The Shareholder Primacy Tightrope: Balancing Profit and Purpose
Written by Arthur Kohn, Skytop Contributing Author and Chair, Editorial Committee, Capitalism Today
Arthur Kohn has practiced law since 1986, focusing on compensation and benefits matters, including executive compensation, pension compliance and investment, employment law, corporate governance and related matters. In 2021, he was appointed as a fellow to the American College of Governance Counselors.
Arthur is an adjunct professor at New York University School of Law and a regular guest lecturer at Columbia Law School. He frequently speaks and writes about executive compensation, taxation and corporate governance matters. He repeatedly has been recognized for his work by the business and legal press, including Best Lawyers, Chambers USA, The Legal 500, Super Lawyers of New York and others.
Arthur received a B.A. from Columbia University and a J.D. from Columbia Law School, where he was admitted into the Accelerated Interdisciplinary Legal Education program, was appointed a Harlan Fiske Stone Scholar and received Phi Beta Kappa honors.
The debate about the responsibilities of corporations to society – referred to these days as the “ESG debate” – goes back at least about a hundred years, to a famous debate between Merrick Dodd and Adolphe Berle, two lawyers, that played out in the Harvard Law Review. The debate occurred, not coincidentally, in the early 1930s, at the outset of the Great Depression, and by way of illustration included the following statement by Professor Berle:
Most students of corporation finance dream of a time when corporate administration will be held to a high degree of required responsibility – a responsibility conceived not merely in terms of stockholders' rights, but in terms of economic government satisfying the respective needs of investors, workers, customers, and the aggregated community.[1]
Alas, recent events suggest that such a time is probably not imminent. The hoped-for responsibility requires a degree of balancing of interests, of compromise, but the current culture tends more towards conflict and centrifugal forces.
The legal thinking that has been playing out in the background concerning ESG and corporate law in Delaware, the leading corporate jurisdiction, is critical to an understanding of the current situation.
Shareholder Primacy – What Does it Mean?
“There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception [or] fraud”[2]
The legal doctrine of shareholder primacy – the idea that corporations have an obligation to their owners to prioritize increasing profits over all else, including environmental, social and other societal considerations, within the bounds of law – has become so engrained in some business, investing, political and other circles over the last 50 years that it seems like an incontrovertible natural law.
Many don’t know, or willfully ignore, the fact that a competing theory of corporate governance, referred to today as “stakeholder capitalism”, in which the interests of multiple constituencies, including society in general, are taken into account in corporate decision-making, prevailed for much of the 20th Century. Indeed, the stakeholder capitalism theory of corporate governance prevailed, perhaps coincidentally or perhaps not, during the development of a globally dominant U.S. economy in the decades after World War II. Stakeholder capitalism is today viewed by some as not workable, because of the need for decisions about which stakeholders should benefit, when, and by how much. By many others, it is dismissed on the basis that “of course” the purpose of a corporation is, first and foremost, to make money for the shareholders.
Shareholder primacy is not natural law. In fact, there is an unresolved debate about whether it is actually the law anywhere. You can read a good summary of that debate in a 2022 law review article entitled “Reconciling Corporate Interests with Broader Social Interest – Pursuit of Corporate Interests Beyond Shareholder Primacy” (here), but the bottom line is that whether shareholder primacy is the law in any State, and what its fundamental contours are, including in states with so-called constituency statutes, is unclear.
That lack of legal clarity is helpful, because it begets an illuminating discussion about what “shareholder primacy” really means. There are not surprisingly a range of proposed interpretations. In addition to the strong form summarized by the noted economist Milton Friedman in the quotation above, there is a weaker form, in which the exception for compliance with law is extended to also cover ordinary course charitable and social expenditures. Relatedly, there is an argument that the doctrine is not meant to preclude the expenditure of resources that do not demonstrably adversely impact shareholders.
In perhaps its softest form, there is an argument that all the doctrine requires is some rational relationship, however extenuated, between a corporate expenditure and the pursuit of profit.
Finally, there is an argument that the idea is not in any case legally enforceable, because most any socially driven expenditure can be characterized as being in furtherance of reputational or other similar corporate benefits consistent with long-term share value, so that the exact parameters of the doctrine are not very important. In the same vein, there is a view that the doctrine is appropriate but merely “aspirational”, so that in the real world it is reasonable to accept that not every decision could be justified as being in pursuit of more profit. Note that all variations on Friedman’s statement of 50 years ago (but not Friedman’s statement itself) permit the possibility that a board of directors could, consistent with their fiduciary obligations, decide to expend some resources for social purposes without having to twist themselves in knots, or strain their muscles winking-and-nodding, to justify the decision as being in pursuit of profit maximization.
A 2021 law review article, entitled “Shareholder Primacy and the Moral Obligations of Directors” (here), takes up at length the question of whether directors can use corporate assets for what they decide is social good rather than in order to increase shareholder value. It concludes that “the existing shareholder primacy paradigm is only plausible if we allow the need for some moral constraints based on publicly widespread shared moral judgments”.
However, the article goes on to conclude that we have no choice but to live with the widely assumed and accepted paradigm – that directors do not have such flexibility and that they must always pursue the last dollar of profit, subject only to legal constraints – without a change in Delaware law.
According, to the authors, “all of the alternatives are found wanting”, and so we must rely on ethically informed legal constraints, as they evolve over time, to cover the field. Until the Delaware legislature changes the law, the authors argue, directors who are not comfortable with the idea that they must pursue the last dollar of profit subject only to legal constraints, and without the additional guidance even of widespread shared moral judgments, can resign.
Thankfully, Leo Strine, the former Chief Justice of the Delaware Supreme Court and Chancellor of the Chancery Court, in another 2021 law review article, entitled “Caremark and ESG, Perfect Together: A Practical Approach to Implementing an Integrated, Efficient, and Effective Caremark and ESG Strategy” (here), provides an insightful and novel analytical alternative to avoid that unfortunate conclusion.
Strine starts out by noting that a director’s first duty under Delaware law, and under the Friedman conception of shareholder primacy, is not to maximize profit for the stockholders, but rather to comply with the law.
Strine argues that directors’ attention, as required by Delaware’s Caremark doctrine, to whether management is complying with law generally in the conduct of its business is consistent with most (note the hedge, as Strine doesn’t say “all”) ESG-focused efforts. Critically, Strine states that:
like a human citizen, a corporation can decide that its reputation for above- board conduct, for acting in a manner that does not skirt the law and that shows respect for society, is valuable, and based on that business judgment, a corporation can also embrace a culture that gives primacy to ethical practices, even when such practices might not generate the most profit. (emphasis added).
Note specifically the reference to “business judgment”, comforting key words for directors. Also note the specific references to ethical considerations and profit maximization, wherein Strine makes it clear that ethical considerations – not just in a single unusual decision, but as a matter of corporate culture – may supersede the profit motive rather than merely create wriggle room on the basis that ethics may be good for long-term shareholder value too.
For those with doubts, the statement is followed by a long footnote with references to Delaware case law.
Strine found a practical and analytically defensible route for corporate directors to appropriately balance their focus on profit maximization with relevant ethical judgments, without venturing into the vagaries of stakeholder interests. His article also provides a useful guide for how companies should integrate ESG considerations into their overall compliance programs. This seems to be what Professor Berle was looking for when he said, in the same Note quoted above:
Now I submit that you cannot abandon emphasis on "the view that business corporations exist for the sole purpose of making profits for their stockholders " until such time as you are prepared to offer a clear and reasonably enforceable scheme of responsibilities to someone else.[3]
The Dilemma of Shareholder Primacy
In sum, the shareholder primacy doctrine presents a dilemma that has not been highlighted in the public understanding of the doctrine: does it prohibit corporate directors from ever pursuing ethical principles rather than profits in making corporate decisions, in the interest of avoiding the pursuit by directors of what are personal political preferences or other personal interests? This was the concern of both Professors Dodd and Berle:
When the fiduciary obligation of the corporate management and " control " to stock- holders is weakened or eliminated, the management and " control " become for all practical purposes absolute. The claims upon the assembled industrial wealth and funneled industrial income which managements are then likely to enforce (they have no need to urge) are their own. (footnote omitted)[4]
With ethics being so hard to define, how should corporate law both accommodate long-term corporate thinking, given that ethical and personal considerations may be difficult to tease apart, and also protect against diminished competitiveness arising from narrowly-ideological-non-shareholder-friendly, decisions based on personal preferences?
The answer, it would seem, lies in Strine’s conception of the Caremark doctrine and with a second important point. The traditional, Milton Friedman-type, shareholder primacy doctrine entirely precludes directors from making decisions based on ethical principles. Applying a variation or deviation from the doctrine in the real world does not require directors to make decisions based on ethics or any non-shareholder-focused criteria, it only permits directors to do so. Under any variation noted above of shareholder primacy, majorities of individual directors at corporations will still have decisions to make, and those decisions will be subject to the discipline of shareholder votes and the market (i.e., sales by dissenting shareholders of their shares). Well-advised companies will tread carefully, from legal, business, investor relations and public affairs perspectives. That is, they will impose their own balance.
One would like to think that there is not a large political constituency, on either side of the current political divide, for the proposition that ethics are in fact irrelevant to director decisions. While that’s what the oft-repeated Friedman statement of the shareholder primacy principle literally seems to say, it can be argued that what Freidman meant to exclude, instead, was politically driven and personal ideological preferences, not well-grounded ethical considerations. For those inclined to permit ethical considerations to enter into the mix, the literature therefore suggests four alternative approaches:
Define “shareholder primacy” in one of its softer forms discussed in the legal literature summarized above.
Count on the exception for compliance with law, and hope that the law gets around quickly enough to addressing the important ethical issues of the day facing business.
Interpret the exception for compliance with law broadly, as Strine did, so that it permits directors to be guided by legal compliance considerations, including to look beyond the strict requirements of law to the underlying ethical principles in making decisions, even at the expense of profit maximization.
Revert from shareholder primacy to some version of stakeholder capitalism.
The OpenAI Situation
Many will recall that at the end of 2023 there was a well-publicized leadership kerfuffle at the artificial intelligence technology company OpenAI. In the course of less than a week, the company, which is not publicly owned and which had an unusual governance structure involving a non-profit board at the top, had its founder/CEO, Sam Altman, fired by its Board of Directors, acting in collaboration with another senior leader of the company, whereupon Altman (and a third senior leader) were immediately hired by its biggest customer and largest investor, Microsoft, to compete.
The Board elevated a senior engineer to interim CEO and hired an outside replacement to take over the CEO position permanently. Following the news, a large majority of the company’s employees, including the rebellious senior leader and the interim CEO, threatened in writing to decamp to Microsoft with Altman unless Altman was reinstated, which he promptly was. At the end, all but one of the disloyal Board members were replaced.
The publicly stated reason for Altman’s termination was his failure to be forthcoming with his board of directors, but the real reason was concerns about the speed of development and implementation of OpenAI’s technology.
The detractors, it has been reported, were concerned about the danger of the technology to the future of human existence – i.e., they were concerned about a huge risk to society-at-large: “Ahead of OpenAI CEO Sam Altman’s four days in exile, several staff researchers wrote a letter to the board of directors warning of a powerful artificial intelligence discovery that they said could threaten humanity” (here). Reporting indicates that others – Elon Musk, a former contributor/investor in OpenAI, for one – shared that concern.
A risk of that magnitude, one would think, should be taken seriously, right? Concerns of that magnitude could not be simply resolved in a matter of a few days. They apparently were, and the resolution doesn’t suggest that there was a simple miscommunication, or perhaps a quick agreement to correct the prior course of managing the risk. Rather, the resolution was that all but one of the board members were replaced and Altman and his team were reinstated. The company is now reportedly considering a plan to convert into a public benefit corporation.
The cultural premise that corporations are required to always focus on profit maximization to the exclusion of all ethical considerations is apparently so deep that this resolution is hardly controversial. As Maureen Dowd wrote in the New York Times (here) a few weeks later, “OpenAI’s wild ride two weeks ago was farcical — a coup against Altman that collapsed and turned into a restoration. But it was also terrifying because it showed that we are totally at the mercy of Silicon Valley boys with their toys, egos crashing, temperaments colliding, ambition and greed soaring.”
Surprisingly, perhaps, directors’ fiduciary duties under corporate law clearly permit them to ignore artificial intelligence technology risks that “threaten humanity” in favor of focusing on their roles and responsibilities – i.e., profit maximization within the bounds of the law. The societal risk takes a back seat under the corporate law. Under current popular conceptions of the shareholder primacy doctrine, directors appropriately decided that the drive for profits makes those risks not relevant.
Notably, in this special case if the risk comes to fruition and humanity ends, the risk has no real downside (to profits or anything else) because no one is around to care! Therefore, even long-term and reputational concerns could not come into play, it would seem.
The OpenAI situation is special in two other respects. First, the company is privately held, not public, distinguishing in fact the example from the focus of the shareholder primacy debate and impacting shareholder primacy considerations in various other ways because of the nature of control in a closely-held company. Second, the governance structure arguably worked out just fine in the end – the directors were ultimately responsive to shareholders and decided, after changing its composition in accordance with the applicable rules, to pursue profits. Thus, this case illustrates a point made above, that there is no real debate that corporations should be permitted to pursue profits above all else; rather, as stated above, the question is whether directors should be permitted to do otherwise, especially when the future of humanity is on the table.
In sum, the example, while special if not unique, is nevertheless illustrative about how much is at stake. If the OpenAI team had in the end departed en masse to Microsoft, the directors of Microsoft (incorporated in the State of Washington, which does not have a constituency statute) could not under the shareholder primacy doctrine have decided to forego the competitive advantage of rapid development and deployment of the technology in favor of a more cautious approach that mitigated the societal risks at a risk to Microsoft’s profits.
Many Other Examples
The OpenAI situation, while somewhat of an unusual drama, is not in principle exceptional. Corporations make decisions that implicate social and ethical issues all the time, albeit perhaps not issues as truly gargantuan as the end of humanity. The principle that corporations are bound by the shareholder primacy theory to doing the minimum that the law requires would I suspect surprise many corporate directors if they thought about applying its profit maximization requirement honestly in the ordinary course of their decision-making.
We have many readily available historical cautionary tales in which hewing to the minimum required by law turns out badly, even though it perhaps maximizes profits. The obvious example that will come first to the minds of many are the half million deaths over the last 20 years from the opioid crisis, or the health issues affecting many millions arising from the business of the tobacco industry. But there are many others. Strine’s article notes that today’s climate change issues are new but adds that we should “not lose sight of the fact that there have been and remain other important ways in which corporate conduct affects the environment. There are other sorts of dangerous emissions (e.g., particulate matter), there are other sorts of harmful excess (think plastic)”. He goes on to note that the environmental example is not isolated. There are examples involving ethical, safe, and non-deceptive conduct toward customers, safe working conditions for employees, an environment that is tolerant toward diverse beliefs and backgrounds, fair wages and benefits and the overall commitment to conducting business with high integrity.
It is noteworthy that these types of issues are focus of more than one side the political spectrum. While climate change and racial equity initiatives have mostly be championed from the left, red states have taken steps to restrict private companies from providing abortion travel benefits (here) and a bill was recently introduced in Florida (as it happens, also in November) that would appear to regulate policies adopted by corporate contractors with the State concerning pronoun use (here). So, corporate operations routinely implicate ethical issues on both sides of the political spectrum.
In other words, ethical questions are intertwined into the daily business decisions, big and small, of most businesses. Shareholder primacy doctrine would say that those are not directors’ problems. Many directors and others, I suspect, would not be so readily dismissive. In the current hyper-partisan environment, it seems doubtful that politicians on either side will in the near term restrain themselves from criticizing corporations for one ethically based decision or another.
The Direction of State Corporate Law
The State of Delaware earned its competitive position as the leading state for corporate law “by scrupulously deferring to companies’ good-faith pursuit of shareholder value, freeing up executives to focus on business”, as former Attorney General Bill Barr put it in a 2023 Wall Street Journal op ed.[5] Citing the Strine article, Barr’s criticizes Delaware and makes the point that Delaware’s courts have significantly expanded the Caremark doctrine to encompass matters well beyond legal violations, including “du jour ESG issues like climate change, DEI, and #MeToo—or even the 2020 presidential election”. In other words, Barr is making the point that these matters are more properly understood as personal ideological or political preferences than ethical considerations.
Barr’s also makes a slippery slope argument, as follows:
The Disney case is significant because it foreshadows the completed evolution of Delaware corporate law. Companies not in step with ESG will have litigation risk under Caremark; companies that go overboard will be free from accountability. Politicizing corporate law will be far more costly in the end. The clear signal is that Delaware’s commitments to both board-level deference and shareholder value will bend to accommodate ESG.
The Barr article’s reference to the Disney case is, of course, a reference to the 2023 decision of the Delaware Chancery Court in a dispute concerning Disney’s public statement about Florida’s so-called “don’t say gay” law. Apparently motivated by employee advocacy, the Disney dispute resulted in a shareholder books and records demand in which “the plaintiff’s theory of wrongdoing is that Disney’s fiduciaries either put their own beliefs ahead of their obligations to stockholders or flouted the risk of losing rights associated with” a special Florida tax arrangement. In other words, the claim alleges a violation of the shareholder primacy principle.
Disney prevailed at the Chancery Court level (see here), and then the parties effectively settled. The Court’s summary of its reasoning shows that it deferred to the business judgment of the directors, but refrained from explicitly analyzing whether that business judgment was premised on the need to put shareholder’s interests above other potential considerations, instead referring to “the corporation’s best interest”:
Delaware law vests directors with significant discretion to guide corporate strategy—including on social and political issues. Given the diversity of viewpoints held by directors, management, stockholders, and other stakeholders, corporate speech on external policy matters brings both risks and opportunities. The board is empowered to weigh these competing considerations and decide whether it is in the corporation’s best interest to act (or not act).
This suit concerns such a business decision by the Disney board—a decision that cannot provide a credible basis to suspect potential mismanagement irrespective of its outcome. There is no indication that the directors suffered from disabling conflicts. Nor is there any evidence that the directors were grossly negligent or acted in bad faith. Rather, the board held a special meeting to discuss Disney’s approach to the legislation and the employees’ negative response. Disney’s public rebuke of [the Florida legislation] followed.
The plaintiff and his counsel may disagree with Disney’s position on HB 1557. But their disagreement is not evidence of wrongdoing. Regardless, the plaintiff has all necessary and essential documents relevant to his purpose. Judgment must be entered for Disney.
Interestingly, from an analytical perspective, the wording of the Court’s summary above seems to carefully avoid addressing whether Disney’s corporate speech could be justified on a shareholder primacy basis. The body of the opinion, authored by Vice Chancellor Will (a former Strine law clerk), is much clearer in stating a soft variation of Friedman’s shareholder primacy principle:
The Board’s consideration of employee concerns was not, as the plaintiff suggests, at the expense of stockholders. A board may conclude in the exercise of its business judgment that addressing interests of corporate stakeholders—such as the workforce that drives a company’s profits—is “rationally related” to building long-term value. Indeed, the plaintiff acknowledges that maintaining a positive relationship with employees and creative partners is crucial to Disney’s success. It is not for this court to “question rational judgments about how promoting non- stockholder interests—be it through making a charitable contribution, paying employees higher salaries and benefits, or more general norms like promoting a particular corporate culture—ultimately promote stockholder value.”
The differences in language hint to the sensitivity in which the Delaware courts seem to find themselves in the current environment, adding to the difficulty of creating an appropriate, responsible balance test in the current environment.
Shareholder Primacy – What Does it Get Us?
“Few trends could so thoroughly undermine the very foundation of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible.”[6]
A foundation of Western civilization is the need to grapple with the big philosophical questions of what is just, right and good, in the individual and in society. Consideration of these ethical issues dates to the ancient Greeks, Homer and Plato and the rest, and continues right on through the course of the history of Western civilization. The idea that permitting – not requiring, but merely permitting – corporate directors and executives to think about ethics in making business decisions risks the very foundation of our free society is, to be blunt, hard to square with the reality I know. In my note “Milton Friedman Versus The Business Roundtable: ESG and It’s Place in Corporate Governance” (here), I walk through the arguments that Friedman makes in favor of shareholder primacy doctrine in his famous 1970 essay on the topic, and find them wanting.
What shareholder primacy doctrine principally gets us is a simple and clear focus for corporate decisions and a solution to the agency problems of modern corporations – i.e., to the problems that arise because the owners cannot be the managers of the enterprise. It is also very favorable for one particular very powerful constituency, the shareholders, and lucrative for another constituency, corporate executives who are paid in stock.
The fact that many of the variations of the shareholder primacy idea accept that there may be some consideration of societal issues in corporate decisions hints at the concession that we do not need an absolute ordering rule for all constituencies for economic reasons, for businesses to compete and succeed, for managements’ personal interests to be constrained or for the law to be properly administered.
The carve-out for compliance with law within the doctrine itself acknowledges the same point. Congress can decide that we care more about public health in one context or another, in which case directors of all corporations are required to prioritize that concern over profits. The system doesn’t thereby fall apart. Surely, the system would also not fall apart if directors were given permission to make the same decision about the same question for a single corporation, in the interest of permitting corporations to appropriately balance the need to maximize profits with the responsibilities of being good corporate citizens.
Permitting societal considerations, or the interests of narrower constituencies, to enter into the director decision-making process does beg the question of whose interests should prevail in any given situation. Which ethics will be given priority? This problem seems overblown. The courts are more than capable of imposing prudence and balancing requirements on directors, and of assessing in any given situation whether the directors have carried out those kinds of responsibilities appropriately. And shareholders who are unhappy about having been given short shrift in any decision can sell, make judgments about the decision-making inclinations of corporate boards before they buy or vote out directors who are adjudged to have pursued an inappropriate balancing of priorities.
Conclusions
Today’s policy level ESG debate is a function of the depths to which the shareholder primacy doctrine has permeated our culture and of the self-interestedness of the shareholder constituency in being at the top of the hierarchy. As a result of these factors, it is perceived as having a continued polarizing effect on defining a unified path forward. Recent events suggest strongly that the issue is unlikely to completely recede from public debate.
It is hard to justify as a matter of principle that even a serious risk to the future of humanity should not deter the board from pursuing the last dollar of profit. Ethical considerations – ideas about what is good, just and right from individual and societal perspectives, including ESG questions – are pervasive in and integral to the conduct of corporate commerce. Deciding as a matter of analytical structure that such considerations should always be of lesser importance in directors’ thinking than maximizing profits is not generally desirable or necessary. These issues will therefore not simply fade away in actual significance to companies, their directors, executives, advisors and other interested groups.
The objection to ESG is not an objection to the idea that corporations should be responsible members of society, but rather to questions of what being responsible means. Interestingly policy makers lean in the direction of enacting new laws (not so much regulations) restricting corporate conduct, rather than pressuring public companies through means that are much more commonly employed on the left. In any case, the interest in these topics from across the policy continuum suggest that the topic of corporate ESG is unlikely to diminish in importance in the near term.
What we need is a rule of law that explicitly recognizes that corporations have obligations to both pursue profits zealously and to act as responsible corporate citizens, and a standard under which directors can exercise their judgment to prudently balance those two sets of obligations. The courts can, and I think would, fashion a balancing test to assess the conduct of directors who acknowledge the ethical elements of corporate conduct and explicitly take societal considerations into account in corporate decisions, including actions in furtherance of what we today understand to be ESG issues, if (only) the right case came along.
[1] Adolphe A. Berle, “For Whom Corporate Managers are Trustees: A Note”, 45 Harvard Law Review 1365 (1932), at https://www.jstor.org/stable/1331920 (“Berle”).
[2] Milton Friedman, “The Social Responsibility of Business Is to Increase Its Profits” (1970).
[3] Berle, at 1367.
[4] Berle, at 1367.
[5] William P. Barr and Jonathan Berry, at https://www.wsj.com/articles/delaware-is-trying-hard-to-drive-away-corporations-business-environmental-social-governance-investing-780f812a?st=t7td54cohysygl4&reflink=desktopwebshare_permalink.
[6] Friedman, Capitalism and Freedom (1962).