I wrote at Medium.com on January 6 about two journalists, both at the New York Times, who penned sympathetic stories about shareholders and other stakeholders that were paid short shrift when dominant shareholders or corporate insiders dominate the agenda. These journalists, in service to shorter and simpler narratives, shortcut coverage of the active and contentious debate about shareholder value maximization.
Nelson Schwartz’s December 6 piece, “How Wall Street Bent Steel: Timken Bows to Activist Investors, and Splits in Two” describes the crying shame in Ohio of “activist investors” that demand the breakup of a 112-year old company run by the 47-year old fifth generation Mr. Timken of Canton. Schwartz finds a villain in corporate law for his tear-stained portrayal of the betrayal of a “community-minded version of corporate capitalism that is fading in the United States”.
“As in all publicly traded companies, TimkenSteel’s board and top executives have a fiduciary duty to shareholders to maximize both profits and investor returns.”
Later in the month, Pulitzer Prize winning reporter Gretchen Morgenson opened up her sad story of investors shut out of an active role in running corporations with a seemingly clear-cut, reasonable argument for more shareholder influence:
“Shareholders own the companies they invest in, but they have long been largely shut out of any role in naming the people who are supposed to represent them: corporate directors.”
As the original saying goes, “L’enfer est plein de bonnes volontés et désirs” (hell is full of good wishes and desires). These journalists aim to tell a sympathetic story of corporate greed and indifference but throw in the myth of a shareholder primacy and value maximization mandate to make the result seem inevitable. The shareholder value maximization slogans show up when journalists need a rationale, or a bogeyman, for corporate activities that ignore other stakeholders and legitimate alternative corporate purposes. That’s despite the fact these myths have been decisively debunked over the last twenty years by numerous experts and in various forums.
My purpose was not to wade into the debate about shareholder primacy and shareholder value maximization as strategy. Instead, my goal was to admonish journalists who ignored the debate completely, writing as if the law, if not the debate over appropriate corporate strategy, is completely settled. Clearly, based on the amount of writing on the subject by academics, legal experts, corporate governance pundits and other interested parties, it’s not.
The corporate strategy of shareholder primacy is debatable. Its legality will continue to be tested in court.
James Kwak, an associate professor of law at the University of Connecticut, wrote a response to my piece that was supportive and went further to explain the law behind the slogans.
Another legal scholar provided some comments to me privately. These comments focused on:
My use of commentary by Professor Lyman Johnson about the Supreme Court’s Hobby Lobby decision to support my argument.
My thoughts, and Professor Lynn Stout’s who was also quoted, on the impact of the Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. decision on these issues.
First Hobby Lobby…
The legal scholar critic says that Johnson’s points about Hobby Lobby are “silly”. Although Professor Johnson has an opinion on the impact of Hobby Lobby on the shareholder primacy argument, it’s Supreme Court Justice Alito who makes the more important points in the Hobby Lobby decision.
Justice Alito, writing the opinion for the Court (my emphasis added):
While it is certainly true that a central objective of for-profit corporations is to make money, modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not do so. For-profit corporations, with ownership approval, support a wide variety of charitable causes, and it is not at all uncommon for such corporations to further humanitarian and other altruistic objectives. Many examples come readily to mind. So long as its owners agree, a for-profit corporation may take costly pollution-control and energy-conservation measures that go beyond what the law requires. A for-profit corporation that operates facilities in other countries may exceed the requirements of local law regarding working conditions and benefits.
My legal scolar critic’s point is that the US Supreme Court is not a higher court for deciding fiduciary duties under Delaware law; these are state law questions, not federal law questions. OK. Concede that point. But no one said Supreme Court would establish precedent here, I don’t think. However, it’s reasonable to assume that Justice Alito’s words will be influential, even in Delaware, to those who adjudicate these issues in the future.
To understand Revlon we need a little background. Professor Lynn Stout published an article in 2002, “Bad and Not-So-Bad Arguments For Shareholder Primacy” in Southern California Law Review that explains the Revlon case and its relevance to her arguments —which I have adopted.
In Revlon, the Delaware Supreme Court held that in an “end-game” situation where the directors of a publicly traded firm had decided to sell the firm to a company with a controlling shareholder—in brief, had decided to turn their publicly held company into a privately held one—the board had a duty to maximize shareholder wealth by getting the best possible price for the firm’s shares. Revlon thus defines the one context in which Delaware law mandates shareholder primacy.
Professor Stout, therefore, doesn’t think Revlon matters all that much. It’s only Delaware—although Delaware is arguably the state where most corporate lawsuits show up— and “subsequent Delaware cases have dramatically reduced Revlon’s significance by making clear that if the directors of the firm decide not to sell, or if they prefer a stock-for-stock exchange with another public firm, Revlon is irrelevant.”
Therefore, Stout says, “directors can avoid Revlon duties when they want to…Although Delaware pruned back Revlon by case law rather than by statute, in the wake of Revlon, over thirty other states have passed “constituency” laws that expressly permit corporate directors to sacrifice shareholders’ interests to serve other stakeholders.”
(Timken Steel, the company in the Nelson Schwartz article, is an Ohio corporation not a Delaware corporation. Ohio has one of the more potent cocktails of anti-takeover statutes in the country according to a 2002 law review article by by Guhan Subramanian, “The Influence of Antitakeover Statutes on Incorporation Choice: Evidence on the “Race” Debate and Antitakeover Overreaching”. In addition to a constituency statute, control share acquisition statute, business combination statute, and pill validation statutes, Ohio also has a fair price statute.)
When I first raised the issue of his error to Nelson Schwartz on Twitter, he used Delaware’s Chancellor of its Chancery Court Judge Leo Strine, now the Chief Justice of Delaware’s Supreme Court, to defend his position.
Unfortunately, he misunderstands Judge Strine’s true feelings.
Later in the Wake Forest Law Review article that Schwartz cites as support, Judge Strine makes his feelings very clear. (Maybe Schwartz didn’t read that far. Emphasis mine.)
By so stating, I do not mean to imply that the corporate law requires directors to maximize short-term profits for stockholders. Rather, I simply indicate that the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders. The directors, of course, retain substantial discretion, outside the context of a change of control, to decide how best to achieve that goal and the appropriate time frame for delivering those returns. But, as I have noted in other writings, the market pressures on corporate boards are making it more difficult for boards to resist the pressure to emphasize the delivery of immediate profits over the implementation of longer-term strategies that might yield more durable and more substantial benefits to stockholders, as well as society in general.
See also Leo E. Strine, Jr., The Social Responsibility of Boards of Directors and Stockholders in Change of Control Transactions: Is There Any “There” There?, 75 S. CAL. L. REV. 1169, 1170–73
(2002).
A recent case further explains the limited use of the Revlon rule to rationalize or support shareholder value maximization, in general. (Emphasis mine.)
“Why “shareholder value” is misunderstood”, Commentary by Margaret Heffernan, CBS News Moneywatch, February 18, 2013
(MoneyWatch) In the agreement last week by Warren Buffet’s Berkshire Hathaway (BRK) to buy H.J. Heinz, the celebrated investor can be confident that the food company won’t now be auctioned off to the highest bidder. That is because Heinz is registered in Pennsylvania, where the law is very different from Delaware, where many companies are incorporated.
Delaware law says that in the event of a sale, a company”s board must do what is best for shareholders. That typically means that an auction starts and the company must go to the highest bidder, no matter what. This is known as the “Revlon rule” after a 1985 precedent in which directors of the cosmetics giant wished to sell to mogul Ronald Perelman to stave off a rival bid. The board’s preference for their white knight was later deemed an abnegation of fiduciary duty.
But in Pennsylvania Heinz’s directors can do pretty much as they see fit. This anomaly beautifully illustrates the crazed state of our public companies. Most people imagine that there is a legal requirement for all publicly traded companies to maximize shareholder return above all else. This belief is used invariably as the ultimate alibi every time a board wishes to defend bad decisions.
But as Lynn Stout, a law professor at Cornell, points out in her book “The Myth of Shareholder Value,” no such legal provision pertains. Even the so-called Revlon rule in Delaware applies only to acquisitions, not to the daily conduct of business.