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“Corporate Democracy” and Political Activism: Do previous assumptions still hold?
Corporations are becoming more active in political matters, with more pressure being placed on CEOs to take stands and even make business…
Corporations are becoming more active in political matters, with more pressure being placed on CEOs to take stands and even make business decisions in order to influence policy decisions. This is inevitably controversial and has potentially reinvigorated several long running debates about what role corporations should play in society and who should determine how that role is played.
Corporations must make decisions as to what they do, whom they do and do not do business with, and even how they exercise their constitutional rights, including the right to free speech. But the question is, who gets to determine how those decisions are made, and for what purpose? Is it management or ownership? In many cases this isn’t a problem because there is no separation between the two (for example, sole proprietors, closely held businesses, and at least some non-profits.) In other cases however, such as public companies with millions of beneficial owners spread out across the country, there is a significant difference.
This matters, because when a CEO weighs in on an issue, the assets, wealth, and importance of the corporation can give the statement much of its heft. You may care what a CEO has to say because they are wealthy, intelligent, and successful, but if their statement has implications for how the corporation the CEO manages will invest, where it will operate, and whom it will do business with, the statement has greater import.
The question of the proper distribution of control between ownership and management is a perennial flash point in corporate law, and while it is no doubt important for mundane issues of corporate activity, it is potentially even more important now that corporations are increasingly finding themselves choosing or being pushed to engage on political issues with possibly attenuated relationships to their core business.
When management is making decisions that are clearly related to the business of the company and based on traditional business concerns, it may be reasonable to assume that investors expect management to decide. As such, the law usually protects the choices of boards and managers and leaves dissident shareholders with limited options either before or after an action.
But does that logic hold if management is using corporate resources, prestige, and clout to influence issues well outside of the core business? And what is “outside” anyway? Managers can argue that many things that seem political at first blush also impact the business. Everything from being able to attract the best talent to protecting the reputation of the firm could justify taking stands on political topics. Conversely, is there a line where the link between the manager’s preferred action and theoretical corporate benefit is too attenuated to be deferred to? Or, is there a sphere of decisions where it cannot be presumed that shareholders should defer to management, even if there is a plausible tie to profitability? Is there an argument that investors should have more protection from the firm’s resources being used to further political ends they disagree with because the potential harm is not just loss of money, as would be the case from a traditional business decision, but also a potential (at least perceived) loss of rights or increased burden? Should shareholders have a greater say when the corporation proposes to weigh in on a topic of social change known to be divisive?
In the past the argument has been made, unsuccessfully, that shareholders needed to be legally protected from forcibly paying for corporate speech they disagreed with. For example, in First National Bank of Boston v. Bellotti the State of Massachusetts tried to justify a law restricting banks’ ability to comment on certain referenda in part on the ground that dissident shareholders should not be forced to pay (through their investment) for speech they disagreed with. Justice Powell, writing for the Court, disagreed. While he acknowledged that protecting shareholders was a legitimate interest that states traditionally had authority over, he found that the law before the Court lacked the “substantially relevant correlation” with the legitimate government interest necessary to justify a restriction on speech.
Part of Justice Powell’s argument was that shareholders could use the powers of “corporate democracy” such as electing boards of directors, charter protections, and derivative suits against corporate disbursements to protect themselves, making the law insufficiently necessary. In a substantive footnote (#34) Powell distinguished some prior cases striking down mandatory union dues being used for political purposes and dissident shareholders by noting that while the union dues were mandatory, investment was voluntary, and a dissident shareholder could sell their shares if they so choose. This argument was also cited by Justice Kennedy in Citizens United V. FEC as a reason why the dissident shareholder protection argument was unavailing as a justification for restricting speech.
Does the Court’s logic in Bellotti still hold up in the modern market? Or has the nature and structure of equity ownership has changed significantly in ways that call the Court’s belief into question?
It is unclear whether the average investor can meaningfully exercise the tools of corporate democracy, even if they wanted to. When Belotti was decided in 1978 individual taxable investment accounts (e.g. retail investors) owned about 60% percent of the U.S. Equity market. Today the number is closer to 25%. This is in large part because most shares (between 60–80% by some estimates) now are not technically owned by the investor themselves, but by an institutional investor (e.g. a pension administrator like CalPERS or an asset manager like Vanguard) who owns the shares on behalf of the individual. This creates a barrier between the individual and the corporation that makes it hard, if not impossible, for the average investor to actually “vote their shares”.
This trend towards institutional investors may risk concentrating equity voting power in the hands of a small number of people. As Professors Paul and Julia Mahoney point out, this may add another layer of ownership versus management issues. And as Prof. Caleb Griffin notes, there is the risk that the institutional investors may vote on behalf of the underlying investors in ways contrary to the preferences or interests of those individuals. This arrangement means that the individual investor who is actually providing the money may be separated from controlling their corporate property not once but twice. To be sure, there are good reasons for this relationship to exist, but it does limit the ability of regular investors to police management via corporate democracy.
Additionally, it is unclear whether the average investor could sell their shares easily and without significant practical cost. To the extent the investments are made as part of a pension or employer-sponsored retirement plan the investor may not have any meaningful say on how the funds are invested. Additionally, even if an investor is able to control their investments it may be hard for them to own a diversified portfolio of common equity without owning the more activist companies. Of course, the investor could also build their own portfolio and manage it, but that would force them to give up on one of the great financial innovations of the past century, passive indexing. Finally, there can be tax penalties for certain premature withdrawals from retirement accounts that could potentially be triggered in some cases.
Even if the Belotti Court was right that exit from ownership is a valid remedy to management using corporate resources contrary to the investor’s preferences, being forced to pay a significant practical penalty to exit may limit the value of that remedy. (Perhaps ironically, section 401(k) was introduced to the tax code in 1978, the same year Belotti was decided, but the retirement plans didn’t get going until the early 1980s so the issue did not appear to be on the Court’s radar at the time.).
Of course, individuals can still buy shares and then put the CEO on the spot in an earnings call, but it is unclear how effective that is against the structural headwinds. Even if a shareholder with a small number of shares can dial in, how much influence will such a shareholder have if their preferences differ from the large institutions?
The question of whether corporate management should be able to use corporate assets and reputation to weigh in on contentious political issues, especially without ownership approval, lies at the intersection between two highly fraught issues: the appropriate role of corporations in a democratic society and the balance of power between ownership and management. If the trend of corporate management becoming more active continues there may well be a reaction. There is a risk is that the reaction will take the form of policy motivated by vindictiveness, with the goal being to punish companies rather than correct problems. This would risk not only harming specific corporations but the larger economic system that provides so much broad-based prosperity.
However, that doesn’t necessarily mean that nothing should be done. If our previous assumptions about how ownership can check potential management excesses no longer hold as a practical matter, changes to corporate law may be in order. These issues need to be addressed in a clear-eyed and even-handed manner, ideally with a minimum of partisanship and situational ethics.