Redesigning Corporate Law
Design as if nature matters
By Robert Hinkley
The specific change suggested is simple: add
twenty-six words to corporate law and thus create what is called the 'Code
for Corporate Citizenship'. 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.
AFTER TWENTY-THREE years advising large corporations on
securities offerings, mergers and acquisitions, I left my position
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 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 that it
encourages good corporate citizenship rather than inhibiting it.
The provision in the law I am talking about is the one that says
that the purpose of
the corporation is simply to make money for shareholders.
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.
This explains why corporations find social issues such as human
rights irrelevant - because they fall outside the corporation's legal
mandate. Secondly, 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. Directors and officers know that their jobs, salaries,
bonuses and stock options depend on delivering profits for
shareholders. Companies believe that their duty to the public interest
consists in 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 hair-splitting and jurisdiction shopping.
Directors and officers give little thought to the fact that these
activities may damage the public interest.
Lower-level employees know that 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 the 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
focussed 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 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 that the
battle against corporate abuse should be conducted in a more holistic
way. We must enquire 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 continue letting them dictate terms to
us.
We must
remember that corporations were invented to serve humankind. Humankind
was not invented to serve corporations.
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
lies in 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 behaviour changes when
directors are held personally responsible. Everyone in the corporation
improves their game to meet the challenge. 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
twenty-six words to corporate law and thus create what I call the 'Code
for Corporate Citizenship'. 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 make individuals responsible for the
damage companies cause to the public interest, and would be enforced in
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 behaviours 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 Citizenship 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 chase
endlessly 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 that 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.
First published in Business Ethics, January/February 2002.
Robert Hinkley, previously a corporate securities attorney, lives in
Brooklin, Maine, USA. rchinkley,@media2.hypernet.com
http://resurgence.gn.apc.org/issues/hinkley213.htm