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Motivation




By Robert C. Hinkley*

22 September 2021


In my last post,[1] I suggested the Code for Corporate Citizenship (Code)[2] would be largely self-enforcing. This attracted the following comment from a reader in Ohio:


“In describing how the Code will require a corporation's directors to pivot from ensuring the stockholders' interests are protected to making sure the public interest is protected, I still don't see what motivates them. Fear of social humiliation? Loss of insurance?”


The reader expresses doubt that the Code will be sufficient to motivate directors to be more socially responsible. It made me realize that I had not spelled out in sufficient detail the consequences directors and their companies would face if it was ignored. I should have been clearer.


It’s not that government will not have a means to enforce the Code. Rather, the enforcement provision will be so harsh that no director will want to challenge it. The provision’s effect will be to make a company stop the damage on its own before government steps in to compel it.


Most business regulation operates by threatening companies with fines. If a company violates the regulation and is caught, it pays a fine. Sometimes businesspeople weigh the chances of getting caught and the amount of the fine into their decision to violate the law or not. In that case, the fine simply becomes a cost of doing business.


The Code does not rely on fines. Its primary purpose is to make clear that the law does not encourage anti-social corporate behaviour. In support of this purpose, it provides that business operations which inflict severe damage on the environment, human rights, the public health and safety, the dignity of employees or the welfare of the communities in which it operates, will be liquidated.


Liquidation

In the United States, when companies go into bankruptcy, they are either reorganized or liquidated. The law favours reorganization, but for companies which can no longer make money, liquidation is the result.


The Code changes the purpose of the corporation from simply making money for investors to doing so in a manner which does not severely harm the public interest. If both conditions cannot be attained, then the business should not be allowed to continue.[3]


Enforcement will not be complicated. Whether a company operation is causing severe damage is easily ascertained.[4] Does it emit significant quantities of greenhouse gases? Does it mass produce and sell products which are carcinogenic killing millions of people annually? Is it engaged in a business that otherwise inflicts harm of a similar magnitude?


When severe damage is certain, the only purpose of the enforcement proceeding should be to adopt a plan for the violators’ orderly liquidation. Courts with jurisdiction over bankruptcies and liquidations will be ideal for these proceedings. The increase in their workload due to the Code’s enforcement should be minimal. The reason is twofold.


First, the number of companies who cause severe damage is relatively small. The vast majority of companies either already fully protect the public interest or cause damage which is less than severe. Secondly, almost every company which is today causing severe damage will come into compliance with the Code (by changing its operations to no longer cause severe damage) before such a proceeding is necessary.


Motivation


It’s not just individual companies that cause severe damage--whole industries do. Whether a company abuses the public interest is more of a function of the nature of its business than conscious decisions by its directors. The Code will change that dynamic.


Companies which are not causing severe harm will not be forced by the Code to alter their operations. For the directors of these companies, the threat of liquidation will be a remote risk. The Code will encourage them to monitor this risk and make protection of the public interest a component of every significant corporate decision.


Directors of companies that are causing severe harm will no longer have the excuse that their only job is to look out for shareholders. They will be required to take steps which reduce the damage their company is inflicting. Failing to do so will result in the operations causing the harm being liquidated, a risk too great to ignore.


These directors will still have a duty to preserve their shareholders’ money. No board of directors wants to run the risk of their company being forced to shut down. Leaving aside the damage to their own reputations, closing operations usually involves taking substantial losses which directors have a duty to avoid as much as possible. Companies would rather shut down an operation themselves than have the government do it.


The lending and securities markets will also reinforce the Code well before forced liquidation. The prospect of liquidation and losses will cause lenders and investors to monitor the progress companies make towards eliminating the risk. If insufficient progress is being made, lenders will become less willing to lend. Investors, conscious of the uncertainty, will flee by selling their stock. The price of the company’s stock will drop. The company’s access to capital will dwindle.


The Code will also facilitate the shift from harmful technologies which foist severe damage on the public to new technologies which do not. Existing technology has a significant advantage because it generates costs which are not accounted for in the company’s net income (e.g., global warming). The Code will remove this advantage and thereby encourage research and development in potential solutions which are attractive to consumers and “do no harm.” Investors will rush to fund these solutions. As one company adopts an improved method of doing business, the directors of its competitors within the industry can be expected to follow.


Conclusion


The answer to the question, “What will motivate directors?” is a combination of factors. The first is the existential risk the Code will pose to business operations which cause severe damage to the environment, people, and our communities. The threat of being forced out of business is a significant motivator.


Capital markets will reinforce the risk (and expedite the Code’s efficacy) by withdrawing the ability to raise funds unless a company can show it is implementing a plan to timely eliminate the severe harm it is causing. In addition, investment markets can be expected to become more vigilant regarding all anti-social corporate behaviour (i.e., not just the kind which causes severe harm). Companies which damage the public interest less than severely can expect greater scrutiny and find less favour.


The second is that the law will empower directors to look out for the public interest rather than discourage them from it. Existing law discourages corporate social responsibility. The Code, on the other hand, encourages it and demands a minimum level of social responsibility that all corporations must meet.


It will inspire directors to become problem solvers rather than embolden them to continue being problem perpetuators. It is likely that directors will welcome this direction. Rather than being forced to serve shareholders slavishly, they will be permitted to be as good citizens in their director’s roles as they are on their own.


Substantial momentum has been built up over the last twenty years demanding that companies show more respect for other stakeholders (e.g., the environment, employees, customers, and the communities in which they operate). Many directors and senior managers are already sympathetic.[5] They know that protecting the public interest is good both for their company’s reputation and its business.


Finally, the Code will change expectations of corporate behaviour in a major way. The law will no longer silently approve corporate abuse of the environment, human rights, the public health and safety, the dignity of employees and the welfare of our communities. Abusive behaviour will no longer be considered normative and acceptable. Legislatures and courts will begin to recognize that making money and protecting the public interest are not mutually exclusive. Modern companies can and should be required to do both. Activists, employees, and other proponents of more socially responsible corporate behaviour will begin to draw attention to corporate anti-social behaviour. Shedding light on this behaviour will become the first step in creating the leverage necessary to change it and act as an additional incentive for directors to follow the Code. -------------------------

[1] See, https://www.codeforcorporatecitizenship.com/post/enforcing-the-code-for-corporate-citizenship. (Hereinafter, Enforcing the Code). [2] The Code is comprised of 28 words to be added to the corporate law. These words balance the duty of directors to act in the best interests of their companies with obligations to not harm the environment, human rights, the public health and safety, the dignity of employees and the welfare of the communities in which the corporation operates. For more on the Code, see www.codeforcorporatecitizenship.com. [3] That is, it should not be allowed to continue after the grace period provided for in the Code. I have suggested that period should be between five and fifteen years (i.e., enough time for a business which is already doing severe harm to either convert its operations to stop the damage or minimize its losses in liquidation.) [4] For a discussion on the amount of damage necessary to be considered “severe” and enforcement of the Code under the Business Judgment Rule, see Enforcing the Code (Note 1 above). [5] See the August 19, 2019 statement by 182 Chief Executive Officers of the American Business Roundtable Statement on the Purpose of the Corporation (https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans.)


*Robert C. Hinkley is a dual Australian American citizen who resides in Berry, NSW Australia. Prior to retiring, he was a U.S. securities lawyer for more than 30 years. His Linkedin profile can be found at https://www.linkedin.com/in/robert-hinkley/.


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