By Jerald Howe for Law360
Law360 (September 13, 2021, 6:26 PM EDT) — Environmental, social and corporate governance factors are becoming increasingly important to investors, legislators and regulators. In this Expert Analysis series, in-house counsel share how they are adapting to the evolving ESG landscape.
Legal opponents of the Business Roundtable‘s “Statement on the Purpose of a Corporation” have launched renewed attacks with its anniversary. On Aug. 19, 2019, the Business Roundtable’s statement was signed by hundreds of CEOs, including my own company’s CEO, committing the backing companies to run themselves “for the benefit of all stakeholders — customers, employees, suppliers, communities and shareholders.”
Representative of the fierce opposition to this idea are two pieces timed to coincide with the statement’s second anniversary: Donald Kochan’s Aug. 19 article in The Hill, headlined “The Purpose of a Corporation is to Seek Profits, not Popularity,” and Lucian Bebchuk and Roberto Tallarita’s Aug. 18 article in the Wall Street Journal, titled “‘Stakeholder’ Talk Proves Empty Again,” encapsulating a longer study.
From the perspective of this public company general counsel and student of economic history, such attacks are fundamentally flawed and display a serious misunderstanding of contemporary investor priorities and dynamics.
When Kochan mentions popularity he is unmistakably referring to the momentum gathering behind environmental, social and governance initiatives as an essential element of stakeholder capitalism. How are the Business Roundtable and ESG related?
While the Business Roundtable’s statement technically covers only a portion of the business community, its explicit embrace of stakeholder capitalism offers a framework for ESG efforts by virtually all contemporary corporations. For companies big and small, ESG thinking and connecting with the entire range of stakeholders have become business imperatives. The Business Roundtable’s statement reflects that reality.
Kochan and his fellow critics anchor their thinking in Milton Friedman’s seminal op-ed in the New York Times in 1970, transparently titled “A Friedman Doctrine — The Social Responsibility of Business Is to Increase Its Profits.” But reread with care and properly comprehended, Friedman’s article actually supports the Business Roundtable’s statement under present market conditions.
The Nobel laureate based his thesis in the law and economics of agency, with shareholders as principals and management as agents. The crux of his contention was that:
In a free enterprise, private property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.
To be fair to Friedman, he offered an immediate caveat: The principals of a corporation with an “eleemosynary purpose — for example, a hospital or school” might not want to maximize profits, but to deliver certain social services. Regrettably, Friedman never addressed the third logical possibility, that a corporation’s owners might have objectives lying somewhere between the two extremes of obsessive profit making and sheer philanthropy.
Yet that is exactly where today’s public companies in the U.S. find themselves. Corporate managers are constantly reminded by their shareholders that they demand not only traditional shareholder returns, but also attention to achieving ESG objectives. As agents in Friedman’s construct, these corporate managers follow the directives of their principals, mainly their institutional shareholders, to pursue ESG objectives as well as profits in transparent, measurable ways.
Anyone who doubts this shareholder sentiment should read BlackRock Inc. CEO Larry Fink’s last few annual letters. Corporate boards quite properly amplify such shareholder concerns. Corporate managers then pay attention and get to work on ESG initiatives. No one who purports to embrace Friedman’s agency logic should be complaining.
The Business Roundtable’s critics also contend the statement, and by extension business attention to ESG concerns, is unprecedented and unlawful. In Kochan’s telling, the CEOs “made this shift illegitimately.” Not so.
In the 1950s and 1960s, corporations regularly embraced corporate social responsibility, precisely what Friedman was pushing back against. The law of corporations in the U.S. has never been that corporate executives must exalt profits over all other stakeholder interests.
Virtually all major American corporations have, and have long had, vision and values statements that connect to stakeholders such as customers, employees, communities, etc. That is how companies succeed, make profits and create shareholder value. Further, because capital market forces now demand that public companies adopt good ESG practices, those firms that do not will eventually be disadvantaged in raising capital, with higher capital costs and ultimately lower profits and growth.
In my experience, Kochan is wrong that it is a zero-sum game between shareholders and everyone else, and I doubt it ever was. The Business Roundtable’s statement was “new” in 2019 more by degree or emphasis than fundamentally.
The Business Roundtable critics next argue that even assuming stakeholders other than shareholders should be considered at all, corporate managers should do this only to the very limited extent necessary to honor contracts and abide by applicable laws and regulations. Sounds simple enough. But what contracts and what laws and regulations should they consider?
At any point in time, a corporation is bound by myriad contracts, but at the same time, it is negotiating numerous new ones. What goes into those contracts depends on what objectives the corporation is pursuing.
Similarly, in the American political system, corporations help shape laws and regulations, as well as being governed by them. Indeed, the political gridlock gripping contemporary American politics has necessitated an enhanced role for corporations in broad social governance. Driving ESG initiatives is an integral part of that expanded role for businesses.
The opponents’ last line of attack, in the words of Bebchuk and Tallarita, is to declare that the CEOs who signed the Business Roundtable’s statement have not been “matching the talk with action” or even intending to deliver value to all stakeholders. Instead, they speculate, the CEOs are just hoping to make themselves and fellow “corporate leaders less accountable to shareholders.”
Nonsense. From what I have witnessed, delivering not only growth and profitability but also ESG results requires more, not less, work and shouldering of responsibility by corporate managers. At possible risk of repetition, this broader version of stakeholder capitalism honors, rather than neglects, declared shareholder priorities.
In sum, the Business Roundtable’s statement is conceptually sound precisely because it enjoys support from shareholders. Questions of implementation and execution remain — for example, what mix of ESG initiatives each company will pursue, and how — but as a framework of purpose, the statement is rightfully here to stay.