Shareholder primacy still prevails in many directors' minds, but it neither reflects where legal purpose discourse began a century ago nor indicates where it is heading as businesses adopt new practices. All firms are accountable to their owners, but sustainability-focused and mission-driven businesses serve the needs of many stakeholders and write this into their purpose.
6 min read | Last updated 24 June 2021
This article does not constitute legal advice.
Purpose is a company’s belief about what it exists to achieve for its key stakeholders. It is fashionable for companies to explain ‘who they are’ by stating their purpose, values and mission, but there is a difference between purpose marketing, which can be part of a reputational campaign, and legal purpose, which is embedded into the company’s governance code. Corporate purpose legislation and amendments to company by-laws give businesses with a social or environmental mission the means of cementing this into their foundation and protecting their directors against claims under the doctrine of shareholder primacy.
The question of legal purpose has a long history. In the 1919 US legal case Dodge v. Ford Motor Company, it was upheld that companies must operate in the interests of their shareholders and not charitably for employees. But it was also acknowledged that this rule is virtually impossible to enforce and that the business judgment rule should be applied, ie the courts should defer to the business judgement of executives since it is presumed that they are motivated by the interests of the corporation and, bar fraud or similarly egregious acts, courts should not intervene in business management. This legal decision led to a long (and long forgotten) era of managerial capitalism. Between 1920 and 1970, it was accepted that directors, while they could not deliberately undermine profitability, were not required to maximise shareholder wealth and could sacrifice profits for a corporate objective, as long as they did not line their own pockets in the process.
Two pivotal essays questioned aspects of managerial capitalism. In 1970, the NY Times published A Friedman Doctrine, an article on business ethics by economist Milton Friedman, in which he argued that the social responsibility of a business is to increase its profits. In their 1976 article Theory of the Firm, economist Michael Jensen and business school dean William Meckling argued that shareholders had been made powerless. The theory of shareholder primacy emerged and pervaded management discourse, leading to short-termism and the ubiquitous objective of maximising returns on a quarterly timetable. Over the next 40 years, shareholder primacy became so ingrained that it was successfully argued in a US legal case in 2010 that not maximising profit for shareholders is inconsistent with fiduciary duties.
Shareholder primacy is blamed for decisions that have maximised profits at the expense of the environment and society and for the ever-increasing division of wealth between investors and workers. In 2010, Unilever’s CEO Paul Polman dared to confront shareholder primacy when he famously scrapped short term financial targets and introduced a sustainable growth strategy to double sales while halving the company’s environmental footprint and enhancing the wellbeing and livelihoods of the millions of people in its value chain. In 2019, the Business Roundtable, an association of CEOs of large US corporations representing 30% of the US stock market, adopted a new non-binding Statement on the Purpose of a Corporation. The 181 signatory CEOs committed to delivering value to customers, investing in employees, dealing fairly and ethically with suppliers, supporting communities and generating long-term shareholder value. With that, mainstream business entered the era of stakeholder capitalism.
Many businesses have begun to rethink their purpose, expressing commitments to the environment and society, but unless the company’s governance code has also been updated and / or the country’s laws provide clarity on which stakeholder groups are to be taken into consideration when a director is deciding for the company, such statements may run no deeper than a marketing campaign and shareholder primacy may still prevail.
Profit-seeking companies with a progressive environmental or social mission need to protect their directors from claims that they are acting in a manner inconsistent with their fiduciary duties. Progressive company founders need a way to protect their company’s original environmental and social intentions through changes in ownership and leadership.
In the US, the benefit corporation legal framework was devised as an alternative for-profit corporate form. Beginning with Maryland in 2010, it now exists in at least 35 US states. This framework expands the legal definition of the term ‘best interests of the corporation’ to include positive social and environmental impacts, and is usually achieved by writing this fuller definition into the company’s by-laws.
Benefit corporation legislation has also been adopted in British Columbia (Canada), Colombia, Ecuador, Puerto Rico and Italy. An example of a benefit corporation is Patagonia.
The UK Companies Act 2006 was amended in 2017, requiring companies to report on their compliance with Section 172 concerning the directors’ duty to promote the success of the company for the benefit of shareholders while having regard to the long term consequences of decisions, the interests of employees, the need to foster relationships with other stakeholders, the impact of the company on the community and the environment, the desirability of maintaining a reputation for high standards of conduct and the need to act fairly between shareholders.
In France, a new law in 2019 revised the definition of a corporation and the treatment of corporate purpose, introducing the idea of raison d’être and affording a corporation the opportunity to define its social or environmental purposes in its Articles of Association to become an Entreprise à Mission. An example is Danone.
In New Zealand, we are off the pace. New Zealand Companies Act 1993 Section 131 outlines the duty of directors to act in good faith and in the best interests of the company. Shareholder primacy still prevails as the orthodox interpretation of this law, ie a shareholder or former shareholder may bring an action against a director for breach of a duty owed to them. The Act is questioned for its relevance to the real duties of today’s director (Chapman Tripp, 2019 (pdf)).
A company is not its shareholders, so surely a director must make decisions about how to act in the best interests of the company in the long term, not for its current shareholders. A company’s best interests may be most fruitfully served by accepting responsibilities to multiple stakeholders, including employees, suppliers, communities and customers.
As they currently stand, New Zealand’s legal structures are built to suit limited liability firms and charities, but not profit-making companies with a social or environmental purpose. Current structures give access to mutually exclusive types of funding; either commercial sources, such as bank lending and equity investment, or philanthropic sources and associated tax benefits. This limits an enterprise’s financial resources and adds an administrative burden, affecting how they operate and impeding their scale (Akina, 2019).
Since 2013, international not-for-profit B Lab has been advocating for a change in laws in Australia and New Zealand to enact benefit corporation legislation. B Lab issues B Corporation Certification, a private certification available to for-profit companies in the Americas, Europe, Australia and New Zealand. Not to be confused with benefit corporation status, B Corporation Certification has no legal status and there is no legal liability to using it. To qualify, a business must undergo a periodic assessment, obtain a minimum score on a comprehensive assessment of commitments to key stakeholders, pay an annual fee and, if and however legally possible, integrate their stakeholder commitments into their by-laws (eg by becoming a benefit corporation).
‘Certified B Corporations are a new kind of business that balances purpose and profit. They are legally required to consider the impact of their decisions on their workers, customers, suppliers, community, and the environment. This is a community of leaders, driving a global movement of people using business as a force for good.’
A recent lobbying attempt by B Lab in Australia to amend the Corporations Act 2001 was unsuccessful (Ramsay and Upadhyaya, 2021, (pdf)). B Lab continues to campaign for a law change in New Zealand and advocates for New Zealand businesses to voluntarily codify purpose by amending their constitution. Currently, New Zealand companies are not required to amend their constitution as a condition to B Corporation Certification, but from mid-2021 this will be a new requirement (MinterEllisonRuddWatts, 2021). Examples of New Zealand companies that are B Corp certified are Synlait and Kathmandu.