The Dark Side of Colombia’s Benefit Corporation
The US ‘benefit corporation’ model, developed principally by B Lab, is a fascinating regulatory innovation. Going all the way back to its original emergence in Maryland in 2010, the basic goal was to provide a middle ground between the pure ‘for-profit’ and ‘non-profit’ corporate forms. The hope was that, by introducing a ‘hybrid’ organisational option of this kind, its utilisation at scale would eventually mitigate some of the perceived excesses of the current capitalistic system, which, for many, has become increasingly intolerable against the backdrop of rising social inequalities and worsening environmental conditions. Today, a majority of US jurisdictions feature benefit corporation legislation.
Can the model deliver? That remains an open question, but legislators abroad seem to think that it can. For example, Italy introduced its version – the ‘Società Benefit’ – in 2016 (for an analysis of the Società Benefit see here). Colombia was not far behind. In 2018, it unveiled the ‘Beneficio e Interés Colectivo’ (BIC). Regarding the BIC in particular, it was recently claimed that it can be expected to ‘contribute to the promotion of responsible capitalism in Colombia’. In this post, I challenge that claim. I want to suggest that the BIC is a legal transplant with a dark side.
One might wonder why this matters – Colombia is not typically treated as a jurisdiction of import in the corporate governance field. Whilst this is a fair point, I think we need to look at the BIC as part of a larger phenomenon in which B Lab is attempting to export the benefit corporation model to jurisdictions around the world, without its flaws being corrected. Therefore, the issues discussed below may well be relevant for legislators elsewhere.
True, the legislation says that BICs need to both operate in a responsible way generally and also express a specific mission in the articles of association. For example, a firm would be in breach where it positively advances the chosen objective of clearing industrial waste whilst at the same time it mistreats workers. Similarly, a firm would fall short where it maintains ethical, local supply chains but does not further the chosen objective of providing subsidised eyeglasses to the worse off. These ‘general’ and ‘specific’ components of purpose are, theoretically, meant to prevent a firm from ‘purpose washing’ (ie, giving the false impression that it is adhering to higher standards of corporate social responsibility when it is not). In practice, though, I think it will be far more difficult to do so. This is because the Colombian legislators did not address key design flaws when they imported the US model. I shall give two examples and focus, loosely, on Delaware’s statute as a representative illustration of those design flaws.
First, like the Delaware statute, a BIC’s directors have a positive duty to account for multiple stakeholders’ interests – the interests of the firm, its shareholders, those non-shareholder constituencies materially affected by firm conduct and the public benefit objective defined in the articles of association. On the one hand, that the law does not prescribe how these interests ought to be balanced is helpful, because it allows individual firms freedom to discover what works best for them in practice. On the other hand, however, with no specification of even a rudimentary methodology for how to quantify and pursue multiple interests simultaneously, this task is left to the discretion and judgment of directors. Of course, a given firm’s articles of association could furnish such a methodology, but in the absence of that possibility the Colombian legislation relies on directors to ‘do the right thing’. They must use their business judgment and discretion to integrate stakeholders’ interests into their firms’ agendas. The mandate this provides is a double-edged sword. Granted, to some degree they have breathing room under this arrangement from shareholder value pressure, but it also positions directors to behave selfishly (or foolishly), which may lead to increases in agency costs and resource waste.
This is a perennial objection against ‘stakeholder’ capitalism, and one that has been consistently raised by commentators researching US benefit corporations, not just in Delaware but more broadly. Whilst a BIC’s shareholders could sue, that does not mean that they would be successful. So long as directors are clever, it would not be difficult for them to justify any number of choices that might balance in different ways the multiple interests they can pursue (including their own). The only exception would likely be where directors take truly extreme decisions that consistently and for an extended period systematically discount or ignore a firm’s purpose-related agenda.
Second, if the Delaware experience is any indicator, BICs may invite the interest of traditional private equity firms focused on profit maximisation. Before saying why this could be a problem, consider the BIC’s counterpart in the UK – the ‘community interest company’ (CIC). The overwhelming majority of CICs in operation in 2021 were companies limited by guarantee (19,769). A primary reason for this is that the CIC limited by shares is not an appealing vehicle for investors. The CIC includes a hard cap on the amount of profit shareholders can extract year-to-year through dividends (as well as at the end of the CIC lifecycle). There are good reasons for this approach since it dissuades investors from using their governance influence to subvert a CIC’s social or environmental mission for personal financial gain (for a commentary on the CIC, see here). However, the corollary of this is that CICs limited by shares seem to struggle to source equity capital.
BICs may encounter the opposite problem – that is, attracting the interest of (potentially) predatory investors – because, like the Delaware model, there are no legal constraints on profit extraction. Recent empirical evidence from the US suggests significant amounts of capital are flowing into Delaware ‘public benefit corporations’ from venture capitalists, particularly in consumer-facing industries. Whilst there are alternative explanations, it is just as likely that this phenomenon is being driven by purpose washing. Put differently, profit-seeking investors may be attracted to the form because it is not difficult to externally signal a commitment to social good and simultaneously operate the firm internally like a traditional corporation. Therefore, because the law does not guard against investor predation as with the CIC approach, consumers could be paying higher premiums for what they believe are ethical goods or services, when in reality the surplus gains are being funnelled to shareholders (and possibly also management) at expense of the social or environmental mission. Naturally, this depends upon ownership structure, but if a specific BIC is private-equity-backed, which necessarily entails augmented control rights, it is implausible that shareholders would act to divert gains to other stakeholders. This defeats the whole legislative rationale of the BIC.
Disclosure is one way to prevent both of these problems. Consistent with the Delaware framework, the BIC does require a management report explaining how a firm’s activities have created societal or environmental value, which must be assessed against an independent standard approved by the ‘Superintendencia de Sociedades’. The legislation is clear that interested stakeholders can alert the regulator to possible reporting abnormalities, and it also makes provision for random audits. However, the experience with US benefit corporations suggests abysmal reporting compliance, and there are also issues surrounding a lack of enforcement by individual US jurisdictions. For things to pan out differently in Colombia, stakeholders must proactively take interest in the affairs of a BIC and be willing to hold it accountable, and the regulator must have the resources and bandwidth necessary to effectively police the regime. Alternatively, the conditions for purpose washing (for instance consumers’ willingness to pay a premium for the goods or services of businesses perceived to be ‘ethical’) may not be present in Colombia like they are in in the US. However, neither are foregone conclusions and it will take time to see how the BIC is received.
To conclude, taking the above analysis as a whole, it is debateable whether the BIC will actually usher in a new era of responsible capitalism in Colombia. More broadly, for those jurisdictions considering the adoption of a US-style benefit corporation model, legislators need to think carefully about the ‘Trojan Horse’ effect it could have on their business cultures and markets.
A variation of this post was originally published on the ECGI Blog.
J S Liptrap is Assistant Professor of Law at the University of Sussex, and a research associate in the Centre for Business Research, Judge Business School, University of Cambridge.