In a time of climate change, racial and economic inequality, and crisis stemming from the global pandemic, corporations are alternately maligned for their conduct and embraced as a solution for change. Observers have increasingly excoriated the traditional view of corporate purpose—that corporations should be managed for the benefit of shareholders, and specifically, to maximize their wealth—as contributing to societal problems. As a result, only two decades after prominent scholars announced “the end of history” in favor of shareholder primacy, luminaries in the field are again asking: For whom is the corporation managed? Do fiduciaries owe a duty to maximize shareholder value or may they prioritize the interests of other stakeholders?
In a new paper, we contribute to this important debate by enlarging the aperture. Specifically, we provide an original account of the “corporate governance machine”—a complex system of corporate governance in the United States composed of law, markets, and culture. We describe each of these components and show how the machine powerfully drives corporate behavior and solidifies corporate purpose as promoting shareholder interests.
Although legal academics have generally focused on corporate law as a key determinant of purpose, our analysis reveals that this element may well be the least important: a vast array of institutional players—proxy advisors, stock exchanges, ratings agencies, institutional investors and associations—enshrine shareholder primacy in public markets. Indeed, we show the very concept of corporate governance promoted by these players developed alongside the principal-agent model of the corporation, such that “good governance” is often equated with minimizing agency costs in the pursuit of shareholder value. Professional education, the media, and politics further reinforce this cultural understanding.
Our analysis sheds light on the development of corporate law and governance. Corporate social responsibility, for example, was once framed in moral terms as a goal for management irrespective of profit. But after several decades of circulation within the machine, the idea of corporate social responsibility has been largely replaced with investor-driven ESG. Today many companies pursue “environmental, social, and governance” goals, and investors favor ESG funds, not for moral reasons or a prosocial willingness to sacrifice profits, but because ESG is thought to provide sustainable long-term value or higher risk-adjusted returns for shareholders. This reframing has in turn shaped managerial decisionmaking about the kinds of ESG activity in which corporations should engage. As the corporate governance machine transformed corporate social responsibility into value-enhancing ESG, it has also pushed social purpose beyond this framing into an entirely different form of corporation—the benefit corporation—which we show is also driven by shareholders and their values.
We also look to the consequences of the corporate governance machine’s workings and posit that its shareholderist orientation is potentially suboptimal. We argue that when shareholderism is locked in to rules, norms, and power structures, superior governance arrangements from a social welfare perspective may be discouraged or taken off the table. From convergence on one-size-fits all governance “best practices” to reduced corporate governance innovation, we identify a range of negative implications for corporate law and governance wrought by this system. One illustration can be seen in public company boards, which have been pushed to a monitoring model that prioritizes independence and leads to homogenous governance practices across industries.
Finally, our account of the U.S. corporate governance system elucidates much about the path of corporate governance reform, and the success of the stakeholder governance movement in particular. At the outset, we show how over the past several decades, law, markets, and culture have entrenched a shareholder-oriented view in corporate law and governance. Battles over the allocation of power within the corporation occur on policy issues such as proxy access and shareholder proposals, but the larger war has been won.
What does this mean for the future of corporate governance? On the one hand, absent a large shock to the system such as a major federal intervention, the corporate governance machine will likely impede a true paradigm shift toward stakeholderism. On the other, our account reveals how incremental change could take place. As shifts in understanding regarding the merits of various ESG initiatives occur through cultural and market forces, the promotion of stakeholder interests can be reconciled with pursuing long-term shareholder value. For example, institutional investors and asset managers that hold diversified portfolios increasingly recognize the financial benefits of mitigating climate change risk. To the extent that ESG metrics become easier to measure and disclose, more of such activity might occur and a greater number of investors might support it.
Notably, however, this future change is likely to occur through the existing shareholderist model, which limits acceptable rationales and favors activity that can be reduced to measurable metrics tied to risk or financial value. In sum, the legacy of the corporate governance machine is not just the continued constraint of corporate activity in the service of shareholder welfare, but also the co-optation of stakeholderism. The desirability of this reality is subject to much debate, but as our analysis indicates, wholesale change away from this model is unlikely to manifest absent a substantial shock to the system.
The complete paper is available for download here.