The main takeaway, as I read it, is that the widespread belief that CEOs are legally obligated to maximize shareholder value is not really borne out by legal precedent or the current understanding of legal scholars (though it's widely taught by management scholars). The current law appears to be that, while CEOs can be fired by shareholders, as long as the shareholders choose to retain them, the CEOs have a wide range of leeway for what values they can legally take into account when making decisions. Those values don't have to be solely focused on maximizing shareholder returns, and courts will generally not second-guess them except in really extreme cases (though shareholders are welcome to second-guess them by voting in a new board that fires the CEO).
Isn't this pretty much the same as any employee-employer/owner relationship? The employee can do what they want a lot of the time but at some point they'll have to answer for their decisions and if it's found they weren't acting in their employer's interest they can expect to get fired.
I think as the employee gets a larger and larger influence over decisions about their own compensation, the line between 'failure to do your job correctly in the best interests of your employer' and 'embezzling funds' becomes more and more blurry. And the latter of course is more than just a firing issue. So perhaps not quite the same, although where exactly you draw the line I guess is subjective.
"31 of 34 directors surveyed (each of whom served on an average of six Fortune 200 boards) said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximize shareholder wealth, they believed it was their duty to do"
The article points out that this isn't the case. What's interesting to me is the idea that this activity maximizes shareholder wealth anyway. It might maximize the value of entities holding shares in a short-term outlook, but on a long-term outlook (10 year horizon) this is foolish not just because it weakens the brand of the company, but risks future contracts (boycotts from public pressure), and opens settlement possibilities (even a legally released toxin can result in settlements if they were aware it was dangerous at the time).
The long-term outlook only matters to long-term investors. If you can carry out such activities discreetly such that those investors are oblivious, you can reap the profits by selling up before the shit hits the fan. There are enough sociopaths [0] in business that this situation must have occurred several times over.
One excerpt:
Under the doctrine known as the business judgment rule, a shareholder can’t successfully sue a board for failing to maximize shareholder value. To the contrary, directors enjoy wide legal discretion to sacrifice “shareholder value” in order to protect employees, customers, creditors and the community.
Never ever treat a blog post on legal issues as definitive when written by non-lawyers, especially when it cites no sources.
I'm not a lawyer, but the statement "we conducted a systematic analysis of a century’s worth of legal theory and precedent" is utter twaddle. There are disciplines of law on which people build careers attempting to sort out these issues.
Worse yet, a post that discusses conflict between shareholders' interests and directors' actions in the context of an acquisition but that doesn't even mention Revlon duties, which arose from the seminal case in this area (http://en.wikipedia.org/wiki/Revlon,_Inc._v._MacAndrews_%26_...), is seriously suspect. The case law has evolved significantly since then and it is difficult for those without legal training to fully grasp (not to mention that US corporate law has its quirks, which two academics from other countries may not be fully familiar).
Point being, this is a complex area on which there are hundreds of publishing corporate law professors and practitioners. The "myth" is a strawman.
This is a simple matter of people doing what they are incentivized to do. The vast majority of directors have incentives tied to short term gains (short term in the sense of a company - quarterly or yearly), and so their actions are to seek short term gains. They might say they are required to act in the best interest of the stock holder... but it just so happens that they have compensation which is tied to short term gains in the stock price.
I don't believe the conventional wisdom that the stockholder only cares about short term gains. I see, over and over, share prices punished because the stockholders do not see the company doing well long term, and vice versa.
I think we're mixing up a bit of stuff, mainly the training and legal structure of corporations and the actions their directors might or might not take.
Let's be very clear: directors who release a toxin into the environment, if done purposely, will end up in jail. Corporations who do it accidentally will end up paying for damages. If they don't, that's a failure of our criminal justice system, not the way corporations are formed. most directors may be very amoral sorts only caring for the bottom line. That's fine. Our system is full of folks only looking for short term gain, yet the greater good is still served. That's the beauty of our system. No matter how hard we try and how much we want it, nobody has ever created a complex system of people that worked solely on altruism.
What it looks like to me is that directors have evolved corporations into sort of a representative republic. Shareholders elect them to be autonomous and free to manage as they see fit -- not move hither and fro based on the opinion-of-the-day. Just like with Congress, there's probably a very good reason corps have evolved like this. It'd be interesting to see a study of more participatory shareholders and how things shook out. I'm willing to bet there are a lot of problems with direct shareholder rule and that what we're seeing is at least a local maximum.
Corporations who do it accidentally will end up paying for damages. If they don't, that's a failure of our criminal justice system, not the way corporations are formed.
Except that a) most of these cases are civil, not criminal (which, haha, is a crime in my opinion), and b) writing off tragedies of the commons as a "failure of our system" only serves to perpetuate this sort of behavior.
* most directors may be very amoral sorts only caring for the bottom line. That's fine.*
How is it acceptable to support or encouragement amoral behavior? That's a slippery slope. Today we're talking about whether or not it's acceptable to dump toxins, tomorrow we might be talking about whether or not it's ok for companies to foment a coup d'etat (oh wait, that's already happened, too).
Representative republic, really? I'm not advocating to burn the whole system to the ground or anything but I'd say you're overstating the not-brokenness of it in 2011.
I don't have access to their books but it's likely they made more money on the fraud than they paid in the fine. Goes doubly for Goldman.
And that's just externality-brokenness. I don't think the corporations even function as a representative republic. How do you explain HP's board? Or any of the nepotism that seems to happen across many similar boads so regularly? How many non-board-member-shareholders exercise any influence whatsoever?
...nobody goes to jail from Citibank or Goldman for [allegedly] committing [civil, not criminal] fraud...
Fixed that for you.
Note that neither Citi nor Goldman were convicted of fraud, they merely settled with no admission of wrongdoing to make it go away. Further, even if convicted, you don't go to jail for civil offenses.
I don't have access to their books but it's likely they made more money on the fraud than they paid in the fine.
From the article: "The payment includes the fees and profit Citigroup earned, plus $30 million in interest and a $95 million penalty."
In Goldman's case, the settlement money does not subtract the money Goldman lost on ABACUS.
Hey, I know you work in finance on your own, and that's fine, good luck to you, but "too big to fail" should include things like "don't make a bunch of terrible bets and then hoodwink your customers into taking the fall on those bets for you".
Sounds like they did great on the deal to me, considering the alternative was to be the last one holding those CDOs when they exploded. If I were them, I'd call that fine the cost of doing business for a great business decision.
... "too big to fail" should include things like "don't make a bunch of terrible bets and then hoodwink your customers into taking the fall on those bets for you".
I don't understand the mechanics of this. It should be illegal for "too big to fail" banks to sell a security when they believe it's price will go down? Should it also be illegal to buy when one believes a security is going up?
...the alternative was to be the last one holding those CDOs when they exploded...
Goldman was the last one holding (some tranches of) ABACUS when the housing market collapsed. That's why they lost money.
So, the mechanic that did happen is that those banks were holding a ton of CDOs, and unloaded as many as they could before they exploded by calling their customers and saying "Hey, check this out, these bonds are super-hot right now, great deal, you should buy it".
As far as the mechanics of my perfect system, "too big to fail" should be done away with, along with proper enforcement of our existing fraud laws. We'll have eliminated the means (smaller banks) and motive (deterred by steep penalties) for this happening again. As of now, I don't see what's changed since 2008.
That settlement's ridiculous. A few hundred million for each bank? How many of these things did they take off their balance sheet in 2007-2008 while selling them to their customers as perfectly good bonds?
We'll have eliminated the means (smaller banks)...
Smaller banks wouldn't be able to sell securities they believe will go down? I didn't realize that buying low and selling at the peak required scale.
As of now, I don't see what's changed since 2008.
That's because you aren't paying attention. The I-Banks are now bank holding companies, the regulators have laid claim to several floors of their buildings and are imposing massive new programs, the banks have figured out that they need more stringent underwriting standards for homeowners and have drastically cut back on loans [1].
[1] The market for home loans is now over 90% Fannie/Freddie - strangely, the agencies haven't figured out that home loans should be reduced.
More, smaller banks means more diversity and less chance that a few of them can endanger the whole system.
As far as the I-Banks being bank holding companies now, I'm seeing more stuff under fewer roofs than there was before.. that seems less stable to me.
I don't actually have an answer for how to fix the problem, I'm just worried that we haven't had the kind of systemic change that we need. A little more auditing doesn't change anything, the banks pay a lot more than the regulatory agencies so they'll be able to capture them.
> As far as going to jail for being sociopathic burdens on society, well this one's hot off the presses, nobody goes to jail from Citibank or Goldman for committing fraud:
And Barney Frank and Chris Dodd are also still walking around free. What's your point?
The free market is such a beautiful theory that no proof is required. The free market can never fail, you see, it can only be failed. Thirty years of deregulation and regulatory capture led to economic disaster because the market just wasn't free enough.
That is seriously the argument some people make. I find it obnoxious and so trivially, obviously false it baffles me that people who are not rich actually make this argument.(1) I have trouble believing in a system which collapses at the slightest deviation from perfection.
(1) I can, however, easily see why an ethically challenged rich person would make such a self-serving argument. No, I don't think all or most rich people are ethically challenged. Certainly some are. I hate making so many caveats and having such a defensive tone in these footnotes, but I've argued on the internet before. It went okay.
This is the case which is often cited to establish that the corporation's primary duty is to its shareholders, and that this duty overrides all others.
EDIT: never mind, this is already discussed in the article. Sorry.
Fans of shareholder primacy almost always cite the nearly century old case of Dodge v. Ford as their primary legal support for the idea of shareholder primacy. But Dodge v. Ford was really a shareholder-versus-shareholder dispute in a close corporation.
Similarly, the second case typically cited—Revlon v. Mac- Andrews & Forbes Holdings, Inc., is also legally irrelevent. In Revlon, the Delaware Supreme Court held that an end-game situation where the directors of a publicly traded firm had decided to sell the company with a controlling shareholder—in effect, terminating the corporation’s existence as a public firm—the board had a duty to maximize shareholder wealth.
But subsequent Delaware cases have made it clear that if the directors of the firm decide not to sell at all, or prefer to do a stock-for-stock exchange with another public company, the infamous Revlon doctrine no longer applies.
For example, in Paramount Communications, Inc. v. Time, Inc., the Delaware Supreme Court upheld directors’ right to “just say no” to a hostile offer, even though the offer was at a premium over the market price for the company’s stock.
California just created a whole new class of corporation for people who wanted a different standard of behavior, which could include social and environmental concerns.
I think it was unnecessary; California should have just made a statutory affirmation that any corporation may choose whatever goals its owners decide.
There's a reasonable argument to be made that's already the case, and the opposing idea – that 'maximizing profits' or 'maximizing shareholder value' is a legal requirement – is just a persistent misunderstanding.
I think such a misunderstanding is fed by some on both the right and left. On the right, some want to celebrate a singular, elegant rule for moving all decisions into an economic model. On the left, some want to smear the very idea of corporations as amoral at the core.
Neither view respects the idea of a corporation as a voluntarist coordination mechanism. A corporation is its shareholders' property, and just like any other property, may be deployed in any legal manner the owners see fit.
The article mentions that case, saying that while it hasn't been explicitly overruled, the decision is now generally ignored by courts and not cited as precedent. (It was also only a Michigan decision, binding only on Michigan courts.)
The article seems to be confusing fiduciary duty with accountability. As a director, if you make your shareholders unhappy enough, they will fire you. If you breach your fiduciary duty, they will sue you. The article is only addressing breach of fiduciary duty. So I don't agree with conclusion that "In short, directors are to a great extent autonomous.".
