Economy
How
Corporate Law Inhibits Social Responsibility
A corporate attorney proposes a ‘Code for Corporate Responsibility’ in
state law
by Robert Hinkley
After 23
years as a corporate securities attorney-advising large corporations
on securities offerings and mergers and acquisitions - I left my position
as partner at Skadden, Arps, Slate, Meagher & Flom because I was
disturbed by the game. I realized that the many social ills created by
corporations stem directly from corporate law. It dawned on me that the
law, in its current form, actually inhibits executives and corporations
from being socially responsible. So in June 2000 I quit my job and decided
to devote the next phase of my life to making people aware of this problem.
My goal is to build consensus to change the law so it encourages good
corporate citizenship, rather than inhibiting it.
The provision
in the law I am talking about is the one that says the purpose of the
corporation is simply to make money for shareholders. Every jurisdiction
where corporations operate has its own law of corporate governance. But
remarkably, the corporate design contained in hundreds of corporate laws
throughout the world is nearly identical. That design creates a governing
body to manage the corporation-usually a board of directors-and dictates
the duties of those directors. In short, the law creates corporate purpose.
That purpose is to operate in the interests of shareholders. In Maine,
where I live, this duty of directors is in Section 716 of the business
corporation act, which reads:
...the directors
and officers of a corporation shall exercise their powers and discharge
their duties with a view to the interests of the corporation and of the
shareholders....
Although
the wording of this provision differs from jurisdiction to jurisdiction,
its legal effect does not. This provision is the motive behind all corporate
actions everywhere in the world. Distilled to its essence, it says that
the people who run corporations have a legal duty to shareholders, and
that duty is to make money. Failing this duty can leave directors and
officers open to being sued by shareholders.
Section
716 dedicates the corporation to the pursuit of its own self-interest
(and equates corporate self-interest with shareholder self-interest).
No mention is made of responsibility to the public interest. Section
716 and its counterparts explain two things. First, they explain why
corporations find social issues like human rights irrelevant--because
they fall outside the corporation’s legal mandate. Second, these
provisions explain why executives behave differently than they might
as individual citizens, because the law says their only obligation in
business is to make money.
This design
has the unfortunate side effect of largely eliminating personal responsibility.
Because corporate law generally regulates corporations but not executives,
it leads executives to become inattentive to justice. They demand their
subordinates "make the numbers," and pay little attention to
how they do so. Directors and officers know their jobs, salaries, bonuses,
and stock options depend on delivering profits for shareholders.
Companies
believe their duty to the public interest consists of complying with
the law. Obeying the law is simply a cost. Since it interferes with making
money, it must be minimized-using devices like lobbying, legal hairsplitting,
and jurisdiction shopping. Directors and officers give little thought
to the fact that these activities may damage the public interest.
Lower-level
employees know their livelihoods depend upon satisfying superiors’ demands
to make money. They have no incentive to offer ideas that would advance
the public interest unless they increase profits. Projects that would
serve the public interest--but at a financial cost to the corporation--are
considered naive.
Corporate
law thus casts ethical and social concerns as irrelevant, or as stumbling
blocks to the corporation’s fundamental mandate. That’s the
effect the law has inside the corporation. Outside the corporation the
effect is more devastating. It is the law that leads corporations to
actively disregard harm to all interests other than those of shareholders.
When toxic chemicals are spilled, forests destroyed, employees left in
poverty, or communities devastated through plant shutdowns, corporations
view these as unimportant side effects outside their area of concern.
But when the company’s stock price dips, that’s a disaster.
The reason is that, in our legal framework, a low stock price leaves
a company vulnerable to takeover or means the CEO’s job could be
at risk.
In the end, the natural result is that corporate bottom line goes up, and the
state of the public good goes down. This is called privatizing the gain and
externalizing the cost.
This system
design helps explain why the war against corporate abuse is being lost,
despite decades of effort by thousands of organizations. Until now, tactics
used to confront corporations have focused on where and how much companies
should be allowed to damage the public interest, rather than eliminating
the reason they do it. When public interest groups protest a new power
plant, mercury poisoning, or a new big box store, the groups don’t
examine the corporations’ motives. They only seek to limit where
damage is created (not in our back yard) and how much damage is created
(a little less, please).
But the where-and-how-much approach is reactive, not proactive. Even when corporations
are defeated in particular battles, they go on the next day, in other ways and
other places, to pursue their own private interests at the expense of the public.
I believe
the battle against corporate abuse should be conducted in a more holistic
way. We must inquire why corporations behave as they do, and look for
a way to change these underlying motives. Once we have arrived at a viable
systemic solution, we should then dictate the terms of engagement to
corporations, not let them dictate terms to us.
We must remember that corporations were invented to serve mankind. Mankind was
not invented to serve corporations. Corporations in many ways have the rights
of citizens, and those rights should be balanced by obligations to the public.
Many activists
cast the fundamental issue as one of "corporate greed," but
that’s off the mark. Corporations are incapable of a human emotion
like greed. They are artificial beings created by law. The real question
is why corporations behave as if they are greedy. The answer is the design
of corporate law.
We can change that design. We can make corporations more responsible to the
public good by amending the law that says the pursuit of profit takes precedence
over the public interest. I believe this can best be achieved by changing corporate
law to make directors personally responsible for harms done.
Let me give
you a sense of how director responsibility works in the current system.
Under federal securities laws, directors are held personally liable for
false and misleading statements made in prospectuses used to sell securities.
If a corporate prospectus contains a material falsehood and investors
suffer damage as a result, investors can sue each director personally
to recover the damage. Believe me, this provision grabs the attention
of company directors. They spend hours reviewing drafts of a prospectus
to ensure it complies with the law. Similarly, everyone who works on
the prospectus knows that directors’ personal wealth is at stake,
so they too take great care with accuracy.
That’s
an example of how corporate behavior changes when directors are held
personally responsible. Everyone in the corporation improves their game
to meet the challenge. The law has what we call an in terrorem effect.
Since the potential penalties are so severe, directors err on the side
of caution. While this has not eliminated securities fraud, it has over
the years reduced it to an infinitesimal percentage of the total capital
raised.
I propose
that corporate law be changed in a similar manner--to make individuals
responsible for seeing that the pursuit of profit does not damage the
public interest.
To pave the way for such a change, we must challenge the myth that making profits
and protecting the public interest are mutually exclusive goals. The same was
once said about profits and product quality, before Japanese manufacturers taught
us otherwise. If we force companies to respect the public interest while they
make money, business people will figure out how to do both.
The specific
change I suggest is simple: add 26 words to corporate law and thus create
what I call the "Code for Corporate Responsibility." In Maine,
this would mean amending section 716 to add the following clause. Directors
and officers would still have a duty to make money for shareholders, ...
but not at the expense of the environment, human rights, the public safety,
the communities in which the corporation operates or the dignity of its
employees.
This simple
amendment would effect a dramatic change in the underlying mechanism
that drives corporate malfeasance. It would make individuals responsible
for the damage companies cause to the public interest, and would be enforced
much the same way as securities laws are now. Negligent failure to abide
by the code would result in the corporation, its directors, and its officers
being liable for the full amount of the damage they cause. In addition
to civil liability, the attorney general would have the right to criminally
prosecute intentional acts. Injunctive relief-which stops specific behaviors
while the legal process proceeds-would also be available.
Compliance
would be in the self-interest of both individuals and the company. No
one wants to see personal assets subject to a lawsuit. Such a prospect
would surely temper corporate managers’ willingness to make money
at the expense of the public interest. Similarly, investors tend to shy
away from companies with contingent liabilities, so companies that severely
or repeatedly violate the Code for Corporate Responsibility might see
their stock price fall or their access to capital dry up.
Many would
say such a code could never be enacted. But they’re mistaken. I
take heart from a 2000 Business Week/Harris Poll that asked Americans
which of the following two propositions they support more strongly:
Corporations
should have only one purpose--to make the most profit for their shareholders--and
pursuit of that goal will be best for America in the long run.
--or--
Corporations
should have more than one purpose. They also owe something to their workers
and the communities in which they operate, and they should sometimes
sacrifice some profit for the sake of making things better for their
workers and communities.
An overwhelming
95 percent of Americans chose the second proposition. Clearly, this finding
tells us that our fate is not sealed. When 95 percent of the public supports
a proposition, enacting that proposition into law should not be impossible.
If business
people resist the notion of legal change, we can remind them that corporations
exist only because laws allow them to exist. Without these laws, owners
would be fully responsible for debts incurred and damages caused by their
businesses. Because the public creates the law, corporations owe their
existence as much to the public as they do to shareholders. They should
have obligations to both. It simply makes no sense that society’s
most powerful citizens have no concern for the public good.
It also
makes no sense to endlessly chase after individual instances of corporate
wrongdoing, when that wrongdoing is a natural result of the system design.
Corporations abuse the public interest because the law tells them their
only legal duty is to maximize profits for shareholders. Until we change
the law of corporate governance, the problem of corporate abuse can never
fully be solved.
Robert Hinkley rchinkley@media2.hypernet.com ,
formerly a partner at the law firm of Skadden, Arps, Slate, Meagher & Flom
, now lives in Brooklin, Maine and is working to promote the Code. A
Minnesota grassroots group has formed to work on the code (see www.C4CR.org Other
information on the Code can be found at www.CitizenWorks.org Reprinted
with permission from Business Ethics www.business-ethics.com
