- Robert Hinkley
The Goal of Corporate Reform
29 September 2021
Over the last 50 years there has been a significant change in how corporations are perceived. Recently, that change has become more pronounced. In the 1970s, 80s and 90s making money was all they were expected to do. Today, they are looked upon with much more scepticism.
A significant amount of momentum has built up to rein in corporate pollution and other abuses of the public interest. The American Business Roundtable recently announced an expansion of its view of the purpose of the corporation. No longer just to make money for shareholders, 182 CEOs said they now consider the interests of other stakeholders including, the environment, employees, customers, and the communities in which they operate as well. More than $30 trillion is now said to be invested under socially responsible criteria. Business schools now teach that consideration of environmental, societal, and corporate governance (ESG) are important factors for management to consider.
While welcome, these developments aren’t stopping the emission of greenhouse gases or the onset of global warming. Other abuses of the public interest continue as well.
Big business talks a much better game than it is playing. The public relations extolling its social responsibility exceed its actual performance. The need to rein in corporate anti-social behaviour persists. The question is to find a way to do it effectively.
That is easier said than done. Not all corporate anti-social behaviour is the same. Some harms the environment. Some employees. Some customers and some our communities. Not all raises the same level of concern. Some threaten our future existence. Some is just unfair. People in one area of the world are willing to put up with more of it than people in others. The solution that satisfies voters in one jurisdiction won’t necessarily be acceptable to voters in others. These variables make restricting corporate abuse of the public interest incredibly difficult.
A Model to Follow
Existing law provides a model for regulating corporate behaviour.
Corporations wouldn’t exist if governments didn’t pass corporate laws providing for their existence and operation. These laws regulate, among other things, how companies raise money and the obligations of the people (e.g., directors and officers) running them to the people who provide the funds (e.g. shareholders). Management must use its best efforts to act in the best interests of the company (and its shareholders).
This law makes management responsible to investors. If management doesn’t act in the shareholders’ best interests, the possibility exists of investors suing the managers for damages. It’s here that something the courts call the business judgment rule intervenes.
Courts recognize that not every business decision turns out to be profitable. Some are honest mistakes and result in losses. They realize that if shareholders were entitled to sue every time a company lost money, the courts would end up spending 100% of their time entertaining business disputes. Judges would end up substituting their judgment for directors’, without having the benefit of the directors’ expertise.
Recognizing this would neither be a productive use of their time nor necessarily enhance the public interest, courts adopted the business judgment rule, a rule that says managers are presumed to have acted in good faith and their decisions are generally not subject to judicial review. For a court to intervene, there must be some allegation of self-dealing on the part of a director or the board (i.e., a specific showing of bad faith).
The duty of directors to act in the best interests of the company and the business judgment rule together provide a good example of a regulatory regime that works well all over the world. The law sets out an aspirational goal—management’s job is to make money for investors. It then says that investors can only enforce this rule in cases where the violation has been severe and clearly against the both the letter and spirit of the goal. Directors have wide latitude to make decisions, but this doesn’t include stealing.
Corporations are provided by government to be an effective way for investors to aggregate capital in the pursuit of a business venture. They’ve been around for more than 400 years. In the last hundred years, they have become incredibly successful. Many have grown to the point where they earn more in revenues each year than all but the largest countries achieve in gross domestic product.
We have governments because inevitably citizens infringe on each other’s rights. When the parties can’t resolve the matter themselves, then government is often called upon to sort it out. Governments also pass legislation making certain behaviour illegal to punish parties who violate the law and discourage others from committing the same offence.
Corporations aren’t people, but they enjoy the same freedoms as people and use those freedoms to infringe on the rights of others. In several ways they are worse. Their actions represent the actions of hundreds (sometimes thousands) of people working together backed by huge amounts of capital. This makes the damage they cause many times worse than the damage an individual human being can cause acting alone.
Even worse, they have no conscience. Under existing law, managers owe a duty to their company and its shareholders, but they have no obligation to protect the public interest.
This is a flaw. Corporations have all the rights of citizenship but bear none of the obligations. Someone recently mentioned to me they’re like children who’ve had no schooling in civility.
Their dedication to self-interest and lack of conscience and civility is the source of all anti-social corporate behaviour. The former encourages abusive conduct. The lack of the latter keeps managers from putting the brakes on, reducing the damage they know they are doing to the environment, people, and our communities.
Governments all over the world enact legislation to rein in the abuse. Too often, such legislation is a compromise between lobbyists for the industry and the public interest. Rather than eliminate the abuse, they limit how much is permitted. Further, one jurisdiction might enact limiting legislation, but its next-door neighbour will not. Business regulation thus becomes a hodgepodge of “where and how much” rules which move corporate anti-social behaviour around the globe, but overall accomplish little else.
The other side of business regulation is its effect on the economy and jobs. Too little regulation and the public interest is destroyed. Too much and the economy declines and too many jobs are lost.
People in different places sometimes have different views on the proper balance between protection of the public interest and promoting the economy. The level of concern in one country might not be as high next door or across the world.
Drawing the Line
“Where and how much” legislation isn’t inherently bad. In most cases, people should be able to make most decisions locally concerning the acceptable level of corporate abuse of the public interest.
We now know a lot more now about corporate behaviour and the damage it can cause than we did 150 years ago (when the currently existing law was originally adopted). For example, we now know that certain forms of corporate abuse are endemic to industries rather than individual companies. Sometimes they generate damage in one jurisdiction that is experienced in others. In these cases, the adverse effect isn’t limited to being local. It’s global. Sometimes the collective damage is so destructive that no company anywhere should be permitted to contribute towards it. It’s time to draw the line.
Let’s divide all corporate abuse of the environment and public interest into two groups: Severe (the most destructive which should never be tolerated) and Not Severe (everything else). By way of example, I’ll offer two examples of what I believe should fall into the Severe Category: the emission of greenhouse gases in significant quantities and the mass manufacture and marketing of tobacco. The first example is threatening mankind’s continuing existence. The latter kills upwards of 8 million people every year.
By separating abuse into two categories, Severe and Not Severe, corporate anti-social behaviour can be regulated much as is the existing duty of directors to serve their company and its shareholders. The aspirational goal should be for corporate managers to eliminate all anti-social behaviour. The business judgment rule should intervene to protect management from all but the most extreme examples of it, that in the Severe Category.
Companies that historically have had business operations which create Severe damage will be told those operations must either: (i) stop entirely or (ii) be converted to businesses which no longer cause Severe damage. A change in the law of this magnitude cannot fairly be enacted on Tuesday and take effect on Wednesday. Companies should be given a short grace period, from five to fifteen years, to make the transition.
There is a temptation for corporate reformers to make a systems change which will turn corporate managers into angels and punish all corporate anti-social behaviour. This temptation should be resisted.
Promising to hold managers personally responsible for the acts of their companies is mostly a hollow threat. Corporations act through people. Responsibility for corporation action is almost always diffused. This makes it difficult to hold individual managers and employees legally responsible.
When changing the design of a system (e.g., the corporation), it’s better to first make a small change that causes the most improvement and then look for more minor modifications later. Existing law provides a model. We should focus on eliminating the most extreme cases of corporate anti-social behaviour first.
By dividing anti-social corporate behaviour into two categories, Severe and Not Severe, a relatively simple change to existing law can effectively wipe out the Severe and create an incentive for other companies to become more socially responsible.
The duty of directors should be changed from simply “acting in the best interests of the company.” It’s time for humanity to recognize the damage this dedication of the corporation to the pursuit of self-interest has caused and put a stop to it. Corporations are a tool for human beings to conduct business and manage risk. Their organization shouldn’t include a license to destroy the environment or infringe on the rights of people and/or our communities.
The change which will do the most good will be to change the wording to “acting in the best interests of the company, but not at the expense of the environment, human rights, the public health and safety, dignity of employees or the welfare of the community in which the corporation operates.” I call these words the Code for Corporate Citizenship (the “Code”).
The application of the Code in conjunction with the business judgment rule will eliminate the most severe instances of corporate abuse and encourage all companies to be better citizens. This should be the first step towards reforming corporate anti-social behaviour.