The debate around the role and duties of corporations is not a new one. When our country was first founded, corporations were required to submit applications to colonial legislatures for the “privilege” of corporate status. At that time, public benefit was not an explicit requirement, but social and political norms created an implicit requirement of social purpose. This fit within the philosophical framework prevalent at the time. Today, scholars suggest that Adam Smith actually advocated for a free market system within the larger framework of a moral, public-oriented world. Changes began in the mid-1800s. At that point, many states had general incorporation statutes allowing businesses to organize solely for “business purposes.” Laws were also passed limiting shareholders’ liability for a business to their investment.
The next series of changes came in the early 1900s. A series of Republican presidents practiced a laissez-faire approach to business and legal corporate theory began to change. A 1919 case, Dodge v Ford, held that Henry Ford and the Ford Motor Company were not allowed to withhold excess company profits from shareholders, regardless if those profits would be used to subsidize cars below market price. Instead, the Michigan Supreme Court ruled that “a business corporation is organized and carried on primarily for the profit of the stockholders.” This was also the time period that gave birth to the shareholder (the theory that corporations and their management have a duty to maximize shareholder, aka financial, returns) v. stakeholder (the theory that a manager’s duty is to balance the shareholders’ financial interests against the interests of other stakeholders, such as employees, customers, and the local community) debate as two law professors, Adolf Berle and Merrick Dodd, began the debate from opposite sides.
At first, the stakeholder theory seemed to win out. In the middle of the 20th century, the manager or executive of a private company probably would say “the purpose of the corporation was…many purposes: to produce satisfactory returns for investors, but also to provide good jobs to employees, make reliable products for consumers, and to be a good corporate citizen.” We see this view become dominant. Under the banner of Civil Rights from the 60s and in light of reports showing discrimination against minority businesses, President Nixon launched the Black Capitalism Initiative to stimulate corporate investment in low-income, minority, urban areas. Meanwhile, on the environmental front, the Supreme Court’s 1965 case Scenic Hudson Preservation Conference v. Federal Power Commission gave conservation groups the ability to sue on environmental grounds.
However, in the 70s, the Chicago School and Milton Friedman pushed back. Friedman firmly established himself in the shareholder camp, memorably stating that “a corporation is an artificial person and in this sense may have artificial responsibilities, but “business” as a whole cannot be said to have responsibilities, even in this vague sense.” He did not believe a corporation could have a moral responsibility to society since businesses are not people (before the Supreme Court’s recent hearings!) Friedman argued that any change made by a corporate executive to promote social good over profit is simply a tax on someone. For example, he equated lack of profit as a “social good” tax on a shareholder who receives less monetary return than he would otherwise.
On the other side of the debate were the stakeholder theorists. Edward Freeman suggested that “businesses, and the executives who manage them, actually do and should create value for customers, suppliers, employees, communities, and financiers (or shareholders).” This doesn’t mean that a business isn’t focusing on profit or won’t be successful. On the contrary, theorists see this as cementing a company’s future by building strong relationships with all people affected by a business. In fact, theorists suggest this approach to business “is about creating as much value as possible for stakeholders, without resorting to tradeoffs.” It’s not intended to mean less profit for more social good but more of all of those things.
Is this possible, though? The debate did not end then. Stakeholders began to lose ground in the 70s and 80s, despite Freeman’s eloquent reasoning. Companies switched to incentivized pay systems, tying executive pay to share price, to try to solve the principal-agent problem. However, looking back, “all of the recent scandals at Enron, WorldCom, Tyco, Arthur Anderson and others are in part due to executives trying to increase shareholder value.” The concern arose that with this incentive pay structure change, executives were now incentivized to focus on the short-term bottom online rather than stakeholders or even the long-term health of the company. At the same time, companies began to switch from a defined benefit system to a defined contribution system- or even to drop retirement benefits altogether. Finally, perhaps in combination with the above forces, we have also seen a switch from the “lifetime worker” employed by some major companies in the 50s and 60s to a rise of independent contractors and the contingent workforce.
Today, the business landscape is beginning to switch once again, but the underlying argument is still ongoing. We are beginning to see the rise of benefit corporations, essentially a new category of corporation that legalizes the stakeholder model. Maryland passed the first benefit corporation statute in 2010. Today, 26 states and the District of Columbia have some type of benefit corporation statute. They are promoting for-profit businesses that focus on a dual or triple bottom line. This is widely seen as a bi-partisan issue since it utilizes private business to solve large societal problems that were typically only part of the government’s domain. This could mean fewer government resources yet the ability to solve societal issues.
However, this is a new business focus. Not every company is heading in this direction and it will not always be a perfect match. Yet we are heartened to see the longstanding stakeholder v. shareholder argument not only moving in the world’s favor, but being entirely overhauled as social enterprises charge ahead, forging new territory, and irreparably changing the fabric of our society for the better. We must wait to see if it will stay a niche industry or become a driving force that once again shifts the business landscape – but Elysian’s mission is to do all we can to help foster this ecosystem to ensure all stakeholders win.
Stay tuned for an article coming soon about whether this movement to a stakeholder could make financial sense and could prove sustainable.