Shareholder Wealth Maximization: Variations on a Theme
Proponents of the shareholder primacy norm argue that corporate law requires directors and corporations to serve their shareholders’ economic interests. However, my examination of corporate law’s history reveals that courts have never endorsed shareholder wealth maximization as a norm. Rather, state courts have consistently used the rhetoric of profit maximization to uphold the unrestricted power of corporate directors and executives to manage corporations.
Take, for example, Dodge v. Ford (1919)—the poster case of shareholder primacy. At the request of the Ford Company’s minority shareholders, the Dodge brothers, the Michigan Supreme Court ordered the Company’s founder and controlling shareholder, Henry Ford, to pay special dividends, memorably stating: ‘a business corporation is organized and run primarily for the profit of the stockholders.’ Placed in its historical context, Dodge is a weak case to anchor modern corporate law’s purpose. The opinion was a product of the Progressive Era’s concerns about the power that a few wealthy industrialists and their financiers exerted over individual investors and the economy at large, as well as growing fears that such an accumulation of economic power would lead the United States toward a socialist future. As corporations implored public investors, typically of middle-class background, to invest in corporate stock while simultaneously lobbying for legal changes that minimized these investors’ influence, calls for state and federal legislation to protect minority investors mounted. In this atmosphere, the Michigan Supreme Court opted to assure minority shareholders (even as wealthy and powerful as the Dodge brothers) that state courts would protect them from abuse of power by the control group.
In midcentury, as the New Deal regulatory state and war production helped lessen concerns about the power of corporations and their control groups, shareholder wealth maximization lost any normative appeal and became rhetoric validating entrepreneurial freedom. The midcentury courts expanded the scope of the exemption from liability for honest mistakes from which directors benefited in the nineteenth century to develop the modern business judgment rule as a rule of deference to directors’ expert opinion and, at the same time, transformed the duty of loyalty from a duty grounded in utmost trust and honor to the limited requirement that directors’ actions do not unfairly disadvantage their corporations. To justify their growing deference to corporate management and encourage investment in securities, courts often referred to corporate profits in their analyses of directors’ duties. Notably, profit was irrelevant to the legal analysis of directors’ duties; cases addressing a variety of duty-of-loyalty and duty-of-care claims consistently shielded directors and executives from liability while, in passing, assuring shareholders that their corporations were profitable. Directors were free to act, protected by the presumption of the business judgment rule, so long as, in the balance of equities, their companies were profitable. Corporate managers were offered protective standards of review while minority shareholders were promised earnings, albeit in dicta.
The pendulum seemed to swing toward shareholder profit maximization as a corporate purpose in the 1980s, as investment bankers, focused on increasing the value of their portfolios, and institutional investors, keen on achieving the same, began using hostile takeovers to force corporations to maximize shareholder value. Still, state courts did not embrace high stock price as corporate purpose or an affirmative duty on corporate managers; rather, just as large corporations and well-to-do financiers replaced the minority, individual shareholder as the typical plaintiff in corporate litigation, courts embedded profit in the standard of review applicable to directors’ actions, namely fairness, offering directors a simple rhetoric with which they could justify their actions.
Revlon v. MacAndrews & Forbes exemplified this 1980s approach. Responding to a hostile tender offer, the Revlon board adopted several defensive tactics, including an exchange of notes for shares of Revlon’s stock. When the bidder did not back down, Revlon’s board negotiated a sale of Revlon to their chosen knight that, among other things, promised to support the value of the notes. The bidder sued to bar this transaction and the tactics that protected it, and the Delaware Supreme Court obliged. Noting that ‘The Revlon board’s authorization permitting management to negotiate a merger or buyout with a third party was a recognition that the company was for sale,’ Justice Andrew G.T. Moore stressed that such a recognition charged the directors ‘with getting the best price for the stockholders at a sale of the company.’
Many have turned to Revlon to champion Delaware’s commitment to shareholder value, but Moore did not elevate profit maximization as the corporation’s sole purpose, even in a sale of a company. Rather, Moore used the standard of fairness that the midcentury courts introduced and that he perfected in Weinberger v. UOP (1983) to evaluate the Revlon directors’ actions. According to Weinberger, self-dealing transactions had to pass muster under a fairness standard that included two elements: fair dealing and fair price—process and substance. Using fairness to evaluate the Revlon directors’ defensive tactics, Moore concluded that when the Revlon directors allowed their concerns about the noteholders to cloud their judgment, they failed to meet the fairness standard and thus breached their duty of loyalty to the shareholders.
Notably, Moore did not impose an affirmative duty on directors to maximize price. Revlon’s directors did not breach their duties because they did not maximize wealth for their shareholders; they breached their duties because their concerns for the value of the notes tainted their decision process. To pass muster, the Court told directors, they had to explain their actions as aiming to maximize value for their shareholders. If they did so, the Court would not second-guess their decisions. As it has been since the beginning of the twentieth century, profit maximization has remained a rhetoric legitimating directors’ absolute dominion.
Dalia Tsuk Mitchell is a Professor of Law and John Marshall Harlan’s Dean Research Professor of Law at the George Washington University.
A longer version of this essay appears in the University of Pennsylvania Journal of Business Law.
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