July/August 2002 - VOLUME 23 - NUMBER 7&8
C o r p o r a t e R e f o r m A f t e r E n r o n
28 Words to
By Robert Hinkley
Redefine Corporate Duties
The Proposal for a Code for
Over the past 120 years, state and federal governments have enacted volumes of laws and regulations to curb the problem of corporate abuse of the public interest. Examples include legislation to protect the environment, eliminate child labor, create equal opportunity, increase workplace safety, limit anti-competitive behavior and protect the public interest in numerous other ways which corporations have been unwilling or unable to do voluntarily. Notwithstanding all this legislation, the damage that continues to be inflicted is more extensive than ever.
Part of the reason for this ongoing damage is that such legislation only addresses where and how much companies should be allowed to damage the public interest, rather than eliminating the reason why they damage it. The "where and how much" approach is a little like trying to cure a disease by treating the symptoms. The patient feels better for a while, but soon the disease returns, sometimes in a more virulent form. In order to cure the disease of corporate abuse of the public interest, its cause must be understood and either changed or eliminated.
The cause of most corporate abuse is no secret. The thing that keeps greenhouse gases pouring out of smokestacks and tailpipes is the same thing that results in vendors of designer sneakers paying Third World children less than a dollar an hour. It's also the same thing that keeps tobacco companies marketing their products to children, fast food companies paying less than a living wage and meat packing companies maintaining dangerous working conditions. That thing is the dedication of the corporation to the pursuit of profit.
Under the corporate law, corporations are established for one purpose -- to make money for shareholders. This purpose is included in the law as a duty imposed upon directors and is sometimes called the doctrine of "shareholder primacy." Failure to satisfy this duty can result in directors being sued by shareholders. As a result of this duty, the purpose of the corporation becomes the marching orders for everyone who works for the corporation. Very little, if anything, happens in the corporation that does not have this goal in mind.
Professor Lawrence Mitchell at George Washington University Law School has said that this dedication of the corporation to the pursuit of profit has the effect of requiring people who work for the corporation to give up a part of their personhood when they become a director, manager or employee. They must play roles where the only thing that matters is making more money.
Corporations act through their employees. Consider the likely result of dozens if not hundreds of employees acting together under pressure to produce a profit and with no concern for the public interest (other than not doing what their legal departments tell them is specifically prohibited). Then factor in millions or billions of dollars of capital backing this collective action. The natural result is shortcuts being taken that increase the corporation's bottom line, but damage the public interest on a grand scale.
As long as directors, managers and employees are guided only by the doctrine of shareholder primacy, their companies will continue to do damage to the environment, human rights, the public health and safety, the dignity of employees and the welfare of their communities. As long as companies continue to grow in size, such damage will become more extensive right along with it.
The Code for Corporate Citizenship
An overwhelming 95 percent chose the second proposition. In other words, they rejected the doctrine of shareholder primacy (which is the current law) in favor of a system where profits should be sacrificed in order to protect the interests of workers and communities (which, reasonably understood, includes both the environment and people outside the corporation such as customers).
Corporations only exist because state legislatures, the elected representatives of the people, have passed laws allowing corporations to be formed and be recognized. These laws can be changed.
What are we waiting for? Let's change the law to reflect what the vast majority of people want, eliminating the doctrine of shareholder primacy. This can be accomplished by adding 28 words to the duty of directors to make money for shareholders,
This simple Code for Corporate Citizenship balances the rights of citizenship that corporations already have with obligations of citizenship that they have been able to avoid.
How it Will Work
After enactment of the Code, companies will have to run their operations so they do not pollute and do not manufacture products that pollute. No longer will they be able to engage in development or the harvesting or extraction of the earth's natural resources that is not sustainable.
In addition, companies will no longer be allowed to violate human rights in the Third World. Nor will they be allowed to put untested unsafe products in the marketplace. If an unsafe product does get into the marketplace, they will be required to warn the public and, if necessary, recall it at the first sign of a problem (rather than wait until hundreds of people have been injured or killed).
The Code will also give employees and communities more leverage to deal with corporations. At a minimum, the Code will guarantee a living wage, the right to collectively bargain and the right to work in a safe environment. In fact, the Code may change many employers' attitudes towards unions. Such employers may actually encourage union participation so they can enter into collective bargaining agreements that are assured of complying with the Code.
Finally, no longer will a major employer in a community be able to threaten to leave town unless the community accedes to the company's demands. Companies that create economic hardship will be responsible for compensating the community for the damage they cause. This may cause companies to negotiate with towns prior to making a plant closure decision and factor into that decision the cost of such compensation. This may or may not result in fewer closures, but it will put a stop to closures where the local community is left to pick up the pieces on its own.
Under U.S. federal securities laws, investors can bring private lawsuits against a company and its directors for losses incurred as a result of the company's false and misleading statements irrespective of the company's intent or motive in making such statements. The Code can be enforced in a similar manner.
In addition to the 28 words eliminating shareholder primacy, the Code should include a provision allowing it to be enforced by private lawsuits brought against the company and its directors by any member of the public that is damaged. Private litigants would have the ability to band together and bring class actions. It is likely they would be supported by attorneys willing to accept cases on a contingency basis. The attorney general would also have the right to bring suit to enforce the Code on the public's behalf, including obtaining injunctions to halt prohibited corporate behavior and criminal sanctions for intentional violations.
The threat of civil litigation and possible criminal sanctions will serve as a powerful deterrent to violating the Code. It will cause directors to change the way they run their companies, much the way the securities laws that were passed in the 1930s caused them to change the way they offered securities to the public and distributed information to investors on an ongoing basis. They will become much more cautious.
Being able to win lawsuits under the Code will not be good enough for directors. Having to defend such suits is a time-consuming, expensive, hair-raising pain in their collective necks. To avoid this, directors will order their managers to operate the company clearly within the boundaries of the Code. For them, an ounce of caution will be well worth a pound of cure (successfully defending a lawsuit).
Notwithstanding the doctrine of shareholder primacy, the Code will not be the first change to the corporate law that recognizes that certain things can be more important than increasing the financial return of shareholders. In response to the explosion in the number of hostile takeovers during the 1980s, 35 states passed amendments to the doctrine of shareholder primacy (sometimes called stakeholder statues) that allow directors to consider the rights of parties other than shareholders (and sometimes sacrifice the financial interests of shareholders) in order to justify the rejection of a hostile takeover offer.
The Code takes this idea one step farther. It makes consideration of the public interest mandatory 365 days a year (not just in the event of a takeover). If directors can consider the environment and the rights of others when their company is under a takeover threat (and their jobs as directors are at risk), why can't they always consider such factors?
Making it Law
This is not as complicated as is may sound. States amend their corporate law quite regularly. The doctrine of shareholder primacy exists either in the statutes or case law of every state in essentially the same form. The change in every state will be more or less identical.
Moreover, the Code is simple. Its essence can be boiled down to a phrase at the end of the obligation to make money that every director, manager, employee or even school child can understand -- some things take precedence over making money, and making money and safeguarding the environment, human rights, the public health and safety, the welfare of our communities and the dignity of employees do not have to be mutually exclusive.
Even after passage of the Code, it will take some time before large corporations come into full compliance. Billions of dollars are invested in technologies that damage the public interest. Existing management systems are well entrenched. This momentum must be slowed before it can be turned around. It will take some time.
The Code should be passed with provisions that contemplate a 10- or 15-year transition period. This transition period will allow all states and many foreign jurisdictions to effectively implement the Code at the same time. And, it will avoid making opponents of the Code of those that would otherwise support it but for their inability to comply with it immediately.
During the transition period, the Code would fully apply except that the enforcement provisions would not be effective. In this way, the Code would serve as a statement of what is expected of corporations -- encouraging them to make progress re-tooling their plants and changing their management systems to be in full compliance by the time the enforcement provisions become effective.
What it Means
The Code will bring these costs inside the corporation. Some will charge that this will decrease corporate profits, but that is not necessarily the case. In order to increase their competitiveness, corporations will look for ways to reduce these costs. This should open a virtual floodgate of investment in research and development designed to find ways that less expensively protect the environment, improve product testing and enhance management practices. Although not contemplated by the Code, government incentives and subsidies could be provided to offset the cost of such investment.
Rather than be considered as a restriction on corporate management, many managers will find the Code liberating. At last, they will be empowered to operate their business in a way that is more in line with their own behavior away from work -- protecting the public interest, not destroying it.
The Code does not destroy the profit motive, but it does eliminate the doctrine of shareholder primacy. It says that corporations should behave the way the vast majority of the public want them to -- sometimes sacrificing the interests of shareholders in order to protect workers and the community.
No one should feel bad for shareholders in supporting the Code. Ultimately, all shareholders are people. The financial institutions (e.g., mutual funds, 401(k) plans, insurance companies, etc.) that hold most of the shares in U.S. companies do so on behalf of real people.
The Code will benefit these shareholders in ways that increased profits, dividends and share prices cannot -- through a better environment, improved public health and safety, better treatment for workers and stronger communities. Imagine a world 15 years from now where corporate pollution has been eliminated, every employee is paid a living wage and human rights are fully respected.
By finally addressing the reason why corporations abuse the public interest, the Code can be a first step towards making these things happen.
Robert C. Hinkley has been a corporate lawyer for more than 20 years. In June 2000, he resigned his partnership at Skadden, Arps, Slate, Meagher & Flom LLP in order to devote more time to promoting the Code for Corporate Citizenship.