Martin Lipton is a legend in the field of corporate law. So, when Mr. Lipton speaks on the purpose of the corporation, as he did in his recent posts on the Harvard Law School Forum on Corporate Governance and the Columbia Law School’s Blue Sky Blog, people definitely should listen. The point of his posts, co-authored with his Wachtell, Lipton, Rosen & Katz partners William Savitt and Karessa L. Cain, was to present a definition of corporate purpose that can be applied to every business enterprise:
‘The purpose of a corporation is to conduct a lawful, ethical, profitable and sustainable business in order to create value over the long-term, which requires consideration of the stakeholders that are critical to its success (shareholders, employees, customers, suppliers, creditors and communities), as determined by the corporation and the board of directors using its business judgment and with regular engagement with shareholders, who are essential partners in supporting the corporation’s pursuit of this mission.’
Unfortunately, I am disappointed with this definition, a definition that ignores the social value created by for-profit businesses, namely the goods and services they produce; ignores that this social value is being produced for the financial benefit of its shareholders; and uses the pretense that uninformed institutional investors are partners in the management of a company.
To be blunt, what Lipton, Savitt, and Cain really provide is not a definition of corporate purpose, but advice from outside counsel to a board of directors and executive management on how to approach their interaction with shareholder activists, institutional investors, and regulators. Unfortunately, I believe this conflation of objectives distorts and makes inadequate their definition of corporate purpose for all but the providing of corporate governance advice.
This does not mean I disagree totally with their statement. I do agree with their focus on stakeholders as critical partners in a business enterprise and that it must be the corporate managers that are in charge of these relationships. As I stated in a recent op-ed,
‘In a public company, stakeholders represent an enormous number of entities and individuals, including shareholders, directors, managers, employees, independent contractors, consultants, consumers, creditors, vendors, distributors, communities affected by the company’s operations, federal, state, and local governments, and society in general, when it is positively affected by the social value created by the company or negatively affected when the company generates third-party costs such as air or water pollution. The management of these relationships is complex and is usually placed in the hands of those who have the knowledge and expertise to manage them: the company’s management team, up and down the line.
Efficiently and innovatively dealing with these critical relationships is what the work of corporate management is all about. Moreover, these relationships can change on a daily basis: consumers who have ever-changing tastes or are becoming increasingly sensitive to the negative externalities that the company may create; competitors that introduce new products; changing technologies; threats to global and domestic supply chains for key components and raw materials; credit and equity markets that require ever-changing terms; and competitive labor markets for skilled talent. A failure to deal with these stakeholder relationship issues in an integrated manner can lead a company to report mediocre financial results and eventual failure.’
I also believe their endorsement of the business judgment rule (the ‘Rule’) is correct. As I stated in my most recent article on the business judgment rule, ‘The Importance of the Business Judgment Rule:’
‘[W]ithout the Rule, the raw power of equity …could conceivably require all challenged Board decisions to undergo an entire fairness review. In the face of this power, the issue for courts is to determine how the interests of stockholders are to be balanced against protecting the Board’s statutory authority to run the company without the fear of constantly facing potential liability for honest mistakes in judgment… This requires equity to be restrained so as not to create an imbalance. To do this, Courts use the Rule as a tool to distinguish situations in which a Board decision should stand without further review from situations in which an entire fairness review is required and the full force of equity is to be applied.’
What is most important about their definition is what is missing. First, they make no mention of the social value created by the corporation through the successful management of its stakeholder relationships, the goods and services it provides. How can a definition of corporate purpose not mention this? It’s as if a corporation should be ashamed of why it exists. Even oil and gas companies produce tremendous social value for society. Yes, in the production and consumption of their goods and services they do create significant negative externalities that need to be addressed, but can you imagine our economy or any other economy without them? Larry Fink, in his 2020 letter to CEOs, made the concession that they will remain important for the decades to come: ‘Under any scenario, the energy transition will still take decades. Despite recent rapid advances, the technology does not yet exist to cost-effectively replace many of today’s essential uses of hydrocarbons.’
Moreover, if the social value created by a corporation is to be included in its corporate purpose, then it must be based on the social value that each company creates. This means that their one-size-fits-all approach is inadequate. For example, several years back a Pfizer executive was asked to explain Pfizer's social purpose: ‘the social purpose of Pfizer is to discover and develop new and innovative medicines that prevent and treat disease, allowing individuals to live longer and healthier at every stage of life.’
This statement is closer to the mark as a statement of corporate purpose as it incorporates the social value created by this specific company. However, it lacks the inclusion of its overall objective. As stated, it has only a strategy of how it will create social value, the discovery and development of new drugs, that could work as an end-in-itself if Pfizer were a non-profit. But Pfizer, as a for-profit corporation, also has the legal obligation of looking out for the interests of its shareholders. This is the only stakeholder group that the board owes fiduciary duties to, who can sue the board for a breach of those duties, who can approve major corporate decisions, and who can initiate and implement a proxy contest to remove board members. Thus, shareholder wealth maximization is the objective of Pfizer’s social value creation.
As a general proposition, shareholder wealth maximization is only a default objective, as unanimous shareholder consent, a clause in the corporate charter, or being established as a public benefit corporation may allow for it to be a different or at least a non-exclusive objective. However, it is a tried and true objective that allows a company to be successful in competitive input and output markets and minimizes the risk that a company will become a target of acquisition in the market for corporate control, including through the means of a proxy contest. Therefore, it is easy to argue that a board has both a legal and an economic obligation to seek shareholder wealth maximization as its corporate objective.
Moreover, to make Pfizer’s definition of social purpose useful as a definition of corporate purpose, I would add ‘For the financial benefit of our shareholders, Pfizer will discover and develop....’ By contrast, the Lipton, Savitt, and Cain definition of corporate purpose is missing both an objective and a strategy on how it will create social value.
Finally, in my new article, ‘The Risks and Rewards of Shareholder Voting,’ I argue that a collective action problem in shareholder voting leads to uninformed institutional investors, resource-constrained investor stewardship teams and proxy advisors that cannot solve this problem, and the current lack of enforcement of an investment adviser’s fiduciary duties does not solve the additional problem of institutional investor bias in shareholder voting. This is particularly true of investment advisers to passive indexed funds, both in mutual and exchange-traded form. These investment advisers expend hardly any effort in trying to value the firms that are held in the portfolios of those funds. If they know nothing about their value, then they certainly won’t know anything about how to manage them. This is why institutional investors cannot be partners with the board and executive officers in the management of the company. Yes, institutional investors must be placated when they leverage their enormous voting authority to act opportunistically, but they cannot be true partners in the realization of a portfolio company’s corporate purpose.
In sum, the Lipton, Savitt, and Cain definition of corporate purpose is missing too many critical elements for it to be useful as anything more than advice on how to deal with troublesome stakeholders. Their definition is lacking the inclusion of a strategy for creating social value that is consistent with the objective of shareholder wealth maximization. It must also be less reticent about the true nature of the relationships between uninformed institutional shareholders and the board of directors.
Bernard S. Sharfman is Senior Corporate Governance Fellow, RealClearFoundation.