The traditional view of corporate law can be summarized as follows. Shareholders have a single well-defined objective, namely ‘to maximize the net present value of the firm’s earnings per dollar invested’ (Hansmann, 283). Managing companies in the interest of shareholders that aim at maximizing the net present value of their firm leads to a higher level of social welfare than any realistically available alternative. Within that framework, the goal of corporate law is straightforward: aligning managers’ preferences to those of shareholders.
In a recent paper of ours, we show that this view is premised on two assumptions that are no longer true. First, the idea that all shareholders want to maximize the net present value of the firm’s earnings per dollar invested. Second, the view that, on the one hand, microeconomic shocks do not produce macroeconomic consequences and that, on the other, there are no systemic externalities that tort law cannot address. The rise of institutional investors undermines the first assumption: share ownership is now concentrated in the hands of large asset managers holding the entire market and displaying a preference for maximizing the value of their portfolio as a whole rather than the performance of individual companies. That is, they are portfolio value maximizers (PVM), rather than firm value maximizers (FVM). At the same time, the increasing interconnectedness of the economy and the climate crisis undermine the second assumption. In fact, there is ample empirical evidence that microeconomic shocks to a well-identified subset of ‘central’ firms can propagate through the existing interconnections and generate catastrophic consequences. In addition, a small subset of firms is responsible for the vast majority of greenhouse gas emissions and hence is disproportionately contributing to worsening the global climate crisis.
We suggest that these phenomena have profound implications for corporate law. First, managers might have limited incentives to maximize the value of their own firm if their most powerful shareholders are PVM. Second, central firms that act in the interest of FVM have incentives to disregard the catastrophic—and at times irreversible—externalities that they may cause.
But how can corporate law react to these trends? We suggest that it should react by abandoning the traditional one-size-fits-all approach to favor a two-pronged system. As a clearly defined subset of central firms has a significantly higher chance to impose catastrophic externalities, not all firms are created equal. Therefore, not all firms should necessarily be subject to the same corporate law rules.
On the one hand, corporate law should ensure that in non-central firms FVM shareholders have enough voice to push managers to compete aggressively to maximize the value of their corporation. On the other hand, in central firms it should harness the preferences of portfolio value maximizing shareholders with the goal of reducing the risk of catastrophic externalities like climate change or financial crises. In fact, in central firms PVM shareholders will be better positioned to counter the preferences of FVM shareholders that are oblivious to systemic externalities. An obvious example is that of a systemically important financial institution (SIFI). A FVM shareholder only invested in the SIFI has incentives to push the SIFI to engage in aggressive risk taking, as it would not internalize any potential harm caused by the SIFI to the economy at large. On the contrary, a widely diversified PVM shareholder would have weaker incentives to support such kind of strategies, as it would internalize via its other portfolio companies a significant portion of the externalities caused by the possible distress of the SIFI.
To offer a concrete example of how a two-pronged approach could work within the domain of corporate law, we focus on ownership disclosure rules and explain how the two-pronged approach could be applied in this context.
Luca Enriques is a Professor of Corporate Law at the University of Oxford.
Alessandro Romano is an Assistant Professor of Law at Bocconi University.