Editor’s Note: On August 15, 2018, Senator Elizabeth Warren (D-MA) introduced the Accountable Capitalism Act, legislation that would require corporations to consider the interests of all stakeholders within the firm—not only shareholders—in company decisions.
Corporations are made up of a wide range of stakeholders: workers, managers, executives, and shareholders. Currently, only executives and shareholders have the power to make decisions about corporations’ investments and use of company profits, and these decisions usually further benefit shareholders at the cost of workers.
Workers should be included in these decision-making conversations, creating a more democratic system within corporations. This change would significantly help to move us toward a prosperous economy where many more workers and families are economically secure.
The idea is also politically popular: In a recent poll by Data for Progress, in which Senator Tammy Baldwin (D-WI) made the case for stakeholder governance, 52 percent of likely 2018 voters supported “establishing worker representation on companies’ boards of directors.” Another 25 percent were unsure. Overall, employee governance had net positive support in 100 percent of states and congressional districts.
If we understand the way that corporations are run today—according to a neoliberal model of shareholder primacy governed by the laws of a single state—it is clear that it’s time to overhaul the rules that structure decision-making powers within America’s corporations and create a system of broader stakeholder corporate governance.
Shareholder primacy explains why in 2018, while profits boom, corporations are spending $1 trillion on stock buybacks while real wages for average workers have declined .2 percent. Within corporations, shareholders have the power to demand that corporate wealth flows exclusively to them. As such, workers have become a cost to be cut, rather than a source of innovation for improving whatever the company produces.
In the words of law professor David Yosefin, “shareholder primacy pushes managers to exploit non-shareholders in pursuit of shareholder gain.”
Corporations have rules for decision-making—termed “corporate governance”— that are set by law. As business entities with publicly granted privileges, stakeholders beyond just shareholders should make these decisions.
That’s why I propose several changes to corporate governance: Employees should have substantial representation on corporate boards, and boards should have to take the interests of all stakeholders into consideration, including customers and the broader public. This is “stakeholder governance.”
In an earlier piece for Boston Review, “Public Benefit, Incorporated,” I lay out the broad case for stakeholder governance of corporations. Below, I provide more details on the current regulatory system and its history, review models from other nations, and recommend a way forward in the United States.
Shareholder Primacy and Delaware’s Dynamic
Corporations are privileged business entities that shield individuals from liability if things go bust, and they are able to raise huge amounts of capital and become enormously profitable. Because of these privileges, the public sector gives them license to exist—this happens at the state level in the United States. A state’s secretary of state must approve a corporation’s founding documents for it to begin operations. In the U.S., corporations do not need to incorporate in a state that has any connection to their business. They aren’t even required to have a headquarters or to employ a single person in that state. Once they choose a state to incorporate in, that state’s rules of corporate governance will apply to that corporation, even if no one affiliated with the company ever sets foot in the state.
This norm, known as the “internal affairs doctrine,” has led to the majority of America’s large corporations incorporating in Delaware—a state of less than 1 million residents that houses nearly two-thirds of Fortune 500 companies. Delaware has extraordinarily shareholder-friendly laws, rooted in a shareholder primacy approach to corporate governance. According to legal scholar Mark Roe, “Delaware’s corporate law is itself a quasi-contract between managers and shareholders that is written by the two and enforced by the legislature.” Other states are wary of straying too far from Delaware’s corporate governance laws for fear that the corporations that have chosen to incorporate within their state will leave.
Shareholder primacy—the belief that everything a corporation does must be for the benefit of shareholders (who should extract as much wealth from the company as possible) and no one else—is the dominant legal framework operating within firms today, and corporations incorporated in Delaware are governed by these rules. Ignoring the contributions of all stakeholders to corporate success, the shareholder primacy model has driven the deep-rooted economic inequality that we live with in America today.
Corporate governance ultimately refers to who elects the board, and who the board has to take into consideration when it makes decisions.
Today, shareholders have the only vote in electing the board. And the board of directors has a “fiduciary duty”—a legal set of responsibilities—to manage the corporation in the best interest of the shareholders. In other words, directors must “work hard and honestly” to advance the interests of shareholders.
The board of directors is in charge of a company’s major decisions, like who to hire for chief executive, whether to merge with another company or move operations to another state or overseas, and, crucially, how much to pay out to shareholders in dividends and stock buybacks.
Board members who want to hold onto their seats are going to do what they can to please short-term oriented shareholders. And chief executives are now largely compensated in ways that are tied to the price of shares, so they have an additional incentive to steer the board towards decisions that push up short-term share prices. The existing shareholder primacy model means that boards focus too much on increasing their share price. That’s why Goldman Sachs estimated that American corporations are on track to spend $1 trillion dollars in 2018 on stock buybacks1, essentially propping up the entire stock market by repurchasing their own stock.
This system creates a problematic dynamic: States are incentivized to create shareholder-friendly corporate governance laws to attract big businesses—they have much to gain from the licensing fees they can collect—and firms are incentivized to incorporate in shareholder-friendly states. And shareholder incentives will lead firms to spend more on shareholder windfalls and less on wages and investment.
What is Stakeholder Governance?
There is a better way to make decisions inside corporations that will benefit all stakeholders who create the firm’s success. Stakeholder governance means that the different groups that contribute to a corporation’s success—employees, customers, the broader public, as well as shareholders—all merit some role in the major decision-making that a corporation faces.
This means that employees have real representation on corporate boards, so that decision-making is shared among stakeholders, instead of shareholders electing all board members. Accountability to stakeholders also means that the board has to consider all of the company’s stakeholders when making decisions, including customers, suppliers, and the broader public.
As Professor Kent Greenfield describes, employees have more of a lasting investment because they are the most affected by major corporate or, in the extreme, what happens if a company goes bankrupt or merges with another company in which jobs are shed. In contrast, shareholders hold large portfolios of stocks, and the vast majority has bought their shares on the secondary markets, rather than directly from a firm. It’s much easier for them to sell a share than it is for an employee to find a new job.
Workers have a significant stake in the success of the company and should have a significant say in its governance. Rebalancing power within corporations will ensure that boards don’t vote to spend billions in stock buybacks while shedding jobs and cutting wages.
Our current system of state incorporation comes from a time when most corporations transacted their business literally within a single state. Today, we live in an economy where big corporations operate globally, and certainly across multiple state lines.
We need to federalize corporate law in order to redefine how power is shared inside companies for our largest corporations.
Proposals to federalize incorporation have had a long history in America, demonstrating that shareholder primacy is not the only model for corporate governance. And recognition of the impacts corporations have on society and on their workers is spreading, as increasingly advanced industrialized nations are working with variations of stakeholder corporate governance models.
The History of Stakeholder Governance vs. Shareholder Governance
During the Progressive era, which began in the 1890s, the idea of federalizing incorporation rules was central to economic policy debates. The push to explore new models of corporate governance came, just as today, from the heightened powers of the mega-corporations that emerged during this era. Various bills focused on granting the commissioner of corporations—at that time, a federal regulator within the then-existing Bureau of Corporations—the power to approve applications for corporate charters, in large part as a trust-busting mechanism. These bills provide guidance to those who are working to undo today’s era of corporate power and shareholder primacy. (The legislation from that time is documented in detail in Professor Marc Steinberg’s Federalization of Corporate Governance.)
At the time, many of the nation’s smaller companies still conducted business truly within state boundaries, so the focus was only on the trusts that had reached a level of market dominance that extended past state lines. One bill, 1912’s H.R. 26415, would have created a bipartisan “United States Corporation Commission” and mandated that all corporations whose business exceeded a certain dollar volume were required to become corporations under the laws of the United States. Like today’s SEC, the Corporations Commissioners would have been appointed by the President and confirmed by the Senate. Only after a satisfactory statement was submitted would the commission grant the corporate charter, allowing the corporation to function and, essentially, exist. No stock could be issued without the approval of the commission, and it would not allow companies to issue new stocks and bonds that exceeded the company’s “true value of its physical assets and the good will of its business.” Mergers would also have to be approved by the commission. The bill also limited officers and directors from serving in multiple roles in other companies without commission consent. All of these rules would have given the commission substantial power over corporate decisions.
Another bill, 1911’s S. 232, was specifically established to curb the outsized influence of the financial sector within the non-financial corporate sector. It would have prevented corporations from issuing stock except “for the purpose of enlarging or extending the business of such corporation or for improvement or betterments,” and would have required explicit permission from the secretaries of commerce and labor. This would have dramatically tamed the power of the rising financial sector by limiting stock issuance to the actual industrial needs of the firm. If the corporation’s amount of outstanding stock exceeded the value of its real assets, the government would require the company to recall its stock, and issue new stock such that the value of the stock was equal to the company’s actual assets.
Various bills gave the commissioner of corporations the ability to choose whether or not to grant corporate existence. In one bill, corporate existence was not perpetual; rather, it was limited to 30 years before a new application was required. Other bills placed substantive requirements on shareholder distributions; for example, one mandated that shareholder dividends should only come from the corporation’s surplus or net profits, not from debt. Penalties for failing to obtain a federal license ranged from forced closure to penalties on directors for any fraudulent or negligent acts in the application for a charter.
None of these bills became law.
Since then, states continue to govern incorporation, and Delaware became the dominant provider of business-friendly incorporation laws. But the federal government’s role also evolved in time. The Federal Trade Commission (FTC) grew out of the Bureau of Corporations, creating a powerful federal role (in theory, if not in practice) in regulating market structure, but leaving corporate governance—what happens inside the company—still in the hands of the states. Today, the Securities and Exchange Commission (SEC) is the de-facto federal regulator of public corporations, but its mandate is to govern securities transactions through disclosure of important information to shareholders, not to regulate substantive corporate decisions. In other words, the SEC focuses on ensuring that companies share critical information about corporate activity conducted with (or for) their shareholders. This hole in federal law means that corporations remain unbound by a substantive federal corporate law.
The 20th century saw a prolonged debate between scholars of corporate law, beginning with Adolf Berle and Gardiner Means versus E. Merrick Dodd: Berle and Means championed shareholder primacy as the way to rein in the excesses of self-interested management, while Dodd advocated for a stakeholder model.
The debate continued throughout the century, as shareholder primacy advocates championed the “nexus of contracts” approach of the corporation. This theory says that since all corporate stakeholders except shareholders are covered by contracts and other branches of the law, such as labor law, shareholders need to have their investments protected. This leads to the conclusions that the board is responsible only to shareholders. Importantly, the model does not take into account what happens when shareholder-driven corporate interests dramatically weaken legal protections for other stakeholders (for example, Janus and what’s happening right now inside Trump’s Environmental Protection Agency).
Progressive corporate law scholars, on the other hand, continued to excavate the history of public grants of corporate charters and demonstrate the viability of the stakeholder model, while Chicago School legal scholars claimed it was the end of corporate history and that shareholder primacy had won.
In the 1980s, scholars and advocates of the board’s responsibilities to corporate stakeholders developed state “constituency statutes” that allowed corporations to choose the stakeholder model and include employees in selecting board members. Such statutes, however, gave corporate boards the option to choose the stakeholder model, but they did not obligate them to do so.
With the exception of the rise of the benefit corporation movement, which allows firms to opt in to a stakeholder governance framework, large corporations today generally incorporate in Delaware in order to govern themselves for the maximal benefit of shareholders. For large corporations, shifting the chartering process to the federal level would give policymakers, and thus the broader public, an opportunity to determine the rules of corporate behavior, adding a much-needed democratic voice to the system.
International Models of Stakeholder Corporate Governance
Stakeholder governance is much more common around the world than Americans know; reading about the laws in other countries can be the same kind of a-ha moment that comes when you realize how much better other countries’ health care systems are for the majority of citizens.
In other advanced industrialized economies, balanced models of corporate governance are the norm. In two-thirds of Europe, workers have a role on the corporate board, and in 13 countries, including Germany and France, worker governance rights are extensive across much of the private sector. Germany’s stakeholder model, comprised of workers on boards and works councils, and alongside sectoral bargaining—or the power to bargain with all companies in an industrial sector at once, rather than at the level of the individual worksite—has been widely covered by my colleague Susan R. Holmberg. It is worth noting that various worker board models exist across Europe, including how workers are elected, who can be a board representative, and their composition and structure on the board.
Typically, among the European countries with a worker representation requirement, the standard is to mandate that one-third of the board members be worker representatives. In Germany, worker representatives must make up half of the board for companies with over 2,000 employees. These representatives are typically elected by the workforce or nominated by their unions. Most countries require that representatives be company employees, as they are most deeply invested in the company, while the Netherlands imposes the opposite: representatives cannot be employees or union members, instead they must be a step removed. In both cases, the individual is intended to speak on behalf of the interests of workers.
There are, of course, limitations to these mandates. Most countries employ a minimum number of employees before a company is required to elect worker representatives. These minimums range from 25 to 5,000 employees, ranges that determine the frequency of worker-friendly boards. Also, even in Germany where there can be up to 50 percent worker representation, they do not have the power to block or override a vote by the rest of the board. In the German case, the chair of the board is always a shareholder and holds the tie-breaking vote.
In these examples, shareholders still maintain a substantial and powerful presence, but workers are also able to participate in the conversation. Europe shows us that there are many ways a stakeholder model can be implemented, and ours does not need to duplicate any one existing framework.
The common critique of stakeholder corporate governance is that a departure from the shareholder model will drastically reduce investment. Regardless of the validity of this concern, the stakeholder model we are proposing explicitly includes shareholders as key stakeholders. Our stakeholder model does not take away investors’ role in corporate governance; it only broadens the table to other stakeholders, as well. Moreover, the rate of newly issued stocks has been negative in the non-financial corporate world for nearly two decades—meaning investors are not providing corporations directly with fresh capital. Instead, investors are buying and selling existing shares to each other on the secondary market. Though such trading does indirectly benefit corporations by showing that investors believe their stock has value, secondary market trading does not directly give corporations any capital to make new investments in future productivity. This means that even if investors felt duped by a shift away from shareholder primacy, their power to negatively affect the company’s capital inflow is very limited regardless.
A second, perhaps more important, concern is that the stakeholder model would lead to more power in the hands of central management because management will be able to play stakeholders off of each other and consolidate their own power. The whole point of the stakeholder model, however, is to rebalance power among different types of stakeholders, so that all stakeholders have the ability to at least attempt to claim some of the value they’ve created. Meaningful stakeholder representation on the board—of at least 50 percent of board seats—would go a long way to ensuring a balance of power. Nevertheless, management power is a real concern that thoughtful policy design should strive to address.
This concern is why it’s not enough to simply make the board’s duties of loyalty and care apply to all stakeholders; they must also be in decision-making positions in order to exercise some accountability over management decisions. That is why it is crucial that employees have meaningful representation on the board of directors.
Conclusion: The Case for a Federal Corporate Stakeholder Governance Model
This proposal—to add stakeholder representatives to corporate boards, federalize incorporation for large corporations, and make board duties of care and loyalty run to all stakeholders—will inspire many questions, which deserve robust discussion and debate. What is not up for debate, however, is the fact that while real wages are dormant, the wealthy are getting wealthier due to an explosion of unchecked corporate power.
Large corporations—that employ four-fifths of the nation’s employees—are multinational. Our current incorporation model is based on the outdated notion that they operate inside a single state. That is why it is time to federalize incorporation for our large multinational companies. The state-based model has led to an economic race to the bottom and rising economic insecurity for individuals and households.
Most importantly, it is the public that grants corporate privileges, so the public should have a democratic role in determining the rules that govern corporate decision-making. Large corporations that operate nationally—like the Apple, Berkshire Hathaway, and Coca-Colas of the world—require national democratic input into the rules of their governance. Models of board participation and stakeholder governance are far from perfect, but there’s no reason why they should be completely off the table as we work towards solutions to income inequality in America.
When corporations do well, it’s reasonable to expect that all who contribute to that success should have a share of it. It’s past time to redefine who holds corporate power.
1. Jeff Cox, “Companies Set to Buy Back $1 Trillion Worth of Shares this Year, and that Should Keep Market Afloat, Goldman Says,” CNBC (Aug. 6, 2018), https://www.cnbc.com/2018/08/06/companies-set-to-buy-back-1-trillion-worth-of-shares-this-year-to-kee.html ↩