Exploring the path to change on shareholder primacy

Since the global economic meltdown in 2007, the debate over shareholder primacy and who ‘owns’ a company has raged on.  

But at no time has the debate been as contentious as today with more stakeholders and industry commentators challenging the view that a corporation should exist principally to maximise shareholder wealth – a notion that was re-popularised by economist Milton Friedman in the 1970s. 

Just as climate change is no longer a topic taken seriously solely by environmentalists, ‘stakeholder primacy’ – if we were to give the concept of a company operating for the greater good a name – is no longer a philosophy company boards refuse to dismiss outright. 

But how far is this philosophy evolving, and is it evolving fast enough? 

According to respected economist Richard Tudway, principal at the Centre for International Economics, the answer to the latter is a firm no.  

In an impassioned letter to the FT this month, Tudway warned it is time for real action if we are to tackle the “self-serving doctrine” of shareholder primacy.  

To truly move things forward, Tudway believes countries such as the UK and America should adopt a governance model similar to that in Germany. 

His solution would certainly shake things up. Under the model, publicly listed corporations would be obliged, by law, to appoint and operate with independent supervisory boards. 

“These boards [would] be expected to reflect the wider social and economic interests of all stakeholders. The supervisory board will be responsible for overseeing the activities of the executive board of management in the realisation of these objectives,” Tudway explained. 

This proposal would indeed go beyond what we have seen so far.  

While in the UK the government has revised its corporate governance code to encourage companies to be more transparent in their dealings, company directors are still effectively in control of the board’s governance and how they engage with shareholders.  

However, there does appear to be a growing awareness among company bosses of a need for change. 

For example, in August, the Business Roundtable (BRT), which represents CEOs of America’s largest corporations, declared its corporate governance agreement would eliminate shareholder primacy and commit to represent the interests of all stakeholders, including customers, employees, suppliers, communities and shareholders. 

This is a significant step when you consider it’s the first time in over 20 years the BRT has not endorsed the principles of shareholder primacy. 

Even more significantly, the new agreement was signed by more than 180 of America’s biggest companies including American Airlines, Boeing, Goldman Sachs, Amazon, Ford, Apple, American Express, Walmart, and Coca-Cola.  

While many welcomed the move, some commentators took a more cynical view and accused the companies of virtue signalling.  

Of course, signing an agreement to run your business for ‘all Americans’ and actually doing it are two entirely different things. 

For those wondering if it was indeed all talk, there is good and bad news. 

Last month, research by the Drucker Institute revealed the extent to which signatories of the BRT governance agreement had put their money where their mouths are. 

In an attempt to discover whether companies that follow a stakeholder model are more effective, the researchers assessed 752 firms – 137 of which were BRT signatories.  

Using key indicators including customer satisfaction, innovation, employee engagement, and financial strength, the researchers found the BRT companies did “quite well,” but with “notable room for improvement.” 

While on average their performance was impressive, scoring in the top half of the 752 firms in every area explored, many of the 137 BRT companies scored below the mean in critical areas – and sometimes well below.  

For example, 26 companies scored below the mean in, of all things, ‘social responsibility’.  

“While signing the BRT statement was a significant step, now comes the hard part: turning this vision into something measurably meaningful,” the researchers concluded. 

This ‘something meaningful’ brings us back to Tudway’s proposal.  

If his assertion is true that executive-dominated boards will resist change without radical intervention, is it time to implement some form of law? 

Certainly, the legalities surrounding shareholder primacy has complicated the road to change.  

On the one hand, it appears there is no actual law that upholds or imposes shareholder primacy on businesses.  

This is highlighted in a 2017 paper by the University of Florida on the legal theory of shareholder primacy. 

“Shareholder primacy is a legal enigma…that seems to exist not as a pinpoint citation, but in the ether. It is real in that no one disputes the sense of obligation in the boardroom and executive suites, but finding the law’s command is elusive,” the paper states.  

“No corporation statute of the fifty states imposes a duty on the board to manage a business corporation to maximize shareholders wealth.” 

But nor, of course, is there a law stating shareholder primacy is illegal, though some have pushed to introduce stricter regulations.  

Last year, US senator Elizabeth Warren introduced the Accountable Capitalism Act, which would force US firms to tackle issues such as income inequality and promote more sustainable corporate profitability. 

But so far, the US courts appear happy to stay out of it, preferring to stick to the rule that businesses can make their own decisions as long as they act in good faith. 

While a law abolishing shareholder primacy might be a consideration, even those wanting radical change may question whether this would take us down an authoritarian path we don’t want, or are not ready, to tread.  

Of course, implementing such a law would also be extremely complex, especially if you hold the view that shareholder primacy is hard to quantify.   

In an article published in August, senior manager of Aspen Institute’s Business & Society Program, Miguel Padró, highlights this dilemma. 

“One of the big problems with the idea of shareholder primacy is that in fact there’s no such thing as a unified “shareholder interest,” and no one definition of what it means to “maximize shareholder value. 

“Even if we assume shareholders care only about stock price (an incorrect assumption for an increasing number of investors), shareholders have wide-ranging investment time horizons. A company’s stock performance looks very different depending on whether a shareholder plans to sell this week or hold their shares for 25 years,” he said. 

Nevertheless, Padró, like Tudway, believes a new system of corporate governance is well overdue. 

Describing shareholder primacy as “accountability to the few”, Padró believes more stakeholders should be in the board rooms and given greater controls. 

“No one is suggesting shareholders shouldn’t have a place at the table. But they are neither representative of society nor well positioned to succeed as enforcers of the social contract for corporations.  

“And just as we shouldn’t expect corporations to solve all of society’s problems, we should not place the burden of corporate accountability on shareholders alone,” Padró said. 

However, as Padró notes, it remains to be seen whether these stakeholders will be welcomed, even if they are allowed through the door. 

Last Updated: 15 November 2019
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