WHAT WE TALK ABOUT WHEN WE TALK ABOUT SHAREHOLDER PRIMACY.

• Author: Lipton, Ann M.
• Position: 2018 Leet Business Law Symposium: Fiduciary Duty, Corporate Goals, and Shareholder Activism

CONTENTS INTRODUCTION I. THE INDEFINITE DEFINITION OF SHAREHOLDER PRIMACY II. CURRENT STATE OF THE LAW A. Delaware Law B. Federal Law III. WEALTH MAXIMIZATION: PRIVATE CHOICE OR PUBLIC ONE? A. Long-Term Wealth Maximization as Hypothetical Bargain B. Long-Term Wealth Maximization as Government Planning IV. IMPLEMENTING CORPORATE PURPOSE V. HYPOTHETICAL BARGAIN, REDUX CONCLUSION INTRODUCTION

In January 2013, activist investor Potomac Capital Partners took a stake in a company called PLX Technology and, via a series of open letters, urged it to find an acquirer. (1) When the board of directors balked, Potomac launched a proxy contest, seeking to replace three members of PLX's board with its own nominees. One of these nominees was Eric Singer, a Potomac managing member. (2) During the respective proxy campaigns, Potomac promised a quick sale, while PLX's incumbent board outlined its strategy for long-term improvement. (3) In the end, 70 percent of PLX's stock, including the 9.4 percent stake owned by Potomac, voted in favor of the Potomac slate. (4)

Once seated on the board, Singer took over the sales process, ultimately landing a deal for Avago Technologies Wireless to acquire PLX at $6.50 per share. (5) Dissenting stockholders sued the PLX board in connection with the merger, alleging that they had violated their fiduciary duties to PLX by pursuing a short-term firesale at the expense of long-term wealth maximization. (6)

After a trial, Vice Chancellor Laster of the Delaware Chancery Court agreed that Singer, as a member of PLX's board, had breached his duties to PLX stockholders. (7) Underpinning the holding was his conclusion that Singer's interests diverged from those of the other stockholders. (8) As Vice Chancellor Laster explained his reasoning:

[P]articular types of investors may espouse short-term investment strategies and structure their affairs to benefit economically from those strategies, thereby creating a divergent interest in pursuing short-term performance at the expense of long-term wealth. In particular, "[a]ctivist hedge funds ... are impatient shareholders, who look for value and want it realized in the near or intermediate term. They tell managers how to realize the value and challenge publicly those who resist the advice, using the proxy contest as a threat." The record in this case convinces me that Singer and Potomac had a divergent interest in achieving quick profits by orchestrating a near-term sale at PLX. (9)

This was a curious statement. Only eight months earlier, the shareholders of PLX had made it very clear by voting to seat Potomac's nominees that they rejected the incumbent board's long-term plans and preferred a short-term sale of the company. Even if Potomac's own votes are discounted, a convincing majority of PLX shareholders, as of the December 2013 stockholder vote, expressed a preference for a strategy that maximized short-term gains at the (potential) expense of longer-term benefits. Yet despite this obvious history, Vice Chancellor Laster confidently asserted that the interests of "the stockholders as a whole" were to pursue more long-term strategies. (10)

The PLX case illustrates a longstanding (and unresolved) tension in corporate law, namely, the extent to which corporate purpose is a privately ordered one, selected by stockholders themselves, or whether corporate purpose is dictated by the state. That puzzle is what I address in this Article.

Debates about corporate purpose are often shot through with an air of futility. After all, the duties of corporate directors, whatever they may be, are only legally enforced in the event of a dispute among shareholders; to the extent shareholders have no disputes, they are free to choose their own purpose. In that sense, then, shareholder preferences dictate corporate behavior so long as they are uniform. Where there is disagreement--which, we may assume, will always be present for public corporations--the business judgment rule and the high barriers to bringing a derivative action function to prevent courts' (and thus the state's) intrusion into the matter in all but the most extreme circumstances.

Still, there is a reason the theoretical question of the nature of directors' duties continues to fascinate. First, it informs the regulatory design, both at the state and federal level, and thus is influential in setting both default and mandatory rules. Second, there are the difficult-to-quantify, but still very real, psychological effects that an understanding of corporate purpose has on directors. (11)

More generally, the issue whether corporate purpose is selected by shareholders or imposed by government fiat has broader implications for the proper role of corporations in society. As a tool of the state, corporations must be subjected to mechanisms of accountability and control similar to those of government actors; as an entirely private entity, corporations by default may be presumed to be entitled to considerable freedom. (12)

Though this debate is an old one, it has new urgency today due to the changing nature of the shareholder base. So long as shareholders were docile and silent, their preferences could be presumed in a manner that preserved state authority over corporate purpose while simultaneously attributing the state's choices to private ordering. Then, inconveniently, institutional investors made it known that their actual preferred outcomes often diverged from the ones predicted by corporate theory. (13) As this Article discusses, that shift has prompted a round of corporate soul-searching, resulting in inconsistent legal regimes both at the state and federal levels, and renewed attempts to identify a "true" set of shareholders whose private preferences perfectly map to the governmental policy sought to be advanced.

1. THE INDEFINITE DEFINITION OF SHAREHOLDER PRIMACY

   Corporate law is often characterized as "private" law, meaning that it concerns the ground rules for voluntary relationships among individuals. (14) Much of modern corporate theory is built on the notion that corporations represent a type of contract (literal or metaphorical) (15) among shareholders setting the terms and conditions under which they will supply capital to finance a business. The corporate "contract" includes the obligation of corporate directors to pursue shareholders' interests (within the boundaries of the law) on the theory that, as residual claimants, shareholders would be unwilling to invest absent such assurances. (16) This theory of corporate purpose is commonly known as "shareholder primacy," and though there are continuing debates about whether the law mandates shareholder primacy--and even more debates about whether the law should place shareholder welfare at the center of corporate purpose--most commenters would likely agree that shareholder primacy, whatever its faults, accurately describes the legal regime today, either as a formal matter or in practical effect. (17)

   Shareholder primacy, then, would seem to describe a regime in which shareholders themselves identify their own interests, and privately determine the ultimate purposes toward which their capital should be directed. Yet--at least until recently (18)--that is not how it has been described. In most theoretical discussions of corporate purpose, shareholder primacy has been equated with the notion that corporate directors have a fiduciary duty to maximize the long-term wealth of the stockholders, (19) with little consideration paid to the possibility that shareholders themselves may prefer a different outcome.

   To a naive observer, it might seem that a legally imposed corporate purpose of long-term stockholder wealth maximization is anything but "private" law or private choice; it is a state dictate that governs the conduct of business entities on which it bestows a charter. Yet many commenters have resisted that characterization by the simple expedient of assuming that long-term wealth maximization itself represents shareholders' chosen corporate purpose. (20) Though some may acknowledge that this purpose can be modified by shareholders themselves, (21) in public companies, it has usually been assumed that shareholders are dispersed, unsophisticated, and passive, and thus incapable of even expressing a preference; therefore, the default assumptions control. (22)

   But even as the "wealth maximization" view of corporate law gained ascendancy, the nature of shareholding changed. Whereas once most shares were held by natural persons--retail investors--by the 1980s, institutions owned more than 40 percent of public corporate equity. (23) Today, that figure it as high as 70-80 percent of the outstanding equity in the 1,000 largest U.S. corporations. (24) Moreover, institutional ownership is increasingly concentrated: the biggest mutual fund companies, taken together, hold the largest block of stock in 40 percent of all United States listed companies, and 88 percent of the S&P 500. (25) Though these companies hold their stock across many different funds, sponsoring firms often rely on a centralized governance office to decide voting policy. (26) As a result, the actual preferences of shareholders are visible (in some cases, visibility is legally mandated (27)) and difficult to ignore. That fact makes it more obvious that many shareholders' preferences do not extend to the hypothesized desire for long-term wealth maximization.

   First, many shareholders may operate on shorter terms. If markets are not perfectly efficient and therefore do not fully price the long-term potential of the firm, (28) shareholders who seek immediate payoffs-either because they need to liquidate their investment or because they are agents who need to justify their choices to their ultimate beneficiaries--may prefer strategies that, in effect, eat the seed corn. (29)

   Second, some shareholders may be guided by ethical principles in addition to their desire for returns on their investment...