For Efficiency and in the Interest of the Public

It is argued, that managing primarily on behalf of shareholders would make for

efficient corporate governance69_{. Sustaining the interests of one constituency of}

stakeholders in the firm ensures that the executive is clear on its objective and as

Jensen put it “multiple objectives is no objective”70_{. Berle argued that it was in the}

public interests that shareholder interests be prioritised71_{. Berle believed that}

managing for shareholders was the only way to protect the firm and community from managerial abuse. It is asserted that because Berle was communitarian in his

approach72_{, he believed that the only way to ensure a socially responsible corporate}

entity, would be to manage on behalf of shareholders73_{. As such a focus on firm value}

would evidently increase social wealth.

Admittedly, shareholder wealth maximization obviously positively impacts the firm’s immediate environment in the sense that an increase in corporate value could affect job creation and spending, both having obvious benefits to the local economy. In

68 _{It was held in the Disney Company Derivative Litigation [2005] 907 AC 2d 693, that business decisions should}

not be questioned solely because they fail to adhere to what could be best practice.

69 _{T. Smith, “The Efficient Norm for Corporate Law: A Neo-Traditional Interpretation of Fiduciary Duty” (1999)}

98 Michigan Law Review 214, 215.

70 _{Michael. Jensen, “Value Maximization, Stakeholder Theory and the Corporate Objective Function” European}

Financial Management, [2001] Vol.7 No.3, 297-317.

71 _{Berle (n13) 1367, 1368.}

72_{Lorraine Talbot, “Enumerating old Themes? Berle the Progressive” University of Warwick School of Law, Legal}

Studies Research Paper No 2010-02 at p.24.

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contrast, the shareholder value approach could lead to directors managing in the

short-term at the expense of true value creation74_{. It could also negatively impact}

inequality and skew income distribution, by creating wealth for a privileged class. A class which includes company executives, whose pay packets are often affected by

share price movements75_{. This creates a cycle whereby managers become entirely}

focused on raising the share price often at any expense, bearing in mind the positive effect on their own compensation and regardless of the effect on the environment or

employees and so on76_{. It becomes extremely difficult to comprehend how}

shareholder value could be in the public’s best interest.

Dodd countered Berle’s efficiency argument, by questioning the rationality of insisting that the company, a separate legal person, be managed primarily in the interests of its investors. He answered this question from two logical perspectives: firstly, positing that since corporations are separate from their owners, the managers who run these companies should be regarded as fiduciaries not of the members, but of the company.

Which itself is more than an aggregate of its members, “as they are………. trustees for

an institution rather than attorneys for stockholders”77_{. Second, if the corporation was} to be regarded as a legal person, then it should be held to the same standards as any other in a similar position, with regards to its standing and responsibilities to society.

74 _{The focus on short-termism has often been fuelled more by managerial greed than a desire to enhance}

shareholder value. This could largely be blamed on the design and structure of incentive arrangements, which tie compensation closely to movements in the share price. Managers seeing the need to enhance their personal wealth could be driven more by the latter need, than the need to optimize shareholder wealth. On this point see, Alfred Rappaport: Saving Capitalism from Short-termism: How to Build Long Term Value and Take Back Our Financial Future (McGraw Hill, 2011).

75_{Lucien Bebchuk and Jesse Fried, “Pay Without performance: An Overview of the Issues” Journal of Applied}

Corporate Finance, Vol. 17 No 4 2005 pp.8-23, at p.18.

76 _{See Stuart Gillan and John Martin, “Financial Engineering, Corporate Governance and the Collapse of Enron”}

University of Delaware, College of Business, Economics and Corporate Governance Working Paper No: 2002- 001, p. 22.

59

He stated further that increasing designation of ‘business’ as a profession, would imply that it be held to some ethical standards as any other professional person, and such a standard could not be exercised to the benefit one stake-holding class to the exclusion of all others78_.

Furthermore, shareholder primacy does raise concerns about its potential to create an enabling environment for managerial excess, which it is ironically supposed to inhibit. Agency theorists argued, that closely linking executive pay to company performance, would lead to greater efficiency, both in its comparative and intrinsic value. That said there is a tangible link between shareholder primacy and high executive compensation, which skews the income distribution framework and concentrates wealth at the top. That research shows higher levels of income inequality in the jurisdictions which adhere to shareholder wealth maximization, cannot be dismissed as mere coincidence. The latter makes it difficult therefore to follow the argument the shareholder primacy works in the public interest or increases aggregate wealth79_.

2.5. A Case for the Pluralist Corporation: The Stakeholder Theory of the Firm

In contrast to the latter argument, there are those who contend against the notion that shareholder primacy works in the public interest, arguing instead, that

78 _{Ibid at 1161.}

79 _{Paddy Ireland ‘Shareholder primacy and the Distribution of Wealth’ Modern Law Review [January 2005]}

60

considering the public interest in corporate governance, works to benefit the firm and all its stakeholders.

Freeman believes managing for stakeholders is the most pragmatic form of corporate governance, as profits should be the outcome and not the raison d’ etre of value creation. Freeman posits that, the primary goal of corporate value creation is best

attained when value is created for all the firm’s stakeholders80_{. He argues further, that}

a pluralist approach to corporate governance would lead to the long-term value creation and create sustainable wealth for investors.

One of the strongest criticisms of shareholder primacy is the overarching focus on the

share price, which could lead to “managerial myopia” and lead to short-term value

creation often with quite significant and negative consequences in the longer-term81_.

It could be argued, that this overarching focus on shareholders, often works to the detriment of the other constituencies. When the dominant goal is profit maximization, firms are more likely to cut jobs, suppress wages, or less likely to consider the environment or the welfare of its immediate community, with even greater externalities.

The crux of the debate is the role of the corporation in the society it inhabits; are corporations to be considered solely to be profit-oriented, amoral institutions, obligated only to investors? or are they to have a broader remit, having a moral responsibility to society as a whole? Donaldson believed corporations had a moral

80 _{R. Edward Freeman ‘Stakeholder Theory and “The Corporate Objective Revisited” Organization Science,}

[May-June 2004] Vol.15, No3, 364-369 at 366.

81 _{Lucian Bebchuk and Lars Stole ‘Do Short-Term Objectives Lead to Under or Over-Investment in Long-Term}

61

obligation which exceeded the need to be profitable82_{. The preceding view may seem}

out of kilter with modern corporate ideology, however, this appeared to be the more normative approach over a century ago.

That the corporation was to be viewed as more than a profit-making entity was

reflected in the attitude of the 19th _{century courts, which urged the consideration of}

wider interests, so long as doing so worked to the benefit of the shareholders83_.

However, in Dodge v Ford, the Delaware court seemed to suggest that it was the duty

of directors to manage the corporation in the interest of shareholders. This ruling witnessed the beginning of a change in attitudes and precipitated a debate on the issue of corporate social responsibility. Shareholder primacy advocates argue that corporations are to be primarily responsible to shareholders, stating further that was ultimately to the benefit of all corporate stakeholders, that the former’s interests be prioritised84_.