Ideoblog

Discussing universal health care at shareholder meetings

Per the NYT, the SEC has decided that companies must allow shareholders to vote on a proposal for universal health insurance coverage – yet another shift in position on the types of shareholder proposals firms must allow.

This sort of proposal was allowed in NYCERS v. Dole Food Co., Inc. 795 F. Supp. 95 (SDNY), dismissed as moot, 969 F.2d 1430 (2d. Cir. 1992). The issue makes for a great law school hypothetical on the shareholder proposal rule. Health care is, of course, quite significant for most firms, so it’s arguably not just a matter of general social policy, one of the exclusions under the shareholder proposal rule. That would also take it out of “ordinary business.” Of course universal health care is beyond a company’s power to effectuate, but each company can take a lobbying position on this issue. But a company’s lobbying position would seem to get back to ordinary business. . . .

A better approach would seem to be common sense. Look, folks, this is no more a part of a shareholders’ meeting than the Iraq war, right? But the whole business of shareholder proposals doesn’t really lend itself to common sense.

Perhaps an even better approach is to eliminate the issue of whether a corporation needs to subsidize shareholder proposals by making them dirt cheap – e.g., through an internet chatroom type arrangement. The SEC is moving in this direction, but there are many logistical issues.

The best approach of all, which I’ve advocated all along, is simply to get the SEC out of the business of reviewing shareholder proposals. What gets discussed at a shareholder meeting should be a matter of state law and, if enabled by state law, the company’s charter. The domain of the securities laws stops at accurately disclosing the company’s rules.

Sure, this would mean that companies would have a selfish incentive not to allow discussion of socially important matters. But they are, after all, private companies, aren’t they?

Update: Bainbridge suggests that "[c]ourts should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares.." Otherwise, he says, forcing the corporation to discuss this is

a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soap-box to disseminate their views.

I'm sympathetic with the conclusion, but if we're going to get all constitutional about it, I think the appropriate analysis is forced speech under the First/14th amendment, and I'm not sure reifying the corporation is the right approach. See my Corporate Governance Speech and the First Amendment, 43 U. Kans. L. Rev. 163 (1994) (with Butler), a chapter in our Constitution and the Corporation.

As for Steve's proposed rule, I wish it were that simple. Though I side with Steve, opponents would argue over what a "reasonable shareholder" would want. Since people are going to disagree, it's important to get the institutional framework right. As I've said, it's a state law issue.

Dealbreaker wisely comments:

The capture of so many arms of our government--party machinery, congressional committees, regulatory agencies--by lobbyists for special interests is well-known, and is viewed by many as a serious threat to democratic legitimacy. Probably the beset that can be said is that competition between special interests often act as a kind of check-and-balance mechanism. These shareholder proposals about universal health are also likely to be captured by special interests, especially labor unions acting through labor dominated pension funds. Handing control of corporate lobbying efforts over to these interests could remove the check-and-balance aspect of corporate lobbying.

Mars-Wrigley and social responsibility

Steve Davidoff does his usual careful analysis (see also ATL) of the Mars/Wrigley deal. He’s surprised that after the string of broken private equity deals a deal like this (a strategic transaction done as private equity) wouldn’t explicitly provide for specific performance, instead of allowing an out with a reverse termination fee.

I’m speculating that it has something to do with this provision in the agreement, which Davidoff quotes:

(b) Following the [Merger], [Mars] . . . will conduct its business and operations as a separate, stand-alone business unit operating under [Mars]. . . . . (d) Following the Effective Time, [Acquired Wrigley Co.] shall continue with civic and charitable activities and contributions that, in the aggregate, are at the level and of the general nature consistent with past practice of [Wrigley].

In other words, Mars – or more precisely its shareholders – may have traded deal security for social responsibility. Perhaps, to be more precise, the Wrigleys recognized that the social responsibility provisions are fragile, and wouldn’t be honored if the Mars folks weren’t very comfortable with the economics. So if they’re not, let them back out rather than move the company.

Remember, it was the Wrigley family that kept night baseball out of Wrigley Field, put all those shrubs on the wall, and maintained their flagship building as a spotless and glowing anchor on the Magnificent Mile. Shlensky v. Wrigley, 95 Ill. App. 2d 173, 237 N.E.2d 776 (1968) famously said that Wrigley could sacrifice gain (or at least short-term gain) over the objection of Cubs' minority shareholders. Now the Wrigleys may have done that to some extent with the public shareholders in Wrigley.

On the other hand, it’s also important to remember that Mars is buying and maintaining a brand, the value of which depends partly on those “civic and charitable activities.” So this isn’t a straight outflow of cash. It's not at all clear to me that Federated did well with its hard-headed decision to slap the Macy's name on Marshall Field.

In short, the Mars/Wrigley deal is a great example of the hazy nature of the line between social responsibility and profit. For more on that, see my Accountability and Responsibility in Corporate Governance, which discusses Shlensky among other famous CSR examples.

Whatever the reason, I'm happy as a Chicagoan that we'll still have the Wrigley Building.  Though I would have probably kept calling it that whatever Mars did.

The market for altruism

Todd Henderson and Anup Malani’s Corporate Philanthropy and the Market for Altruism takes an interesting approach to the appropriate extent of corporate philanthropy – why not just look at this as one of the products the firm sells? Here’s the abstract:

The existing literature on corporate philanthropy asks why corporations engage in philanthropy. But corporations are not alone in doing good works. Non-profit charities and the government also lend a hand. Together the three sectors compete in a larger market for good deeds where individuals seek to satisfy their desire to help others. The existing literature on public goods ignores the role for-profit firms play in this market, which we call the market for altruism. Once the demand and supply for altruism is understood, asking why firms are philanthropic becomes about as meaningful as asking why Ford produces the Explorer or Apple produces the iPod Nano. Instead the question becomes how is this market different from other markets, and when are for-profit corporations best suited to supplying it. The market for altruism is special because one of the competitors - the government - also regulates competition in the remainder of the market. After analyzing the market for altruism, and explaining the comparative advantages of corporations, this paper highlights one area - tax policy - in which the government discriminates among competitors. We argue that this discrimination is not justified and propose a number of tax reforms to level the playing field and improve the efficiency of the market for altruism.

My Accountability and Responsibility in Corporate Governance also discusses what I call “markets for social responsibility.” But I have a somewhat different perspective from Henderson & Malani. I show that the existence of these markets drastically narrows the issue of the extent to which corporate governance needs to be reformed to make firms more "socially responsible." In other words, I look at the demand side of the altruism market, while Henderson & Malani look at the supply side. Either way, I think it's a productive new way to look at an old topic.

The false promise of reforming one-share-one-vote

Grant Hayden and Matt Bodie have a new paper, The False Promise of One Share, One Vote. Here’s some of the abstract:

Political democracies typically tie the right to vote to the level of a person's interest in the outcome of the election. Corporate democracies, on the other hand, tend to define the requisite institutional interest quite narrowly, and thus restrict the right to vote to shareholders alone. This restriction has found its justification in the assumption that shareholders have a homogeneous interest in corporate wealth maximization. Such homogeneity, it is argued, maximizes efficient preference satisfaction. This assumption of shareholder homogeneity is false. It is becoming increasing clear, for example, that shareholders have many different types of interests in a corporation. * * * As a result, corporate voting schemes are sterile reflections of their more robust political counterparts. The Article argues that corporate law scholars should acknowledge the weaknesses of shareholder voting theory and should examine new ways of translating the preferences of corporate participants into a governance structure.

The basic problem with this approach is that it doesn't clarify what's at stake.  So I'll briefly do that here.

To begin at the beginning, corporations are not in any sense political institutions. They are contracts in the general sense that they are the market expressions of individual preferences. This is not a normative statement of what should be; it is a positive statement of what is. Investors express their preferences by buying shares in firms that let shareholders vote by the amount of their capital contributions and not according to, for example, how much they care about the outcome. Entrepreneurs could form and have formed firms with different voting rules. Indeed, I’ve argued at length that many firms could be and are structured with minimal shareholder voting rights. See Rise of the Uncorporation. But one-share-one-vote is currently the standard form that the market prefers for publicly held firms.

Perhaps we would have a better society if the rules were different. Maybe the current rules, for some reason, don’t reflect investors’ actual preferences, as Hayden and Bodie argue. I doubt it, but let’s admit the possibility. In that case, maybe you want to change the rules. But you would have to make quite drastic changes, as I argue in Accountability and Responsibility in Corporate Governance. There I show that you can get a lot of what passes for “social responsibility” under the current system.

The problem for the reformer is that if the market likes one-share-one-vote and you keep the market system, the market will go elsewhere or into other types of contracts if you outlaw this voting rule. You might allow alternative standard forms (e.g., the new North Dakota statute), but it's possible nobody will use them. So if you want real change, you might need to have a general federal law that mandates that capital-raising of a specified type (now what, exactly, would that be?) has to be done under your new voting rule. Or maybe a world-wide rule, because as we saw with SOX investors have plenty of places to go outside the US.

Maybe Hayden and Bodie are saying that the current system does not allow investors to enter into their preferred contracts. In other words, they may be for deregulating the corporate form. It's not clear to me what, exactly, they want.  I only know that if you don't start from the premise that we now have a market in which individual preferences are expressed, you're going to end up in the wrong place.

Social responsibility and the closely held firm

Corporate social responsibility theorists focus their attention on publicly held corporations. They argue among other things that these firms are irresponsible because their owners are morally disengaged from the consequences of their investments. Thus, they say, public corporation governance should be fixed to make these firms more responsible, as by giving more power to managers. Close corporations, they say, do not present comparable problems.

In Accountability and Responsibility in Corporate Governance I refute these arguments, noting among other things the many market and other pressures on public corporations that serve to align shareholder and social wealth. Along the way I argue against a distinction between closely and publicly held firms on social responsibility grounds.

As SOX and other pressures drive more firms to become closely held, we may get a test of these ideas. In the meantime, today’s WSJ discusses a firm that’s always been closely held – Hunt Oil.

Hunt is engaged in a little project in Peru – namely, to drill in the rainforest for natural gas, build a pipeline across the Andes to a plant that would freeze it into liquid, then ship the lng to North America and Asia for sale. Hunt also managed to change Peruvian oil regulation to promote exports.

The article notes that Hunt could do all this because it was privately held. As the article concludes:

Hunt has more plans for Peru, which has opened wide swaths of the Amazon for oil-and-gas exploration. The company plans to explore for oil in a part of the Peruvian rain forest abandoned earlier this year by another oil major, ConocoPhillips. Conoco pulled out under pressure from Achuar Indians, who protested at the company's Houston headquarters wearing traditional robes and headgear and lobbied shareholders with the help of Amazon Watch, a U.S. environmental group. "We aren't interested in operating counter to the interests of the [local] population," says a ConocoPhillips spokesman. Such tactics won't work with Hunt, Ms. Phillips, the Hunt vice president, told Amazon Watch in a fall teleconference. Hunt has no public shareholders.

At some point the critics of corporate social responsibility and the advocates of stricter regulation of corporate fraud may look at a landscape dominated by private firms and uncorporations and wonder if they had been working at cross purposes.

Partnership social responsibility

Gordon Smith notes that William Draper Lewis, a principal drafter of the Uniform Partnership Act, described an argument against the entity theory of partnership as based on "the effect of the theory in lessening the partner’s sense of moral responsibility for partnership acts." Gordon suggests that it is "odd" to think that lessening moral responsibility would "emanate merely from a change in the nature of the partnership relationship, rather than any change in actual liability risk."

In fact, many modern corporate social responsibility theorists seem to me to be making precisely this argument. In other words, they argue that shareholders' ability to say that the "corporation" – a separate thing – committed the act, helps them avoid at least the feeling of responsibility. Among the more notable proponents of this view are Joel Bakan, The Corporation (2004); Ralph Estes, Tyranny of the Bottom Line (1996); Lawrence Mitchell, Corporate Irresponsibility:  America's Newest Export (2001); Einer Elhauge, Sacrificing Corporate Profits in the Public Interest, 80 N.Y.U. L. REV. 733 (2005).

I don't think these writers would view limited liability as determinative. After all, if exposing owners to a bit more pocketbook risk would take care of the problem, why would you need a "moral" argument for social responsibility?

Ironically, from a practical rather than moral standpoint, entity may be more conducive to social responsibility than aggregate characteristics. I've argued that partnership-type incentive devices make managers more attentive to the bottom line and reduce their practical ability to engage in non-profit-maximizing social responsibility. See Accountability and Responsibility in Corporate Governance, 81 Notre Dame Law Review 1431 (2006), online version. Indeed, the original title of that article was the ironic "Partnership Social Responsibility."

Conversely, entity features such as locking capital in the corporation and putting control in non-owner managers effectively enable social responsibility in large firms. For example, manager power is at the heart of Blair & Stout's "team production" theory of corporate governance. Margaret M. Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 VA. L. REV. 247 (1999).

So Lewis may have had the relationship between entity theory and social responsibility exactly wrong, but he's got a lot of modern company.

The Wal-Mart approach to social responsibility

Michael Vandenbergh has published The New Wal-Mart Effect: The Role of Private Contracting in Global Governance, 54 UCLA Law Review 913 (2007). Here’s the abstract:

This Article argues that networks of private contracts serve a public regulatory function in the global environmental arena. These networks fill the regulatory gaps created when global trade increases the exploitation of global commons resources and shifts production to exporting countries with lax environmental standards. As critics of trade liberalization have noted, public responses often are inadequate to address the attendant environmental harms. This Article uses empirical data to examine how private contracting regulates firm behavior, focusing on supply-chain contracting. The Article shows that more than half of the largest firms in eight retail and industrial sectors impose environmental requirements on their domestic and foreign suppliers. This contracting, which the Article terms "the new Wal-Mart effect," reduces externalities by translating a complex mix of social, economic, and legal incentives for environmental protection into private contractual requirements.

I’ve argued, in Accountability and Responsibility in Corporate Governance (relying partly on Vandenbergh’s earlier work, as well as the work of many others) that these kinds of market and contractual mechanisms are part of the reason why we shouldn’t drastically overhaul corporate governance to make firms more socially responsible.

The corporate governance industry under new ownership

The WSJ discusses ownership changes at Glass, Lewis, now owned by a firm with ties to the Chinese government, and ISS, acquired by RiskMetrics Group Inc., which is considering an initial public offering.

The article notes that ISS both rates and consults, and wonders whether public owners might want to side with management in order to boost clientele.

"The question is, will the short-term needs of shareholders for value influence the voting policies of ISS?" said Richard Ferlauto, director of pensions and benefits for the American Federation of State, County and Municipal Employees, a union group. AFSCME doesn't use ISS recommendations in its voting decisions.

It isn't only shareholders who are concerned. Last year, Rep. Richard Baker (R., La.) asked Congress's investigative arm to look into the proxy-advisory business, mentioning concerns about conflicts of interest. Also, a panel appointed by the New York Stock Exchange asked the exchange to request regulators take a closer look at the industry last year.

These ownership changes will have the side benefit of bringing new scrutiny to the corporate governance industry, which now wields enormous clout because of its perceived ability to discipline agency costs, but in fact brings in another group of agents.

From another perspective, the evolution of corporate governance firms sheds some light on another industry. Can you think of another type of firm where we might be concerned about potential conflicts between owners’ and customers’ interests? If ISS can go public, why not Sullivan & Cromwell?

The Milton Friedman Choir

Check it out.

Corporate reform and the race to dystopia

Gordon Smith has a wonderful new paper on corporate social responsibility, The Dystopian Potential of Corporate Law. Gordon argues, as he says in the abstract, that

changes in corporate law cannot eradicate poverty or materially change existing distributions of wealth, except by impairing the creation of wealth. Changes in corporate law will not clean the environment. And changes in corporate law will not solve the labor question. Indeed, the only changes in corporate law that will have a substantial effect on such issues are changes that make the world worse, not better.

This is very much in sync with my own work, Accountability and Responsibility in Corporate Governance. There I outline the specific alternatives of moving toward more, or less, manager accountability to shareholders. Like Gordon, I believe that less accountability is likely to lead, not to some utopian prospect of "socially responsible" firms, but to higher agency costs and less social wealth.

The corporate debate is not (as many would like to think) between those who like poverty and wealth disparities and those who don't.  In a general sense, everybody in the corporate debate thinks the law should strive, in some general sense, to maximize social wealth. Gordon's contribution is to show how profoundly we will miss that goal if we fail to think realistically about how to get there.