Law Inhibits Social Responsibility
(A Corporate Attorney Proposes
a ‘Code for Corporate Citizenship’ in State Law)
by Robert Hinkley
After 23 years as a corporate securities attorney-advising
large corporations on securities offerings and mergers and acquisitions-I
left my position as partner at Skadden, Arps, Slate, Meagher & Flom
because I was disturbed by the game. I realized that the many social
ills created by corporations stem directly from corporate law. It dawned
on me that the law, in its current form, actually inhibits executives
and corporations from being socially responsible. So in June 2000 I
quit my job and decided to devote the next phase of my life to making
people aware of this problem. My goal is to build consensus to change
the law so it encourages good corporate citizenship, rather than inhibiting
The provision in the law I am talking about is the one that says the
purpose of the corporation is simply to make money for shareholders.
Every jurisdiction where corporations operate has its own law of corporate
governance. But remarkably, the corporate design contained in hundreds
of corporate laws throughout the world is nearly identical. That design
creates a governing body to manage the corporation-usually a board
of directors-and dictates the duties of those directors. In short,
the law creates corporate purpose. That purpose is to operate in the
interests of shareholders. In Maine, where I live, this duty of directors
is in Section 716 of the business corporation act, which reads:
...the directors and officers of a corporation shall exercise their
powers and discharge their duties with a view to the interests of the
corporation and of the shareholders....
Although the wording of this provision differs from jurisdiction to
jurisdiction, its legal effect does not. This provision is the motive
behind all corporate actions everywhere in the world. Distilled to its
essence, it says that the people who run corporations have a legal duty
to shareholders, and that duty is to make money. Failing this duty can
leave directors and officers open to being sued by shareholders.
Section 716 dedicates the corporation to the pursuit of its own self-interest
(and equates corporate self-interest with shareholder self-interest).
No mention is made of responsibility to the public interest. Section
716 and its counterparts explain two things. First, they explain why
corporations find social issues like human rights irrelevant--because
they fall outside the corporation’s legal mandate. Second, these
provisions explain why executives behave differently than they might
as individual citizens, because the law says their only obligation in
business is to make money.
This design has the unfortunate side effect of largely eliminating personal
responsibility. Because corporate law generally regulates corporations
but not executives, it leads executives to become inattentive to justice.
They demand their subordinates “make the numbers,” and pay
little attention to how they do so. Directors and officers know their
jobs, salaries, bonuses, and stock options depend on delivering profits
Companies believe their duty to the public interest consists of complying
with the law. Obeying the law is simply a cost. Since it interferes
with making money, it must be minimized-using devices like lobbying,
legal hairsplitting, and jurisdiction shopping. Directors and officers
give little thought to the fact that these activities may damage the
Lower-level employees know their livelihoods depend upon satisfying
superiors’ demands to make money. They have no incentive to offer
ideas that would advance the public interest unless they increase profits.
Projects that would serve the public interest--but at a financial cost
to the corporation--are considered naive.
Corporate law thus casts ethical and social concerns as irrelevant,
or as stumbling blocks to the corporation’s fundamental mandate.
That’s the effect the law has inside the corporation. Outside
the corporation the effect is more devastating. It is the law that leads
corporations to actively disregard harm to all interests other than
those of shareholders. When toxic chemicals are spilled, forests destroyed,
employees left in poverty, or communities devastated through plant shutdowns,
corporations view these as unimportant side effects outside their area
of concern. But when the company’s stock price dips, that’s
a disaster. The reason is that, in our legal framework, a low stock
price leaves a company vulnerable to takeover or means the CEO’s
job could be at risk.
In the end, the natural result is that corporate bottom line goes up,
and the state of the public good goes down. This is called privatizing
the gain and externalizing the cost.
This system design helps explain why the war against corporate abuse
is being lost, despite decades of effort by thousands of organizations.
Until now, tactics used to confront corporations have focused on where
and how much companies should be allowed to damage the public interest,
rather than eliminating the reason they do it. When public interest
groups protest a new power plant, mercury poisoning, or a new big box
store, the groups don’t examine the corporations’ motives.
They only seek to limit where damage is created (not in our back yard)
and how much damage is created (a little less, please).
But the where-and-how-much approach is reactive, not proactive. Even
when corporations are defeated in particular battles, they go on the
next day, in other ways and other places, to pursue their own private
interests at the expense of the public.
I believe the battle against corporate abuse should be conducted in
a more holistic way. We must inquire why corporations behave as they
do, and look for a way to change these underlying motives. Once we have
arrived at a viable systemic solution, we should then dictate the terms
of engagement to corporations, not let them dictate terms to us.
We must remember that corporations were invented to serve mankind. Mankind
was not invented to serve corporations. Corporations in many ways have
the rights of citizens, and those rights should be balanced by obligations
to the public.
Many activists cast the fundamental issue as one of “corporate
greed,” but that’s off the mark. Corporations are incapable
of a human emotion like greed. They are artificial beings created by
law. The real question is why corporations behave as if they are greedy.
The answer is the design of corporate law.
We can change that design. We can make corporations more responsible
to the public good by amending the law that says the pursuit of profit
takes precedence over the public interest. I believe this can best be
achieved by changing corporate law to make directors personally responsible
for harms done.
Let me give you a sense of how director responsibility works in the
current system. Under federal securities laws, directors are held personally
liable for false and misleading statements made in prospectuses used
to sell securities. If a corporate prospectus contains a material falsehood
and investors suffer damage as a result, investors can sue each director
personally to recover the damage. Believe me, this provision grabs the
attention of company directors. They spend hours reviewing drafts of
a prospectus to ensure it complies with the law. Similarly, everyone
who works on the prospectus knows that directors’ personal wealth
is at stake, so they too take great care with accuracy.
That’s an example of how corporate behavior changes when directors
are held personally responsible. Everyone in the corporation improves
their game to meet the challenge. The law has what we call an in terrorem
effect. Since the potential penalties are so severe, directors err on
the side of caution. While this has not eliminated securities fraud,
it has over the years reduced it to an infinitesimal percentage of the
total capital raised.
I propose that corporate law be changed in a similar manner--to make
individuals responsible for seeing that the pursuit of profit does not
damage the public interest.
To pave the way for such a change, we must challenge the myth that making
profits and protecting the public interest are mutually exclusive goals.
The same was once said about profits and product quality, before Japanese
manufacturers taught us otherwise. If we force companies to respect
the public interest while they make money, business people will figure
out how to do both.
The specific change I suggest is simple: add 26 words to corporate law
and thus create what I call the “Code for Corporate Citizenship.”
In Maine, this would mean amending section 716 to add the following
clause. Directors and officers would still have a duty to make money
... but not at the expense of the environment,
human rights, the public safety, the communities in which the corporation
operates or the dignity of its employees.
This simple amendment would effect a dramatic change in the underlying
mechanism that drives corporate malfeasance. It would make individuals
responsible for the damage companies cause to the public interest, and
would be enforced much the same way as securities laws are now. Negligent
failure to abide by the code would result in the corporation, its directors,
and its officers being liable for the full amount of the damage they
cause. In addition to civil liability, the attorney general would have
the right to criminally prosecute intentional acts. Injunctive relief-which
stops specific behaviors while the legal process proceeds-would
also be available.
Compliance would be in the self-interest of both individuals and the
company. No one wants to see personal assets subject to a lawsuit. Such
a prospect would surely temper corporate managers’ willingness
to make money at the expense of the public interest. Similarly, investors
tend to shy away from companies with contingent liabilities, so companies
that severely or repeatedly violate the Code for Corporate Citizenship
might see their stock price fall or their access to capital dry up.
Many would say such a code could never be enacted. But they’re
mistaken. I take heart from a 2000 Business Week/Harris Poll that asked
Americans which of the following two propositions they support more
Corporations should have only one purpose--to make the most profit for
their shareholders--and pursuit of that goal will be best for America
in the long run.
Corporations should have more than one purpose. They also owe something
to their workers and the communities in which they operate, and they
should sometimes sacrifice some profit for the sake of making things
better for their workers and communities.
An overwhelming 95 percent of Americans chose the second proposition.
Clearly, this finding tells us that our fate is not sealed. When 95
percent of the public supports a proposition, enacting that proposition
into law should not be impossible.
If business people resist the notion of legal change, we can remind
them that corporations exist only because laws allow them to exist.
Without these laws, owners would be fully responsible for debts incurred
and damages caused by their businesses. Because the public creates the
law, corporations owe their existence as much to the public as they
do to shareholders. They should have obligations to both. It simply
makes no sense that society’s most powerful citizens have no concern
for the public good.
It also makes no sense to endlessly chase after individual instances
of corporate wrongdoing, when that wrongdoing is a natural result of
the system design. Corporations abuse the public interest because the
law tells them their only legal duty is to maximize profits for shareholders.
Until we change the law of corporate governance, the problem of corporate
abuse can never fully be solved.
Robert Hinkley (firstname.lastname@example.org)
lives in Brooklin, Maine.