In recent years, interest in alternatives to shareholder-centric corporate governance has increased significantly. It has been driven by a growing sustainability imperative—widespread recognition that business as usual, despite the short-term returns generated, could undermine social and economic stability and even threaten our long-term survival, if we fail to grapple with associated costs. We remain poorly positioned to assess options for reform, however, because prevailing theories of corporate governance limit the debate in ways that obscure many of the most consequential possibilities.
According to those views, our options amount to board versus shareholder power, and shareholder versus stakeholder purpose. This narrow perspective obscures more fundamental corporate dynamics and potential reforms that might alter the incentives giving rise to corporate excesses. In a feature forthcoming in the Yale Law Journal, I argue that promoting sustainable corporate governance requires reforming fundamental attributes of the corporation that encourage excessive risk-taking and externalization of costs.
The feature first reviews prevailing conceptions of the corporation and corporate law, exploring how they condition our thinking about corporate governance and limit our sense of the possible through a narrow language of reform. Nexus of contracts theory argues that corporate law ought to establish default rules reflecting what corporate stakeholders would (hypothetically) negotiate at arm’s length, and that this favors the efficiency benefits of strong boards combined with substantive focus on shareholders, styled as the sole residual claimants. Other stakeholders, meanwhile, are left with whatever protections they can secure through contracts or regulation. Nexus theory reduces corporate governance policy to board versus shareholder power and shareholder versus stakeholder purpose, and the favored approach among nexus theorists combines board power and shareholder purpose.
Team production theory, meanwhile, styles the board of directors as a 'mediating hierarch', duty-bound not to focus exclusively on shareholders, but rather to satisfy all stakeholders, providing credible assurance that each will be protected from exploitation and thereby promoting firm-specific investment by all of them. This reflects a different conception of the aims of corporate decision-making, yet corporate governance policy is again reduced to board versus shareholder power, and shareholder versus stakeholder purpose—the favored approach for team production theorists being board power and stakeholder purpose.
Shareholder primacy theory, then, places shareholders at the heart of the corporation in all respects. Shareholders own the corporation and hire managers to run it for them in straightforward principal-agent terms, rooting corporate power and purpose alike in the shareholders. Once again, corporate governance policy amounts to board versus shareholder power and shareholder versus stakeholder purpose, but for shareholder primacy theorists the favored approach combines shareholder power and shareholder purpose.
To be sure, these are significant theories that prompt spirited debate about important dimensions of corporate governance. But they reduce the corporate form and corporate law to two binary variables, and fail to account for different yet workable governance arrangements adopted elsewhere—for example, German-style co-determination. At the same time, these approaches limit debates about how to reform corporate governance and make it more sustainable. We need a more capacious framework for understanding corporate governance dynamics, moving beyond these twin binaries, and the feature proposes a means toward a more productive conversation.
The normative shift toward shareholder wealth maximization over recent decades reflects a broader trend toward financialization of the economy, which in turn reflects a complex set of economic and social phenomena. The tendency toward excessive risk-taking and cost externalization, however, is most readily understood in simple balance-sheet terms. Financial accounting defines equity as whatever is left after liabilities are subtracted from assets, prompting shareholders to favor actions that increase assets or decrease liabilities. Such actions benefit other stakeholders to the extent they involve mutually value-enhancing transactions, but these ends might be pursued in less benign ways—including through excessive risk-taking and indiscriminate cost-cutting. These tendencies are strongly reinforced by structural features of the modern corporate form—notably limited liability, allowing shareholders to capture the upside without facing the full downside. Other aspects of corporate law, like the business judgement rule, free managers to pursue the risks that shareholders with limited liability prefer.
Corporate financial statements do not, however, reflect 'externalized' costs borne by workers and communities, environmental harms, human rights violations in global value chains, or systemic consequences of excessive risk-taking. This amounts to a public subsidy of businesses.
There is a pressing need to revisit assumptions about the corporate form and corporate law that are embedded in the twin binaries discussed above. As to corporate purpose, my feature argues that giving priority to the sustainability of corporate operations would provide a coherent and normatively desirable framework for evaluating modes of corporate governance and assessing reforms. Sustainability, as described in an influential UN report, aims to ensure that humanity 'meets the needs of the present without compromising the ability of future generations to meet their own needs'—a challenge having environmental, social, and economic dimensions. This conception frames the pursuit of sustainability, including in the corporate context, and offers a coherent long-term policy that serves human interests and directly responds to fundamental problems of corporate governance. Corporate sustainability measures corporate governance against a widely desired outcome to which business and investment leaders have committed, even if its pursuit through corporate governance could take a variety of forms.
In addition to re-thinking our normative priorities, addressing excessive risk-taking and cost externalization will require re-envisioning the corporate form. Specifically, we need to abandon the notion that the corporation embodies a set of fixed attributes in order to take advantage of the flexible capacities that it offers. For example, just as reduced liability exposure for shareholders (and boards) promotes greater risk-taking, so increased liability exposure would have the opposite effect. We have choices about how to structure the corporate form to pursue our goals. We could make governance more or less centralized, impose more or less liability exposure on shareholders and boards, and put more or less emphasis on shareholders’ interests. We could alter the degree to which shareholders control board composition, how much capacity they have to promote their own interests through litigation, and the degree to which directors’ duties put shareholders’ interests above other interests and values. Better choices could promote more sustainable corporate governance.
The remainder of the feature uses this framework to evaluate the proposals now getting the most attention and to direct attention toward broader reforms. Recent sustainability-oriented reforms rely heavily on disclosure, which I argue may be an essential predicate to meaningful reform yet too often substitutes for it. The feature then assesses more ambitious reforms that re-envision the board of directors, and re-think underlying incentives. As to board composition, I explore means of improving sustainability through greater diversity and regard for worker interests. I then explore various reforms that would involve imposing liability on shareholders, in limited and targeted ways, to curb socially harmful risk-taking while preserving socially valuable efficiencies. This is critical where standard modes of corporate governance produce excessive risk-taking and cost externalization—including in financial firms, systemically significant non-financial firms, firms involved in inherently hazardous industries, and firms engaged in far-flung global value chains.
Much work remains to determine what a truly sustainable corporate form would be for such firms. No single version will promote optimal levels of risk-taking in all industries, and more granular and context-specific analysis is required. But asking the right questions will be essential to identify more sustainable modes of governance.
Corporate governance debates too often default to prevailing theories, and reforms advanced too often default to disclosure. Ultimately, we need to focus on a more robust conception of corporate sustainability and to reckon honestly with the corporate features and decision-making incentives standing in the way. Until we engage with the fundamental drivers of risk-taking and cost externalization, real solutions will continue to elude us. Taking seriously the broader range of possibilities that the corporate form offers, however, reveals ample means of redirecting corporate governance toward a sustainable path.
Christopher M. Bruner is the Stembler Family Distinguished Professor in Business Law at the University of Georgia School of Law.
This post was first published on the CLS Blue Sky Blog here.