General Practice, Solo & Small Firm DivisionMagazine
Business and Commercial Law
It all comes down to money
Face it: A board’s main goal is corporate profits
By A.A. Sommer, Jr.
Do boards of directors have a greater purpose than simply the pursuit of profit? Ever since the invention of the modern corporation, there has been controversy concerning its purpose and responsibilities. As corporations grew in size and influence, and it became apparent they could wield significant economic power, social reformers began to insist that this power should be marshaled for the common good. These demands were particularly strong during times of economic distress. Thus, during the depression of the ‘30s the debate was vigorous. Its intellectual manifestation was most clearly seen in the opposing viewpoints that the corporation had a purpose that transcended simply making money for shareholders, and the opposite point of view that it did not.
The battle was renewed during the ‘80s because of the onset of the hostile tender offer. The traditional view that the directors had a fiduciary responsibility that ran solely to shareholders seemed to many to require directors to reach for the highest offer for the company regardless of other considerations, such as effect on employees and communities. To remove the strait jacket in which they found themselves, corporations prevailed on state legislatures to adopt legislation permitting directors to take into account in their decision making constituencies and considerations beyond the shareholders. They could, for instance, consider the interests of employees, suppliers, customers, communities, long-term interests of shareholders as well as short-term interests, the interests of the state and so on. Some have expressed concern as to whether the privilege accorded by the statutes to take into account other interests transcends the fiduciary obligation of directors to shareholders except for the few states that made sure that action favoring constituencies other than shareholders would be upheld. Many contended that the directors had an obligation to the "corporation," which they interpreted to mean that the directors could, even without special legislation, consider the variety of interests connoted by that term.
During the time that the debate was continuing with regard to "other constituencies" statutes, the American Law Institute was considering the principles of corporate governance. In Section 2.01 of the final product of the project, Principles of Corporate Governance: Analysis and Recommendations, it stated that, with certain limited exceptions for ethical and eleemosynary considerations, ". . . a corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain." The Principles provide that in any action to forestall an unsolicited tender offer, the directors may "take into account all factors relevant to the best interests of the corporation and shareholders [and] may . . . have regard for interests or groups (other than shareholders) with respect to which the corporation has a legitimate concern if to do so would not significantly disfavor the long-term interests of shareholders."
The fact of the matter is that courts, lawyers, executives and directors do put the interests of shareholders first in their thinking. This has been seen in recent years in which directors, often acting in response to shareholder rebellion, have ousted management. It is not customers or suppliers or communities or even employees who insisted on the dismissal of executives, but rather directors dissatisfied with the performance of management on behalf of the shareholders. Increasingly, with more and more Americans dependent on equities for their retirement, shareholder value and corporate performance mean more to more Americans.
One of the difficulties of suggesting that directors should consider a variety of interests is the problem of monitoring and evaluating director and executive performance. What may appear as poor performance from the standpoint of shareholders may be applauded by the community or suppliers or employees. The simplest measure, and the one that economic America is most accustomed to dealing with, is simply, "How well has the corporation served investors?" It is this by which the professional analysts, investors, the sources of capital and ordinary shareholders judge the performance of the corporation and determine whether its shares are an appropriate investment.
The primacy of shareholder value is no longer a unique American phenomenon. Increasingly, foreign companies are shifting their focus from the concept of corporations as "social entities" and seeing them more as "profit-making entities" that must gain investor confidence; otherwise they will lag in the struggle for capital essential to survival in today’s economic world.
No one can read with equanimity about massive layoffs with all of the human suffering that entails–reductions in standards of living, economic hardship, family dislocations and a whole range of other undesirable consequences. One cannot be indifferent to the fate of communities that have come to rely over the years on a corporate presence. However, this has been the history of capitalism–what has been described as the "creative destruction of capitalism." Out of the destructive dimension of capitalism has come creativity that carried society to new levels of well being. The industrial revolution is a good example. History records that this resulted in huge dislocations and a virtual revolution in the structure of society as countries industrialized. Many of the enterprises engaged in the old ways of production undoubtedly failed with sizable financial losses to their owners. Their employees and their crafts were made obsolete and had to seek other, usually less fulfilling and less remunerative employment, but the new order brought immeasurable wealth and prosperity to their progeny and to society as a whole.
Often the rewards of this "creative destruction" are unevenly distributed, with those in the vanguard of change reaping what appears to many to be excessive benefits. Witness the compensation levels and the wealth generated for the owners and managers of computer-related enterprises as we make the transition from an industrial economy into an information-oriented economy.
No one can doubt that the emphasis by American management on shareholder value–driven by foreign competition, the threat of takeovers, shareholder pressure and activist boards–has been the key ingredient of the continued phenomenal success of American industry in this decade. Enterprises that lagged in their return to shareholders soon found themselves under awesome pressure to improve performance, and if they failed, they were often absorbed by other enterprises or fell by the wayside.
In the final analysis, managements are not indifferent to other constituencies. Their commitment to shareholder value demands that they be sensitive to their workforce, its training, its quality, its morale, and to the relationships with customers and suppliers, and with the community. A deficiency in the relationship with any of these can adversely affect return on capital. So the question is not whether management and directors should favor other constituencies over shareholders, but how well they can use those relationships to advance the interests of shareholders.
A.A. Sommer, Jr., is counsel at Morgan, Lewis & Bockius in Washington, D.C.
- This article is an abridged and edited version of one that originally appeared on page 36 in Business Law Today, January/February 1999 (8:3).