Restoring Boundaries on Capitalism
Updated: Oct 21
Rather than abandoning capitalism, the Code for Corporate Citizenship will put sensible boundaries on it, making modern business less predatory, more civilized, and more sustainable.
By Robert C. Hinkley
31 March 2022
A limited number of companies are major contributors to global warming and climate change. Governments around the world find themselves powerless to make these companies stop. The companies would not exist if governments did not first give them a license to operate. The purpose of government is to protect the public interest, including the environment. It shouldn’t be helping create companies which may severely harm it.
Suppose corporations didn’t already exist and businesspeople go to government with a proposal designed to make it easier for them to raise capital. They propose a new law establishing business organisations (corporations) whose investors will be shielded from liability to the organisation’s lenders and those that it may harm. What conditions should government put on these new organisations?
The first condition it will impose will be to protect investors from fraud by making sure corporate managers always act in the investors’ best interests. In the law establishing corporations, government dictates that the people running the business must always promote the interests of investors.
Government is also concerned that these new businesses could harm the public interest (e.g., the environment, people, or the communities in which they operate). It considers imposing an additional condition prohibiting companies from causing such harm. Several factors go into its decision, including the likelihood of the perceived threat and whether the damage can be contained through other means. It weighs these factors against its desire to attract new business.
The relative importance of these factors has changed over history. When corporations were new on the scene, government was wary of the unknown. The worry was that these new organisations could later pose a threat to the public interest. Prudently, boundaries were imposed on companies’ inclination and capacity to harm it. Companies which violated these boundaries could lose their charter—their ability to operate as a corporation.
When the Industrial Revolution began to take hold in the last half of the 19th century, governments in America and around the world became excited about the prospects of attracting successful businesses. Earlier fears concerning the threat they posed to the public interest seemed to have been unfounded. The companies of the day weren’t seen as highly destructive. Nobody back then worried that someday a company or industry might heat the atmosphere to the point of changing the climate.
To attract businesses to set up within their jurisdiction, all governments made their laws more business friendly, less restrictive. The previous boundaries which had protected the public interest were removed. Business managers now only had one obligation—to always act in their company’s interest (i.e., by making money and preserving its assets).
Directors still needed to comply with the law, but they had no overriding duty to protect (or, at least, not harm) the public interest. Governments assumed that, if necessary, they could always pass new laws which would contain the damage caused by corporate anti-social behaviour. This assumption turned out to be wrong.
Today’s big companies operate not just locally as they did then, but regionally, nationally, and sometimes globally. They employ modern technology. They combine the effects of thousands of people working in concert backed by billions of dollars of capital. A few do more harm to the public interest in an afternoon than human beings can do in a thousand lifetimes.
Companies also learned they can evade regulation by (i) convincing legislators to not pass new laws or, if that doesn’t work, (ii) moving their operations to places where the public interest is less protected. They learned to lobby and finance campaigns to gain favour with elected officials for the purpose of delaying and frustrating the passage of new laws placing new restrictions on their operations. The result is that government is no longer able to protect the public interest from corporate destruction. In most cases, the best it can do is move the destruction around from this place to the next.
The consequences of government’s decision to create companies without boundaries on their pursuit of self-interest are now plain to see. As companies got bigger, billions were invested in facilities, technology, and products. Later, it became evident that, among other things, those investments funded greenhouse gas (GHG) emissions that are warming the planet to dangerous levels.
Scientists and public interest activists called for emissions to be curtailed. Conferences were held in Rio de Janeiro, Tokyo, Paris, Copenhagen, Glasgow and elsewhere. Governments from nearly every country pledged to do something about the problem. It has not been enough. Company managers obeying their duty to act in their companies’ interests pulled out all the stops to kill new laws which would require the companies to stop.
SRI and ESG
The emission of GHGs is just the most pressing example of corporate anti-social behaviour which causes severe harm. There are others, including tobacco companies kill millions of people a year, sweatshops in the lesser developed world, millions of employees in America and elsewhere being paid less than a living wage, and social media companies which follow business models that tear our communities apart.
Recognising the inability of government to eliminate the destruction caused by big corporations, two new movements recently arose to get companies to change their behaviour voluntarily. First on the scene was socially responsible investing (SRI). The thought was that, if government couldn’t get the job done, maybe investors could. Maybe corporate anti-social behaviour could be arrested by withholding funds from destructive businesses and/or investing in socially responsible businesses. From a few mutual funds twenty years ago, SRI investment managers now claim to have more than $30 trillion under their management.
Another idea was to convince business leaders to voluntarily run their businesses with a view towards lessening their environmental and societal impact and improving corporate governance (sometimes referred to as the ESG movement). Unheard of less than twenty years ago, every business school now teaches it, and every major company has a separate department responsible for making sure the company at least pays lip service to it.
Both SRI and ESG are based on the premise that business should do good while it is doing well. There’s nothing wrong with that. Indeed, it’s the way capitalism should work.
However, so far SRI and ESG have only been able to pick the low hanging fruit. They focus on anti-social behaviour which business is willing to change voluntarily at relatively little expense. They avoid confronting more serious behaviour which they know (because of the greater expense) business won’t change unless it is required to by law.
The reason for this is simple. Both movements are comprised of businesses themselves. There is plenty to be gained by selling investors, students, and businesses on the idea of improving corporate behaviour. There’s no profit in trying to get government to change the law to make corporations less destructive.
Under current law, companies that emit great quantities of GHGs will never voluntarily stop. Their directors are bound by a law which says they have a duty to serve their company’s best interests. These companies are heavily invested in facilities, technology, and products which burn fossil fuels. Stopping will force the companies to write down these investments and recognise billions of dollars of losses. How can taking that step voluntarily be in the best interests of the company? Simply put, it can’t.
Business should never cause severe harm to the environment or another element of the public interest. The assumption under which the corporation was redesigned a century and a half ago, that corporations could be set loose with no obligations to protect the public interest at all and their abuse could later be contained by new laws alone, is no longer true. It’s time for this assumption to be reassessed, and changes made to reflect current reality.
The solution lies not in cajoling managers to ignore their legal obligations to act in their companies’ best interests. Nor does it lie in trying to pass new legislation in the face of strong corporate opposition. The solution lies in putting boundaries on the mission of managers to always act in their companies’ interests. An overriding duty of corporate directors to protect the public interest needs to be restored.
When a company finds itself in the unfortunate position of causing severe harm, the law should make it clear that pursuing the company’s self-interest is no longer the directors’ priority. At that point, their priority should shift to eliminating the harm by rapidly modifying or closing the company’s operations that are causing it.
Corporate obligations to safeguard the public interest might not have been necessary a century and a half ago, but they are necessary today. Shifting directors’ allegiances from shareholders to the public interest when their company is found to be causing severe harm is not all that different from what happens in a bankruptcy when their allegiances shift from shareholders to creditors. Directors are expected to stop causing the harm and start looking after the interests of those that it has harmed.
Changing the law to include this shift will make directors more cautious with the environment and other elements of the public interest. It will also make them less likely to deny the harm their company is causing and to interfere with the passage of new legislation trying to stop it.
The shift can be achieved without volumes and volumes of new laws and regulations. I believe it can be achieved by adding only 28 words to the existing duty of directors to “[always] act in the company’s best interest.” Those words are:
“BUT NOT AT THE EXPENSE OF THE ENIVRONMENT, HUMAN RIGHTS, THE PUBLIC HEALTH AND SAFETY, DIGNITY OF EMPLOYEES OR WELFARE OF THE COMMUNITIES IN WHICH THE COMPANY OPERATES.”
I call these words the Code for Corporate Citizenship (Code). The Code would dramatically change the mindset of business by making it clear to directors that their companies must not cause severe harm to the environment and four other elements of the public interest. If their companies go beyond this boundary, their obligations to the company will be subordinated to obligations to safeguard the public interest.
The Code will be enforced in a like manner to the way existing law to “act in the best interests of the company” is enforced. This will include application of the business judgment rule so that courts only hear cases involving corporate anti-social behaviour which causes severe harm to the public interest. See: Enforcing the Code for Corporate Citizenship at https://www.codeforcorporatecitizenship.com/post/enforcing-the-code-for-corporate-citizenship.
For all companies formed after the Code becomes effective, directors will understand that, from the date of incorporation, their company must not cause severe harm and that there will be dire consequences if it does.
The Code will have differing effects on existing companies depending on the whether they are already causing severe damage to the public interest. It will have a major immediate effect only on the companies which are already causing severe harm. I’d suggest that this initially be limited to companies that are contributing significantly to the worldwide emission of GHGs, starting with power generators and motor vehicle manufacturers that rely on the burning of fossil fuels. The Code and accompanying legislation should force these companies either to quickly (i.e., in no more than 10 to 15 years) convert to alternative energy sources or otherwise eliminate their GHG emissions.
For large companies which are not yet causing severe harm, the Code will act as a warning. To avoid the consequences of violating the Code, directors and senior managers of these companies can be expected to monitor their operations and take steps to reduce the possibility their companies cause severe harm in the future. The SRI and ESG movements will help them mitigate that risk.
For the vast majority of companies which are not harming the public interest because they haven’t the size or capacity to cause severe harm (e.g., small locally operated businesses), the Code will impose no additional regulatory burden at all.
The time for businesses that cause severe harm to the environment, people, and our communities is past. Corporations only exist because government allows them to be created and gives them a license to operate. That license should never be used to inflict severe harm on the very things government is formed to protect.
Enacting the Code is the key to eliminating corporate anti-social behaviour which does severe harm and is now threatening our existence. Rather than abandoning capitalism, the Code will put sensible boundaries on it, making modern business less predatory, more civilized, and more sustainable. The world will be much the better for it.
Robert C. Hinkley is a retired American corporate lawyer and former partner in two of the world’s largest law firms. He has been an advocate for better corporate citizenship for more than two decades. His book, Time to Change Corporations: Closing the Citizenship Gap, is available on Amazon (https://www.amazon.com.au/s?k=time+to+change+corporations+closing+the+citizenship+gap&crid=VPLGO0CWVSA&sprefix=time+to+change+corporations+closing+the+citizenship+gap%2Caps%2C242&ref=nb_sb_noss) . More on the Code can be found at his blog: www.codeforcorporatecitizenship.com.