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The Business Lawyer

Summer 2022 | Volume 77, Issue 3

The Excessive Ambitions of Stakeholder Ideology

Richard A. Epstein


  • Under the traditional shareholder primacy doctrine, corporate decisions were to be made with a single objective: the maximization of shareholder welfare. Paradoxically, that self-regarding view did much to maximize social welfare, because the corporate directors and officers knew full well that they had to do business with suppliers, customers, employees, and the public at large to achieve that end. The recent environment-social governance model seeks to upend that model by seeking to make officers and directors answer to these many masters. That movement believes that shareholders want boards to take into account social values. Surely they do, but there is no agreement which values count and to what extent. The key advantage of the shareholder primacy model is it lets these divergent views be expressed at the shareholder level, so as to tamp down the negative effect on corporate performance in dealing with conflicts of interest on social issues.
The Excessive Ambitions of Stakeholder Ideology
iStock/Martin Lishanski

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Right now, corporate law is in the midst of a great struggle between the traditional shareholder primacy view and the modern view that sees shareholders as but one class of stakeholders to whom corporate boards owe duties. That movement is closely allied with the environmental-social-governance (ESG) movement insofar as both reject the view that today’s standard board practices are aligned with the regnant sociology. The point of departure goes back to 1919, where the defense of shareholder primacy received this cryptic statement: “A business corporation is organized and carried on primarily for the profit of the stockholders.” Some fifty years later, Milton Friedman defended that view in the New York Times Magazine: “[T]here is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits . . . .” In 1997, the Business Roundtable endorsed just that position: “[T]he paramount duty of management and of boards of directors is to the corporation’s stockholders; the interests of other stakeholders are relevant as a derivative of the duty to stockholders.” Friedman and the Business Roundtable echo Adam Smith’s famous observation about how the “invisible hand” of the market aligns private incentives with social welfare. Thus, Friedman’s talk of “social responsibility” and the Roundtable’s 1997 reference to derivative duties both deny any divergence between a corporate and social responsibility. If the corporation gets its ducks in order, the rest will follow.

Since 1997, the rise of progressive politics highlights different weaknesses with the dominant position. Leo Strine and co-authors understand how the shareholder primacy rule applies under current law. But, rather than tweak corporate doctrine, they make a strong progressive claim that “the need for a series of high-profile corporate bailouts, wage stagnation, rising inequality and economic insecurity, and the resulting political and social consequences have put pressure on the shareholder primacy concept.” A second line of attack seeks to work uneasily within the current system under the ESG rubric by taking the position that, in the long run, shareholder wealth is maximized by making strong interventions in environmental and labor issues that advocates think will, in the end, redound to shareholder benefits. I regard this position as highly unlikely for the simplest of reasons: Free-ride off other corporations that do the heavy lifting, and you can get the best of both worlds. The third variation of stakeholder dominance severs the already tenuous connection between ESG and shareholder primacy by favoring nonshareholders’ interests in at least some cases over shareholder interests, but never the reverse, i.e., shareholder interests over nonshareholder interests. In common discourse, these three strands are easily confused, and much of that confusion is reflected in the revised stance of the Business Roundtable, which, in August 2019, issued its new Statement on the Purpose of a Corporation:

America’s economic model, which is based on freedom, liberty and other enduring principles of our democracy, has raised standards of living for generations, while promoting competition, consumer choice and innovation. America’s businesses have been a critical engine to its success.

Yet we know that many Americans are struggling. Too often hard work is not rewarded, and not enough is being done for workers to adjust to the rapid pace of change in the economy. If companies fail to recognize that the success of our system is dependent on inclusive long-term growth, many will raise legitimate questions about the role of large employers in our society.

With these concerns in mind, Business Roundtable is modernizing its principles on the role of a corporation.

The Roundtable’s statement bundles free markets, inclusion, and stakeholder welfare into a single ball, as if there were no tension between the first of these objectives and the last two. Neither ESG nor stakeholderism attacks shareholder primacy in order to rectify some recent institutional market failure, like the stock market crash of 1929 or even the banking meltdown of 2008. Rather, the attacks rest on an uneasy amalgam of business and political malaise. Their common lack of intellectual focus helps explain why the shareholder primacy view cannot be dismissed so easily. Indeed, I see no reason to abandon the traditional shareholder primacy rule, which has been responsible for the accumulation of huge wealth in the United States, to the benefit not only of corporate shareholders but, derivatively, to the other constituencies with whom corporations interact—employees, suppliers, customers, and the larger social fabric. Of course, I do not think the proponents of ESG simply ask corporations to expand their worldview. Rather, they posit a new social orthodoxy that embraces doctrines and dogmas on these environmental and social issues, many of which I (and others) strongly oppose, not only in the context of corporate governance, but also in context of general legislation and regulation. It hardly follows that the rejection of the substantive agenda of either ESG or stakeholderism implicitly requires its acceptance as a matter of state or federal regulation, but that debate over the proper scope of government regulation is beyond the scope of this paper.

In Part I of my defense, I seek to isolate the similarities and differences between the traditional corporate rule of shareholder dominance from the alternative rule of stakeholder parity. In Part II, I then ask the simple question of what the duties of loyalty and care mean in the corporate context, and how those duties could apply to some broader class of stakeholders. In my view, the inevitable conflicts of interest among stakeholders in a given class and between stakeholders in different classes pose insuperable difficulties that are better handled by the traditional shareholder primacy model. Part III provides a brief conclusion.

I. Shareholder Primacy Versus Stakeholder Parity

To compare these two approaches, I shall begin with an accurate account of the shareholder primacy rule, as it applies both to the internal and external relationships of the corporation. In this regard, it is best to start with some of the rule’s key qualifications. Not every one of the thousands of decisions made by a corporate director or officer will, in fact, redound to the profit of the shareholders, even if intended to do so. At least in the absence of some conflict of interest, the business judgment rule normally shields board members and top executives from charges that they, in fact, undermined corporate welfare when things turn out badly. Ex ante, these key people face uncertainty, such that, if they were tagged with the losses associated with every mistake, they would have to be supplied with inordinate levels of compensation and insurance coverage to take their jobs in the first place. The markets for directors and officers would just dry up. Accordingly, the canonical business judgment rule holds that simple negligence is not sufficient to trigger liability, even if there is much disagreement over what forms of misconduct—more culpable than negligence, but less culpable than outright fraud—ought to fall outside the protections of the rule. It is also the case that these rules are not tied to the substantive outcomes in a particular case, but solely to the process whereby that result is reached. The choice of a standard of gross negligence, or reckless disregard for the welfare of others, is commonly selected to split the difference between ordinary negligence and outright fraud. But whatever the differences in these formulations, the duties they impose, except in rare cases, are not so onerous that it becomes impossible to insure against the risk of standard business error.

In addition, the business judgment rule also recognizes that the best way to benefit the corporation is to ensure that its trading partners benefit as well, including, when necessary, by increasing worker wages to secure their greater loyalty and commitment. Indeed, it is only Marxist-like critics who argue that worker exploitation is the best path to corporate profits. Often, the spur to higher productivity lies in higher wages and a close attention to matters of culture, morale, dignity, respect, and other “soft” aspects of the employer/employee relationship. In addition, charitable contributions often create good will for corporations, especially when shareholders are not in a position to make those donations themselves, as with the distribution of old computer equipment to schools. And last, it is well understood that conflicts of interest require special treatment, so that, in self-dealing situations, the heightened standard of care requires the corporation to receive fair value from the transaction, given the risk of looting the corporation.

As writers like Friedman well recognized, management’s obligations to shareholders do not cover the full range of corporate duties, which are independent of the fiduciary duties that officers and directors owe to shareholders, especially in their external relations with government and business parties. Ordinary individuals owe no fiduciary duties to anyone, but they still have to perform their contractual obligations and comply with tort and regulatory obligations, including rules dealing with pollution, to other parties. No one could ever defend against an action brought by the third party by showing that that tortious or criminal activity increases the shareholder rate of return—a reverse Robin Hood defense.

At this point, the classical model integrates all three elements into a single whole, and in so doing leaves open this important question: Into which contracts should the corporation enter? That inquiry is in fact guided by the efforts to maximize the welfare of the shareholders, subject, of course, to these external legal constraints. An ideal world may well have no minimum wage or maximum hour law, but no account of a fiduciary duty lets any corporation, or any individual, ignore these laws because they are inefficient. The same constraint applies to regulation. Any modern environmental regime that protects individuals not only from pollution, but from a loss of view has to be obeyed, no matter how inefficient the law. In effect, therefore, the web of external relations applies under both the older shareholder primacy view and the alternative ESG approach. Hence any proper comparison between these world views must be confined to situations where the two approaches differ, not those where the outcomes are the same.

Those differences, moreover, are both real and more ominous, given that the principles of ESG often require a sacrifice of shareholder value beyond what is required by regulatory or contractual commitments. That is, corporate boards should be prepared to sacrifice some shareholder profits in order to achieve some collateral social goal. This idea has been defended under the shareholder primacy view, and it works tolerably well whenever there is a substantial uniformity of views among shareholders, as with outright gifts to worthy charities where there is no expectation of receiving any direct or indirect benefit in exchange. But the true question is whether it is possible to modify the shareholder primacy model to embrace an alternative shareholder welfare model. One notable effort in that direction was advanced by Oliver Hart and Luigi Zingales, starting from the entirely defensible premise that shareholders are human beings whose preferences are not limited to paying the lowest price for any good or service. Such individuals pay more money to buy fair-trade coffee, electric cars, or free-range chicken. They then observe: “Consider the case of Walmart selling high-capacity magazines of the sort used in mass killings. If shareholders are concerned about mass killings, transferring profit to shareholders to spend on gun control might not be as efficient as banning the sales of high-capacity magazines in the first place.”

All these examples, however, suffer from a common defect. Many shareholders, perhaps a majority, care not a whit about fair-trade coffee, free-range chickens, or even gun control. Worse still, there are some shareholders who actively oppose these movements as creeping totalitarianism that creates an overpowering corporatist-type alliance between governments and large corporations. Thus, in line with John Lott’s controversial work, some individuals might favor the sale of high-capacity magazines in order to deter criminal conduct. The point here has nothing to do with the soundness of either these views or of those of ESG advocates. In this context, we have to take these shareholders’ preferences as given, because people who agree passionately that nonmarket values always count routinely disagree as to which nonmarket values count and why. The shareholder value argument goes through when these nonmarket values are uniform across shareholders, but it founders when they are not, at which point Friedman’s separability argument gains force. Endorse none of these nonmarket values and let people use their private funds to advance their goals independently of each other on gun control or fair-trade goods. And as our society gets more polarized, that separatist approach outperforms its rivals, even, or especially, once shareholder nonpecuniary interests are all considered.

At this point, an abiding and inescapable conflict arises, given the different nonmarket values that different shareholder groups include in their welfarist agenda. The traditional notion of a fiduciary duty steers clear of these conflicted situations, while the expanded ESG conception of fiduciary duty embraces involving either the environmental or social pieces of the doctrine. Hence, the weaknesses of the shareholder welfare model carries over to all ESG arguments involving such critical issues as the use of fossil fuels (bad), the rise of renewable energy sources, like wind and solar (good), the risks of global warming (horrible), the need for gender equality and racial justice in the workplace (overdue), the protection of indigenous people from exploitation (good), and a general receptivity to collective bargaining or other ways for workers to organize against management (all equally good).

These common proposals unwisely elide two different propositions into one. The first is that it is wise to expand the duties of a corporate board to cover a broad agenda beyond the narrow one of shareholders’ profits. The second is that the only way to achieve those ends is to adopt specific substantive proposals. Thus, the infirmities of the shareholder welfare model also doom the stakeholder model, given its skewed social commitments. Both the ESG and the stakeholder models block any claim that environmental improvement requires an increased reliance on natural gas, nuclear power, or clean coal. Similarly, on the social side, it is not permissible to adopt a colorblind policy on discrimination or to assume that the contract at will, which offers no external job security, provides the best way to deal with labor relations. All these propositions are consistent with shareholder primacy, but ESG and stakeholderism condemn them as embracing the wrong environmental or social objectives. By that one maneuver, ESG and stakeholder advocates impose their authoritarian lockstep view of the world that not only binds those companies that believe in these objectives, but ostracizes and condemns those that do not. These closely allied movements then become yet another cog in the “disinformation” machine or “cancel” culture.

The two steps in this one-two punch are not unrelated, because once any corporate board looks beyond the traditional rule, it is likely to support limitations on competitive markets that I, as one among many classical liberals, oppose. That market system is not pure anarchy, because a well-constructed, limited government discharges essential functions like public defense, the creation of infrastructure, the control of monopoly and, of course, the protection of private property and of freedom of contract.

To the defenders of the modern alternative views, these mundane propositions should not distract us from their more ambitious goals, which claim near natural law status. As is often the case, the impetus for this development comes from the United Nations, which has long taken positions that are directly antithetical to classical liberal positions on the dominance of competitive markets, as in its Universal Declaration of Human Rights. There, the UN begins with the correct proposition that all individuals are entitled to protection against “tyranny and oppression.” This is cashed out in Article 3, which says “everyone has the right to life, liberty and the security of person,” and which is followed faithfully by Articles 4 through 21, which work in the classical liberal vein. But with stunning rapidity, and zero conscious reflection, those critical negative rights are then joined with positive rights. Thus, Article 22 says that “[e]veryone, as a member of society, has the right to social security,” while Article 23 states that “[e]veryone . . . has the right to equal pay for equal work. . . . [and] the right to form and join trade unions for the protection of his interests.” Not really. They only have the right to insist on the best deal they can get before accepting an employment position. The Universal Declaration displays not the slightest awareness that the creation of these positive rights imposes correlative duties, which in sum necessarily limits the protected set of negative rights, including the right to be free from coercion announced in the previous Articles. In the end, the protection of the right to join unions becomes a clarion call for the right to create labor monopolies that will coerce employers and exclude nonunion members from jobs.

More recently, the UN has come forward with its equally dangerous Principles for Responsible Investment (PRI), which is quite intentionally designed to undo the shareholder primacy model. Like the Universal Declaration of Human Rights, the PRI’s strong claim for universality echoes the earlier (and much more defensible) version of this principle at common law. Indeed, in one sense, the movement is even more dramatic than that, as the UN position leaps two chasms with a single bound from the traditional view of shareholder primacy. The first, modest step adopts a more expansive view of fiduciary duty by holding it permissible for corporate boards to take into account these other interests in order to encourage sustainable growth through good times. The argument does not stop at half measures, though. The next step is to allow, indeed encourage, corporate boards, in a good, Keynesian sense, to engage in what Aneil Kovvali calls “Countercyclical Corporate Governance” by investing more robustly during economic downturns.

Yet why stop there? The second step mandates that corporate boards act in service of the higher order. Thus, one influential version of this thesis, the Freshfields Report commissioned by the UN to develop new standards for institutional investors, states:

In our view, decision-makers are required to have regard (at some level) to ESG considerations in every decision they make. This is because there is a body of credible evidence demonstrating that such considerations often have a role to play in the proper analysis of investment value. As such they cannot be ignored, because doing so may result in investments being given an inappropriate value.

The statement does not offer the evidence on which it relies, and the entire passage equivocates on the issue as to whether ESG investment is a prudential virtue that will help the firm or a moral virtue that has to be embraced, even if it hurts the firm. Nor does it specify the desired level of engagement. This muddy passage is immediately followed by the usual caveats that all factors need not be given the same weight by different parties and that different approaches can satisfy the basic mandate. But these caveats only suggest that enforcing the mandate raises nettlesome issues that cannot be solved at the abstract level alone.

Yet here, too, lingering ambiguities remain: How many firms will comply? How many firms will offer explanations? And, how many of those explanations will be accepted? The evidence on these points is always decidedly mixed, and recent scholarship by Lucian Bebchuk and Roberto Tallarita manages to walk down both sides of the street at the same time. For good and sufficient reasons, they reject the idea that ESG is illusory by noting the extensive role it plays in corporate deliberations. But then, in the next breath, they write in the Wall Street Journal that the companies that have professed adherence to ESG have largely gone through the motions. The first part of their case is correct because it stresses the advantage of a model in which there are clear lines of responsibility so that directors know with whom they have to deal, denying them the ability to defend against any claim by shareholders on the ground that it serves another stakeholder contingency. In some cases, directors deal with single individuals. In other cases, they deal with persons who, like themselves, are subject to clear fiduciary duties owed, for example, to other firms, voluntary associations, and labor unions. The simplest way to make the point is this: Should labor leaders and employers serve on a joint body with identical fiduciary duties, or should their roles be kept distinct? The latter is immensely preferable, so that neither workers nor shareholders can protest that this combined board favored the other group. It therefore comes as no surprise that, faced with the realities of day-to-day business, these same corporate leaders follow the traditional model, while relying on their counterparts to do the same. The point is true whether we deal with negotiations or with various forms of regulation, where again muddy lines of responsibility lead to subpar performances—in ways that become clear in the next section.

II. How Fiduciary Duties Work

Fiduciary duties first arose in Roman law, which, while addressing contractual obligations, distinguished clearly between those duties that were stricti iuris (strict in law) and those that were bona fide (good faith). The former is represented by the typical loan arrangement, where liability for performance is strict, subject only to limited exceptions. In contrast, good faith obligations are never so clearly delineated in any partnership arrangement, so that, in addition to the explicit terms (e.g., split of proceeds), each partner is under a good faith duty to take into account the interest of other partners to the same extent as he does his own. There is no strict enumeration of how that objective should be achieved in all cases, because partnership tasks are so fluid that setting out the basics does not give any unique and exhaustive obligation. But a good faith obligation test usually works as a guide for most well-run partnerships, and it will have real bite in extreme cases where one partner engages in activities that enrich himself at the expense of other partners, such as by diverting partnership receipts into his own pocket in violation of the partnership (or corporate) opportunity doctrine.

In early partnerships, these obligations were commonly reciprocal, but in modern public corporations and the like, the obligations all run in one direction, from the officers and directors of the corporation to the shareholders, who are both removed from the scene of action and without effective control over key business decisions. The notion of a fiduciary thus has to be expanded to allow for payments to the fiduciary—my financial advisors proudly call themselves fee-based fiduciaries—as a way of signaling how they minimize conflicts of interest. This separation between ownership and management has been a staple in the corporate literature since Berle and Means analyzed the modern corporate structure in 1932. But we now know that all agency relationships raise potential conflicts of interests, even in the best of circumstances, owing to the pervasive nature of the agency cost problem first identified by Meckling and Jensen in their famous 1976 paper, which then led to an unending discussion—what is the best mix of cash, shares, options, and perks that minimizes the conflicts in question?

Setting out “best practices” helps minimize the costs of these conflicts (plus the cost of their correction) by pointing to the business judgment and fair value rules set out above. But the stakeholder model creates avoidable conflicts of interest by rejecting, at the ground floor, the proposition that one person cannot serve two masters. One way to see this point is to note that the corporate structure is likely to be less complex for a large public corporation with billions in assets than for a small corporation with one-thousandth of that amount. Why? Because smaller businesses (many of which are owned within the family)—having no way to separate ownership from control either within or across generations—need more complex business structures.

That problem arises in two very different contexts. In the first is the closed, or family, corporation, where many but not all family members hold both shares and jobs in the same firm. They are of different ages, with different skills and different needs, but related by blood, marriage, or personal affection. The corporate form protects against huge external liability, but amongst the corporate family, unique deals have to be individually struck between firm members to balance between all business and altruistic motivations of the members. At the same time, the business has quite literally to be kept within the family, so safeguards typically prevent any family member unilaterally selling to an outsider during life or leaving shares to an outsider at death. Without such precautions, it would be easy to create the unhappy situation of trying to fit strangers into the tight relationships the firm depends on, which is why various types of buy-sell arrangements at death or divorce always result in cash payments to the departing individuals whose shares are kept within the family. By design, typically all shareholders cash out at the same time, when the business is sold as a unit to outsiders, after which the cash and other property received can be divided in accordance with some predetermined plan.

The second situation arises from the complex set of legal documents that are routinely used in venture capital financings of nascent businesses before going public. Here the complex corporate structures reflect the different priorities of, and the risks assumed by, the initial founders and the subsequent rounds of investors. No simple structure can accurately reflect the various priorities, with the result that different classes of preferred and common investors are needed to set the right risk allocations for different tiers of investors. This structure gives rise to difficult, but unavoidable, conflict-of-interest decisions, which in turn lead to a difficult hypothetical test that asks “‘whether the [common] shareholders would have been better or worse off ’ without the preferred financing.”

There is no comparable need for these complex structures in public corporations where millions of distinct shareholders have effectively no ties with each other, emotional or otherwise. Hence, in this context, the capital structure is kept simple for two reasons. First, the identity of shares makes it possible to do routinely what is rarely undertaken in private corporations. Individuals can sell shares in small lots at any time, without taking into account the interests of anyone else, because everyone else involved is a total stranger. Fungible shares facilitate exchange in a thick market with many potential buyers and sellers able to respond to changes in share value from any source. Even two tiers of stock can create real valuation complications if the worth of the common depends on the uncertain value of the preferred. Hence the preference for fixed-interest or fixed-dividend instruments for positions with higher priority.

Second, hand-in-hand with the alienability of shares comes the ability to satisfy strong fiduciary duties to a diffuse group of shareholders who have neither the ability nor the sufficient stake to monitor the corporation’s activities on a daily basis. The perfect fungibility of shares eases the conflicts of interest among shareholders, so that, as a first approximation, any activity that is beneficial for one is beneficial for the other. Adoption of the common nondiscrimination principle, calling for pro rata payments and charges, suggests that finding the best solution for one is tantamount to finding the best solution for all. As with all such devices, this one is not perfect, because individual shareholders may hold different amounts of shares in the corporation or have different holdings in other corporations, both of which situations could influence how shareholders wish the board and officers of any particular firm to vote on either the liquidation or sale of the business. But again, the best cannot be the enemy of the good. Some conflicts are unavoidable, which is hardly a reason to invite unnecessary conflicts by creating multiple classes of shares. Issuing a single class of stock improves the performance of the directors and officers. But, if so, what should be done with other interests? Here, Friedman and the 1997 Business Roundtable had it right. Shareholders have to protect themselves by negotiation, which they often do by hiring a fiduciary who owes them the sole duty of loyalty.

Regulatory systems often make it impossible to secure the identity of position among statutory beneficiaries. In labor negotiations under the National Labor Relations Act, the union is, under the duty of fair representation, to act in good faith for all the workers in its bargaining unit, leading to both easy and hard cases. Explicit discrimination on grounds of race, for which the duty of fair representation offers a necessary, if insufficient, safeguard, raises red flags against union leaders. But the fiduciary duties implicit in that doctrine clearly apply in principle to nonrace cases, as there are within the union context all sorts of profound conflicts between craft and line workers, between senior and junior workers, between workers in one plant and another plant. The conscientious union leader usually finds it hopeless to set the correct balance on matters including salary, fringes, seniority, grievances, dues, and so on for multiple subclasses of members. The conflicts become especially intense in a merger of two plant seniority lists, where workers in both plants are represented by the same union. The U.S. Supreme Court, in Humphrey v. Moore, said the union decision had to stand so long as “the union took its position honestly, in good faith and without hostility or arbitrary discrimination” of the sort found in Steele v. Louisville & Nashville R.R. Co.

These simple labor cases help explain just how rife conflicts of interest are whenever a trustee must represent divergent interests, which is what happens under the stakeholder model for a public corporation. Consider two scenarios. First, assume that boards are selected by the same methods used today but must deal fairly with the four classes of stakeholders commonly mentioned in the literature: employees, suppliers, customers and the community at large. Necessarily, the relevant conflicts in question arise not only between these groups, but also within each of them, even more acutely than under the shareholder welfare model. Employees are not a homogeneous group. They have different skills, ages, and allegiances; some may be union members and others not. Does the “social” in ESG require the firm to reject the interests of antiunion workers on matters relating to dues and representation, among other conflicts of interest that can emerge? Only if we posit some pro-union bias does the answer come out in the affirmative, ignoring the adverse impact that higher union wages have on suppliers and customers and the public at large. Setting priorities within this diverse group is doomed because no one has offered a clear metric to prioritize one group of employees over another.

The same exercise in futility arises with suppliers and customers. If a board refashions the corporation’s product line, do older suppliers get some preference? What if the board charges higher prices than, or produces inferior products compared to, a competitor? Do old customers get some preference over new ones? What if the board is late in paying the corporation’s bills? And just which local groups represent the community at large? So, the (necessarily toothless) rule in Humphrey v. Moore seems to dictate the same amorphous good faith rule, where all disappointed losers and unhappy winners have to be left unprotected.

Litigation, then, is a dead loser for stakeholder representation, but can administrative oversight check potential board excesses? That shift in forum makes sense if there are definite standards which are just too costly to enforce by private rights of action. For example, inspecting for harmful pollutants from tailpipes is superior to millions of tort actions by each pollution victim against each polluter—even with class actions. But it is a mistake to assume that an administrative agency has up its sleeve some magical substantive standards that no court is capable of articulating.

By way of example, the phrase “public interest, convenience, and necessity” hardly explains who should receive a radio frequency in any head-to-head litigation, so it also fails under the Communications Act of 1934, which created an administrative scheme to determine which licenses would better meet the criteria of “public interest, convenience, and necessity.” That determined New Dealer, Justice Felix Frankfurter, read the Act’s simple standard broadly: “[T]he Act does not restrict the Commission merely to supervision of the traffic. It puts upon the Commission the burden of determining the composition of that traffic.” The traffic officer sets the rules of the road, such that cars don’t crash and frequencies don’t interfere. But how does anyone determine the composition of the traffic? Frankfurter did not have a clue, and, over twenty years later, it turned out that the FCC, for all its expertise, did not have a clue either when it authorized public hearings to tackle the question. In 1965, the FCC identified seven malleable factors for determining the meaning of “public interest, convenience, and necessity”: diversification of control by media companies; full-time participation by station owners; proposed program service; past broadcast record; efficient use of frequency; character; and “other factors”—a meta-factor, as it were.

Two instructive points remain. First, the FCC’s list is as good as any agency can do. Second, it is not good enough. Using lists of factors invites principled disagreements on their relevance and relative weight, and to the correct coefficients for each factor in individual cases. Those two levels of irreducible indeterminacy necessarily lead courts to defer to either the firm or the regulator—no one can say which.

Yet another way to handle the morass is to sit representatives of different interest groups at the same big table, so as to counteract the dominance of the shareholder directors. One recent proposal comes from Senator Elizabeth Warren, whose misnamed Accountable Capitalism Act would require every new and existing corporation with $1 billion or more of annual revenue to obtain a federal charter under which it must allocate at least 40 percent of its board seats to nominees elected by employees. That program is nothing more than a disguised partial confiscation of the firm. How are those nominees to be identified? How are employee-elected directors to be compensated? Would they be bound by confidentiality agreements? Could they be dismissed for cause? How could the board conduct candid deliberations over labor relations if employee-elected directors also owe fiduciary duties to the employees? And why stop with employees, when other stakeholders demand seats on the board? The numbers of any of these groups could easily become unwieldy, as is captured in this wonderful cartoon by Barbara Kelley.

And this bad principle could generalize. Try having union boards include employee and public citizen members.

In defending her Accountable Capitalism Act, Senator Warren refers to the “successful approach” of the German system of mitbestimmung—commonly translated as codetermination—which, as a matter of law, requires large corporations to set aside board seats for employees. Note that mitbestimmung is never reached by simple voluntary agreement, which means that it has hidden inefficiencies. These are not apparent, given that the German union representatives do not sit on the operating board, which oversees day-to-day business operations, avoiding the most obvious conflict of interest. But major conflicts still remain, especially on matters of mergers, acquisitions, spinoffs, and other corporate reorganizations. Management often wants these mergers in order to rationalize production, which could easily lead to the loss of union positions. The union still has its fiduciary duties to its workers and thus is duty bound to resist the deal, unless job preservation is part of the deal, which often gives the union a de facto veto that can kill the deal. Hence the German system suffers from the same form of industrial rigidity as the American system does, when management is required to negotiate with unions about subcontracting out union positions to independent firms.

The troublesome implications of these coercive proposals have led to a more modest proposal that has gotten a great deal of traction: namely, the proposal recently adopted by Nasdaq after much debate. The Nasdaq position is easy to state, but hard to justify. Nasdaq requires that its listed companies:

  • Publicly disclose board-level diversity statistics using a standardized template, and
  • Have, or explain why they do not have, at least two diverse directors.

But why impose these restrictions? With ESG, the motivations cut in both directions. First, the requirement is for the good of the firm. Alternatively, it is good for society writ large even if not for the firm. But why do either of these things matter, given that it is difficult enough to appoint board members that function effectively when advising and informing management on how to proceed in business, and when monitoring, firing, or hiring a CEO? The sensible corporation will pick individuals with backgrounds in the requisite areas, coupled with experience in the arcane world of board politics. This approach might come from a select pool that slights outsiders who could add value to the board. But that risk is not only known to Nasdaq, it is known to every corporate director in the United States, which then leads to this instrumental question: Who has the right incentives and the needed information to make the best choices? Nasdaq operates at the 30,000-foot level when it insists that two diverse board members are better than one or none. But what Nasdaq sorely lacks is any knowledge of the particular needs of any given company with its own distinctive product market, regulatory, environmental, and employment requirements, competitors, and the like.

What the Nasdaq rules say, regardless, is that the two-diverse-members requirement is typically the preferred option unless proven otherwise. Nasdaq claims that empirical studies show the superiority of boards that operate in this diverse fashion. But that argument proves too much. If it were true, the Nasdaq order would be redundant. Corporations led by wise boards would follow those prescriptions, while corporations led by weak boards would perish. Second, it may well be that the same level of diversity is not desirable for different firms in different niches. It may well be the firms with diverse boards do better than firms without them. But it hardly follows that firms that don’t meet these standards have misread their markets. Both groups of firms could be correct. It is all too easy to imagine lots of situations where a firm is faced with the choice of appointing a nondiverse director who knows, for example, the technology market and a diverse director who does not. And it is still possible to game the system. Is it a proper form of diversity to add two more Korean board members to a board that is already Korean? In too many ways, Nasdaq’s basic requirement ignores that—as to diverse boards or otherwise—life is lived at the margin. And it will not do to say that a board can have the best of both worlds just by expanding membership. Board size is absolutely key, and so too is internal cohesion. In the end, the Nasdaq rule allows the least informed parties to constrain the choices of the more informed and better motivated.

The Nasdaq rules give corporations an ostensible out, which is to explain away the failure to diversify. But explanations open up another round of complexity on which the Nasdaq rules have little to say. The first question is: To whom this explanation must be made? And once that explanation is made: Who must pass on the validity of that explanation? Or is the only sanction social? Nasdaq has no special competence to review these applications, but would have to gear up in many highly specialized areas to get both timely and reliable decisions, which may or may not order that certain appointments be made against the will of the company. Yet who pays for these matters? Regarding sanctions imposed for violations, is there anything short of delisting? It may sound odd that an entire legal apparatus has to be developed—on the fly, it appears—to deal with this one question. And for what? Corporations already face enormous pressures on diversity without Nasdaq’s injunctions. Why intervene to make matters worse?

III. To What End?

But what of the three substantive agendas of ESG? At this point, it is unwise to tackle the substantive issues associated with global warming or the gender equity of labor unions. But those merits are not what is stake. Instead, the answer remains that a coercive agenda, if such there be, should come from legislators who can debate these various issues. Private firms can make their own individual adjustments under their own governance rules. Ideally, these changes are done through the terms of an original charter, so that the potential shareholders can decide for themselves whether to invest in a venture that offers lower returns for some welfarist end, whether through equity or debt instruments. The intensity of preferences can be measured, and individuals can sort themselves into different groups accordingly. In the end, there is no need to force novel institutional arrangements on the modern corporation. Instead, it is far better to rely on a mix of decentralized decisions in labor-and-other markets, as well as direct regulation to deal with tort measures. The result is likely a better expression of different views on the one side and a more nuanced response on the other side. Put otherwise, we have to be very leery about the G in ESG. Clearly all boards in all regimes have some norms: Do you or do you not want a staggered board or an independent chairman of the board? But the G takes on a different hue if it covers the issues involved with diversity and outreach, so much so that many of these issues fall into the S or G, both of which have to earn their way in political and market settings, where they should no longer be taken as self-evident truths. Stakeholderism, of course, faces just these problems, and its major tenets also have to earn their way in both political and market settings. The challenge for the future is whether they can make good on a promise to outperform that traditional shareholder primacy rule. My conviction is that they cannot, and therefore I predict that they will not.

This paper was prepared for the ESG Movement Conference organized by the Classical Liberal Institute at the New York University Law School under the direction of Professors Robert Miller and Seth Oranburg. My thanks to Matthew Rittman and Elle Rogers, the University of Chicago Law School Class of 2023, for their usual excellent research assistance, and to Robert Miller for his constant and unerring advice on all matters large and small.