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Abstract

The tension between shareholder primacy and stakeholder capitalism embodies a fundamental debate about the purpose of a corporation. These two perspectives offer contrasting views on whether a company should primarily serve the interests of its shareholders or consider the broader spectrum of stakeholders in its decision-making process, taking into account environmental, social and governance factors alongside financial performance. The Dodd-Berle debate from the 1930s and Milton Friedman’s teachings in the 1970s regarding the purpose of a corporation and the tension between shareholder primacy and stakeholderism have been reinvigorated. On the one hand, ESG considerations have become increasingly important in risk mitigation and shareholder value protection, since externalities are becoming more extreme, requiring urgent coordinated action that cannot be handled by government regulation alone. If not addressed, these issues could create systemic risks impacting all businesses at once. Stakeholder capitalism nonetheless receives criticism for its flaws in capital allocation, unclear measurement and disclosure, lack of accountability, negative impact on financial performance, and distraction from the need for government regulation. Certain extreme situations of stakeholder-centric decisions that cannot be reconciled with value creation for shareholders could potentially constitute a breach of management’s duty of loyalty if they involve self-dealing or conflict of interest situations, resulting in the unavailability of the business judgment rule protection.

Under the current law, a self-dealing situation arises only when it involves a direct financial interest of the manager, but not in cases of indirect or intangible interest where the manager is motivated by her own prestige and reputational benefit (for example, when a director favors a certain constituency group with whom she has a personal alignment or sympathy, when she uses corporate funds to advance an agenda or cause important to her, when she offers corporate support and funding to a party of her political affiliation, or when she makes a corporate donation to a museum or school that will name an exhibition or building after her). In these situations of non-financial conflicts of interests, there should be additional precautions to protect against wrongful use of corporate resources because market forces may not provide a satisfactory solution, as discussed in this paper. In most cases, the market will respond to stakeholder-driven decisions that allegedly destroy shareholder value by stock sales and price declines (exit), through purchase of control (takeovers) or through proxy fights to replace management or advance shareholder proposals (voice). However, in case of controlled companies with dominant shareholders or privately-held companies with no liquidity, the exit, takeover and voice remedies may not be available.

In such circumstances, directors should always conduct a cost-benefit analysis, explain the value created to shareholders from stakeholder-friendly decisions, and disclose in general terms the basis for such decisions. Whenever possible, boards should seek the approval of disinterested directors or shareholders when decisions could reasonably trigger an indirect conflict of interest or personal benefit situation. Without necessarily triggering judicial review under the entire fairness rule, courts should be permitted to review the facts and circumstances, make a proportionality assessment, and require compliance with procedural prophylactic steps. The author advocates for a system that would require managers to engage in good faith attempts to identify all constituencies involved, to quantify and reconcile the impacts on each constituency, and to explain why they believe that a decision favoring a nonshareholder constituency ultimately brings long-term value to the corporation and the shareholders. The author also supports a system of enhanced disclosure whereby the market, in possession of clear and verifiable cost-benefit analysis information, would curb companies and managers taking excessively stakeholder-friendly decisions at the cost of the trading price of their shares. Finally, clarity about the purpose of a given corporation is paramount, and companies should describe in their organizational documents if they intend to serve the interests of stakeholders other than shareholders, and the process by which the board will mediate prospective conflicts between stakeholders and shareholders.

Clear, well-structured, and properly executed stakeholder-friendly decisions will likely create long-term value to shareholders and are germane to the shareholder primacy doctrine, but impulsive, poorly structured decisions taken by managers seeking personal reputation and recognition will often translate into destruction of shareholder value and therefore should be deterred by the law.

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