European Union Looks to Improve Corporate Behaviour
Updated: Mar 2, 2021
The duty of corporate directors “to act in the best interests of the corporation” is a worldwide impediment to making companies more socially responsible. Businesses usually don’t start out to harm the public interest. The damage they cause only becomes apparent after they have become successful and shareholders have invested huge amounts of money. Examples of these harms include pollution and greenhouse gas emissions, dangerous products that kill customers (e.g., tobacco), third world sweatshops and other dignity destroying labour practices.
These problems then raise questions for corporate directors. What it will take to stop the damage? Can it be done in a manner that is cost-effective? Is this in the best interests of the company? Too often, the costs of stopping are expensive or prohibitive. The duty of directors then serves as legal justification for them allowing the harm to continue.
This justification should be eliminated. In December 2020, the European Parliament come to the same conclusion and recommended that the duty be changed in each of its 27 member states.
When considering the problem of anti-social corporate behaviour more than 20 years ago, I conceived a solution which I called the Code for Corporate Citizenship (Code). When added to corporation laws around the world, it will cause a significant reduction of anti-social corporate behaviour. The Code will amend the existing duty of directors “to act in the best interests of the corporation” by adding the following 28 words:
“but not at the expense of the environment, human rights, public health and safety, dignity of employees or the welfare of the communities in which the corporation operates.”
My hope is that the European Commission and other government bodies around the world will find the thinking which went into the origination of the Code (as described here), helpful in deliberations concerning how to reduce corporate behaviour that harms the environment and other elements of the public interest.
On Thursday, 17 December, 2020, the European Parliament (“EP”) suggested a change be made to the corporate laws of the 27 member states of the European Union (“EU”). The change would modify the duty of directors by adding obligations to protect the environment, employees and other elements of the public interest. The idea is supported by an EP study completed last summer captioned Director’s Duties and Sustainable Corporate Governance (the “2020 Study”).
The suggested change is the latest in a series of steps taken by various parties to make business less harmful to the public interest. For decades, the purpose of the corporation was interpreted to serve the interests of shareholders exclusively. Under this interpretation, companies were entitled to take any legal act in pursuit of profit. It resulted in corporate behaviour that, although legal, did significant harm to the environment or other elements of the public interest (e.g., pollution and the distribution of tobacco products).
Not that long ago, the wisdom of that view began to be questioned. At first, a few businesses voluntarily agreed to operate in a socially responsible manner. Socially responsible investment vehicles sprung up to provide capital to these enterprises.
Twenty years ago, I wrote that the voluntary agreement of a few companies was not enough. I believed the law should be changed to require the directors of every company to protect the public interest as well as shareholders. See Human Rights and Corporate Responsibility: A Dialogue, Stuart Rees, Editor (Pluto Press, Sydney 2000).[i]
In August 2019, 181 CEOs of America’s Business Roundtable (including Jamie Dimon, Laurence Fink and Jeff Bezos, the leaders of JP Morgan, BlackRock and Amazon, respectively) stated they believed that the purpose of the corporation should be expanded to include consideration of other stakeholders’ interests (including the environment, employees and society at large).
Now, the EP has gone even farther. It has opened the possibility that the duty of directors in all companies may finally be balanced with mandatory obligations to protect the environment and other elements of the public interest.
Assuming the EU proceeds, the question now becomes: What form should the new legislation take? I’d like to share my thinking when I considered the same question twenty years ago.
To be effective, the new legislation needs to:
· Convert every corporation that currently harms the public interest into a company that does no harm,
· Be easily understood and followed by everyone working for the corporation, and
· Be largely self-enforcing and not have to rely on government’s constant intervention to enforce compliance.
I concluded back then that 28 words should be added to the duty of directors “to act in the best interests of the corporation.” These words are:
“but not at the expense of the environment, human rights, public health and safety, dignity of employees or the welfare of the communities in which the corporation operates.”
I call these words the Code for Corporate Citizenship (the “Code”). In 2007, the Australian Financial Review likened the Code to medicine’s Hippocratic Oath because both required practitioners to first do no harm.
When I originated the Code, I had already been a corporate lawyer for more than 20 years. I had the advantage of knowing many things the EP recognized in the 2020 Study. For example, I knew that (I) the conventional wisdom about the corporate law requiring directors to maximize profits was a myth (II) the duty of directors drove everything a company does, (III) the duty was essentially the same in every developed country, and therefore (IV) by modifying this duty, it was possible to craft a “one size fits all” solution for every jurisdiction (including the EU member states).
I also knew that American corporate law originally required directors to run their companies without damaging the public interest. If they violated that requirement, they risked losing their charter and license to do business.
More than a century ago, the law was changed to eliminate this requirement. This change has proven to be a mistake, but it’s a mistake that can be reversed.
Finally, I was aware that more than half of the American states had recently adopted “stakeholder statutes” specifically permitting company directors to consider the environment, employees and communities when evaluating competing offers to sell their company. If directors could voluntarily consider the public interest when their company was being sold, they could be required to consider it all the time.
Passing stakeholder laws in every jurisdiction won’t convert companies into enterprises that do no harm. The existing statutes have not achieved this result. Passing the same laws elsewhere will be no more effective.
Stakeholder statutes allow directors to use the public interest as a shield when their company is under attack. That’s not the same as requiring directors to behave responsibly all the time.
To be effective, the EU’s new directive must require directors to do no harm all the time (twenty-four hours a day/seven days a week). In other words, the new laws must impose mandatory obligations rather than merely allow directors to protect the public interest when, and if, they are so inclined.
Secondly, the new obligations must be clear--not only to directors, but to everyone inside the company (i.e., its managers and employees). The duty of directors sets the corporate objective. It is clear and simple. From their first day at work, officers and employees know their job is to help directors achieve this goal. Any change in the law regarding directors’ duties must be just as clear, simple and easy to follow.
The new duty of directors cannot charge directors with “balancing” the interests of shareholders and competing stakeholders. Nor can it timidly ask directors to “consider” the interests of other stakeholders.
These formulations will only create conflict, confusion and lack of accountability. Businesspeople cannot serve more than one master. The law shouldn’t require them to try.
Directors can, however, work in the best interests of their company while at the same time taking care not to damage the environment, infringe on human rights or violate the dignity of employees. Likewise, a company can follow the principle of shareholder primacy without harming the public health and safety or the welfare of the communities in which it operates.
The key to establishing a new duty of directors lies not in asking directors to “balance” or “consider” competing interests. It lies in telling them to work for shareholders while imposing co-equal duties to not harm other stakeholders. This can be achieved by adding the roughly two dozen words of the Code to the corporate law.
The revised duty of directors must also be largely self-enforcing and not require litigation or the constant intervention of government regulators to be enforced. The natural thought process when considering any new statue is how will it be enforced and what will be the penalty for it being violated. I admit I initially fell into this trap when I was developing the Code. However, I soon realized that not every law needs enforcement provisions to be effective.
Some laws set ideals or aspirational goals and then rely on other laws for enforcement. Setting aspirational goals also has the benefit of facilitating the passage of other laws that move towards the goals (e.g., stricter. environmental laws).
The existing duty of directors is a good example of a law that sets an aspirational goal. It works in tandem with the disclosure rules of the securities laws which require directors to fully inform investors on how their company is being managed.
Long ago, judges decided they weren’t going to be put in the position of second-guessing boardroom decisions taken in good faith. Instead, courts adopted the “business judgment rule” which severely limits the nature of disputes they will entertain from shareholders wanting to sue when they think directors haven’t acted in the company’s best interests. So long as directors don’t steal from their companies or lie to their shareholders, the board is usually free to make decisions without the threat of judicial intervention.
This doesn’t make the obligation to act in the best interest of shareholders toothless. Everyone within the company understands their job is to help the company make money and preserve its assets. It’s the driving force behind all company action. It is a powerful force without needing to be the subject of constant legal action.
Adding the Code should not change the business judgment rule. It will just put actions that materially damage the environment and other elements of the public interest in the same category as stealing from the company and lying to shareholders. These actions become clearly prohibited and the new obligations should be largely self-enforcing.
The continued application of the business judgment rule should ensure the additional duties imposed under the Code do not result in volumes of litigation or require constant government oversight.
Even without specific enforcement provisions, the Code will significantly improve corporate behaviour. Its passage will remove all justification for the anti-social behaviour that now occurs in the name of serving shareholders.
The result should be significantly reduced corporate abuse of the public interest and more socially responsible companies, a new normal.
The Code makes existing law more precise by declaring out of bounds anti-social corporate behaviour which, though technically legal, harms the environment, employees and our communities.
It charges directors to stop their company’s damage of the public interest. The question is: When must it stop? For newly formed companies, the answer is clear. They must follow the Code from the date of incorporation. For existing companies that do not currently harm the public interest, they must not start.
However, many of the companies which are currently doing harm to the public interest will need time to stop. It’s not realistic to add the Code to the duty of directors on a Wednesday and expect companies that have huge investments in businesses that harm the public interest to be fully compliant by Thursday.
These companies will need time to convert their operations from businesses that harm the public interest to businesses which do not. How much time? It shouldn’t be longer than fifteen years. I suggest a period from five to ten years, but it could be shorter.
This will create a transition period during which the Code gradually becomes fully effective. During that time, companies can be required to monitor and report to government the harm they are causing and their progress towards eliminating it. Companies taking advantage of the transition period should be expected to reduce their abuse of the public interest each year.
If insufficient progress is being made towards eliminating the abuse, then business laws and regulations can be tightened as necessary to more rapidly decrease the ongoing harm.
Establishing an outside date for the Code to become fully effective will pressure company directors to make timely progress towards the goal of full compliance. Companies which fall behind are likely to see their investors begin to “vote with their feet.” When they shed their investments, prices will fall, and the companies’ ability to access additional funds will begin to dry up. This threat should provide a powerful incentive for companies not to fall behind.
The final question which should be asked is will it really work? Will adding two dozen or so words to the corporate law really have that much effect on corporate behaviour? Or will corporations ignore the change in law and simply continue destroying the public interest in their pursuit for profit?
The short answer to these questions could be what’s the harm in finding out?
Anti-social corporate behaviour doesn’t occur because businesspeople decide to start up new companies that they know will harm the public interest. Instead, they start a business to make money genuinely unaware of the adverse side effects that business may be causing.
Those businesses then sometimes become successful. Millions and sometimes billions odollars are invested. Then it’s discovered there is a problem. For example, the business is contributing to climate change, its products cause a deadly disease, or that the algorithms employed by its platform to generate revenue are tearing our communities apart.
The problem then comes to the attention of the board of directors. It has to decide the company’s course of action. Should it cease operations, undertake a risky investment in new technology or processes to eliminate the harm or simply continue? It’s at this point where existing law to act in the best interests of the company comes into play.
The duty of directors under existing law presents directors with a difficult problem. Should they put the company out of business or bet its future on the costly development of new technology which may not be successful? How can that be in the company’s or shareholders best interests?
It can’t. In this way existing law encourages directors to continue. They sometimes employ a strategy which includes denying the extent of the damage being done. They also lobby legislatures to allow the company to continue a little bit longer or so long as they cause a little less damage. The company drags its feet. We’ve all seen this happen. The tobacco industry and fossil fuel burning electricity generators are two prime examples.
Incredibly, this behaviour is justified by existing law. In effect, existing law encourages corporations to engage in anti-social behaviour—to be bad citizens. It’s a law passed by the elected representatives of the people that, when the going gets tough, encourages the world’s most powerful citizens to harm the people, the planet and our communities. This is mad.
The Code will alter the factors that now go into the board’s decision making when it is discovered their company is doing substantial harm to the public interest. Current law gives directors an excuse to continue. “Our job is to watch out for shareholders. We have no choice.” At the very least, the Code will eliminate this justification.
It will also relieve the constant tension between government and the private sector by firmly establishing the powerful notion that, in Europe, corporations have obligations to protect the environment, employees and other elements of the public interest. Making money is a worthy goal, but not if it comes at the expense of other things more important. An economy that thrives without harming the public interest is far better than one that does harm it.
The Code will impose on big companies, our most powerful citizens, the obligations of citizenship to go with the rights they have always had. Passing the Code may put new life in European capitalism. It should cause European companies to begin the search to find new ways to make their businesses more socially responsible. This will require innovation and investment. The change has the potential to become a powerful example for the rest of the world to follow—a world in which EU companies will have the advantage of first mover status.
The 2020 Study concludes that something must be done. It is no longer acceptable for business to harm the environment, employees and others in its pursuit of profit. It suggests that legislation designed to improve the duty of directors is the best alternative. As someone who thought this alternative through previously, I agree and humbly recommend the Code as the legislation which will work best.
The European Commission has asked the public to contribute its thoughts regarding the 2020 Study and the EP’s recommendations. All Europeans are being given the opportunity to have their say.
This is an opportunity for European business and all Europeans to move on from the old paradigm of turning greed loose and then trying to harness it with volumes of laws and regulations to a new paradigm where all companies are required to operate in a socially responsible manner all the time. The Code is the way to make that shift a reality. Spread the word.
Robert C. Hinkley is a US qualified attorney experienced in corporate law. He worked over 30 years in private practice and is a former partner in Skadden, Arps, Slate, Meagher & Flom LLP. Most recently, he advised the Civil Division of the US Department of Justice regarding investigations into the fraud which caused the 2008 financial crisis. Those investigations recovered more than $65 billion for the US government, various state governments and homeowners.
[i] See also, “How the Law Inhibits Corporate Social Responsibility: A Corporate Lawyer Proposes a ‘Code for Corporate Citizenship, in State Law,’” commondreams.org. (January 19, 2002), https://www.commondreams.org/views02/0119-04.htm.