By Robert C. Hinkley*
17 August 2021
Until now business regulation has relied on government regulators imposing fines to be enforced. The Code for Corporate Citizenship (Code), 28 words added to the duty of directors to limit anti-social corporate behaviour[1], will work differently.[2] It will improve corporate behaviour by creating a new risk that company directors and senior managers must respect and take steps to avoid.
The legal duty of directors is to try to make money and protect the company’s assets (i.e., “act in the corporation’s best interests”). This obligation applies even when it is discovered that a company is causing severe damage to the public interest.
It’s here where the modern corporation goes wrong. Rather than encourage directors to stop the damage, existing law encourages them to continue. The results are clear. They include, among other things:
· Global warming and climate change threatening our survival,
· Millions of people dying every year from the effects of tobacco,
· Human rights and the dignity of employees being violated with impunity,
· Big tech companies employing business models that spread falsehoods and tear our communities apart.
None of these things violate the law. Worse, people have come to accept that, if the economy and jobs are to be maintained, these unfortunate side effects of business are unavoidable and must be endured.
Changing this mindset starts with the recognition that it originates with the duty the law places on people in charge of corporations. This law causes directors and managers to play roles in which they have no duty to anyone but the company they serve. Further, they view their jobs as including the responsibility to confront, delay, and frustrate proposed legislation which would make their company’s destructive behaviour illegal.
This article is about how enforcing the Code will put a stop to the instances of corporate abuse which are causing the most damage. It further describes how, without harming the economy or disrupting the profit motive, the Code will change people’s expectations regarding acceptable corporate behaviour.
A New Risk
Investors put money into companies on the understanding that management will use the money to make the investors’ shares more valuable. For more than a century, this understanding has been supported by the corporate law which provides that directors must always act in the company’s best interests.[3]
The Code will change this equation by making the continued loyalty of directors contingent on the company not causing severe damage to the environment or any of four other elements of the public interest (human rights, the public health and safety, the dignity of employees and the welfare of the communities in which the company operates). Once a company is found to be causing severe damage, the duty of directors transfers to protecting the public.
Investors will realize their directors’ loyalty is no longer absolute. They will recognize that if the company does not protect the public interest, management will be required to modify its operations or close its business, irrespective of the costs to shareholders.
Investors will demand management do everything possible to avoid this contingency. Securities regulators (e.g., the U.S. Securities and Exchange Commission, the London Stock Exchange and the Australian Securities and Investments Commission), will demand ongoing disclosure to assure investors that the risk is being properly managed.
To provide this information, management will monitor the company’s conduct and make sure any harm it causes is contained. Companies will become more cautious with the public interest.
Changing Expectations
For some time, the corporation’s sole purpose has been simply to make money for investors. Lately, we’ve been led to believe that the economy comes first, and mankind must put up with the damage big companies inflict on the public.
The Code will change this mindset. After the Code, the corporate purpose will become tomake money for investors without harming the public interest. It will change corporations from institutions with a proclivity to ignore and exonerate anti-social behaviour to institutions that identify such behaviour early and take steps to eliminate it. It will break the cycle where the severity of the amount of abuse increases as companies grow.
As new methods and technology are found that better protect the public interest, early adopters will quickly be followed. Instead of a race to the bottom, corporate social behaviour will start to become a race to the top. In short, the Code will initiate a new form of capitalism, a capitalism where business is expected to protect the public interest rather than harm it.
This change will be experienced by more than just investors and company managers. For example, the Code will create new opportunities for engineers, inventors, and entrepreneurs. As companies begin to research and develop new technology, processes, and products that reduce the harm they now cause, entrepreneurs will also form new companies to develop this technology. Funding the additional research and development will spur on new investment opportunities.
When a company has already made a substantial investment in a product line or manufacturing process that causes severe damage, it’s difficult for senior management to walk away from that investment. Under the Code, walking away will be required. That threat will encourage and empower employees to identify potential Code violations early in the planning process, before large investments are made.
It is hoped that the Code will also change the mindset of legislators and regulators. The Code will make it clear that not all legal corporate behaviour is appropriate. Public officials should begin to realize their job is not to decide how much harm the public should bear. Instead, the function of government is to constantly do more to protect the public interest and gradually eliminate corporate anti-social behaviour.
Corporate social responsibility activists fighting corporate abuse should also find the Code helpful. It provides them with a new tool that challenges the underlying cause of all corporate anti-social behaviour. It has the potential to unite all activists in common cause and give new hope that the environment and other elements of the public interest can be preserved.
Enforcing the Code
The cause of all corporate anti-social behaviour is the corporation’s dedication to profit unbalanced by any obligation to the public interest. The law is the same all over the world. The Code, by making it a director’s obligation to also not harm the public interest, is a global solution to socially irresponsible corporate conduct.
Under existing law, all corporate behaviour is legal unless a law specifically makes it illegal. This sounds reasonable until you realize corporate legal behaviour probably does more harm to the public interest than corporate illegal behaviour. Greenhouse gas emissions are a perfect example.
It also means corporate abuse of the public interest must be contested repeatedly, abuse by abuse, toxic chemical by toxic chemical, labour violation by labour violation, one jurisdiction at a time. Finally, each time there is a new breakthrough in technology, new opportunities for corporate abuse arise which the law does not yet prohibit.
Without the Code, corporate social responsibility proponents need to convince legislators and judges to stop anti-social behaviour. Under the Code identification of the abuse alone should be enough to force directors to take action to stop it. It will use the corporation’s survival instinct to protect the public interest as opposed to existing law where corporate survival is used to justify the public interest’s continuing destruction.
For newly formed companies and the 99% of companies which do not harm the environment and other elements of the public interest, enforcement of the Code will not be an issue, simply because these companies aren’t violating it. The Code will discourage them from starting. These companies will take risk management measures to reduce the risk the Code raises. The additional marginal costs of these measures should be minimal.
For the few large companies that have already crossed the line and are doing severe damage, the Code will have more serious implications. Their opposition to the Code can be expected to be vigorous, but not insurmountable. The damage they do is great. Their numbers are small. Both factors should make the Code’s passage easier than the passage of business regulation of similar import.
The Code will be enforced very similar to the way existing law is enforced. Requiring directors to “act in the best interests of the corporation” would appear to allow shareholders to bring a lawsuit against directors every time a boardroom decision doesn’t result in a profit. This would be unworkable.
Directors would be too frightened of getting sued to serve on boards. The courts would be clogged with cases brought by shareholders whose purpose would be to have judges second guess directors. Fortunately, courts don’t allow this to occur.
Long ago judges instituted something called the “business judgment rule” (BJR). It provides that, so long as directors don’t misappropriate the investors’ money for their own use (i.e.,steal), courts won’t review boardroom decisions. Essentially, it raises a presumption in favour of their good faith. Lawsuits are only allowed to proceed where there is evidence of what the law calls a theft of corporate opportunity.
The Code can be enforced the same way. The BJR should include a presumption that the company’s operations are not causing severe damage. Unless the extent of that damage is unquestionably severe, courts should invoke the BJR and not get involved. Examples of such damage include making significant contributions to global warming and climate change or annually killing millions of people.
Corporate anti-social conduct which does not cause extreme harm will be discouraged by the Code, but not punished. Conduct which causes less than severe damage will need to continue to be contained by separate business regulation (e.g., environmental, labour and consumer laws) as it is now.
The new risk the Code raises for investors and companies will have what lawyers call an in terrorem effect. It literally scares them into avoiding anti-social behaviour that could result in their company’s undoing.
Exactly what the term “severe damage” means should be decided on a case-by-case basis. The decision should be made purely on the question of the severity of the damage without consideration of offsetting benefits to the economy or the jobs the company provides.
Justice Potter Stewart of the U.S. Supreme Court once said of hard-core pornography that he didn’t need to define it because he knew it when he saw it. The same can be said about “severe damage.” The adverse consequences to a company of it violating the Code are huge. Leaving open the question of what constitutes “severe damage” will make directors and management more cautious.
Making corporate management more cautious with the public interest is an important feature of the Code. Existing business regulation needs to be precise for it to be enforceable in court. Precise legislation creates a bright line for managers to obey or face the consequences. It also makes regulation easier to evade and encourages companies to get as close to the line as possible.
The Code instead relies largely on self-enforcement. Not only does it not need to be as precise, but it also shouldn’t be. The significant risk it creates, and its lack of precision regarding what constitutes severe damage, combine to make managers more careful regarding the impact of their company’s conduct. This is the whole point.
Whether the decision needs to be made in the court system or may be made in the court of public opinion is of little consequence. Damage that is severe sooner or later becomes obvious. As the damage a company inflicts trends towards severity, the risk raised by the Code should cause it to automatically take steps to reverse course.
In some cases, a company’s anti-social behaviour is fundamental to the way it makes a profit. I’m thinking of companies that generate electricity in ways that contribute to global warming and climate change. I’m also thinking of companies which produce and market fossil fuel driven transportation vehicles. The damage these companies cause is, beyond doubt, “severe”. It threatens our planet and maybe even mankind’s existence.
Other companies that fit this category are companies whose main business is the manufacture and distribution of products that make people sick and kill them. Tobacco is responsible for killing 8 million people every year. Companies backed by billions of dollars in capital shouldn’t be allowed to mass produce, market and distribute products that cause addiction, widespread illness, and death.
The Code doesn’t prohibit smoking. However, is does prohibit the corporate mass production and distribution of addictive, carcinogenic, tobacco products. It will save millions of lives each year simply by making smokers grow and roll their own.
For companies where the severe damage it causes is fundamental to it making money, stopping their abuse of the public interest will likely cause significant financial hardship. This hardship should be managed over a period that gives the companies time to arrive at alternative solutions.
Governments may also want to offer these companies other forms of financial assistance to lighten the burden of the Code. Such assistance may be considered a small price to pay for the elimination of the damage the companies now cause.
Giving companies time to back away from damaging conduct has precedent in the way the world is now trying to deal with greenhouse gas emissions. In 2015-2016, political leaders from all over the world came together in Paris and pledged to reduce their country’s emissions in the future.
This effort now seems to be failing because political leadership has not found a way to convert their promises into corporate action fulfilling those promises. Emitters of greenhouse gases don’t want to incur the costs of limiting the damage they cause. Political leaders are too beholden to force them to change. The Code, by imposing on directors a duty to protect the public interest, will break the stalemate and help bring the promises of the Paris Climate Accords (Accords) to fruition.
Alternative energy and transport solutions are available and are becoming more economic every year. The more these solutions are pursued, the more economic they become. By raising the risk for investors and companies in these industries, the Code will provide an incentive to increase resources dedicated to the pursuit of these alternatives.
How quickly a massive reduction in greenhouse gas emissions can occur is open to debate. Fifteen years? Ten years? Five years? In any case, enactment of the Code should accelerate the reduction period contemplated by the Accords.
There are other cases of abuse where the time to alter the company’s operations can be less, either because the solutions do not require the development of new technology, or the financial consequences of modifying the business are not as drastic. Companies that distribute products which, when used improperly (e.g., firearms and opioids), cause severe damage are a good example. Under the Code, these companies will need to take steps as soon as possible to stop such misuse and the resulting harm.
Still other companies operate in ways that are within the law in the jurisdiction of their operations yet violate human rights and the dignity of employees. I’m thinking of companies that maintain third world sweatshops or similarly take advantage of unprotected labour in their supply chains. These practices cause severe damage and, under the Code, should be stopped as quickly as possible.
There are also companies which recently have found it profitable to offer electronic platforms where people gather to tear each other apart. This “product line,” though highly profitable, is anti-social and disruptive. These companies are a good example of changes in technology getting lengths in front of the law before government regulation protecting our communities has left the starting gate.
If the Code were already in place twenty years ago, these companies would have had to consider its implications before developing a line of business that heightens community discord. It shouldn’t take a long time or a lot of money for these companies to bring their business models into compliance with the Code.
Finally, I am thinking of companies that leave a large hole in a community when they move their operations to other countries to take advantage of cheaper labour, lower taxes and/or less strict regulation. Protecting our communities from corporate harm is a fundamental tenet of the Code. Courts should interpret it to prevent corporate decisions which hollow out communities where companies have maintained significant operations.
Each of the foregoing are examples of anti-social behaviour that does severe damage to the public interest. These companies built their businesses before the Code at a time when abusing the public interest was, if not fully accepted, at least encouraged. It’s probably fair that they be granted a relatively short grace period (and possibly financial accommodations) to allow them to find alternatives to their anti-social behaviour.
Conclusion
The Code addresses the major flaw of the modern corporation. A small number of very large companies employ technology, processes and methods or manufacture products that do incredible damage. The destruction continues because existing law encourages them to continue. The Code inserts a circuit breaker in the system and puts the onus on directors to make the destruction stop.
It also continues because corporate managers use their right to free speech to lobby government and convince elected leaders to not pass laws which would make their companies stop. The shifting of the duty of directors from the company to the public, will eliminate this temptation without violating managers’ constitutional rights.
The Code will bring on a big change in the obligations of corporate directors, but it’s a change business is well on the way to making already. No company wants to be known for its anti-social behaviour. It hurts their brand. More and more, consumers are demanding companies are good citizens.
Today, more than $30 trillion is invested through funds and other means that claim to be socially responsible. Over the past two decades, it’s become investing’s fastest growing sector.
Consumer and investor sentiment has not gone unnoticed by company managers. Recently, 182 members of the Business Roundtable in the United States (an organization made up of CEOs from many of America’s largest companies) have declared that they have begun running their companies with more than just shareholders in mind. The environment, employees, suppliers, customers, and the communities in which they operate are now also being considered.
The prospect of the Code’s passage is enhanced by changes in consumer and investor attitudes and the voluntary steps many companies have already taken towards more responsible corporate behaviour. The Code takes what is already being trended to voluntarily and makes it law (mandatory).
For too long, companies have used the economy and jobs as a threat to preserve their ability to cause severe harm to the environment, human rights, public health and safety, dignity of employees and the welfare of our communities. Cowering to those threats has resulted in incredible damage and brought mankind to a place where it serves corporations rather than the other way around.
Like King John, modern corporations have reached a Magna Carta moment. There ought to be limits on their ability to inflict damage. Those limits need to be mandatory and reduced to writing. The time to stop corporate abuse of the environment, humanity, and our communities is at hand. The Code is the answer.
------------------------------
*Robert C. Hinkley is a dual Australian American citizen who resides in Berry, NSW Australia. Prior to retiring he was a securities lawyer for more than 30 years. His Linkedin profile can be found at https://www.linkedin.com/in/robert-hinkley/
[1] The duty of directors is to act in the best interest of the corporation. To this the Code would add, “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.”
[2] In my last article, Changing the Golden Rule of Business, I promised I would show you how the Code for Corporate Citizenship will be enforced. For more on the Code for Corporate Citizenship go to https://www.codeforcorporatecitizenship.com.
[3] While courts have permitted directors to spend relatively small amounts of company funds on charitable and other public purposes, these expenditures are seen as valid ways to boost the company’s public relations and are therefore “in the company’s interests.”