The Myth of Shareholder Capitalism
by Loizos Heracleous and Luh Luh Lan
When Kraft took over Cadbury in January, the deal was viewed as a victory of shareholder capitalism. The acquired company’s deeply English roots were no match for the wealth shareholders could gain by selling out to what one Cadbury family member called “a company that makes cheese to go on hamburgers.” Cadbury chairman Roger Carr said, “The reality is we are part of a global business.”
Did Carr have a choice? Was he truly beholden to his shareholders’ desire to take the deal? If not, how can directors act against the wishes of shareholders to preserve value for other stakeholders—value that is often less easily measured than a buyout price? In the wake of the scandals that caused the recession, the management world has been immersed in trying to answer such questions.
Oddly, no previous management research has looked at what the legal literature says about the topic, so we conducted a systematic analysis of a century’s worth of legal theory and precedent. It turns out that the law provides a surprisingly clear answer: Shareholders do not own the corporation, which is an autonomous legal person. What’s more, when directors go against shareholder wishes—even when a loss in value is documented—courts side with directors the vast majority of the time. Shareholders seem to get this. They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times. In short, directors are to a great extent autonomous.
And yet, in an important 2007 article in the Journal of Business Ethics, 31 of 34 directors surveyed (each of whom served on an average of six Fortune 200 boards) said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximize shareholder wealth, they believed it was their duty to do.
Why are directors so convinced of their obligation that they’d make decisions with such damaging results? If the law clearly doesn’t call for all the kowtowing, couldn’t Cadbury’s Carr have assumed a more defiant stance against a takeover?
The problem, we believe, is that managers and lawyers have failed to meaningfully collaborate on defining directors’ role. That lack of communication has led to the election of directors who, frankly, don’t know what their legal duties are. Indeed, they’re being taught the wrong things. The case still most often used in law schools to illustrate a director’s obligation is Dodge v. Ford Motor (1919)—even though an important 2008 paper by Lynn A. Stout explains that it’s bad law, now largely ignored by the courts. It has been cited in only one decision by Delaware courts in the past 30 years.
Collaboration between legal and management entities should start at the MBA and executive-education level, to change the way directors are trained and developed. But it should also shape director selection, a process where trustworthiness and independence from all stakeholders, not just from managers, is critical.
The impact on directors’ decision making could be significant. The Cadburys of the future may not end up selling out just because it looks like a good deal for the shareholders.
by Loizos Heracleous and Luh Luh Lan
When Kraft took over Cadbury in January, the deal was viewed as a victory of shareholder capitalism. The acquired company’s deeply English roots were no match for the wealth shareholders could gain by selling out to what one Cadbury family member called “a company that makes cheese to go on hamburgers.” Cadbury chairman Roger Carr said, “The reality is we are part of a global business.”
Did Carr have a choice? Was he truly beholden to his shareholders’ desire to take the deal? If not, how can directors act against the wishes of shareholders to preserve value for other stakeholders—value that is often less easily measured than a buyout price? In the wake of the scandals that caused the recession, the management world has been immersed in trying to answer such questions.
Oddly, no previous management research has looked at what the legal literature says about the topic, so we conducted a systematic analysis of a century’s worth of legal theory and precedent. It turns out that the law provides a surprisingly clear answer: Shareholders do not own the corporation, which is an autonomous legal person. What’s more, when directors go against shareholder wishes—even when a loss in value is documented—courts side with directors the vast majority of the time. Shareholders seem to get this. They’ve tried to unseat directors through lawsuits just 24 times in large corporations over the past 20 years; they’ve succeeded only eight times. In short, directors are to a great extent autonomous.
And yet, in an important 2007 article in the Journal of Business Ethics, 31 of 34 directors surveyed (each of whom served on an average of six Fortune 200 boards) said they’d cut down a mature forest or release a dangerous, unregulated toxin into the environment in order to increase profits. Whatever they could legally do to maximize shareholder wealth, they believed it was their duty to do.
Why are directors so convinced of their obligation that they’d make decisions with such damaging results? If the law clearly doesn’t call for all the kowtowing, couldn’t Cadbury’s Carr have assumed a more defiant stance against a takeover?
The problem, we believe, is that managers and lawyers have failed to meaningfully collaborate on defining directors’ role. That lack of communication has led to the election of directors who, frankly, don’t know what their legal duties are. Indeed, they’re being taught the wrong things. The case still most often used in law schools to illustrate a director’s obligation is Dodge v. Ford Motor (1919)—even though an important 2008 paper by Lynn A. Stout explains that it’s bad law, now largely ignored by the courts. It has been cited in only one decision by Delaware courts in the past 30 years.
Collaboration between legal and management entities should start at the MBA and executive-education level, to change the way directors are trained and developed. But it should also shape director selection, a process where trustworthiness and independence from all stakeholders, not just from managers, is critical.
The impact on directors’ decision making could be significant. The Cadburys of the future may not end up selling out just because it looks like a good deal for the shareholders.
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