Legal and Economic Implications
It is not clear what tangible impact a commitment to stakeholders has on the manner in which a corporate director advises and oversees management and the corporation. Fiduciary duty under Delaware law requires that shareholder considerations be primary. The adoption of ESG-related principles does not change this.18 According to Delaware Supreme Court Chief Justice Leo E. Strine, Jr:
[A] clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare.19
Similarly, former Chancellor William B. Chandler III of the Delaware Court of Chancery wrote:
I cannot accept as valid … a corporate policy that specifically, clearly and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its shareholders.20
Nevertheless, Delaware law does allow stakeholder considerations to be taken into account to the extent that they protect the value of a firm or decrease its long-term risk. According to Skadden Arps:
The shareholder primacy path does not preclude a for-profit company from taking social issues into account in the conduct of its business. What is required to stay on the path is that the company’s consideration of those social issues have a sufficient nexus to shareholder welfare and value maximization.21
In evaluating a stakeholder’s need, the board is expected to gather reasonably available material, evaluate the costs and benefits, and make a decision in a disinterested manner in the best economic interest of shareholders—just as it does all other business decisions. The board’s decision then falls under protection of the business judgment rule.22
As such, it is not clear that the board of a company that explicitly adopts ESG-related principles can or would make substantially different economic decisions than a corporation that does not. In order for a board to make a decision that reduces economic outcomes for shareholders to benefit other stakeholders, a fundamental change to corporate law would have to occur. (Some politicians have advocated such a change.)23 If the decision does not reduce outcomes, then it could be argued that the decision-making framework of a board that adopts ESG-related principles is no different than the standard decision-making framework that directors currently and have historically employed. ESG is just a different strategic approach to achieving similar economic ends. (The Business Roundtable statement cited earlier appears to walk this line when it says that the long-term interests of shareholders and stakeholders are inseparable. Many ESG-related initiatives also appear to walk this line. See the following sidebar.)
Corporate executives need to make rational strategic and investment decisions for both the short and long term.30 The debate about the importance of ESG hinges on the time horizon that public company executives use to make those investment decisions (and, by extension, the board of directors that approves those decisions). ESG advocates contend that companies, motivated by compensation incentives and shareholder activism, are too short-term oriented and do not make sufficient investment in important stakeholder groups (such as employees, customers, suppliers, or environmental preservation) because they are overly focused on quarterly profit maximization to increase the current share price. As a result, their business model is presumed to be unsustainable: At some point in the future, this lack of investment will either lead to a deterioration in performance or contribute to a societal ill that the company is forced to redress through government action (an externality).31 An important assumption underlying these claims is that shareholders do not notice the damage being done to the company today and will bid the stock price up based on current earnings without accurately pricing in the long-term risk created by foregone investment.
The solution to the problem, when framed this way, is to create more sustainable companies. This explains in part the advocacy of BlackRock and its emphasis on “sustainable, long-term growth.”32 It also explains the support for ESG-related initiatives by prominent corporate law firms such as Wachtell, Lipton, Rosen & Katz, which urges companies to reject a “short-term myopic approach” and embrace “sustainable improvements … [that] systematically increase rather than undermine long-term economic prosperity and social welfare.”33
Unfortunately for those who want to resolve the issue, robust empirical evidence does not exist to evaluate the claim of whether CEOs are too short-term oriented. (We discuss the viewpoints of executives and directors on this question in the next section.) Denis (2019) reviewed research evidence on shareholder investment horizon, shareholder activism, corporate investment, and shareholder reaction to corporate investment over a three-decade period and concluded that “there is little systematic evidence to suggest that short-termism is a pervasive problem plaguing U.S. companies.”34
Ioannou and Serafeim (2019) found that sustainability initiatives are adopted first by market leaders and then spread over time to become common industry practice. Sustainability initiatives contribute most positively to corporate performance when environmental and social issues are relatively more important in the industry. They concluded that sustainability initiatives are strategic choices.35
The impact of a stakeholder orientation on corporate governance is also uncertain. Jensen (2002) argued that stakeholder theory allows managers to design their own objective functions and run firms in their own interests. That is, a stakeholder orientation has the potential to increase agency costs by replacing a measurable objective (shareholder value) with a less measurable objective (stakeholder value).36 Mehrotra and Morck (2017) argued that shareholder value maximization constitutes a bright line to evaluate performance, “whereas stakeholder welfare maximization is an ill-defined charge … that gives self-interested insiders broader scope for private benefits extraction.”37 Similarly, Bebchuk and Tallarita (2020) contended that a stakeholder orientation insulates management from shareholders, reduces accountability (by lessening financial performance as a disciplining mechanism), and harms economic performance. They concluded that a stakeholder orientation has the potential to be costly to shareholders, stakeholders, and society alike, and counterproductive to the objective of advancing the very interests that ESG advocates embrace.38
Note, these are theoretical arguments. It is likely that companies that adopt a stakeholder orientation do so out of a variety of motives and experience a variety of outcomes from their initiatives. The impact of requiring a stakeholder orientation on all firms through a change to corporate law, however, is likely negative. We return to this question at the end of the chapter.