On August 19, 2019, the Business Roundtable ((The Business Roundtable is an association of CEOs from the leading American companies who work to support and grow the economy of the United States and increase opportunity through its influence on public policy. Bus. Roundtable, https://www.businessroundtable.org/ (last visited Oct. 2, 2019).)) released its “Statement on the Purpose of a Corporation.” ((Bus. Roundtable, Statement on the Purpose of Corporations (2019), https://opportunity.businessroundtable.org/wp-content/uploads/2019/09/BRT-Statement-on-the-Purpose-of-a-Corporation-with-Signatures-1.pdf (last visited Oct. 2, 2019).)) This statement broadly articulates that a corporation’s purpose is to serve the interests of (1) its customers; (2) its employees; (3) its suppliers; (4) its communities, and (5) its shareholders. ((Id.)) The statement concludes, “Each of our stakeholders is essential. We commit to deliver value to all of them . . . .” ((Id.))
The business community focused on this statement, questioning its true meaning: is it a statement in support of stakeholder theory or is it a recantation of shareholder primacy dressed in a pretty bow? ((See, e.g., Alfred Rappaport, How CEOs Can Forge a New Kind of Shareholder Value, Bloomberg (Sep. 4, 2019, 12:31 PM), https://www.bloomberg.com/opinion/articles/2019-09-04/business-roundtable-statement-of-purpose-fails-on-specifics; Andrew Winston, Is the Business Roundtable Statement Just Empty Rhetoric?, Harvard Bus. Rev. (Aug. 30, 2019), https://hbr.org/2019/08/is-the-business-roundtable-statement-just-empty-rhetoric; Council of Institutional Investors Responds to Business Roundtable Statement on Corporate Purpose, Council of Institutional Inv’rs (Aug. 19, 2019), https://www.cii.org/aug19_brt_response; Irving Wladawsky-Berger, The (Updated) Purpose of the U.S. Corporation, WSJ (Aug. 30, 2019, 11:00 AM), https://blogs.wsj.com/cio/2019/08/30/the-updated-purpose-of-the-u-s-corporation/; Jena McGregor, Group of top CEOs says maximizing shareholder profits no longer can be the primary goal of corporations, Wash. Post (Aug. 19, 2019, 6:18 PM), https://www.washingtonpost.com/business/2019/08/19/lobbying-group-powerful-ceos-is-rethinking-how-it-defines-corporations-purpose/.)) More optimistic commentators see the statement as a shift in the corporate mindset equating the interests of all corporate stakeholders. ((Wladawsky-Berger, supra note 5 (“Now shareholder interests are on the same level as the interests of all its other stakeholders, including customers, employees, suppliers, and communities.”).)) Conversely, some—perhaps more cynical—commentators label the statement as “empty rhetoric” that effectuates no real change. ((See Rappaport, supra note 5; see also McGregor, supra note 5 (quoting 2020 presidential candidate Bernie Sanders: “[W]e need more than a public relations stunt.”).))
Whatever is meant by the group of approximately 200 CEOs, their statement clearly reignited the fire underlying the debate between the proper place of shareholder primacy and stakeholder theory within the U.S. corporation. ((Wladawsky-Berger, supra note 5.))
The shareholder-primacy-vs.-stakeholder-theory debate emerged with the Michigan Supreme Court’s decision in Dodge v. Ford Motor Company, which established the mandate for corporations to “focus on shareholder interests above all else.” ((Id. at 220 (citing Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919) ).)) The case focused on Henry Ford and Ford Motor Company’s board of directors’s decision to reinvest the company’s profits back into the company rather than distributing dividends to shareholders. ((Standley, supra note 9, at 220 (citing Dodge, 170 N.W. at 684).)) Aghast by the board’s decision, the Ford Court ruled that the purpose of the corporation is “primarily of the profit of the stockholders.” ((Standley, supra note 9, at 220 (quoting Dodge, 170 N.W. at 684).))
With the Ford decision, shareholder primacy was born. Shareholder primacy refers to the duty of a corporation to maximize the wealth of its shareholders; whereas, stakeholder theory pertains to the role of corporations as focusing on the interests of all its constituency bases—employees, suppliers, communities, etc.—in its decision-making processes. ((Nathan E. Standley, Note, Lessons Learned from the Capitulation of the Constituency Statute, 4 Elon L. Rev. 209, 210 (2012).))
Jumping forward to the 1930s, a “war” of academic scholarship ensued between Adolf Berle and Edwin Merrick Dodd. ((Standley, supra note 9, at 210–11.)) Berle, who took the position of the staunch proponent of the ingrained shareholder primacy theory, purported “that all corporate activity should be evaluated in terms of the extent to which it benefits the company’s shareholders.” ((Anthony Bisconti, Article, The Double Bottom Line: Can Constituency Statutes Protect Socially Responsible Corporations Stuck in Revlon Land, 42 Loy. L.A. L. Rev. 765, 790–91 (2009) (internal citations omitted).)) While Dodd, advocating for the alternative view of stakeholder theory, saw the corporation as serving the public and maximizing its utility. ((Id. at 790 (internal citations omitted).)) There was a resounding agreement among the period’s commentators that Berle’s shareholder primacy prevailed as the leading theory underlying corporate governance. ((Id.))
This debate quieted down for a few decades but returned to the forefront of the public eye when famous economist Milton Friedman fired shots at stakeholder theory, stating: “Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible.” ((Alexander C. Gavis, Comment, A Framework for Satisfying Corporate Director Responsibilities Under State Nonshareholder Constituency Statutes: The Use of Explicit Contracts, 133 U. Pa. L. Rev. 1451, 1451 (1990) (emphasis omitted) (quoting Milton Friedman, Capitalism and Freedom 133 (1982) ).)) Concurrently, the debate over the purpose of the corporation reappeared in the context of the rise of hostile corporate takeovers. ((Standley, supra note 9, at 211; see also Bisconti, supra note 14, 780 n. 113 (“A hostile takeover occurs when an outside party (usually another corporation or a group of investors) makes a bid on the target company without the approval of the target company’s board of directors.”).)) Like in Ford, the courts got involved and decided in favor of shareholder primacy in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., in which the court held that when a corporation is in the process of auctioning itself off for sale, it must maximize value for its shareholders. ((See Bisconti, supra note 14, 778–79 (2009) (citing Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 184 n. 16 (Del. 1986) ).))
States, however, responded to the court’s intervention and reaffirmation of shareholder primacy by enacting constituency statutes to minimize the divergence between “the ‘common benefit of all stockholders’ and the ‘best interests of the corporations’ . . . ” “[w]hen fundamental issues are at stake . . . ” by guiding a corporation’s focus to the interests of its other, non-shareholder stakeholders. ((Standley, supra note 9, at 211–12 (quoting Thomas Bamonte, The Meaning of the “Corporate Constituency” Provision of the Illinois Business Corporations Act, 27 Loy. U. Chi. L.J. 1, 3 (1995) ).)) While the constituency statutes were born in the context of hostile takeovers, many states adopting these statutes crafted their purpose broadly to cover “all corporate decisions.” ((Standley, supra note 9, at 213–14 (indicating that states, such as Pennsylvania and Illinois, have adopted the broadly applicable versions of the statute while Oregon enacted a constituency statute tailored to hostile takeover situations).)) Generally, constituency statutes contain five common provisions that push the stakeholder-theory-based agenda into the minds of the corporate directors:
1. The board of directors of a corporation may consider the interests and effects of any action upon non-shareholders.
2. The relevant non-shareholder groups include employees, suppliers, customers, creditors and communities.
3. The directors may consider both long-term and short-term interests of the corporation.
4. The directors may consider local and national economies.
5. The directors may consider any other relevant social factors. ((Id. at 212 (quoting Bisconti, supra note 14, at 781–82).))
While the last debate over shareholder primacy and stakeholder theory centered around hostile takeovers, its resurrected form has found a new muse: the role of Corporate Social Responsibility (CSR) in the U.S. corporation. ((See Saphira A.C. Rekker et al., Corporate social responsibility and CEO compensation revisited: Do disaggregation, market stress, gender matter?, 72 J. Bus. & Econ. 85, 86 (2014).)) While there are many points of intersection between CSR, corporate governance, and the shareholder-primacy-vs.-stakeholder-theory debate, there has been little attention given to the interplay between these concepts and executive compensation.
Traditionally, courts have had little to say on executive compensation as executive compensation, at its core, is usually an internal matter of the corporation decided by independent compensation committees. ((See Minor Myers, Perils of Shareholder Voting on Executive Compensation, 16 Del. J. Corp. L. 417, 423 (2011).)) The Delaware courts’ application of the business judgement rule prescribes this judicial deferrence. ((See In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 124 (Del. Ch. 2009) (“The business judgment rule ‘is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.’ The burden is on plaintiffs . . . to rebut this presumption.”) (internal citations omitted); see also Bisconti, supra note 14, at 775 n. 63 (“[D]irectors’ decisions will be respected by courts unless the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.”) (quoting Brehm v. Eisner, 746 A.2d 244, 264 n. 66 (Del. 2000) ). A focus is given to Delaware law as most U.S.-based corporations are incorporated in Delaware.)) Despite the courts’ deference, executive-compensation-based lawsuits have emerged challenging large executive compensation packages as waste—the “outer limit” to the business judgment rule. ((See Louis Truong, Note, Say-on-Pay with Bite: Shareholder Derivative Suits on Executive Compensation, 65 Hastings L.J. 1191, 1215 (2014) (“[T]he Delaware Supreme Court was clear when it stated that ‘there is an outer limit’ to the board’s discretion to set executive compensation, at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste.”) (internal citations omitted) (internal quotation marks omitted) (quoting Citigroup Inc., 964 A.2d at 138). )) In response to the presumed waste seen during the 2008–2009 financial crisis, Congress enacted §951 of the Dodd-Frank Act, which granted the SEC with the authority to create rules mandating shareholder votes on executive compensation—the “say-on-pay” provision. ((Truong, supra note 26, at 1201 (“The language of the statute provides that at least ‘once every 3 years, a proxy or consent or authorization for an annual or other meeting of the shareholders for which the proxy solicitation rules of the Commission require compensation disclosure shall include a separate resolution subject to shareholder vote to approve the compensation of executives.’”) (quoting Dodd-Frank Act, Pub. L. No. 111-203, § 951, 124 Stat. 1376 (2000) (codified as amended at 15 U.S.C. § 78n-i) ).))
Prior to the implementation of the “say-on-pay” provision, shareholders had little recourse for issues stemming from executive compensation: shareholders could either “sell their shares in the firm or keep quiet.” ((Truong, supra note 26, at 1193.)) But “say-on-pay” provided shareholders with a third option of seeking recourse—lawsuit. ((Keith L. Johnson & Reinhart Boerner Van Dueren, Say-on-Pay Lawsuits – Is This Time Different?, Harvard L. Sch. Forum on Corp. Governance & Fin. Reg. (Feb. 5, 2012), https://www.reinhartlaw.com/wp-content/uploads/2016/01/Say-on-Pay-Lawsuits.pdf.)) Shareholders pursue legal action “to protect their long-term interests in the company . . . .” ((Truong, supra note 26, at 1209 (quoting William Alan Nelson II, Ending the Silence: Shareholder Derivative Suits and Amending the Dodd-Frank Act so “Say on Pay” Votes May Be Heard in the Boardroom, 20 U. Miami Bus. L. Rev. 149, 157 (2012) ).)) Shareholders exercise this power when boards of directors neglect their “nay” votes on proposed executive compensation packages. ((Truong, supra note 26, at 1208 (internal citations omitted).))
While much of the litigation brought by shareholders has focused on the overall size of the compensation package, the composition of executive compensation may become the center of the next wave of litigation. Typically, executive compensation includes base salary, annual bonus, pension, and performance-based compensation. ((Paul Emerton & Aled Jones, Perceptions of the efficacy of sustainability-related performance conditions in executive pay schemes, 9 J. Sustainable Fin. & Inv. 1, 1 (2019).)) Performance-based compensation was conceived to align executives with shareholders’ interests by tying executive compensation to shareholder-wealth-maximization through financial performance metrics. ((Andrew L. Bethune, Comment, An Efficient “Say” on Executive Pay: Shareholder Opt-in as a Solution to the Managerial Power Problem, 48 Hous. L. Rev. 585, 591 (2011).)) Traditionally, the metric used in performance-based compensation is the earnings-per-share ratio (EPS). ((Marc Hodak, Letting Go of Norm: How Executive Compensation Can Do Better Than “Best Practices”, 17 J. Applied Corp. Fin. 115, 119 (2005); see also James Chen, Earnings Per Share – EPS Definition, Investopedia (Jul. 14, 2019), https://www.investopedia.com/terms/e/eps.asp (last visited Oct. 21, 2019) (“Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.”).)) But this metric has led to negative outcomes and corporate behavior, such as manipulation of earnings results, as executives strive to maximize returns for their shareholders in the short-term and, therefore, their own short-term compensation. ((See Hodak, supra note 34,at 117; see also Dan Cable & Freek Vermeulen, Stop Paying Executives for Performance, Harvard Bus. Rev. (Feb. 23, 2016), https://hbr.org/2016/02/stop-paying-executives-for-performance.))
There have been recent attempts to lessen these negative outcomes by including CSR-based metrics in the design of executive compensation. ((D.G. McCullough, Putting your money where your mouth is: companies link green goals to pay, Guardian (Jan. 26, 2014, 11:43 AM), https://www.theguardian.com/sustainable-business/2014/jun/26/green-executive-compensation-intel-alcoa-pay.)) The employment of CSR-based metrics ties executive compensation to a firm’s goals related to sustainability, community involvement, employee relations, diversity, and so on. ((See Rekker et al., supra note 23, at 89–90.)) Unfortunately, achievement of these goals typically decreases shareholder value in the short-term. ((See Bisconti, supra note 14, at 771.))
Regardless of this impact, at least 24% of companies employ some form of CSR-based metrics in their executive compensation. ((See, e.g., McCullough, supra note 36; Caroline Flammer et al., Corporate governance and the rise of integrating corporate social responsibility criteria in executive compensation: Effectiveness and implications for firm outcomes, 40 Strategic Mgmt. J. 1097, 1107 (2019) (“[A]bout 24% of the S&P 500 companies use CSR criteria in executive compensation.”); Glass Lewis, In-Depth: Linking Compensation to sustainability 2 (2016), http://www.glasslewis.com/wp-content/uploads/2016/03/2016-In-Depth-Report-LINKING-COMPENSATION-TO-SUSTAINABILITY.pdf (indicating that the percentage of S&P 500 companies employing CSR-based metrics could be as high as 44%).)) Such companies include Alcoa, American Electric Power, Intel, Novo Nordisk, and Xcel Energy. ((Flammer et al., supra note 39, at 1098.)) When CSR-based metrics are employed by these companies, they usually focus on environmental and sustainability (“green”) goals. ((See McCullough, supra note 36.)) For example, Alcoa ties 5% percent of its executive bonus to CO2 emissions. ((Id. (noting that Alcoa also ties 5% and 10% of executive bonus to safety improvement and workforce diversity goals respectively).))
The question becomes whether these CSR-based metrics are legal under the Delaware court’s adherence to shareholder primacy and the business judgment rule. The business judgment rule “falls short of unambiguously authorizing the pursuit of non-shareholder interests other than instrumentally for the benefit of the shareholders.” ((Bisconti, supra note 14, at 787 (quoting Ian B. Lee, Efficiency and Ethics in the Debate About Shareholder Primacy, 31 Del. J. Corp. L. 533, 557-58 (2006) ).)) If the business judgment rule’s shortcomings with respect to accounting for non-shareholder stakeholder interests were not troubling enough, Delaware is one of the few states without a constituency statute actively protecting stakeholder interests. ((Standley, supra nota 9, at 219 (suggesting that Delaware’s lack of a constituency statute “is significant as Delaware corporate law is the bellwether for other states and its guidance is probably the most important of all of the states.”).)) The answer to this question hinges on whether CSR-based metrics are value additive or decretive for shareholders.
The definition of CSR used in this context can create a gloss on its value. The academic community is split on two distinct, conflicting definitions of CSR: (1) “the sacrifice of corporate profits for the public benefit” ((Bisconti, supra note 14, at 771.)) and (2) “voluntarily taking actions that go beyond compliance with laws and regulations on environmental and social issues[.]” ((Rekker et al., supra note 23, at 86.)) The definition used when considering CSR-based metrics for executive compensation could inform a board’s expectations of how its CSR activities will impact its bottom line and whose interests they are intending to serve.
Just as there is a split on the definition of CSR, the relevant literature is just as divided on the issue of whether these metrics create shareholder value. ((See, e.g., Flammer et al., supra note 39, at 1118 (concluding that CSR-based executive compensation metrics increases firm value); Bryan Hong et al., Corporate Governance and Executive Compensation for Corporate Social Responsibility, 136 J. Bus. Ethics 199, 208 (2015) (finding that executive compensation designed with CSR-based metrics “is likely to be financially beneficial . . . for shareholders.”); Rekker et al., supra note 23, at 86 (“[T]he body of literature often indicates that engaging in CSR is not bad for shareholders.”). But see, e.g., Glass Lewis, supra note 39 (suggesting that the prioritization of CSR initiatives comes at the expense of short-term profitability); Bisconti, supra note 14, at 771 (“CSR means sacrificing profits for public benefit.”). See generally Hong et al., supra note 47, at 200 (“Despite the considerable amount of academic attention, few definitive conclusions can be drawn from the collection of findings produced thus far.”).)) Bryan Hong, Zhichuan Li, and Dylan Minor investigated a series of hypotheses considering the impact of CSR-based executive compensation metrics on the agency cost theory, shareholder value, number of a company’s large institutional investors, management-level ownership within a corporation, and CSR activity levels undertaken by the corporation. ((See Hong et al., supra note 47, at 201–03 (proffering a series of hypotheses tested as part of the paper’s investigation).)) Hong et al. concluded that CSR-based executive compensation metrics have a positive effect on shareholder value. ((Id. at 206.))
On the other hand, Paul Emerton and Aled Jones conducted a qualitative analysis examining the relationship between CSR-based metrics in executive compensation packages and overall firm outcomes. ((Emerton & Jones, supra note 32, at 5.)) They found that there “appears to be a general acceptance that [CSR-based] metrics might be useful” but are less confident in the relationship between such metrics and positive financial outcomes for shareholders. ((Id. at 9.)) Emerton and Jones’s study focused on “U.K. listed companies,” ((Id. at 1.)) but there remain few academic inquiries into the efficacy of CSR-based metrics in creating shareholder value for U.S. listed companies.
Regardless of the sparse discussion in the academic realm, professionals are jumping into the discussion. Glass Lewis, a shareholder proxy consulting firm, indicates that companies with CSR-based executive compensation metrics are more likely to receive buy recommendations from investment analysts and to outperform their competitors in the stock market and through accounting metrics in the long-run. ((Glass Lewis, supra note 39. )) However, Glass Lewis also notes that firms employing such metrics do not have processes for distinguishing between “sound environmental strategies” and more symbolic initiatives. ((Id.)) In a similar vein, others echo Milton Friedman’s approach to CSR as being a symbolic initiative and avenue of self-interest at the expense short-term shareholder profitability. ((See Hong et al., supra note 47, at 200; see also Cydney Posner, Does inclusion of executive compensation metrics related to corporate social responsibility lead to long-term value creation?, Cooley PubCo (Jan. 11, 2018), https://cooleypubco.com/2018/01/11/does-inclusion-of-executive-compensation-metrics-related-to-corporate-social-responsibility-lead-to-long-term-value-creation/.)) The difficulty in determining the impact of CSR-based metrics on a firm’s bottom-line performance is likely due to the fact that these metrics account for approximately 1% of executive compensation and may not significantly alter the composition of their firm’s strategic decisions and CSR commitments. ((See McCullough, supra note 36; see also Emerton & Jones, supra note 32, at 5 (“[O]thers have failed to show that the use of [CSR-based] criteria in executive pay causes increased action on sustainability by a firm . . . .”) (internal citations omitted).))
Further research is needed to see if CSR-based metrics increase shareholder value, what information boards of directors consider when making these decisions to employ these metrics, what the outcomes of “say-on-pay” votes involving CSR-based metrics are, and if shareholders have been pushing for their inclusion. Such research would help show whether CSR-based metrics align with the shareholder primacy theory. Ultimately, it will be a question for the (Delaware) courts to determine if these pursuits satisfy the business judgment rule or if there is a need to articulate a specific standard similar to what was seen with hostile takeovers.
Kermit the Frog said it best: “It’s not easy bein’ green.” ((Kermit the Frog, Bein’ Green, on A Sesame Street Celebration, Vol. 2 (Sesame Workshop Catalogue 2018) (1970).)) Unfortunately, corporate executives may find this out the hard way.