THE LEGAL PRINCIPLE that corporate boards must focus exclusively on maximizing value for shareholders wasn’t always taken for granted. It was enshrined in a 1919 court decision involving Henry Ford and two of his car company’s shareholders, the Dodge brothers. As chairman and majority owner of Ford Motor Co., he had repeatedly raised his workers’ pay, cut the price of the Model T, and reinvested profits in expansion. If Ford were around today his stance might be applauded by the environmental, social, and governance (ESG) movement on Wall Street. “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,” he said in a speech introduced at trial.
Ford lost, though not entirely. Minority shareholders John Francis Dodge and Horace Elgin Dodge, who were scraping together money to launch a rival automaker, sued him to stop frittering away profits and to raise dividends. In Dodge v. Ford Motor Co., the Michigan Supreme Court ordered Ford to pay an extra dividend. But it simultaneously undercut the principle of shareholder primacy by affirming what’s now known as the business judgment rule, which gives boards of directors wide latitude to decide what’s in the best interest of the corporation.
That ambiguity has never been resolved. For a century there’s been a struggle between advocates of shareholder primacy and those who say corporations should take into account other priorities, particularly environmental, social, and governance issues. As ESG has gained prominence it’s generated a quiet backlash. In the waning days of the Trump administration, three federal agencies are promulgating rules to narrow the scope for considering ESG factors in business and investing decisions, even as lawyers predict the Biden administration will go in the other direction.
Which side is right? Well, that’s where it gets interesting. The latter-day Henry Fords are correct that companies can and should aspire to more than just pushing up their stock prices, while today’s Dodge brothers are right that managers and boards shouldn’t have free rein to do whatever they wish with a company’s money.
Managing conflict over the purpose of the corporation is difficult, but some see it as part of the art of running a company. Barnali Choudhury, a law professor at the UCL Faculty of Laws in London, compares corporate directors to the resourceful main character Truffaldino in The Servant of Two Masters, an Italian comedy written in 1746. “Like Truffaldino, corporate managers should also be able to serve both the financial interests of shareholders and the interests of non-shareholder corporate constituents through use of the ambiguity of the corporate purpose,” she wrote in a 2009 article for the University of Pennsylvania Journal of Business Law when she was at Charleston School of Law.
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