Shareholder Primacy versus Shareholder Accountability

When corporations inflict injuries in the course of business, shareholders wielding ESG principles can, and now sometimes do, intervene to correct the matter.  In the emerging fact pattern, corporate social accountability comes out of its historic collectivized frame to become an internal subject matter—a corporate governance topic. As a result, shareholder accountability emerges as a policy question for the first time.  My draft article, ‘Shareholder Primacy versus Shareholder Accountability’ pursues the question of shareholder accountability in connection with recent governance interventions made by institutional investors, the Big Three in particular, to advance the ESG agenda.  The article’s evaluative framework poses a fundamental opposition between shareholder accountability and shareholder primacy.  It describes the institutions’ ESG initiatives as a defection against shareholder primacy in the service of a voluntary (and unprecedented) assumption of social accountability by noncontrolling shareholders.    

Shareholder primacy builds on a pair of norms.  The first is substantive and concerns purpose—the firm should be managed for the shareholders’ financial benefit.  The second norm is procedural and concerns power—the shareholders should have the power to tell managers how to run the firm.  The two norms, once put into operation, are supposed to assure that market control over production, and hence economic efficiency, is maximized.  Prior to the Big Three’s turn to ESG activism the two norms operated in tandem—power on the ground assured shareholder value maximization in the boardroom toward the generally accepted efficiency goal.  But power on the ground now also triggers questions about shareholder accountability and the Big Three, upon switching into activist mode to address those questions, put the two norms out of sync, causing the directive of management for the shareholders’ financial benefit to lose focus and compromising shareholder primacy in the performance of its mission. 

The article poses three questions respecting this institutionally driven confrontation between shareholder primacy and shareholder accountability.

The first question, which has been much mooted, is relational: Can investment institutions legitimately sacrifice their investors’ financial returns in connection with the installation of socially responsible business practices at operating companies?  The article answers in the negative where most previous observers have answered in the affirmative.  They offer positive accounts in which fund managers wielding governance power are depicted as at-the-margin actors responding to neutral market diktats.  The theoretical goal is to integrate the institutional turn to social responsibility within the microeconomic framework that long has imported legitimacy to shareholder primacy. By explaining institutional social voting in market-driven terms they simultaneously cabin the turn to social welfare on the private (and legitimate) side of Milton Friedman’s public/private divide.  

The article questions this approach.  The actors in question are not market automatons. They exercised agency, taking advantage of economic slack—market failure rather than market control.  With slack comes economic, and in this case, political power, along with inevitable demands for its responsible exercise.  The fund managers, perceiving this, reenacted the balancing role played by the managers of operating companies during the post-war period, endeavoring to defuse regulatory threats by playing cooperatively with constituent demands.  Meanwhile, they made their social contributions with other peoples’ money.  Legitimacy problems inevitably followed. 

As the problems manifested themselves, the Big Three did a volte face, turning the vote over to their clients.  The article makes three observations about this.  First, there is a negative implication for the legitimacy question.  It seems that when intermediaries play at CSR with other people’s money, arguable legitimacy isn’t enough.  The case must be strong and airtight—and to make that case is to turn the decision over to the beneficiaries.  Second, the empowered intermediaries need to be very careful about how they exercise their power, which means in turn that they are not nearly as powerful as they seemed to be only a couple of years ago.   Third, our sudden experience of voluntary shareholder accountability may have been ephemeral.  The Big Three finally gave us identifiable and influential but noncontrolling shareholders, shareholders who could be held accountable for the exercise of their power.  With their retreat, that accountable actor goes up in smoke, returning us to the traditional, safe, unaccountable public company shareholders of yore. 

The second question concerns shareholder primacy: Assuming ESG concerns take a permanent place at the top of the governance agenda, can shareholder primacy continue to provide a viable cornerstone for corporate legal theory?  The answer again is no. 

Shareholder primacy seeks to reduce management agency costs by empowering shareholders, asking no further questions about costs and benefits.  If all other things are equal, then agency cost reduction does indeed make a productive contribution.  Unfortunately, however, all other things are not equal.  The means to the end of value enhancement by agency cost reduction are shifts in business plans that monetize producing assets with a view to distribution to the shareholders.  Ancillary harms follow for other stakeholders, along with two knock on perverse effects: first, productive relationships become harder to sustain, and, second, risk averse managers turn away from long term investment in favor of near-term stock market gain.  Meanwhile, none of this shows up on the screen of shareholder primacy, which does not deem corporate externalities to be a governance problem.  Per Milton Friedman, they are conveniently, albeit ineffectively, remitted to state regulation.  Thus do primacy and accountability emerge as paradigmatic opponents.

ESG advocates seek to modify shareholder primacy to eliminate this dysfunction.  The result is shareholder primacy in part—the insistence on shareholder power remains but shareholder value drops out as the end in view.  Shareholder power, originally a means to the end of shareholder financial gain and efficient production becomes an end in itself, a tail that wags the dog.  Shareholder primacy emerges as power without purpose, a posture in which it does not make for a plausible anchor for corporate governance going forward.  An objective function needs to be articulated, and the process instruction needs to serve it. 

The third question asks whether the recent institutional interventions herald a structural shift to a welfarist corporation.  The answer is again negative, for no commitment to social welfare has been forthcoming.  When the Big Three pulled preferred agenda items out of an ESG grab bag and used their influence as well as their votes to effect results at portfolio companies, they broke two historical patterns, both lurching out of passivity and taking steps away from pursuit of shareholder value enhancement as a goal.  But selective incentives were operating—the break just happened to coincide with the coalescence of potentially outcome determinative voting blocks in their hands along with attendant scrutiny.  The events certainly point in a welfarist direction, but that’s about all they do.  Moreover, the countering effects of pushback by Red State politicians are only beginning to be felt. 

The sequence of questions and answers delivers us to an unsatisfactory destination riven by contradiction and tension.  No, as yet there has been no structural shift toward a welfarist corporation.  Yet, were that to happen, shareholder primacy could no longer provide a viable cornerstone for corporate legal theory.  Meanwhile, the nascent steps recently taken in a welfarist direction compromise shareholder primacy.  Finally, the investment institutions that took those steps acted illegitimately, even as they exercised shareholder power unprecedented in magnitude.   The tensions stem from the underlying encounter between shareholder primacy and shareholder accountability, two notions, the former old and the latter new, that are natural enemies, like cats and dogs.   

William W. Bratton is Nicholas F. Gallicchio Professor of Law, Emeritus at at the University of Pennsylvania Carey Law School.