Getting real

Getting real: stakeholder theory, managerial practice, and the general irrelevance of fiduciary duties owed to shareholders.
Author: Marens, Richard.; Wicks, Andrew. Source: Business Ethics Quarterly v. 9 no2 (Apr. 1999) p. 273-93 ISSN: 1052-150X Number: BSSI99013842 Copyright: The magazine publisher is the copyright holder of this article and it is reproduced with permission. Further reproduction of this article in violation of the copyright is prohibited.

INTRODUCTIONOver the last several years, business ethicists (Goodpaster, 1991; Boatright, 1994; Freeman, 1994; Goodpaster and Holloran, 1994; Donaldson and Preston, 1995) have disputed the implications for stakeholder theory of the fiduciary obligations owed by corporate management to shareholders. They have argued extensively as to whether this duty privileges shareholders and whether public policy could or should recalibrate the balance vis-à-vis other groups. The actual impact of these fiduciary responsibilities upon real-world business practice has received comparatively little attention. This paper attempts to address this neglect through a thorough examination of the relevant case law. In doing so, the authors have arrived at two conclusions. The first is that the existence of a fiduciary duty owed to stockholders presents few practical problems for a management team that wishes to implement a stakeholder-oriented approach to business. Second, the specific responsibilities generated by this fiduciary duty are in no way "over and above" the kind of treatment shareholders could reasonably expect to receive under a stakeholder regime.
Although stakeholder groups other than shareholders may not be able to enforce a fiduciary duty against corporate management, this legal reality does not preclude managers from behaving as if they were actually under such obligations. Legal relationships, and particularly legal relationships that emerge under a common law system, are not based on complete, elegant, and consistent sets of principles. They are instead the result of incremental modification of often vague and overlapping doctrines that must be selectively applied toward solving practical business problems or settling a variety of disputes. As a result, the precise legal doctrines that define the relationships between top corporate management and the various groups holding a stake in the firm's performance will differ from stakeholder group to stakeholder group precisely because each group holds a different economic and social relationship to the firm.
This axiom of legal realism generates two important results for stakeholder theory. First, as Goodpaster argued (1991), legal obligations subsumed under the rubric of fiduciary will not readily lend themselves to all stakeholder relationships. Second, there is no reason to assume, and empirical reasons to doubt, that owing a duty to one class of stakeholders creates serious practical constraints upon how the law allows managers to treat other groups.
This paper develops this argument through five sections. We begin by summarizing the discussion of the "stakeholder paradox" that allegedly arises from the fiduciary duties of corporate managers. This is followed by an explanation of the precise nature of these duties owed to stockholders. Next, the paper will argue that a century of legal precedent generally permits management the freedom to adopt and implement a stakeholder approach with regard to various constituencies. We then show that while fiduciary obligations do little to limit managerial autonomy to do so, no current statute or common law principles compel a full-scale stakeholder approach. The paper then proposes a new extension of legal doctrine to encourage such an approach and finally concludes by discussing implications for theory and teaching.
THE "STAKEHOLDER PARADOX"Since Freedman's (1984) seminal book on stakeholder theory appeared in print, scholars of business ethics have increasingly used stakeholder theory as a conceptual framework to discuss the ethical dimensions and implications of corporate activity. Freeman began the discussion by arguing that successful managers must systematically attend to the interests of various stakeholder groups. Later pieces, including contributions by Freeman himself (Evan and Freeman, 1983; Freeman and Gilbert, 1988; Donaldson and Preston, 1995), moved beyond this "enlightened self-interest" position by taking the more radical position that the interests of stakeholders have intrinsic worth irrespective of whether these advance the interests of shareholders. Under this view, the success of a firm is not merely an end in itself but should also be seen as providing a vehicle for advancing the interests of stakeholders other than shareholders.
Since each class of stakeholder has a different legal, economic, and social relationship to a particular business, a general stakeholder approach does not explain how managers should balance different kinds of dependencies. Particularly troublesome is the legal reality that managers owe shareholders a "fiduciary" duty not generally granted to any other group. While Donaldson and Preston (1995) are correct in pointing to contractual obligations and regulatory responsibilities designed to protect other groups from specific malefeasances such as discrimination or pollution, we argue below that Goodpaster (1991, 1994) was also accurate in characterizing the duty to stockholders as more general and proactive than what other constituencies can claim.
Goodpaster, however, goes further than this by insisting on a potential conflict arising out of this legal asymmetry, arguing for the existence of a "stakeholder paradox," where corporate management would find themselves (under all but the most ideal circumstances) having to choose between fulfilling this fiduciary duty and serving the interests of other stakeholders. Boatright (1994) argued that this paradox could be overcome by extending the fiduciary duty to cover other stakeholders, a suggestion criticized by Goodpaster and Holloran (1994) as both impractical and potentially unwise.
Freeman (1994) took a different approach, suggesting that the stakeholder paradox was fundamentally linked to the separation thesis--a conceptual artifact that both presupposes and reinforces the divisions between ethics and business. He also claimed that the mere existence of fiduciary duties owed to shareholders are theoretically irrelevant to the normative justification of stakeholder theory since such duties themselves must be morally defended and do not give managers license to violate normative ethics in their interactions with nonstockholders (see also Jones, 1995). Donaldson and Preston (1995) go even further by suggesting that the legislation of protections to other groups implies that the broader norms of ethical behavior are consistent with stakeholder philosophy.
Not all behavior, however, that might be defensible as consistent with normative ethics will always prevail in a court of law, the arena in which legal rights are established and applied. Consequently, directors and managers might rightly concern themselves with their legal as well as their ethical position in relating to various stakeholder groups. As this paper will make clear, however, they have little to fear. An examination of the origin and meaning of fiduciary responsibility shows that this duty does little to threaten managers who set out to implement stakeholder-oriented policies.
THE ASYMMETRY OF LEGAL RELATIONSHIPS WITHIN THE CORPORATE "WEB"Courts did not historically encumber corporate management with a fiduciary duty toward company stockholders in order to privilege shareholders vis-à-vis other stakeholder groups. Rather, it was designed to prevent self-dealing on the part of directors and top management that fell short of criminal behavior such as embezzlement (Brudney, 1985; Clark, 1985). Traditionally, this meant preventing business decisions, typically involving expenditures, that were made primarily because they personally benefited top managers or their friends (Berle and Means, 1933), while more recent charges of malfeasance tend to focus on managerial entrenchment as much as enrichment.
When conflict of interest is not at issue, no case law or corporate statute argues that management's fiduciary duty should be equated with a right of stockholders to oversee managerial decision making (Brudney, 1985; Mitchell, 1992). If business ethicists seem to implicitly assume otherwise, the source of this misconception is not hard to deduce. Stakeholder theory is, at least in part, a response to neo-classical theories of the firm that impose an empirically false symmetry of legal relationships among corporate constituencies. By assuming that there might be some truth to such legal chimeras as "nexus of contracts" and "agency theory," stakeholder theorists would reasonably counter that these legal relationships are inadequate to support a stakeholder approach to business management. If stakeholder theorists erred, it was in assuming that these hypothesized relationships had some basis in law.
Corporations are not, in any meaningful legal sense, nexi of contracts, nor are directors agents of stockholders. To take the second point first, "agency" (Clark, 1985) is a highly specific two-way relationship in which the principal can direct or override the agent and the agent can, under highly restricted circumstances, legally bind or create liabilities for the principal. Neither directional arrow holds, in any meaningful way, between stockholder and director. Not only do individual stockholders lack legal standing to specify details of how a business should be managed, directors and top managers can neither bind individual shareholders to contracts with third parties or generate personal liabilities for them through debt or tort.(FN1) On the other hand, directors (and their agents, high-level managers) can legally bind the corporate entity as a whole to either contractual obligations or financial liability.
This distinction is not merely semantic. The duties required of a fiduciary are not to obey a person, as an agent might, but to make every effort to protect their property, in this case the funds or other assets the stockholder has exchanged for corporate shares. As a fiduciary, a corporate director's relationship is not with the shareholder personally but with her investment.
Not only is this relationship not that of agency, it is also not contractual in any legally meaningful way. The general fiduciary obligation is one of fulfilling a normatively defined level of responsibility toward beneficiaries with little connection to contract law and its underlying presumption of voluntary bargaining between informed parties (Mitchell, 1992). By contrast, the fiduciary principle evolved from the far older law of property, which directs trustees to manage property in the interest of those judged incompetent to do so themselves, historically because of age, gender, or infirmity (Mennell, 1994; Mitchell, 1992). Fiduciary duties were imposed on these trustees in order to protect legal owners who were not in a position to manage their own affairs from the unscrupulous self-dealing of those administrators the incompetent were forced to rely upon (Johnston, 1988; Mennell, 1994). This is a set of circumstances that would describe any outside corporate investor, whose involvement in the business is based upon the expectation of a financial return through either dividends or sale of the security, and who is almost never in a position to oversee that this investment is neither negligently handled nor exploited for personal gain by the handler.
The beneficiary/fiduciary relationship is considerably more straightforward than those derived from contracts in which parties negotiate some terms and explicitly or implicitly adopt others from extant regulations or currently accepted practices (Mitchell, 1992). The typical penalty for breach of contract involves monetary damages, making all but the most egregious breaches a business decision as to whether cost of the penalty (and, possibly, damage to reputation) exceeds the gain from repudiation. By contrast, the fiduciary duties required of trustees--honesty, adequate care for the entrusted property, providing the owner with any relevant information, avoiding any unauthorized personal gain even when such gain does not hurt the beneficiary (Block et al., 1989)--are not typically subject to negotiation, and a judge would carefully scrutinize the circumstances of any claim that a beneficiary freed the fiduciary from any of these duties (Mitchell, 1992).
As a result, contractual duties and fiduciary duties are measured differently. Contractees are expected to complete certain acts while fiduciaries are required to act under certain motives. In the corporate setting, fiduciary duties do not impose a requirement that a business be run in a certain manner. No court equates this duty with "maximizing shareholder value,"(FN2) even assuming such an indeterminate concept could be estimated. What the duty does require is honesty and candor in the relationship with the stockholder and a general avoidance of using one's office for illegitimate personal gain. Traditionally such illegitimate self-dealing might have meant dealing with another company because a director has some financial interest in the other concern. A more modern application might mean keeping stockholders from voting on a tender offer because the inside directors fear for their jobs. There is nothing in the relationship that absolutely bars acts of generosity on the part of fiduciaries who are not themselves the beneficiary of the act, unless such generosity can be shown to harm the beneficiary.
Given the modest nature of this duty list, there are at least three reasons to doubt that they provide any serious obstacle to the implementation of stakeholder principles. First, it is not obvious that the right of shareholders to expect honesty, candor, and care on the part of management gives them a higher level of protection than the legal rights available to other stakeholders. Creditor interests, for example, are protected by bankruptcy law. Suppliers and customers can seek redress under the Uniform Commercial Code or more recent statutes such as "lemon laws" that cover used car sales. Tort victims are the beneficiaries of insurance requirements for various kinds of businesses. And employees can enlist government assistance in collecting unpaid wages or compensation for income-diminishing injuries and can demand fiduciary protection for pension assets and other benefits (Donaldson and Preston, 1995).
Second, courts are starting to impose on corporate management fiduciary duties with regard to other groups under certain circumstances. Last year, the Supreme Court ruled in Varity v. Howe (1996) that a corporation that reorganized all of its money-losing ventures into a single subsidiary that eventually went bankrupt (leaving a healthy surviving parent) had breached its fiduciary duty to the employees of the subsidiary. The company had not only urged employees to transfer to the subsidiary without disclosing its precarious condition, it even transferred the benefit administration of several retirees to the subsidiary without their knowledge. As a result the parent corporation and several of its executives were found to have violated duties created under the Employee Retirement Income Security Act (ERISA) and assumed by corporations that administer their own benefit plans (Shein, 1996). The Court just recently extended this reasoning to the protection of non-retirement benefits when it found for employees dismissed after refusing to accept employment with another company, but a company with whom their original employer had arranged for them to do exactly the same work but with reduced benefits (Intermodal v. Sante Fe Railroad, 1997).
And finally, as we will demonstrate in detail below, when stockholders have attempted to challenge managerial behavior as being overly generous toward another constituency, they have almost always lost.
BUT WHAT ABOUT DODGE BROS. V. FORD?Stakeholder theorists who argue that shareholder interests are (fortunately or unfortunately) paramount typically cite the famous dictum from the Michigan case Dodge Bros. v. Ford that "the corporation exists for the benefit of the shareholders" (Goodpaster, 1991; Boatright, 1994) as evidence of a restraint on the discretion of management. Leaving aside the question as to whether dicta from a state court decision remains influential after seventy-five years, an examination of the context of the statement and the circumstances of the lawsuit makes it clear that this perspective was not meant to empower the shareholder at the expense of managerial discretion.
The lawsuit was aimed at Henry Ford's tightfisted dividend policy. Ford Motors had become one of the world's most profitable companies and was literally piling up unspent cash that it could not invest fast enough, yet was recently refusing to pay out much more than 1 percent of its net income in dividends. Because it was the company's principal shareholder, Henry Ford, who managed the company, this was a classic case of upholding the rights of minority shareholders against the tyranny of a majority investor. Ford Motors was, at the time, a privately held corporation and courts have been particularly sensitive to protect minority interests in such firms (Mitchell et al., 1996), such as the Dodge brother plaintiffs. Unlike holders of publicly traded shares, minority shareholders in a private corporation are not usually in a position to readily sell out and thereby exit from an unsatisfactory relationship(FN3) and by definition minority holders possess little or no power to replace an unsatisfactory board of directors with one more amenable to their perspective. One might, in fact, argue that the stockholders of privately held companies deserve more consideration as stakeholders than their public counterparts. Because minority shareholders in a privately held company are far less free to exit the relationship if management makes a decision they find objectionable, they are more dependent upon a right to have their interests considered by management.
The court rejected Henry Ford's defense that "my ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes" (Dodge Bros. v. Ford, 1919: p. 505). While his assertion is usually taken at face value to violate accepted norms of proper business purpose, the court may well have been aware that he was speaking with dubious sincerity (Jardim, 1970). Testimony indicates that Ford Motors had issued higher dividends in the past, suggesting perhaps that Ford's primary motive in refusing to pay out was to prevent the Dodge Brothers from creating their own rival auto manufacturing company, which, in fact, they eventually did. But whatever Ford's true motives were, it would be difficult to imagine that any normative stakeholder theory would deny shareholders the right to share in some of the prosperity generated by a successful business.
It should also be noted that the court did not hold that investors could interfere with managerial business planning or insist that their immediate financial gain become the only consideration of the board of directors. The judge actually dismissed most of the complaints filed by the Dodge Brothers, holding for example, that Ford and his fellow directors had the right to plan the business as they judged best, free from second guessing on such business decisions as expanding production and smelting his own iron, and certainly under no obligation to forego these in favor of distributing further dividends.
Moreover, there is no evidence that the decision in any way affected Henry Ford's peculiar brand of paternalism in relations toward his employees. The court did not prevent Ford from continuing to pay higher-than-market wages or prevent him from subjecting them to speed-ups, invasions of privacy, and expectations of social conformity that went far beyond what was attempted by other employers. Working for Ford remained a tradeoff of high wages and tight behavioral restriction (Meyer, 1981).
Reading the case, one might reasonably conclude that it strongly confirmed the principle that shareholders cannot interfere with managerial decisions that can be plausibly justified as enhancing business performance. The court acknowledged that Ford could build new plants, vertically integrate, or otherwise run the business as he saw fit. What they forbade was the company's decision to sit on a mountain of cash for allegedly philanthropic, not business, purposes, particularly when the court had reasons to doubt Ford's candor regarding his actual motive.
In fact, since Ford v. Dodge Bros., courts have proven very reluctant to force corporations to pay out additional dividends or otherwise examine the economic wisdom of business decisions (Brudney, 1980).(FN4) In Grobow v. GM (1988), the board of directors was permitted to exercise its collective judgment that paying H. Ross Perot seven hundred million dollars in order to remove him from the board of directors was in the best interest of the corporation. In finding a legitimate business purpose in spending these funds to eliminate Perot's unflagging dissension (as opposed to larger dividends or new investments), the highly influential Delaware Supreme Court implied that there would be few decisions not involving outright self-dealing that stockholders could enjoin boards from making.
DOING WELL BY DOING GOODAn examination of a century of case law under circumstances less dramatic than what faced the Michigan Court in 1919 demonstrates that corporate managers have successfully defended generosity and consideration toward non-shareholding constituents. In the process, courts have often accepted arguments that anticipated instrumental stakeholder theory (see Jones, 1995). Whatever skepticism the court expressed in Dodge Bros. v. Ford toward charitable giving has largely disappeared in American jurisprudence since A. P. Smith v. Barlow recognized in 1953 an enlightened self-interest rationale for spending profits in this manner (Von Stange, 1994). Similarly, courts established long ago that corporations can voluntarily agree to pay a tax bill that is higher than the law might strictly require as part of a political compromise with local communities (Kelly v. Bell, 1969). General Motors recently applied this principle when, having won the right in court to disregard its own promises made in return for a property tax reduction, it agreed to a new investment program with the offended community (Hattori, 1994).
Historically, generosity toward employees has almost always won when, unlike in Dodge Bros., the generous treatment is justified as a means of improving efficiency or productivity. A century ago, in Steinway v. Steinway and Sons (1909), a family shareholder lost his court challenge to the building of a company town for manufacturing employees on the grounds that such an act of communitarianism would improve labor relations, and, as the court noted, help keep out unions. Later, corporations routinely defeated challenges by stockholders to various bonus and profit-sharing plans when justified by creating incentives for better corporate performance (Diamond v. Davis, 1935; Gallin v. National City Bank, 1945) until they too became legally unassailable.
ESOPs, or Employee Stock Ownership Plans, might appear to be theoretically more vulnerable to challenge since they often require the assumption of debt or the dilution of current stock holdings to implement. Yet, except in very rare cases in which the ESOP was thrown together at the last minute to prevent a takeover (more on this below), ESOPs have been consistently upheld by courts as consistent with management's right to set personnel policy and select means of raising productivity (see Herald v. Seawall, 1972). One court, (In re Dunkin Donuts, 1990) even accepted management's argument that an ESOP would help heal the effects of a corporate downsizing on surviving employees.
One might argue that the need to justify acts of generosity through a finding of a rational business purpose such as higher productivity, long-term earning horizons, or beneficial public relations limits a stakeholder approach to a very timid instrumental use of the concept. However, it is also important for stakeholder theorists to understand that courtrooms are not forums for the expression of deeply held moral philosophy. Lawyers are trained to make the most conservative, precedent-supported argument that can plausibly defend a particular act or policy.
No competent attorney would allow her client to argue in court that their corporation made a decision because it "was the right thing to do" in the face of evidence that management knew of legal alternatives whose impact on the bottom line, short term and long term, were indisputably superior. It may smack of moral cowardice, but given the uncertainty of what sustains and makes a business profitable over a period of years, virtually any act that does not financially threaten the survival of the business could be construed as in the long-term best interest of shareholders.
TAKEOVERS AND THE PURSUIT OF A RATIONAL BUSINESS PLANIf board fiduciary duties toward stockholders prove significant in any issue of corporate policy it is in their treatment of takeover bids. Top managers might reasonably see such takeovers or mergers as a threat to their continued tenure in well-paid and fulfilling jobs. Consequently, the appearance of a tender offer might tempt them into a breach of their fiduciary duty by looking for ways to cling to their high-paying jobs rather than making decisions based on a judgment as to what furthers the financial interests of stockholders.
The structure of a large portion of takeover efforts made it relatively simple for management to defend their resistance in terms other than self-entrenchment.(FN5) To begin with, not all tender offers will necessarily make most stockholders better off. A corporate board could reasonably find some tenders offers coercive of shareholders, as, for example, a two-tiered offer which promises a premium to the first stockholders to sell, whose purpose is to create a stampede of acceptance on the part of those who fear being the ones to miss out (e.g., Baron v. Strawbridge, 1986). In addition, any offer that is so poorly financed that the long-term survival of the firm is put in doubt arguably triggers a fiduciary duty to reject it in order to protect the interests of any shareholder who does not wish to sell (e.g., Amanda v. Universal Foods, 1989). Such judgments gain credibility when they are made by directors of demonstrable stature and independence without employment or other significant financial ties to the company. These "outside" directors are presumably more disinterested than "inside" directors who risk losing a managerial position in a takeover battle.
But on numerous occasions courts have also found for boards of directors who have rejected tender offers that are neither patently manipulative nor clearly fiscally unsound. The language of the judicial opinions in several of these cases sounds remarkably similar to that of a normative stakeholder approach. The Supreme Court of Delaware, by far the most influential state court with respect to corporation and securities law, has consistently rejected the notion that directors have a duty to sell the company whenever a takeover proposal offers a premium over current market value of company stock (Paramount v. Time, 1989: p. 1144), and the court has even established a positive duty to "adopt defensive measures to defeat a takeover attempt contrary to the best interests of the corporation and its shareholders" (Revlon v MacAndrews, 1986, p. 184). The court had implicitly defined these corporate, but non-shareholder, interests very broadly when it had ruled the previous year in Unocal v. Mesa Petroleum (1985) that boards might consider impact on "customers, creditors, employees, and perhaps even the community generally" (p. 955, italics mine).
Numerous court decisions in other jurisdictions have concurred by supporting the right of boards to choose the continuation of corporate policies over obtaining premium stock price for shareholders. Companies could refuse highly leveraged offers likely to put an end to philanthropic and research policies (Amanda v. Universal, 1989) or fight to keep a company independent when it rationally saw such independence as vital for customer, community, and employee relations (Baron v. Strawbridge Clothier, 1986). One court, for example, upheld a bank's decision to choose one takeover "suitor" over another, explicitly accepting as legitimate the bank's justification that the winning bidder was better on "social issues," including the prospect of creating more opportunity for the company's employees (Kayser v. National Finance, 1987, p. 265).
On one of the few occasions that the Supreme Court has spoken to the three-way relationship between directors, shareholders, and other stakeholders (CTS v. Dynamics Corp. 1987), it upheld a state anti-takeover statute that allowed a corporate board to fight off such an attempt.(FN6) Its justification rejected the need for state legislatures to follow "any one particular economic theory of the firm" (p. 92) such as shareholder supremacy, while acknowledging a state interest in "maintaining stable relationships between parties involved in corporations" (p. 90). Another court went further by actually finding a proactive duty to protect employee benefits such as pensions and severance pay by eschewing mergers or takeovers that might threaten these (GAF v. Union Carbide 1985). This case first established the duty that the Supreme Court more recently extended in Varity and Intermodal to transactions that did not involve takeovers.
On the other hand, the potential for self-dealing implicit in takeover defenses has provided virtually the only circumstance where stockholders can challenge the legitimacy of establishing an ESOP. ESOPs sometimes serve as a form of takeover defense, either because the debt, cash, or dilution required to create them might scare away suitors, or because the management-appointed trustees of the plan (and eventually, the vested employees) could probably be expected to vote with management.
ESOPs upheld by courts, despite their concurrence with a hostile takeover, are typically rationalized in stakeholder terms. Xerox, for example, could triple the size of its existing ESOP in response to a takeover bid, because the ESOP could be characterized with some credibility as part of a long-running program of building a "partnership" relationship with employees in order to improve productivity (Monks and Minow, 1991). Moreover, current Xerox shareholders would not have been hurt by the plan since employees would pay for most of it with pay cuts, a move employees might prefer to losing their jobs in a hostile takeover. ESOPs that materialize at the "last minute," however, have, on occasion, been ruled a breach of fiduciary duty (see, e.g., Yoshihoshi, 1992; Franz Mtg. v. EAC Industries, 1985).
A similar split has occurred regarding the enforcement of "tin" parachutes, generous severance packages for non-executive employees triggered only by hostile takeovers. They were upheld, for example, in GAF v. Union Carbide. Other courts, however, have thrown them out when such generosity was never extend to employees who were laid off by the incumbent management team (Block et al., 1989 and 1991).
While the precise details are complex and frequently mind-numbing, a legal conclusion can be drawn from these various results. Management, almost by definition, has a personal stake in opposing unsolicited takeover offers. Nonetheless, if benefits from a defense can reasonably be construed as beneficial to other stakeholder groups, and the defensive strategy is not clearly detrimental to stockholders, managers do not entirely surrender the legal autonomy allowed them in making virtually any other class of common corporate decisions.
COMPELLING A STAKEHOLDER APPROACHIf American corporate law does little to inhibit a stakeholder orientation on the part of corporate managers, it also does little to compel one. Management teams exercise a wide range of discretion as to whether to embrace a stakeholder view of constituencies when instituting major corporate changes. While National Steel worked with employees and the Weirton community to sell them its steel plant when it became unprofitable for the company to operate (Lieber, 1995), U.S. Steel chose only a few years earlier to shut down its Youngstown, Ohio, facility rather than risk creating competition by selling it to its employees (USW v. U.S. Steel Corp., 1980), a decision recently emulated by British Petroleum regarding one of its refineries (Cooper, 1997).
This autonomy vis-à-vis stakeholders has not been altered by the rash of corporate constituency statutes passed by the majority of state legislatures in recent years (Fort, 1995).(FN7) This result is not surprising considering that all but one of these laws (the exception being Connecticut's) only permit directors to take the interests of customers, creditors, employees, or the community into consideration; they do not compel such concern, and even Connecticut law does not create a specific cause-of-action on which stakeholders can sue. Nor has any court extrapolated such a right (Singer, 1993). While Maine's corporate constituency law has been one of only three that has ever been cited by a court in finding in favor of a managerial decision (Georgia Pacific v. Great Northern, 1989), seven years later the same court could still assert that no Maine statutory or case law allowed an employee or creditor to sue for breach of fiduciary duty (Tiernan v. Barresi, 1996: p. 37).
The 100,000 complaints of age discrimination that have been filed with the Equal Employment Opportunity Commission during this decade also support this conclusion. Although a sizable fraction resulted from either downsizing or reorganization following a merger or acquisition (Grimsley, 1997), not a single aggrieved worker has sued on the basis of a corporate constituency statute. Given the numbers involved, it seems highly implausible that no attorney would have attempted to sue on these statutes if there was a realistic hope that these statutes might be used to challenge, as well as defend, the policies pursued by corporate management.
It is perhaps not surprising, then, that the three instances where such statutes have been used in appellate decisions all involved directors resisting takeover bids. Even here, these statutes provided only secondary support for a more central justification. This supporting role is demonstrated by the way each court introduced its use of the relevant stakeholder statute, using the words " f urthermore" (Kayser v. Commonwealth National Financial Corp., 1987, p. 265), " i n addition" (Abrahamson v. Wadell, 1992, p. 272), and " t his is particularly so in light of the stakeholder statute " (Georgia Pacific Corp. v. Great Northern Nakoosa Corp, 1992, p. 33). If constituency statutes have had any impact, it has probably been the informal one of giving directors, who might be confused regarding their legal obligations and possibly worried about personal liability, a degree of legal cover for taking the interests of other stakeholders into consideration (Lorsch, 1989).
The record of legislation aimed to protect specific classes of stakeholders has had a mixed record. In general, the more specific and less intrusive into managerial decision making the legislation, the greater its eventual impact, in part because the more ambitious legislation has been overturned. While the Supreme Court upheld a Maine law in Halifax Packing Co. v. Coyne (1987) that required severance payments to victims of a plant closing calculated by a fixed formula based on years of service, other courts have thrown-out more complex and ambitious statutes: a Massachusetts law that required severance for layoffs after any change in control (Simas v. Quaker Fabric Corp, 1993), and a Hawaiian law that compelled severance for virtually any layoff that could be connected to some structural change in the business (Akau v. Tel-A-Com, 1990).
In a parallel fashion, Federal WARN legislation requiring notification of employees of impending layoffs has become accepted as part of the business landscape, in part because of its many exceptions and loopholes in case of a business emergency. On the other hand, courts have generally refused to find age discrimination when older unionized employees are discarded in favor of operating newer plants staffed by younger non-union employees (Allen v. Dierbold, 1994). The court reasoned that if a company wishes to replace more expensive unionized employees with cheaper non-unionized ones by switching production to another plant, it is not discriminating merely because the average age is significantly higher in the first group.
A similar spectrum is evident in cases centered on community responsibility of corporations that accept government aid. The more specific the requirement, the easier it is to enforce. In a case involving development bonds, issued by the State of Minnesota with the explicitly stated intention to help investors buy troubled firms in order to preserve jobs, a court found for the state and against an investor who used the subsidies of these bonds to buy and dismantle a factory in order to ship its assets to North Carolina (In re Duluth, 1989). On the other hand, although the City of Yonkers condemned some land to enable Otis Elevator to expand and stay in the city, this deal did not require Otis to continue investing and manufacturing in Yonkers when Otis Elevator could show a few years later that this particular plant was becoming increasingly unprofitable to operate (Yonkers v. Otis Elevator, 1988). Similarly, the Michigan Supreme Court would not hold General Motors to its promise to perpetually manufacture a particular automobile model in Ypsilanti Township in return for tax benefits (Hattari, 1994).
Unions are certainly one stakeholder group recognized by law as entitled to exercise power in limiting employer discretion regarding compensation, working conditions, and work rules. However, a Supreme Court decision twelve years ago, First Maintenance v. NLRB (1981), denies unions any legal right to participate in other kinds of corporate decision making, including some categories that directly affect employees. As a result, unions have little pressure to exert regarding mergers, downsizing, layoffs, or contracting out work previously performed by union members unless they can show that such acts were committed out of an anti-union animus. It is long established law that unions can not prevent a company from abandoning a plant in the middle of a contract period in favor of another more profitable site, and even concessions granted in the middle of a contract period do not obligate the employer to continue to recognize the union at the end of the period (Marine Transport Lines v. International Organization of Masters, 1986).
Unions are, of course, entitled to bargain for severance pay and other layoff benefits should reorganization cost jobs, but one survey found that only 40 percent of union contracts actually include a severance package (Summers, 1995). Moreover, unions who have managed to bargain for job-security provisions in their contracts have often found it difficult to enforce these in court (Stone, 1991). And should even such mild limitations on managerial autonomy be found intolerable, a generation of declining rates of private-sector unionization suggests that management is often in a position to "rid themselves of these meddlesome stewards.".
MOVING THE COMMON LAW IN A STAKEHOLDER DIRECTIONThe common law system, with its selective use of precedent in both deciding cases and interpreting legislation, is a mix of tradition and improvisation capable of generating a great deal of innovation, albeit at an uncertain rate and with somewhat unpredictable results. As the law evolves, there are arguments attorneys can make that, by building on analogy, might move the law incrementally toward compelling recalcitrant managers toward more consideration of stakeholder interests without radically interfering with the general independence of management to run a business as it feels best.
One is the general extension of fiduciary duty to other financial participants (Boatright, 1994). This has begun to happen in conjunction with the previous mentioned fiduciary duties created by ERISA. As the law now stands, corporations cannot make business decisions to avoid their responsibilities to their present and future pension beneficiaries and now with Inter-modal, this has been extended to forbid business decisions that disregard duties to recipients of other kinds of benefits such as medical insurance, sick leave, or overtime pay that is more generous than the legal requirement.
Theoretically, fiduciary duties might be imposed on corporations that benefit from the various investment decisions stakeholders must routinely make when relying on the representations of a particular business. Businesses routinely benefit from the investments made by others: suppliers who install new machinery to meet the company's requirements; retailers who invest in advertising, training, and store modifications to accommodate their products; communities who build roads, establish educational programs, and make various sorts of civic improvements; and customers who pay with their cold hard cash. Law professor Katherine Stone (1991) has proposed that internal labor market theory, which asserts that employers pay below marginal value for neophytes with an implicit promise to overpay after years of commitment to a particular firm, presents courts with a fiduciary rational for protecting employee "investments" of years or decades of service in hopes of such a payoff.
These arguments for extending a fiduciary duty, however, are likely to require more of a stretch than most courts are comfortable making, particularly when extant law in contracts, torts, and employment already covers some of the same territory. Stone's proposal in particular requires the acceptance of an economic theory that has hardly achieved universal legitimacy.
A less conceptually radical way of covering much of the same territory has been suggested by O'Neil (1993) in connection with the employment relationship. Rather than trying to analogize too broadly and perhaps inappropriately from the narrow property orientation of fiduciary duties, he suggests modifying a legal obligation already embedded in the employment law. Currently, employers can demand a duty of loyalty from their employees derived from the original law of "master and servants." Employees can be sued for acts of disloyalty that are not actually criminal, such as revealing secrets or "stealing" business opportunities, learned about through one's job, away from the employer. O'Neill proposes making this duty reciprocal so that employers cannot take advantage of their workers through deliberately misleading them or unnecessarily disregarding their interests in making decisions.
Such a reciprocal duty of loyalty might enjoin a profitable employer from laying off employees if it can offer no rational business purpose beyond that of trying to convince investors to bid up the price of the stock. Similarly, corporations would be held accountable for lying to employees regarding their future relationship, or replacing permanent employees with temporaries or part-timers in order to avoid paying benefits. Loyalty defined as honest communication and the avoidance of corporate enrichment at employee expense would go a long way toward creating fiduciary-like protections for employees. At the same time, managers would not be constrained from any ethically justifiable business decisions, including such unpleasant ones as downsizing in order to stay competitive. Moreover, if compelled by threat of lawsuit to behave ethically toward employees and other stakeholder groups, many firms might actually discover that two-way loyalty creates no impediments to long-term profitability (Jones, 1995).
A similar duty might be extended to the communities. Communities could rely and, if necessary, sue upon promises made by businesses in return for tax favors or infrastructural investment. Companies would be forced to temper their requests with realism and honesty. Some might argue that these new legal duties place corporate boards and top executives under "too many masters." But as Macey and Miller point out (1993), corporate leaders already serve many masters, and it is difficult to see that requiring that they treat those from whom they expect cooperation with honesty and care would be unduly burdensome. Moreover, even if such behavior does, in some instances, raise the cost of doing business, it is difficult to understand why society as a whole would not be better served with slightly higher prices here and there, if they were the by-product of more dependable and trustworthy interactions.
CONCLUSION: IMPLICATIONS FOR STAKEHOLDER THEORY AND PRACTICEIf a corporate board's fiduciary duty to stockholders amounts to little more than protecting their investments from self-dealing, and if neither shareholder nor raiders, courts or legislatures, communities or labor unions impose very serious restrictions on management's ability to direct the corporation, then what are the implications of this reality for stakeholder theory?
To begin with, our analysis suggests that stakeholder theory does not necessarily involve the kind of radical transformations of current legal relationships that some of its advocates and critics might assume. That is, meeting fiduciary duties to shareholders does not entail that managers must side with shareholders and against stakeholders. Firms have the legal autonomy to act proactively and advance the interests of a number of stakeholders simultaneously. Managers and organizations have considerable latitude in defining core values and philosophy, including exactly what kind of responsibilities it wishes to assume with respect to a wide array of stakeholders. Managers are also free to exercise a wide latitude regarding the kinds of investments they wish to make and the way they evaluate alternative uses of corporate resources. So, while stakeholder theory may sound radical to our colleagues in finance, economics, and strategy, it is well within the boundaries of the law, and particularly with respect to the fiduciary duties owed to shareholders (see also Donaldson and Preston, 1995).
Managers will still face some tough decisions about how to allocate resources and which priorities to establish among stakeholder claims. However, this analysis suggests that these are, for the most part, moral choices which the law gives managers discretion to make without fear of violating their fiduciary duties to shareholders, and thus, not having to make wholesale choices between stakeholders and shareholders. Thus, researchers would do well to get beyond the stakeholder paradox, spend less time worrying about fiduciary duties as a significant impediment to stakeholder theory, and refocus inquiry in ways that avoid this conceptual roadblock.
A second and related point is that despite its aspirations to managerial relevance (Donaldson and Preston, 1995), stakeholder theorists have, for the most part, avoided this challenge. Applying the collective wisdom of several of the premier works in this domain (e.g., Donaldson and Preston, 1995; Evan and Freeman, 1983) offers managers little concrete direction as to how to allocate resources, make decisions, and sort out the legitimacy and importance of various stakeholder claims. Indeed, we suspect that one reason for the emergence of the stakeholder paradox is the generality and relative ambiguity of stakeholder theory. Without more direction and specific guidance on its implications, theorists are free to suppose there exists considerable conflict between stakeholders and shareholders. Developing more specific and managerially directive forms of stakeholder theory, we maintain, would not only improve its managerial relevance, but provide further support for our claims about the stakeholder paradox.
Thus, we suggest that isolating distinct and clearly practicable approaches to managing corporations provides a potent new method for advancing stakeholder theory and helping to extend its influence beyond the walls of the academy. As part of this task, researchers should engage both fellow theorists and managers in dialogue to convince them of the efficacy and persuasiveness of stakeholder-oriented management approaches--in both their instrumental and normative dimensions. Doing so need not set up unrealistic expectations of theorists. For instance, it isn't reasonable to expect stakeholder theory (or any theory) to provide highly specific guidance for most situations managers are likely to face. Still, offering greater substance and direction is clearly necessary if stakeholder theory is to lay claim to "managerial relevance." Developing and illustrating such a proposal is beyond the scope of this paper, but it deserves our attention as a central challenge for the field. Several authors have already begun moving in this direction (e.g., Elms and Berman, 1997; Freeman, 1994; Jones and Wicks, 1998).
A final and equally important challenge lies in education. If our analysis is correct, and the presumed legal obstacles to stakeholder theory are largely absent, this suggests that while conflict between the interests of shareholders and other stakeholders will not disappear, they need not be structurally inevitable or as unreconciliable as many would assume. Arguably, managers and much of the public have accepted a relatively unquestioned and problematic ideology that defines the shareholder/manager relationship as that of principal/agent, assuming, perhaps naively, that it was based on deep social consensus and legal precedent. In that case, a major challenge for ethicists and business schools lies in exposing this myth to students and the public at large and clarifying that whatever differences exist between stakeholder and shareholder theorists, these are ideologically based and thus contestable. Students and managers also need to know that they do not risk violating the law or well-founded social norms should they choose to manage their firms in a manner that weighs the interests of other groups with the same gravity that they bring to questions of shareholder value. Specifically, education should include the following:.
1. The stakeholder paradox is largely a false, ideologically created and avoidable problem since managers are not compelled to choose between the law and stakeholder ethics.
2. Managers have considerable freedom to make decisions regarding firm operations and investments and are not legally bound to reach decisions purely on the basis of their impact on shareholders.
3. Stakeholder theory need not be the antithesis of Friedman's shareholder theory, but can serve as a more compelling, inclusive, and realistic account of how business organizations can and should operate.
These educational efforts, combined with efforts at the kinds of modest legal reform outlined above, can help reshape the institutional landscape in a direction that would make it more receptive to stakeholder formulations of ethical business practice. We believe that by addressing these managerial and practical challenges, significant headway can be made both in expanding the influence of stakeholder theory and moving beyond some of the conceptual roadblocks present in much of the recent literature.
Added material.
RICHARD MARENS is a doctoral student in Strategy at the University of Washington School of Business. He has previously earned a J.D. and an L1.M. in the Law of Economic Development, also at the University of Washington. His articles have appeared in Economic and Industrial Democracy and Business and Society.
ANDREW WICKS is an Assistant Professor in the Management and Organization Department at the University of Washington School of Business where he teaches Business Ethics and Corporate Social Responsibility. He is a frequent contributor to Business Ethics Quarterly, and has also appeared in Business and Society, the Journal of Business Ethics; Organization Science, and Academy of Management Review. He received his Ph.D. from the University of Virginia in Religious Ethics.
FOOTNOTES1 In the rare case that a court will "pierce the corporate veil" and find a stockholder personally liable for a tort committed by a corporation, the stockholder is almost invariably involved in the tortuous act and/or has clearly aimed to use incorporation as a personal shield to avoid personal liability for highly negligent or reckless behavior.
2 See Paramount v. Time (1989) for a refutation of the idea that the primary legal duty of corporate boards is to achieve the highest possible stock price.
3 Stakeholder theorists have been less than careful about making this distinction between private and publicly traded corporations. The text of most stakeholder proposals seem to assume a publicly traded status for the object of the theories, but, arguably, there is no reason that stakeholder principles might not be applied to the privately held company.
4 While courts have occasionally ruled on dividend policy over the last eighty years, the most important decisions have focused on payouts so generous that plaintiff stockholders have claimed that they threatened the survival of the business. Even then, judges have generally avoided interference, and in the leading case (Sinclair Oil, 1971) the court decided that firm-bankrupting dividends were permissible as long as minority shareholders were not discriminated against in the looting of the till.
5 Brudney (1985) suggests that courts have in recent years erected procedural barriers limiting plaintiffs' ability to challenge self-dealing by shifting the burden of showing improper motive onto the plaintiff. See Buffalo Forge v. Ogden, 1983.
6 These statutes, typically passed during the early 1980s, legalized various measures corporate boards could take to "defend" the firm from hostile takeover attempts. These statutes tended to be narrower and more technical than the corporate constituency statutes that began to appear a few years later.
7 States that have passed corporate constituency statutes include: Connecticut, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Massachusetts, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, New Mexico, New York, Ohio, Oregon, Pennsylvania, Rhode Island, South Dakota, Tennessee, Wisconsin, Wyoming.
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