In an article discussing Whole Food’s recent sale to Amazon, and the shareholder activist campaign that preceded it, I suggested that benefit corporations might prove more resilient than conventional corporations when faced with shareholder activist campaigns fueled by short-termism:
If Etsy or Whole Foods were benefit corporations, would the outcome of their activist campaigns turned out any different? Perhaps not, if their shareholders were legitimately concerned about management quality issues.
If the activists were only interested in finding quick fixes that boosted share price in exchange for mortgaging the future of their corporations and the interests of all their stakeholders, then yes, benefit corporation status could have changed those outcomes by attracting shareholders who shared that long term vision, and by adding authenticity and credibility to management plans to create durable value over the long run.
But is this just wishful thinking? If a benefit corporation rejects shareholder primacy as an operating principle, but otherwise retains standard corporate governance rules, will the outcome of shareholder activist campaigns be any different? Won’t shareholders have the exact same tools with which to challenge the incumbent board and management—and doesn’t that mean that if shareholders want to force the company to take short term measures to increase share price, the ultimate result of their efforts will be the same? To put a finer point on it, the ultimate tool for activists is the ballot box- they can run proxy contests to replace incumbent directors with candidates who are perhaps more willing to take steps like cutting long term research, borrowing money to buy back shares, or selling the company in order to boost the share price.
Thirty years ago, when I began practicing law, such campaigns were rare—almost all proxy battles back then revolved around takeover battles, and were led by hostile bidders. Now, due to a host of factors, there are hundreds of activist campaigns every year, many led by hedge funds, who tend to take concentrated positions for relatively short time periods In 2016, for example, there were close to 500 activist campaigns at public companies. Most of these campaigns never go all the way to a proxy contest, and many never even become public. Instead, management and the insurgents use PR firms, proxy solicitors and other advisors to try and get a sense of the likely outcomes of a vote, and negotiate based on the perceived strength of their respective hands.
In light of this dynamic, the question is whether the presence of benefit corporation governance would strengthen the hand of management or otherwise change the outcome. Since any potential proxy fight would be governed by the same rules (benefit corporation law has no effect on shareholder franchise rights), it might seem as if the expanded purpose and accountability provisions of benefit corporation law would not come into play at all: the directors’ expanded obligation to consider all stakeholders would not in any way affect the ability of shareholders to replace those directors.
Shareholder Relationships: Building Trust
A large part of the answer to this conundrum lies in something my mentor Lew Black taught me back in the days of hostile takeovers: most proxy battles are decided before they start. Good management teams develop quality relationships with their shareholders on clear days, so that shareholders have confidence in management and understand its strategy. This is borne out by the fact that most activist campaigns settle early—boards know who is going to support them and activists know who isn’t.
It is in this process of building trust where benefit corporation governance can play a crucial role in combatting short-termist activism. As long as a corporation retains traditional governance, there is really only one story that it can tell its shareholders: we have figured out the best way to maximize your return on our shares—because that is what shareholder primacy demands. In contrast, once a company becomes a benefit corporation, management has the ability—and credibility– to explain that a project or process creates a positive impact on society and the environment, even if the delivery of that benefit (or refraining from harm) has a potential cost that is reflected in the share price. In short, benefit corporation governance allows management and shareholders to formally recognize that what might appear to be “trade-offs” between shareholders and stakeholders are in fact patient and wide-apertured methods for creating long term value for shareholders and society.
Universal Owners and Responsible Stewardship
If shareholders understand that decision and have been brought into it, then an activist campaign to raise the share price by forgoing responsible practices or eliminating a strategy that creates long term value for all stakeholders is less likely to succeed. This might sound naïve, because it suggests that shareholders would agree to sacrifice share value to allow corporations to create value for other stakeholders. But shareholders acting with the enlightened self-interest recognize that the value of their portfolios depend on corporations acting responsibly. In a publication earlier this year, ICGN, one of the largest networks of institutional investors in the world, made exactly this point:
Investors generally do not want to encourage the financial sector to focus on generating short-term returns if this could lead to further systemic risks and negatively impact overall portfolio returns.
Saker Nusseibeh, CEO of Hermes Asset Management, a large UK pension fund manager, explained it this way:
The ownership of shares must therefore evolve so that it becomes the conduit for bringing about long term sustainable prosperity for the entire system.
Universal owners, like Hermes and the members of ICGN, are broadly diversified, and have no choice but to hold their shares for the long term. They also own most of the market—much more than do short term, concentrated holders like hedge funds, who can take the money and run when corporations boost share price with tactics that create systemic risk. Benefit corporation governance allows universal owners to use their voting rights to combat these tactics. This is important not simply for those funds, but for the human investors whose funds they ultimately manage, as explained in the academic writing of Leo E. Strine, Jr., the Chief Justice of the Delaware Supreme Court:
Most human investors in fact depend much more on their labor than on their equity for their wealth and therefore care deeply about whether our corporate governance system creates incentives for corporations to create and sustain jobs for them. And because human investors are, for the most part, saving for college and retirement, they do not gain from stock price bubbles or unsustainable risk taking. They only gain if the companies in which their capital is invested create durable value through the sale of useful products and services.
So where does this leave us? Some activists seek short term measures that increase share price, but do not benefit the enterprise over the long run. There are many stakeholders who may benefit from a strong enterprise: employees, the community, and yes, shareholders. To be honest, it isn’t always clear who will benefit the most from long term responsibility because, well, long term predictions are hard.
The Benefit Corporation Path to Trust and Durable Value
What is clear however, is that shareholders who are dependent on a robust economy and stable environmental and social systems will care about a company’s effects on those systems. And companies that adopt benefit corporation governance have the legal orientation to explicitly work with those shareholders to ensure that corporate strategy promotes real and durable value creation. The adoption of this orientation is itself a way of building trust with shareholders and other stakeholders: a benefit corporation’s commitment to positive impact is real, and will survive changes in management, in ownership and in circumstance. The existence of these relationships of trust will make it harder for activists to win the hearts and minds of shareholders by promoting risky short term tactics that detract value from the real economy we all depend on.
This will play itself out when CEOs faced with activist campaigns are able to remind firms like BlackRock, State Street and Vanguard that the shininess of a quick share price increase does not outweigh the long term interests of their beneficiaries. Those beneficiaries are ultimately the human beings described by Chief Justice Strine, who rely on stable and thriving social and economic systems to support the value of their entire portfolio, not to mention the quality of their lives. Just as these universal owners are coming to understand the importance of supporting shareholder resolutions intended to protect the climate, they will also support managers against campaigns that threaten all of our long term interests in a vital and growing real economy, as long as they can trust that the company is committed to those interests as well. Conventional corporate law and contemporary capital markets have eroded that trust; benefit corporation governance can reestablish it.