(Reuters) - Fashions change and presidential administrations come and go, but the feud between corporate guru Martin Lipton of Wachtell Lipton Rosen & Katz and Harvard law professor Lucian Bebchuk will apparently always be with us.
On Tuesday night, Wachtell put out a client alert castigating Bebchuk for a new paper, “The Illusory Promise of Stakeholder Governance.” (Bebchuk summarized the paper in a March 2 post at the Harvard Forum on Corporate Governance.) Lipton, as you probably know, has been a leading advocate for the new corporate paradigm of directors and officers considering the interests not just of shareholders but of an array of stakeholders, from employees and suppliers to those who live in environments affected by the corporation’s actions.
The ‘stakeholder’ movement has swept across the corporate landscape like a thunderstorm: After the Business Roundtable announced last August that 181 CEOs of major public companies had signed a new purpose statement embracing stakeholder governance, the World Economic Forum and the head of the asset management juggernaut Black Rock urged all companies to ditch shareholder primacy in favor of the holistic stakeholder approach. Wachtell has called the stakeholder movement “a watershed … in the evolution of corporate governance.”
In Tuesday’s memo, Wachtell reiterated its view that the new paradigm is driven by inescapable “business, political and social imperatives.” Activist hedge funds may not like the holistic approach to governance because it’s at odds with their short-term priority of maximizing shareholder returns, the Wachtell memo said. But ultimately, Wachtell asserted, “ill-conceived” arguments by Bebchuk and his hedge fund allies “can do nothing to impede the growing momentum among mainstream investors toward stakeholder governance.”
Bebchuk said in a statement that Lipton and his co-authors failed to engage substantively with the arguments in his paper. “If Wachtell can provide substantive objections to these arguments, we will be happy to address them,” he said. Bebchuk also said that the paper’s critique of stakeholder governance is not intended to suggest that stakeholders do not have an interest in corporate governance – but that the flood of recent pronouncements does not actually serve those interests. “By making corporate leaders less accountable and impeding stakeholder-protecting reforms, stakeholderism would hurt stakeholders, shareholders and society,” Bebchuk said. “Stakeholder governance should therefore be rejected, including by those, like us, who care deeply about stakeholders.”
Lipton told me via email he had nothing to add to the memo.
Now, I’m all for the idea of corporate leaders prioritizing their workers, communities and environments when they make decisions. But I have to say that Bebchuk paper, which is coauthored by Roberto Tallarita, the associate director of Harvard’s program on corporate governance, argues quite persuasively that the purported new stakeholder paradigm is little more than feel-good corporate P.R. that will enable unaccountable decision-making by CEOs and corporate board members whose economic incentives are aligned almost entirely with those of shareholders – not workers or community members.
The big problem with assessing the stakeholder movement, the paper pointed out, is that it’s all very vague. In a bit of gotcha research, Bebchuk and Tallarita checked the board-approved corporate governance guidelines of the 20 companies whose CEO sits on the Business Roundtable’s board of directors to see if those companies changed their guidelines in 2019 to reflect the new stakeholder paradigm. None of those corporations, according to the paper, “amended its corporate governance guidelines to incorporate stakeholder welfare as an independent end.”
Without real guidelines about implementing stakeholder governance, the paper said, the immense burden of weighing stakeholder interests is left to “the discretionary judgment of decision-makers.” So far, advocates of the new paradigm, like Wachtell, the Business Roundtable and the World Economic Forum, have downplayed the prospect that shareholder interests will diverge from those of other stakeholders. But Bebchuk and Tallarita said it’s easy to think of hypotheticals that complicate the question of tradeoffs. If a company is considering a move to a new location, should it take into account the prospective benefits to its new neighborhood? If a business acts to increase its market share, must it consider the impact on its competitors’ workers? When CEOs and corporate boards have to make tough decisions, how will they balance stakeholder interests?
To evaluate the incentives of those decisionmakers, Bebchuk and Tallarita looked at the compensation structure for officers and directors of the 20 companies in the Business Roundtable’s board sample. There are some variations, but generally, the paper said, corporate leaders are incentivized to boost share prices and keep shareholders happy. That’s how they keep their jobs and fend off proxy challenges. Stakeholders, on the other hand, “play no role in, and have no power with respect to, the selection or removal of directors,” the paper said. “They have no voting rights and no other tool to influence the election of directors. As a consequence, making choices that would benefit stakeholders would not improve directors’ chances of retaining their position or obtaining positions on other boards.”
The paper also looked at how real-life decisionmakers have prioritized different stakeholders. Bebchuk and Tallarita said that in the 1980s and 1990s, most states enacted so-called “constituency” laws to help companies fend off hostile takeovers by corporate raiders. Those laws allowed corporate boards to consider the interests of employees, customers, suppliers and even local communities in determining the best course for the company – the same interests, more or less, that are promoted in the new stakeholder governance paradigm. To test whether directors and officers in states with constituency statutes acted in the interests of these other stakeholders, Bebchuk and Tallarita analyzed the 10 biggest private-equity takeovers of the last ten years of companies in states with such laws.
I’ll cut to their conclusion, which I’ll bet you can predict: “Corporate leaders negotiating a sale of their company used their power to bargain for benefits to shareholders, as well as for top executives and directors, but bargained very little for stakeholders,” the paper said. Corporate leaders, said Bebchuk and Tallarita, could have used their bargaining power to protect their workers or communities. They generally chose not to, “notwithstanding the constituency statutes in force explicitly authorizing them to do so.”
In other words, Bebchuk and Tallarita said, experience shows that corporate decisionmakers who are incentivized to benefit shareholders can’t be expected to act in the interests of employees or other stakeholders, regardless of CEOs’ signatures on statements of purpose.
If anything, the paper said, the “illusory expectations” raised by the Business Roundtable and other proponents of stakeholder governance will allow directors and officers to get away with managerial inefficiencies and even self-interested decisionmaking. Stakeholder governance will lessen scrutiny from would-be corporate reformers in Congress and other legislative bodies, instead giving additional leeway to corporations to make progress on societal interests. But empirical evidence, Bebchuk and Tallarita said, shows that lessening accountability leads to worse decisionmaking and decreased corporate performance.
Obviously, we haven’t heard the last about stakeholder governance. But Bebchuk and Tallarita have thrown down a gauntlet to its proponents.