The Third Way

• Publication year: 2013

SEATTLE UNIVERSITY LAW REVIEWVolume 37, No. 2, Winter 2014

The Third Way

Kent Greenfield(fn*)

INTRODUCTION

In this Article, I have both a descriptive and a normative claim about corporate governance. As a descriptive matter, I believe that we in the United States and, indeed, perhaps worldwide, find ourselves in an unusual and potentially pivotal moment in the intellectual history of corporate law theory and doctrine. As a normative matter, I believe we should use this moment to adjust corporate governance so as to situate corporations more dynamically within a broader social, political, and economic context.

The descriptive claim is based on a judgment, shared by some others, that there is more openness to revisiting the core questions about what corporations are, to whom they owe obligations, and how best to conceptualize them and their regulation than at any time in a generation. This moment has been engendered because of the increasing skepticism the public is showing toward corporations and the people who manage them. The skepticism springs from shocks in the economic and political fields that revealed the risks of unbridled corporate power, short-termism, managerial opportunism, and shareholder (read Wall Street) supremacy.

To paraphrase Rahm Emanuel, one never wants such a moment to go to waste.(fn1) The question, of course, is what to do with such an opportunity to question, rethink, and re-conceptualize some first principles in the field.

One obstacle to taking advantage of this moment is the failure of academic analysis to break out of the conceptual dichotomy that has long dominated these debates within corporate law. The typical debate has been between shareholder supremacists and managerialists. All too often, moments of ferment in the field have brought about merely a swing of the pendulum from one of these paradigms toward the other.(fn2)

Shareholder supremacists lament the instances of managerial mismanagement and self-dealing, and offer a remedy of increased shareholder power.(fn3) If only management were constrained, they argue, by additional shareholder power to nominate directors, approve executive pay, or receive financial disclosures, then management's incentives would better align with shareholder interests. The downside of this remedy is that many of the risks of corporate power would increase with increased shareholder say. Shareholder empowerment would hardly resolve the problems of short-termism, environmental degradation, employee mistreatment and disempowerment, and risk externalization. In fact, the opposite would likely be true. This is because the interests of shareholders at best align only haphazardly with the interests of other stakeholders and of society as a whole, and at worst align not at all.(fn4)

Meanwhile, the managerial and directorial apologists suggest that the way forward is to protect managerial prerogative.(fn5) The goal is to empower the benevolent corporate elites to resist the shortsighted urges of the marketplace and manage the firm for the long-term benefit of its investors and perhaps even society as a whole. If only management would be loosened from the bothersome constraints of shareholder activism and government regulation, we would witness a burst of competitive energy that would carry us toward economic nirvana. The downside of this remedy is that managerial prerogative is, as a descriptive matter, overwhelmingly used to benefit managers. Explosions in executive compensation and perquisites, the manipulation of financial reporting and disclosure, and self-dealing in various guises are a more common outcome than benevolence. If the treatment for the ills of shareholder primacy is managerial empowerment, the cure may be worse than the disease.

There is a third way, and my normative claim is that we should use this moment to consider it. Managerial obligation could be increased without the obligation running solely to the holders of equity. Fiduciaries of companies could be subject to meaningful constraints and obligations, enforceable by courts, without disabling their ability to use the corporate form for economic gain. The conceptual innovation of this third way-I use "innovation," though the idea is actually quite ancient-is for the fiduciary obligations of management to run to the firm as a whole, which would include an obligation to take into account the interests of all those who make material investments in the firm. Within this framework, it would continue to be a violation of fiduciary duties for management to self-deal, act carelessly, or exercise something less than good faith judgment. It would also be a violation of their duties to prioritize one stakeholder over others consistently and persistently or to fail to consider the interests of all stakeholders in significant corporate decisions.

This Article proceeds in four parts. First, I situate the current moment of intellectual churning in corporate law in a larger historical narrative and explain why we find ourselves in this moment now. Second, I suggest what a third way might require in terms of conceptualization, process, and substance of corporate governance. Third, I propose some affirmative benefits we could achieve with these changes. Lastly, I answer a few of the principal objections to such a conceptual and regulatory shift.

I. A MOMENT OF INTELLECTUAL CHURNING

The intellectual history of corporate law, of course, must be understood in broader historical and legal trends. Not surprisingly, the law of business reflects social understandings and presumptions about both business and law.

A. A Look Back

A century ago, federal courts in the United States protected businesses from regulatory mandates and limits by use of a broad Due Process Clause and a narrow Commerce Clause.(fn6) The most emblematic constitutional case of the time, Lochner v. New York, in which the Supreme Court struck down New York's attempt to limit the hours that bakers would be forced to work by their employers, gave its name to the juris-prudential era. Meanwhile, the corporate law doctrine reflected a similar emphasis. The most famous corporate law case of the era, Dodge v. Ford Motor Company, announced that "[a] business corporation is organized and carried on primarily for the profit of the stockholders."(fn7) Though this was a statement articulated only by a court in one state, it encapsulated the zeitgeist of the Gilded era ideals of private property and the judiciary's willingness to protect them aggressively. The courts saw the companies as the private property of shareholders and were willing to protect them from legislative encroachments with constitutional tools and from managerial encroachments with corporate law tools.

The Great Depression amounted to an intellectual turning point, as the economic upheaval caused people to re-conceptualize the market itself as a creature of the state rather than existing in a state of nature.(fn8) A part of this shift was a fundamental rethinking of the role of business corporations, the nature of their ownership, and of their obligations to broader society.(fn9) The ramifications of this re-conceptualization were immense, with the most profound changes for business coming in the form of the great Securities Acts of 1933 and 1934,(fn10) the labor protections in the National Labor Relations Act of 1935(fn11) (protecting the right to bargain collectively), and the Fair Labor Standards Act of 1938(fn12) (creating a federal minimum wage).

We again saw a burst of interest in the fundamental questions of the nature of corporations from the 1960s through the 1970s as a part of a broader social critique on the status quo that also included the civil rights and anti-war movements. Environmental scholars such as Rachel Car-son(fn13) and consumer activists such as Ralph Nader(fn14) raised awareness of how the political influence, unsustainable practices, and global reach of corporations posed dangers to society. In response, environmental law, anti-discrimination law, anti-corruption law, and consumer protection law were all strengthened on the regulatory side.(fn15) On the corporate side, we saw the rise of the so-called stakeholder statutes, which claimed to protect the ability of company management to look after the interests of companies' non-shareholder constituents.(fn16) Among academics, we saw an increasing skepticism about Delaware's status as the preeminent and predominant provider of corporate governance law in the United States.(fn17)

Thereafter, we saw a significant pushback-even retrenchment-in politics, law, and academia. The "Reagan Revolution" was about more than merely who won the White House in 1980 and 1984. More broadly, it engendered an attack on regulation generally and fostered a belief in and a presumption in favor of the market. In the legal academy in the United States, we saw the rise of the "law and economics" movement, whose scholars applied a simplistic version of neoclassical economic thought to law, arguing that individuals are rational maximizers of utility and act with free will.(fn18) These scholars argued that the grand purpose of law is to allow people to satisfy their preferences, primarily by empowering private agreements and otherwise standing aside.

The law and economics scholars gained particular purchase in the corporate law field. The corporation was re-conceptualized as a nexus of contracts, with the law...