Autor: Richard S. Horvath y Paul Hastings
The debate regarding the adoption of sustainable governance principles has reached a crescendo. This debate started with whether corporate boards should factor Environmental, Social, and Governance (“ESG”) and similar sustainability concerns into their decision-making process. That debate is fairly settled. Boards should. The debate has since shifted to whether the dominant shareholder primacy model embraced by Delaware should be replaced by a stakeholder governance model as a proxy for ESG initiatives.
Under existing Delaware law, a board of directors can—and many times should—consider ESG factors in their efforts to prioritize shareholder value. That a board of directors is protected in approving ESG initiatives with the potential to promote shareholder value, however, is not enough. The board also needs investor support. If desiring to adopt ESG initiatives, a board could develop meaningful relationships with the company’s long-term shareholders—including permanent investors such as mutual funds and ETFs. Indeed, many of these long-term shareholders are increasingly issuing ESG policy statements and committing to long-term stewardship principles. There is thus a growing overlap between long-term shareholders on one hand and stakeholders more broadly on the other to create sustainable value. And that value creation squarely fits within the current shareholder primacy model. No change to a stakeholder governance model is needed.
Directors Can Embrace Long-Term Value Creation
A meaningful discussion about sustainable governance should begin with basic tenets of Delaware law, the guiding force for corporate law in the United States. A fundamental precept of Delaware law is that the board of directors—and no one else—is tasked with managing the business and affairs of a corporation. In that role, directors have broad discretion to exercise their business judgment and are presumed to act in the corporation’s best interests.
Directors’ broad discretion is not without limit. It is equally well-settled that directors must “promote the value of the corporation for the benefit of its stockholders”. Directors also often approve stakeholder initiatives, such as employee wage increases and community outreach. It is appropriate for directors to consider these stakeholder initiatives “that do not maximize corporate profits currently” so long as “such activities are rationalized as producing greater profits over the long- term.” Under Delaware law, a tie between corporate returns and stakeholder interests thus goes to the shareholders. This stands in contrast to stakeholder governance, adopted by approximately 34 states, under which directors decide who wins the tie between shareholders and stakeholders.
Does shareholder primacy require directors to place short-term profits above long-term value? No. While an argument can be made that directors should focus on the long-term, Delaware law is agnostic. “The fiduciary duty to manage a corporate enterprise includes the selection of a time frame for achievement of corporate goals…”. With narrow exceptions, directors can exercise their business judgment in evaluating long-term initiatives.
Delaware’s shareholder primacy framework accordingly grants directors broad discretion to consider stakeholder interests in furthering the long-term value of an organization for its shareholders. Notwithstanding its name, the shareholder primacy model is broad enough in application to permit directors the discretion to embrace sustainable ESG goals.
Directors Can Embrace ESG Initiatives that Create Value
In the ESG debate, there is little concern with pursuing ESG initiatives likely to earn a return in the near- and long-term. That is simply sound business judgment. Can directors adopt ESG initiatives without meaningfully creating value under any scenario? That is unlikely. While stakeholder governance may favor certain valueless initiatives, the expenditure of corporate funds without hope of any return or corporate benefit could raise concerns about corporate waste.
That leaves a third-question. Can directors adopt ESG initiatives that have short-term costs with only a potential for long-term return? Yes. Most importantly, and seemingly absent from the debate, is that many ESG decisions with a short-term cost have the potential for long-term returns. ESG initiatives can future-proof long-term cash flows, reduce regulatory risk, and open up new opportunities in the future. Borrowing from corporate finance theory, such long-term ESG initiatives could reduce the discount rate and improve the terminal value and future cash flows of the organization thereby creating shareholder value. It is this very type of decision focused on the distant horizon that directors have the discretion to make under the current shareholder primacy model.
Developing Investor Support for Sustainable Governance
Some argue that without a shift from a shareholder primacy model to stakeholder governance, directors will be unable to adopt sustainable ESG initiatives. It is argued that markets are too fickle, that analysts are too demanding, and that short-term activists are too great a threat for company leadership not to place short-term value creation over ESG concerns. Changing to a stakeholder governance model will not eliminate these pressures so long as shareholders maintain their franchise and thus should be expected to protect their interests from encroaching stakeholders.
To combat a short-term focus by a percentage of the shareholder base, directors embracing ESG initiatives as a meaningful way to create long-term value can consider building alliances with institutional investors. While possibly disagreeing on the means, both the Business Roundtable and the Council of Institutional Investors recently acknowledged that promoting long-term value is material to the corporation as a going concern. Nothing in the Delaware framework precludes these mutually recognized goals of sustainable returns. If anything, the shareholder-centric focus of the Delaware framework could provide a common point of accountability to enable boards and investors to work together to promote long-term, sustainable governance.
It is well-settled that directors of Delaware for-profit corporations must act for the benefit of shareholders. For directors who make the bold choice to embrace value creating ESG initiatives, Delaware law will protect that choice so long as the directors otherwise act loyally, on an informed basis, and in the good faith furtherance of shareholder interests. This protection is a testament to the flexibility of the shareholder primacy model that has guided corporate law for over a century.