Contracting into social responsibility

Geoff Manne, guesting on Conglomerate, has an interesting post on a new British business form called the Community Interest Company, which essentially lets firms contract into social responsibility by restricting (though not prohibiting) dividends. As Geoff points out, this form of business at least makes the contract clear, as well as providing a way to “brand” social consciousness. 

This relates to a recent discussion between Bainbridge and Cowen on social responsibility, on which I briefly commented, as well as to my paper, Accountability and Responsibility in Corporate Governance (new draft recently posted). As I argue in that paper, it’s necessary to distinguish between how managers ought to behave and the legal rules of corporate governance that regulate their behavior.

I point out that “there is no question whether the parties to the firm may contract to take society’s interests into account.” The question I focus on in the paper is whether firms should be able to restrict managers’ discretion serve non-shareholders’ interests. 

In fact, that’s not much of a question under current law because managers have so much discretion under the business judgment rule even apart from whether the needs of society ought to restrict this discretion.  But the csr debate might heat up if firms effectively could opt into partnership type forms that bound managers to distribute much of the firm’s cash.

One might call my partnership option an “anti-social-responsibility” form. The CIC is a sort of “pro-social-responsibility” standard form.  The CIC clarifies, consistent with my paper, that the key csr question concerns the extent of managers’ control over the cash.  In a standard publicly held corporation, managers significantly control corporate cash subject only to shareholders’ fairly weak voting, selling and fiduciary rights.  In a CIC, the managers have even more control over the cash.  In my partnership form, the managers would have less.

Geoff poses an interesting question about the effect of CIC legislation: “If corporate directors want to maximize something other than shareholder interests, let them. But why not also make them (permit them to?) identify their organizations accordingly.”  In other words, would a jurisdiction with a CIC effectively prohibit non-CIC’s from acting like CIC’s?   Actually, I doubt it, again because of the difficulty of forcing managers to maximize shareholder wealth under the current corporate rules. 

This suggests that the main effect of opting into the CIC form is that the governing statute would then limit the extent to which the firm's governance ever could be changed through a takeover or similar device to restrict the manager’s control over the cash.  In other words, the CIC could be seen as a form of anti-takeover device.  Such a device could be useful to incumbent managers if my suggested partnership form ever becomes a realistic tool for forcing more accountable management.

Comments

[geoff manne]

You wrote:

This suggests that the main effect of opting into the CIC form is that the governing statute would then limit the extent to which the firm's governance ever could be changed through a takeover or similar device to restrict the manager’s control over the cash. In other words, the CIC could be seen as a form of anti-takeover device. Such a device could be useful to incumbent managers if my suggested partnership form ever becomes a realistic tool for forcing more accountable management.

This is a fantastic point, and I didn't even begin to think of it. As you must realize, in order to maintain the modified nondistribution constraint, one of the restrictions on the CIC form is that its assets may not, upon dissolution, be distributed to investors -- a fact which would seem to further bolster your anti-takeover point.

[Larry Ribstein]

That is interesting. I'm going to have to study this whole thing more closely. Thanks for bringing it up.