Shareholders v Stakeholders

Shareholders v Stakeholders is in the news again, driven by the Business Roundtable. Someone asked Quora: Regarding corporate social responsibility, do you agree more with the shareholder view or the stakeholder view theory? Below is my response with a few edits, after some additional thought.

Shareholders v Stakeholders: BRT Statement

I presume you are asking this question in response to the Business Roundtable (BRT) and the 181 CEOs who endorsed their new Statement on the Purpose of the Company (the “Statement”), embracing the importance of companies’ commitment to key stakeholders. While the Statement is commendable, many of us are concerned that it may be simply distracting the public from lobbying and other activities aimed at reducing their own accountability. The Statement highlighted corporate responsibilities to five key stakeholder groups.

• “Delivering value to our customers.” Will we see an end to planned obsolescence and fast fashion?
• “Investing in our employees.” Will this include letting employees unionize, participate in share ownership through ESOPs, sit on the Board? Will CEOs reduce their pay ratio to worker pay from Disney’s 1400 to 1? Check your company. Will we see a return to the 40 to 1 ratio we had when America was at peak dominance? Perhaps the BRT is trying to head off Elizabeth Warren’s legislation requiring that 40% of corporate directors be elected by employees. “Investing in our employees” seems like milk toast in comparison.
• “Dealing fairly and ethically with our suppliers.” Have these companies committed to fair trade practices?
• “Supporting the communities in which we work.” Will signatory companies like Apple stop routing profits to other countries to avoid paying US taxes?
• “Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.” Will companies stop fighting shareholder proposals to make corporate expenditures for political contributions and lobbying transparent? Will they stop urging the SEC not to take up a rulemaking petition to require transparency by corporations? That petition has more than a million letters in support on file with the SEC.

In an ideal world, stakeholder theory and shareholder primacy are not in contradiction. Companies that promote the interests of key stakeholders, rather than boosting short-term shareholder returns, will be more successful over the long term. Companies that follow the spirit of the law, as well as the letter of the law, are also more likely to treat all their stakeholders ethically. In contrast, companies that cheat their employees are more likely to also cheat customers and shareholders. Of course, we do not live in an ideal world.

We hope the BRT Statement will stimulate dialogue between companies, key stakeholders and the broader public. BRT could demonstrate its good faith by reversing its positions in a number of areas, asking the SEC to reverse its current course of protecting CEOs at the expense of shareholders and the public. Like the Declaration of Independence’s “all men are created equal,” used by Fredrick Douglas to point to America’s hypocrisy, we can now point to the Statement in discussions with signatories.

BRT Statement: Cover for Efforts at SEC?

The mission of the SEC is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” Yet, their recent actions prompted by the BRT, US Chamber and National Association of Manufacturers result in a market unfriendly to the ability of investors to hold CEOs and companies accountable. See My Letter to Business Roundtable on Shareholder Resolutions – Corporate Governance.

• Raising Proxy Proposal Submission Thresholds. Organizations like the Business Roundtable have requested the SEC to substantially raise the thresholds for submitting and resubmitting shareholder proposals. In a June 3 letter to the SEC, the BRT stated: “[F]rom 2016 to 2018, the same three individuals and their families submitted or co-filed over 24 percent of all shareholder proposals each year at Russell 3000 companies.” “Unsurprisingly, these types of proposals have limited success and seldom receive the majority support of shareholders if they are not first excluded from a company’s proxy statement via the SEC’s no-action process.”

As noted in McRitchie 2019 Proxy Season Win for Market Beta, I am one of the three individuals criticized for submitting proposals that have limited success. However, my proposals averaged majority support by shares voted. I do not believe it is a concidence these attacks on shareholder rights and the BRT’s Statement are coming at the same time shareholders are winning more and more votes, especially proposals of interest to a wider group of stakeholders. For example, see Proxy Process Opens Door to Constructive Engagement on Climate, and the graph by Jackie Cook below.

• SEC Clarifies Investment Advisers’ Proxy Voting Responsibilities and Application of Proxy Rules to Voting Advice. This “clarification” appears to make assumptions of preferred behavior, and so borders on underground regulations, since the public had no opportunity to weigh in. Will the SEC attempt to enforce uncodified assumptions? See Investment Advisers SEC Clarification: Allison Lee.

Paul Hodgson highlights problematic provisions: “Solicitations that are exempt from the federal proxy rules’ filing requirements remain subject to Exchange Act Rule 14a-9, which prohibits any solicitation from containing any statement which… is false or misleading with respect to any material fact.” The guidance reconfirms that “the furnishing of proxy voting advice does constitute a ‘solicitation.’” “Providing advice that is “false or misleading” would lead to a violation of the exempt solicitation rule, the rule that allows proxy advisors to do their job.” Proxy advisors must analyze thousands of complex proxies over a very short time span. Some errors are unavoidable. Proxy advisers have been recommending more frequently against CEO pay packages. See The 100 Most Overpaid CEOs 2019 — As You Sow. That, and BRT lobbying, may account for the timing and substance of the SEC “clarification.”

• Announcement Regarding Rule 14a-8 No-Action Requests. Oral, rather than written, decisions may make it difficult for both sides to understand the SEC’s rationale and will end transparent written records, creating more of an incentive to go to court – a much more expensive process.

Key points: “Starting with the 2019-2020 shareholder proposal season, however, the staff may respond orally instead of in writing to some no-action requests.” “And, as has always been the case, the parties may seek formal, binding adjudication on the merits of the issue in court.”

As noted by Nell Minow, “Needless to say, since the Code of Hammurabi in ancient Mesopotamia, the idea has been that it is a good thing to have the rules in writing so that everyone knows what they are and they will be consistent. We consider this a poor decision with ominous implications.” (SEC to Give Oral No-Action Letters)

See also Corp Fin changes approach to responding to no-action requests to exclude shareholder proposals.

Shareholders v Stakeholders: False Choices

Brian Kropp found that “whether people felt their compensation was fair was 25 times better at predicting their engagement at work than their actual salary.” Fairness, he says, requires a transparent process. (The Fairness Factor) Studies have shown that open-book management pays. Yet, few companies have adopted such practices.

Alternative theories of corporate governance, such as stakeholder theory, are frequently based on the notion that corporations ought to be accountable to more than just shareholders. Everyone who has a stake in a corporation’s success or is impacted by a corporation’s operations should have some say in how it is governed. Those subscribing to stakeholder theory often favor government intervention to require representatives from the community, employees or others on the board, federal chartering and other mechanisms designed to spread accountability to a broader-based authority. The BRT’s Statement provides no such call.

If companies are accountable to multiple stakeholders, they can all too easily end up being accountable to no one. The board and CEO can play one group off against another. See Stakeholder Theory: Impact and Prospects for a history of that perspective and Review: The Corporate Objective for my thoughts on a more innovative attempt to move forward within that framework. Few BRT signatories are calling for stronger unions or a stronger regulatory framework to hold companies more accountable to all stakeholders.

Employees and investors present an interesting comparison. Employees typically invest a great deal where they work. Margaret Blair documents growth of the knowledge economy and builds on the concept of “firm specific human capital.” Employees develop knowledge and skills, much of which is specific to their individual firm’s operations. In addition, employees often have 401(k) or other investment plans that are over-weighted in their employer’s stock. In contrast, most shareholders have a relatively small proportion of their investments in any one company because they recognize the reduced risk of a balanced portfolio.

Despite noble protests from Lynn Stout (Review: The Shareholder Value Myth and 2013 Millstein Forum: Beyond Shareholder Primacy), the fiduciary duty of directors is widely recognized. They are to maximize the wealth that can be extracted from the corporation by shareholders, typically in the form of dividends, buy-backs or increased share value. Fundamental to standard operating procedures is the idea of minimizing expenses such as wages and income to employees.

Even though employees have a greater stake in the corporation’s success, they have no formal say as employees in corporate governance — no vote for the board of directors. Far from being treated as corporate citizens, they are subjects. In today’s corporate governance paradigm, you either own property or you essentially are property. I would love to see that change but the BRT is not driving such change.

Most companies provide named executive officers (NEOs) with restricted stock and/or options. Hopefully, NEOs are contributing substantial firm specific human capital. However, most employees further down the chain of command also contribute firm specific human capital. If they do not, maybe they should be fired. Research finds companies with employee ownership plans, especially coupled with meaningful opportunities for participation in decision-making, add considerable value. (Research on Employee Ownership, Corporate Performance, and Employee Compensation)

Turn Stakeholders into Shareholders

One way to rebuild the ship of capitalism without wholesale refurbishing, would be to expand employee ownership programs. Consider allowing employees to directly elect board representation through mechanisms such as preferred or dual class shares entitled to vote on specified board seats. North Dakota has a Legacy Fund, which potentially gives it a voice in corporate governance. Other states and communities should explore investment opportunities. Shareholders v stakeholders does not need to be a dividing line if stakeholders are also shareholders.

By limiting shareholder liability, corporations have been the greatest engine of wealth generation ever devised. However, success has also led to a growing crisis and a growing frustration that neither business nor government is adequately addressing societal needs.

While a few have profited greatly from the technological boom, many have been thrown out of work or out of the middle-class. Frustrated, we turn to leaders, both in business and government, who promise to think for us, offering short-term perspectives that in the long run often make our situation worse. My fear is that BRT’s Statement is in this vein. Those in power have financial and other incentives to support the status quo and keep us distracted.

Board- and shareholder-centric models of corporate governance are substantially less democratic than cooperatives, whose principles embrace democratic control on the basis of one vote per person, continuing education, etc. However, corporations do have elections, which are sometimes meaningful and at least have the trappings of democracy.

We have recently witnessed a number of companies moving to democratic-free zones, where founders and initial shareholders hold ruling class shares, while peasant class shares are sold to the larger public with rights that turn voting into a meaningless gesture. See Dual-Class Shares.

Given the magnitude of climate change, wealth inequality, terrorism and the like, it is time to experiment with new forms of corporate governance, which empower all those willing to invest not just money but human capital into creating new corporate governance paradigms. The contribution to productivity stemming from human ideas and intellectual property has outstripped the contribution of money investment for decades. The legal basis for corporate control should recognize such realities. We should refocus corporate governance to help empower average citizens through life-long learning, independent thinking and collaborative work. Combining the best elements of publicly traded companies and cooperatives could help move our world from what is, to what ought to be.

As long as 84% of corporate stock is owned and controlled by 10% of Americans, corporations will not be trusted. As noted by the president and CEO of the U.S. Chamber of Commerce,“Despite overall economic gains nationwide, “many Americans have lost faith in core institutions—public and private alike. They don’t believe that government or business understand the challenges they face, or are willing or able to address them.”

A one percentage point increase in the Gini index for income inequality leads to a fall of two percentage points in the share of individuals who believe that ‘most people can be trusted. [Inequality and Prosperity in the Industrialized World: Addressing a Growing Challenge]

For capitalism to be compatible with democracy, we need most American families to participate in share ownership. That should be part of the mission of every corporate director, as well as the SEC in order to maintain legitimacy.

After World War II, the New York Stock Exchange developed a marketing campaign, Own Your Share of American Business (OYS), to rebuff communism, restore profitability to retail brokerage firms, and persuade Americans to lower capital gains taxes. OYS was never aimed at shifting power from the few to the many. Participation in corporate governance was not an objective. Giving small retail shareholders a “sense” of participating in capitalism was enough.

Imagine, instead, if most Americans had a substantive stake, as well as a meaningful voice in corporate governance. Imagine if investing in shares was promoted as a way to participate in financial returns and in voting on what future we want to live in based on each company’s “social purpose,” as Larry Fink of BlackRock has called it.

Creating a nation of small shareholders involved in corporate governance would be transformative. We will never get there by stripping small shareholders of their rights as recommends by the BRT, despite their recent Statement. That path is The Road to Serfdom. Shareholders v stakeholders would become a false dichotomy in a world of broader share ownership.