'Enlightened shareholder value': corporate governance beyond the shareholder-stakeholder divide.

• Author: Ho, Virginia Harper

1. INTRODUCTION II. INSTITUTIONAL INVESTOR ACTIVISM: PANDORA'S BOX? A. Institutional Investor Power and the Rise of Shareholder Democracy B. The Problem of Stakeholders III. STAKEHOLDERS UNDER CORPORATE LAW A. Shareholder Wealth Maximization B. Control of the Firm C. Shareholder Preeminence IV. DEFINING AND DRIVING ENLIGHTENED SHAREHOLDER VALUE: PATHWAYS BEYOND THE SHAREHOLDER-STAKEHOLDER DIVIDE A. Enlightened Shareholder Value Under the U.K. Companies Act B. Investor-Driven Enlightened Shareholder Value 1. Expressions of Enlightened Shareholder Value: ESG Risk Management & the United Nations Principles for Responsible Investment 2. The ESG Rationale a. Firm-Level Risk Management and Financial Performance b. Portfolio-Level Risk Management and Financial Performance 3. Implementation & Diffusion a. Institutional Investors & Enlightened Shareholder Value b. Translating Enlightened Shareholder Value to Firms i. Litigation ii. Voting & Engagement V. SHAREHOLDER ENLIGHTENMENT AND THE CORPORATE OBJECTIVE FUNCTION A. Enlightened Shareholder Value: Revising the Corporate Objective Function 1. The Enlightened Shareholder Value Alternative: Distilling Decision Rules a. Enlightened Shareholder Value & Shareholder Wealth Maximization b. Enlightened Shareholder Value Decision Standards i. Long-Term Firm Value or "Joint Output" ii. Two-tier Constrained Optimization 2. Enlightened Shareholder Value Decision Rules Under Corporate Law B. Normative Advantages of Enlightened Shareholder Value 1. Of Law and Markets 2. The Nature of the Corporate Contract 3. Of Means and Ends 4. Stakeholder Representation C. Enlightened Shareholder Value & The "Problem" of Stakeholders: Responding to Efficiency-based Concerns 1. "Too Little" Attention to Stakeholders 2. "Too Much " Attention to Stakeholders a. A Response to the "Two Masters" Problem b. A Response to the Problem of Private Interests VI. CONCLUSION The global financial crisis has led to calls for greater corporate accountability and heightened controls over public corporations. As a result, the past year has seen a marked increase in regulatory initiatives that give shareholders a greater voice in corporate affairs, While debate continues to rage in the academy and beyond over the promise and pitfalls of these measures, an important undercurrent in the controversy is the potential impact of "shareholder democracy" on corporate stakeholders.

   This Article urges a vision of the corporation and its purpose that transcends the shareholder-stakeholder divide. Under this "enlightened shareholder value" (ESV) approach, which has been introduced statutorily in the United Kingdom, attention to corporate stakeholders, including the environment, employees, and local communities, is seen as critical to generating long-term shareholder wealth,

   This Article observes that a similar paradigm is being advanced in the United States by leading institutional investors who also identify stakeholder interests as key to long-term firm financial performance and effective risk management, It moves beyond prior literature by articulating a statement of the corporate purpose that is consistent with this investor-driven enlightened shareholder value approach and presents normative arguments in its favor, The Article then considers how enlightened shareholder value intersects with existing corporate governance rules in the United States and whether it implies managerial decision rules that align with or part course from the standard shareholder wealth maximization norm, In so doing, it offers a response to some of the concerns surrounding corporate stakeholders that have been raised by skeptics of greater shareholder voice.

1. INTRODUCTION

   Over the past decade, a rise in shareholder activism has sparked wide-ranging academic debate about the optimal role of shareholders in U.S. corporate governance and the benefits (and perils) of shareholder democracy. (1) These debates have attracted public attention in the wake of the global financial crisis, which has led to calls for greater corporate accountability and prompted renewed interest in the power of shareholders to police corporate management, Although debate continues to rage over whether shareholders can and will restrain corporate mismanagement, the past year has seen a marked increase in regulatory initiatives that give shareholders a greater voice in corporate affairs, including most recently the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Reform Act). (2)

   An important undercurrent in the academic and popular controversy is the potential impact of shareholder democracy on corporate stakeholders, such as employees, creditors, the environment, and local communities. (3) Director primacy proponents, who argue that control of the corporation is the proper purview of the board, not shareholders, note that corporate directors and officers already enjoy broad discretion under existing law to consider stakeholder interests. (4) Shareholder empowerment might then disadvantage stakeholders by compelling management to focus solely on shareholder wealth maximization, Powerful shareholders might also pressure management to transfer value from stakeholders to shareholders. (5)

   Opposite concerns are voiced as strongly that powerful shareholders will use their power to advance "special interests," realize short-term gains, or promote narrow causes to the detriment of the firm (6)--even though some of the "causes" and "interests" advanced are in fact the causes and interests of employees and other firm constituencies. In short, the problem with stakeholders is both that they might get too little attention and that they might get too much.

   This Article engages with this aspect of the shareholder democracy debate by advocating an "enlightened shareholder value" vision of the corporate purpose that transcends the shareholder-stakeholder divide. Under this conception, attention to traditional "stakeholder" interests such as the effect of corporate operations on the environment, employees, or local communities, is seen as a means of generating long-term shareholder wealth and improving portfolio- and firm-level risk assessment. Enlightened shareholder value thus emphasizes the benefits to shareholders that can result from focusing corporate management on areas of shared shareholder and stakeholder concern while recognizing the very real challenges posed by the diversity of shareholder and stakeholder interests. At the same time, by asserting that shareholders should not achieve wealth through disregard for the impact of corporate decision making on stakeholders, enlightened shareholder value also parts course to some degree from the standard shareholder wealth maximization conception of the corporate purpose.

   Enlightened shareholder value is not a novel concept, but has in fact already been statutorily introduced in the United Kingdom under the U.K. Companies Act of 2006. (7) Theoretical precedent for the approach can be found in the narrower "enlightened stakeholder value" theory advanced by economist Michael Jensen. (8) It also has parallels in the United Nations Principles for Responsible Investment (PRI), which urge analysis of stakeholder interests as part of firm- and portfolio-level risk management. (9) Although there are good reasons to doubt that regulatory reform in the United States will follow the path of the United Kingdom, this Article points to indications that an enlightened shareholder value model is emerging in the United States, in part at the behest of major institutional investors.

   A substantial literature spanning two decades has critically examined the role of institutional investors in promoting good corporate governance and supporting "responsible" business practices. Much of this literature concluded that institutional investor activism was unlikely to fulfill its hoped-for potential as a catalyst of corporate change, and cause for skepticism remains today. (10) But the market and regulatory context has changed substantially since many of these studies of institutional investor activism were first undertaken. In particular, the rise of shareholder democracy has shifted the balance of corporate power toward shareholders, making their priorities more important to corporate boards. At the same time, movements across the economy favoring long-term investment strategies, "sustainable" business practices, and broader conceptions of corporate accountability and risk management have created an environment in which shareholder and stakeholder interests are more likely to align.

   Clear signs of a pro-stakeholder orientation among leading institutional investors can already be seen in initiatives to incorporate environmental, social, and governance (ESG) measures in firm and portfolio risk analysis, supported by both investor-led efforts to encourage sustainability reporting and trends in shareholder activism. To date CalPERS and other prominent public and union pension funds are at the forefront of many of these trends, with more moderate movement from mutual funds, which account for a significant percentage of U.S. equity holdings. (11) Nonetheless, because of its potential to generate long-term economic value for shareholders, facilitate more effective firm- and portfolio-level risk management, and improve the quality of information available to the markets, enlightened shareholder value--as defined in this Article--has appeal for mainstream investors and investment intermediaries that is already deepening its impact.

   Although a limited number of prior studies have explored the possibility of an investor-driven enlightened shareholder value model in the United States, (12) this Article offers a new look at the potential of enlightened shareholder value to motivate market-driven corporate reform in light of current investor practices and recent regulatory measures that amplify shareholder voice. This Article is also the...