as responsible citizens and add value to the communities in which they operate. He argued that corporations should develop a purpose, in order to attract and retain employees, customers and investors, all of whom have become more critical with regards to the purpose of the corporation. However, Prof. Daems argued that legal changes to the corporate form are not necessary, as there is sufficient room for the board to develop a purpose for the corporation within the existing legal framework and the current financial markets. He argues that in Europe, many firms (but not all) are already pursuing a purpose-driven strategy, not for green-washing reasons, but because they are pushed to do so by shareholders and society.

Afterwards, Prof. Renee Adams (University of Oxford and ECGI) offered her comments, mainly with regards to the finance debate. Her single point of criticism was that Prof. Rock had not been critical enough of the motivations of the participants in the debate. Economists are trained to discuss policy recommendations only after an extensive analysis of the evidence, which Prof. Adams currently considers insufficient. For example, before recommending that directors should change for whom they are managing the corporation, we should first understand for whom they are currently managing it. However, almost by construction, finance scholarship does not investigate this. According to Prof. Adams, finance journals are exclusively focused on publishing papers that use firm value (i.e. shareholder value) as the dependent variable, to the exclusion of stakeholder outcomes. In joint work with Amir Licht and Lilach Sagiv, Prof. Adams has investigated on whose side directors are when there are conflicts between shareholders and stakeholders. The results are consistent with the leeway that directors are given by corporate law, as Prof. Rock has described: directors seem to balance the interests of shareholders and stakeholders in a way that depends on their personal values. These results challenge the idea that directors currently do not take stakeholder interests into account, and that changing corporate law would have an impact on this. Prof. Adams argued that evidence like this should be incorporated into the finance debate over corporate purpose, to avoid the danger of generalising from anecdotal cases where firms sacrifice stakeholders in favour of shareholders (or vice versa).

Prof. Guido Ferrarini (University of Genoa and ECGI) agreed with much of Prof. Rock’s paper and offered some reflections from a European perspective. He noted that Germany, for example, which was described by Prof. Rock as taking a stakeholder approach, in practice has increasingly followed a shareholder primacy approach, especially for listed companies. He also noted that other countries, including Italy, follow a shareholder primacy approach that is similar to the one in Delaware. On the other hand, corporate governance codes in Europe tend to emphasise the need to take into account a long-term perspective and ESG factors are increasingly emphasised in definitions of the corporate purpose. Prof. Ferrarini gave the example of the Loi Pacte in France, which amended the definition of the corporate purpose to include sustainability considerations. Finally, he agreed with Prof. Rock that stakeholders are mainly protected by contract and regulation, while corporate law is oriented to the protection of firm value. On the other hand, he emphasised that sustainability considerations have a clear impact on the way corporations are managed. Stakeholders are currently taken care of by corporations, not only because this is instrumental to long-term shareholder value, but also because of ethical constraints imposed by reputational concerns, pressure by investors and consumers, and the personal conviction of management. Prof. Ferrarini concluded that firms currently behave morally under incentives created by the market.

Finally, in his comments, Prof. Steven Davidoff Solomon (University of California, Berkeley School of Law and ECGI) gave the example of the IPO of Vital Farms, a Delaware public benefit corporation, which stated that its purpose was to bring joy to their customers though their products and services, as well as to bring ethically produced food to the table. Prof. Solomon argued (based on a joint paper with Jill Fisch) that this illustrates how the corporate purpose has very little to do with the law, because the purpose is so broad that it is unenforceable. He agreed with Prof. Rock and Mr. Strine’s argument that corporate law is structural, since shareholders run the corporation in the end. Prof. Solomon argued that if we want to change how corporations are run, the fundamental structure of the corporation needs to be changed, which is not yet the case with the public benefit corporation. Prof. Solomon concluded by identifying two key issues in the debate: first, the allocation of profits between shareholders and other constituencies, such as workers; and second, the problem of green-washing and using the corporate purpose as a diversion tactic.

Prof. Amir Licht then summarised some of the questions from the audience, essentially asking what would be wrong with more regulation of the corporate purpose. Prof. Rock responded to this question and to the panelists’ comments. Prof. Rock first classified the non-shareholder interests in mainly two groups, the interests of workers and interests related to climate change and sustainability. With regards to workers, he raised the question whether including workers in corporate governance is to be preferred over alternatives, such as increasing the minimum wage or reviving the collective bargaining systems. Prof. Rock would not be enthused about changes to corporate governance to favour workers, because at the end of the day, it is the institutional investors and the hedge funds who elect the directors. Given the importance of human capital, it may be advisable to have a board committee that is focused on it, but according to Prof. Rock, that is not going to give employees a greater share of the surplus.

With regards to climate change, Prof. Rock notes that he and Prof. Daems are aligned that it is mainly a public policy issue, and that having the legislator set a social cost of carbon and enforcing that, is far more effective than having boards taking sustainability into account. The question is how to get there. It may be that making climate change a board issue is a good step towards a political solution to the problem, given who sits on boards. There may be a synergy between the corporate governance initiative and the political initiative.

Prof. Rock agrees with Prof. Adam’s point that finance scholarship is too focused on firm value, and too fixed on the idea that firm value is measured via share price. There is some empirical evidence that a focus on the business purpose increases corporate performance, such as the paper by Claudine Gartenberg, Andrea and George Serafeim. What is interesting about this paper is that the driver seems to be middle management having a clear statement from senior management as to what the purpose is of the corporation. If this is true, then the traditional model of corporate governance, with the board pursuing long-term shareholder value, is completely consistent with this finding. According to Prof. Rock, that evidence is not an argument for putting business purpose anywhere else than where it already is.

Finally, Prof. Rock responded to the question of why the regulation of corporate governance would not be the answer. Part of the reason is that Americans do not like regulation, and part of it is that regulation is a crude tool to change corporate behaviour. This is similar to the idea of Martin Lipton, who argues that his “new paradigm” is needed to prevent mandatory regulation, which is going to be bad for investors and for firms, and that it is better to give more discretion to the board of directors on how to manage the firm. Many people do not agree with that, but that is the strongest argument against mandatory regulation of corporate governance. If, on the other hand, you would decide mandatory regulation is the best approach, the question is what it would look like. According to Prof. Rock, the legislation that has been proposed, for example by Elizabeth Warren and by Bernie Sanders, would do much more harm than good.

The full video of the seminar (60 minutes) is availabe on the ECGI website and YouTube channel.

Prof. Rock's paper is available here.

More information about the ECGI Spotlight Series is available here.

Subscribe here to follow announcements in the series.

ECGI is co-organising, with IESE Business School, an online event "Can Purpose Deliver Better Corporate Governance?" on 28-30 October 2020. Registration is open to all. 


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