THE CORPORATE GOVERNANCE MACHINE - Columbia Law Review

The conventional view of corporate governance is that it is a neutral set of processes and practices that govern how a company is managed. We demonstrate that this view is profoundly mistaken: For public companies in the United States, corporate governance has become a “system” composed of an array of institutional players, with a powerful shareholderist orientation. Our original account of this “corporate governance machine” generates insights about the past, present, and future of corporate governance. As for the past, we show how the concept of corporate governance developed alongside the shareholder primacy movement. This relationship is reflected in the common refrain of “good governance” that pervades contemporary discourse and the maturation of corporate governance as an industry oriented toward serving shareholders and their interests. As for the present, our analysis explains why the corporate social responsibility movement transformed into shareholder value–oriented environmental, social, and governance (ESG) standards, stakeholder capitalism became relegated to a new separate form of entity known as the benefit corporation, and public company boards of directors became homogenized across industries. As for the future, our analysis suggests that absent a major paradigm shift that would force multiple institutional gatekeepers to switch their orientation, advocacy pushing corporations to consider the interests of employees, communities, and the environment will likely fail unless such effort is framed as advancing shareholder interests.

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* Associate Professor of Law, USC Gould School of Law.

** Professor of Law, University of Pennsylvania Law School. We thank Steve Bainbridge, Bill Bratton, Chris Brummer, Christopher Bruner, Jill Fisch, Stavros Gadinis, Zohar Goshen, Keir Gumbs, Chris Havasy, Don Herzog, Virginia Harper Ho, Nico Howson, Sue Konzelmann, Da Lin, Ann Lipton, Amelia Miazad, Peter Molk, Gaizka Ormazabal, Mariana Pargendler, Bob Rasmussen, Rob Rhee, Sergio Gramitto Ricci, Wolf-Georg Ringe, Danny Sokol, Leo E. Strine, Jr., Avi Weiss, Andrew Winden, and workshop participants at the Organizations and Social Impact Workshop at Berkeley Law, Foundations of Law and Finance Research Seminar at Goethe University-Frankfurt, Corporate and Securities Law in Society Workshop, University of Florida Levin College of Law, Fordham University School of Law, Corporate Law Academic Webinar Series (CLAWS), LSE-UCL Law and Finance Seminar, University of Texas Business Law and Economics Workshop, Oxford Law and Business Workshop, ECGI and Yale Global Corporate Governance Colloquium, National Business Law Scholars Conference, Wharton Legal Studies & Business Ethics Workshop, and University of Richmond School of Law. We also thank Hayk Badalyan and QC Vu for excellent research assistance.

Introduction

In a time of climate change, racial and economic inequality, and crisis stemming from the global pandemic, corporations are alternately maligned for their conduct and embraced as a solution for change. Observers have increasingly excoriated the traditional view of corporate purpose—that corporations should be managed for the benefit of shareholders and, specifically, to maximize shareholder wealth—as contributing to societal problems. 1 See, e.g., Colin Mayer, Prosperity: Better Business Makes the Greater Good 31–45 (2018) (arguing that shareholder wealth maximization is a fundamentally flawed understanding of corporate purpose). Spurred by this debate, and only two decades after prominent scholars announced “the end of history” in favor of shareholder primacy, 2 Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 Geo. L.J. 439, 440–42 (2001). Scholars have used the term “shareholder primacy” to refer to two different concepts, reflecting the ends and means or purpose and power of corporations: (1) that corporations are, or should be, managed in the interests of shareholders; and (2) that shareholders have, or should have, ultimate control over the corporation. Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U. L. Rev. 547, 573 (2003) [hereinafter Bainbridge, Director Primacy]; Robert B. Thompson, Anti-Primacy: Sharing Power in American Corporations, 71 Bus. Law. 381, 387–88 (2016) [hereinafter Thompson, Anti-Primacy]. We primarily use the term descriptively in the first sense. luminaries in the field are again asking these central questions of corporate law: For whom is the corporation managed? 3 For a sampling of this literature, see generally Lucian A. Bebchuk & Roberto Tallarita, The Illusory Promise of Stakeholder Governance, 106 Cornell L. Rev. 91 (2020); Jill E. Fisch & Steven Davidoff Solomon, Should Corporations Have a Purpose?, 99 Tex. L. Rev. 1309 (2021); Edward B. Rock, For Whom Is the Corporation Managed in 2020? The Debate Over Corporate Purpose, 76 Bus. Law. 363 (2021) [hereinafter Rock, Debate Over Corporate Purpose]. Do fiduciaries owe a duty to maximize shareholder value or may they prioritize the interests of other stakeholders?

We contribute to this important debate by enlarging the aperture. Specifically, we provide an original descriptive account of the “corporate governance machine”—a complex governance system in the United States composed of law, institutions, and culture that orients corporate decisionmaking toward shareholders. We describe the key players in the system and show how the machine powerfully drives corporate behavior and influences corporate regulation.

In so doing, we make three primary contributions. First, we provide a holistic account of the contemporary U.S. corporate governance infrastructure and show how it solidifies corporate purpose as promoting shareholder interests. Although legal academics have generally focused on corporate law as a key determinant of purpose, our analysis reveals that this element may well be the least important: A vast array of institutional players—proxy advisors, stock exchanges, ratings agencies, institutional investors, and associations—enshrine shareholder primacy in public markets. 4 See infra Part II. Indeed, we show the very concept of corporate governance promoted by these players developed alongside the principal-agent model of the corporation, such that “good governance” is often equated with minimizing agency costs in the pursuit of shareholder value. 5 See infra Part I. Professional education, the media, and politics further reinforce this cultural understanding. 6 See infra section II.C.

We also explore examples that demonstrate the machine’s influence over important aspects of public company governance. Corporate social responsibility, for example, was once framed in moral terms as a goal for management irrespective of profit. 7 See infra section I.B. But after several decades of circulation within the machine, the idea of corporate social responsibility has been largely replaced with investor-driven environmental, social, and governance (ESG). Today many companies pursue ESG goals, and many investors favor ESG funds, not for moral reasons or a prosocial willingness to sacrifice profits, but because ESG is thought to provide sustainable long-term value or higher risk-adjusted returns for shareholders. 8 See infra notes 216–226 and accompanying text. This reframing has in turn shaped managerial decisionmaking about the kinds of ESG activity in which corporations should engage. As the corporate governance machine transformed corporate social responsibility into value-enhancing ESG, it has also pushed social purpose beyond this framing into an entirely different form of corporation—the benefit corporation—which we show is also driven by shareholders and their values. 9 See infra section III.C.

Second, we look to the consequences of the corporate governance machine’s workings and posit that its shareholderist orientation is potentially suboptimal. When shareholderism is locked into rules, norms, and power structures, superior governance arrangements from a social welfare perspective may be discouraged or taken off the table. 10 See Mark J. Roe, Chaos and Evolution in Law and Economics, 109 Harv. L. Rev. 641, 648 (1996) [hereinafter Roe, Chaos and Evolution] (explaining how path dependence can “permit structures that were once satisfactory to become inefficient but not be worth changing” due to the high costs of switching). From convergence on one-size-fits-all governance “best practices” to reduced corporate governance innovation, we identify a range of negative implications for corporate law and governance wrought by this system. 11 See infra Part IV. The resulting lack of diversity in governance might fall short of the expectations of contractarian scholars as well as those who recognize that network benefits can accrue from common use and advocate for a menu approach to corporate law. See Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 5, 34 (1991) [hereinafter Easterbrook & Fischel, Economic Structure of Corporate Law] (stating that “[n]o set of promises is right for all firms” and arguing that corporate law’s purpose is to provide efficient default rules that can be customized); Michael Klausner, The Contractarian Theory of Corporate Law: A Generation Later, 31 J. Corp. L. 779, 797 (2006) (“Corporate law can . . . promote innovation and customization by providing menus of alternative governance structures that firms can adopt in standardized form by designating in their charters that they choose to do so.”).

Third, and finally, this “meta” account of the U.S. corporate governance system elucidates much about the path of corporate governance reform and the success of the stakeholder governance movement in particular. At the outset, we show how over the past several decades, law, institutions, and culture have entrenched a shareholder-oriented view in corporate law and governance. Battles over the allocation of power within the corporation occur on policy issues such as proxy access and shareholder proposals, but the larger war has been won. We predict that legal reform and soft law standards will continue to be filtered through this lens, and stakeholder-oriented reforms that are framed as benefitting shareholders will have a chance of survival and indeed, be increasingly embraced. As evidence, recall that the ESG movement took off when it was framed in terms of shareholder value. Consider, too, the evolution in corporate purpose away from share price maximization and toward “long-term shareholder value” or even “shareholder welfare” maximization. 12 See Jesse M. Fried, The Uneasy Case for Favoring Long-Term Shareholders, 124 Yale L.J. 1554, 1565 (2015) (observing that “as a matter of economic theory, the effect of managers’ time horizons (that is, whether managers serve short-term or long-term shareholders) on stakeholder welfare is actually indeterminate”); Frank Partnoy, Specificity and Time Horizons, 41 Seattle U. L. Rev. 525, 533 (2018) (arguing that stakeholder advocates should articulate an optimal time horizon for firm managers to use, as well as the grounds for concluding it is optimal); see also Virginia Harper Ho, “Enlightened Shareholder Value”: Corporate Governance Beyond the Shareholder-Stakeholder Divide, 36 J. Corp. L. 59, 62 (2010) [hereinafter Harper Ho, Enlightened Shareholder Value] (discussing the concept of “enlightened shareholder value” that views attention to stakeholder interests “as a means of generating long-term shareholder wealth and improving portfolio- and firm-level risk assessment”); Ann M. Lipton, What We Talk About When We Talk About Shareholder Primacy, 69 Case W. Rsrv. L. Rev. 863, 866–67 (2019) [hereinafter Lipton, Shareholder Primacy] (discussing how most scholarly discourse equates shareholder primacy with wealth maximization, but recent literature has described it in terms of welfare or values that shareholders determine for themselves). In many ways, these developments soften the hard edges of shareholder primacy, but this evolution is itself a legacy of the corporate governance machine: Those who wish to change corporate decisionmaking are forced to do so within the bounds of shareholderism.

What does this mean for the future of corporate governance? On the one hand, absent a large shock to the system, such as a major federal intervention that would force multiple institutional gatekeepers to change their orientation, 13 Although the COVID-19 pandemic could prove a catalyst, the emerging consensus is that it will not likely result in sweeping change to corporate and securities law. See, e.g., Steven A. Bank & Brian R. Cheffins, Corporate Law’s Critical Junctures,
Bus. Law. (forthcoming) (manuscript at 72–76), https://ssrn.com/abstract=3877329 [https://perma.cc/K8YJ-Z5BN] (“[W]hile the possibility that corporate America will ultimately suffer a reputational black eye due to the COVID-19 pandemic cannot be discounted, as matters stand the culpability that has accompanied previous corporate law critical junctures is absent.”). the corporate governance machine will likely impede a true paradigm shift away from shareholderism. On the other hand, our account reveals how incremental change could take place. As shifts in understanding regarding the merits of various ESG initiatives occur through cultural and market forces, the promotion of stakeholder interests can be reconciled with pursuing long-term shareholder value. For example, institutional investors and asset managers that hold diversified portfolios increasingly recognize the financial benefits of mitigating climate change risk. 14 Madison Condon, Externalities and the Common Owner, 95 Wash. L. Rev. 1, 6 (2020); Jeffrey N. Gordon, Systematic Stewardship 3–5, 24 (Eur. Corp. Governance Inst., Law Working Paper No. 566/2021, 2021), https://ssrn.com/abstract=3782814 [https://perma.cc/4LHL-JT8A] [hereinafter Gordon, Systematic Stewardship]. Likewise, corporate sustainability initiatives can protect undiversified investors against downside risk. 15 Stavros Gadinis & Amelia Miazad, Corporate Law and Social Risk, 73 Vand. L. Rev. 1401, 1410 (2020); Leo E. Strine, Jr., Kirby M. Smith & Reilly S. Steel, Caremark and ESG, Perfect Together: A Practical Approach to Implementing an Integrated, Efficient, and Effective Caremark and EESG Strategy, 106 Iowa L. Rev. 1885, 1888 (2021). To the extent that ESG metrics become easier to measure and disclose, more of such activity might occur and a greater number of investors might support it. Notably, however, this future change is likely to occur through the existing shareholderist model, which limits acceptable rationales and favors activity that can be reduced to measurable metrics tied to risk or financial value. 16 An even greater incorporation of stakeholder interests could occur if shareholders were understood to be individuals with diverse preferences, including ethical and social concerns. See Oliver Hart & Luigi Zingales, Companies Should Maximize Shareholder Welfare Not Market Value, 2 J.L. Fin. & Acct. 247, 270 (2017) (arguing that “shareholder welfare and market value are not the same, and that companies should maximize the former not the latter”). Such an approach would require developing improved means to aggregate shareholder preferences.

Part I traces the historical and intellectual underpinnings of corporate governance and charts its rise alongside the shareholder primacy movement. Part II provides an original descriptive account of the U.S. system of corporate governance and its components, showing how law, institutions, and culture enmesh shareholderism at public corporations. Part III explores how the corporate governance machine works using three examples. It describes how the machine has transformed public company boards, shaped the shift from corporate social responsibility to investor-driven ESG, and led to the development of a new form of business organization—the benefit corporation. Part IV examines the broader implications of this analysis for the debate about corporate purpose and other pressing debates in corporate law. It concludes with predictions about the future of corporate governance.