Why does the Shareholder refuse to die?

First the context...

In 2006, John Ruggie of Harvard was appointed UN Special Representative of the Secretary-General on human rights and transnational corporations and other business enterprises. He would go on to reshape the human rights and business landscape by clarifying the duties of states and businesses. The Protect, Respect and Remedy framework emerged. States had the solemn duty to protect human rights; Businesses to respect human rights; and both to remedy troubling human rights impacts. The framework was expanded by the UN Guiding Principles. John Ruggie always believed his work was not about creating new rights but clarifying the human rights duties of businesses. In Just Business, one of John’s reasons why the international legal order should discard the Draft Norms on the responsibilities of transnational corporations and other business enterprises with regard to human rights – drafted in 2003 to impose the full range of human rights in treaties on businesses - was because the Norms were so radical that they would reorganize domestic corporate law systems, particularly by shifting the base from the shareholder theory to the stakeholder theory.

In this blog post, I assess how this justification has aged. Is the shareholder model still alive or is it dead (or dying)?

The shareholder model

The shareholder model is a hangover from the joint stock company days, the predecessor of the modern company. The assets of the joint stock company were owned by the shareholders of the company. The joint stock company, for all intents and purposes, was the shareholders, and the shareholders were the joint stock company. The nineteenth century spurned reforms in a different direction, integrating the concept of separate legal personality and decoupling company law from partnership law. Over the years, judicial interpretation of the rules of company law has held that the assets of the company do not belong to the shareholders, but to the company itself as a separate legal entity; what shareholders own is the share. The share has now become the thing which guarantees participation in the profits of the company’s operations and allows the shareholder to participate in the governance of the company. The twentieth century brought new transformations. Ownership and control were seen as separate, with ownership vested in the shareholders and management vested in the directors (the well-known Berle-Means Thesis). The terminology was still problematic and remains so today. If the company is just a separate entity and all shareholders can own are shares, describing shareholders as owners is not quite accurate. Then the rise of the retail investor and the institutional investor (pension funds, insurance companies etc) have both depersonalized the modern company to a significant degree. In the past, the company may have been run for the benefit of the shareholders, but that is now debatable.

While in the nineteenth century, shareholders might have enjoyed significant control over the company, the changes which have since taken place have been so drastic that the accumulated power of shareholders has significantly shrunk. At the end of the twentieth century, many scholars were already questioning whether the shareholder model was a good justification for shareholder rights. The changes in modern company law have severely tested the logical limits of classical company law. It is for this reason that the stakeholder model appears to be gaining ground.

The stakeholder model

The stakeholder model picks off where the shareholder model ends. It takes the position that the company is run for the benefit of a range of stakeholders including the shareholders, directors, employees, creditors, host communities and the public. In decision-making, the stakeholder model insists that the interest of all stakeholder groups should be considered, balanced, and counterbalanced. The stakeholder model makes the shareholders one stakeholder group and not the only consequential group.

While corporate law systems around the world have yet to depart significantly from the shareholder model, businesses are humbly admitting to themselves that it might be in their best interest to listen to other stakeholder groups beyond the shareholders. Many have had to learn the hard way what blatant disregard for other stakeholder groups can cause. Some have entirely lost what is termed “the social license” to operate because of the environmental concerns of host communities. Just ask Shell in Nigeria. Some have lost profits because of bad publicity arising from poor labor regulations. Just ask Nike in Asia. Others may be forced to spend heavily on defending lawsuits brought by disgruntled ex-workers. Just ask James Finlay and Co in Kenya. Others are compelled to release statements condemning adverse reports of land dispossession. Just ask Heineken in Ethiopia. It is becoming more and more evident that disregarding the concerns of host communities and employees can make or unmake a business. Moreso, businesses which want to attract decent funding must make green commitments these days; creditors want environmentally sustainable businesses and the lesser the carbon footprint of a business’s activities, the better.

Listening to other stakeholder groups and trying to accommodate their interests have taken on fancy names: environmental and social governance (ESG), corporate social responsibility (CSR), social enterprising, et cetera. Others are joining international fora like the Global Compact, BCorp or FairTrade. Whatever the case might be, whether these names and fora are worth anything is a deeply contested question. However, businesses understand that their operations go beyond their shareholders.

If the evidence in favor of the stakeholder model was uneven or unequally weighed in favor of the shareholder model, the Covid-19 pandemic tilted the scales and provided abundant justification for why the stakeholder model was the model of the future.

Lockdowns were common; public gatherings were banned. Companies had to find innovative ways of riding the storm, taking the interests of various stakeholder groups into consideration. Remote work became acceptable. This was a good way of protecting employees and customers from the virus. Companies could not and dared not insist that employees work physically in office spaces or company locations. Companies reinvented themselves overnight and started producing goods and services to help the pandemic effort. In Ghana, Kasapreko started making hand sanitizers. In other parts of the world, it was the same. General Electric made ventilators during the period. The interests of customers and the public were prioritized in this way. Many boards, uncertain about the impact of the pandemic on their operations, chose not to declare dividends for a good reason: to ensure that the business continues to exist for the benefit of all stakeholders.

Post covid-19, many of the ad-hoc measures introduced have come to stay. Companies are more open to remote work, four-day weekdays and generous leave packages. The employee is no longer a pseudo- indentured worker. The employer is given greater control and flexibility. In Ghana, crushing macroeconomic conditions have led some companies like Nestlé and Kasapreko to offer one-time payments to their employees to cushion them against the harsh economic conditions. Employee welfare is going to the top of corporate boardroom discussions.

What does all this mean for the future of company law?

Thus, in the first two decades of the twenty-first century, other stakeholder groups have gained much more visibility and their interests and concerns have moved from the peripheries to the center. For the most part, these interests are evaluated and considered by the company through official structures at which the affected stakeholders are not present or if they are, have their roles reduced to attending meetings and articulating the interests of their parties. The shareholder model is no longer an adequate corporate structure, and neither is it desirable. Directors dominate boardrooms and shareholders dominate annual or extraordinary general meetings. In these meetings, one thing is missing, the real presence of other stakeholder groups.

Admittedly, incremental changes are being made in corporate laws around the world. Some jurisdictions are improving corporate reporting and expanding it beyond financials. Ghana’s recent Companies Act of 2019 asks directors in the exercise of their duties to consider: “…the likely consequence of any decision in the long term;… the impact of the operations of the company on the community and the environment;… the desirability of the company in maintaining a reputation for high standards of business conduct”. Are changes like this enough? Doubtful. What they seek to do is to infuse the same internal corporate structures (boards and shareholder meetings) with new perspectives. But they do not shake the core of these corporate structures.

If the stakeholder model takes is to take its place in the grand scheme of things, and come of age, we need a new way of thinking about internal corporate structures and the participants who have decision-making powers. This may lead to radical reforms and employees, creditors and even customers will have seats in the boardroom or at the general meeting. Other stakeholders may be able to vote on critical decisions for example, on critical projects. It is possible that while decision-making may become a tortuous process, the end may justify the means. Representatives of host communities may vote against business projects which will make their people landless. Creditors might be able to vote against transactions which they believe will plunge the company into debt and cause liquidity challenges. Businesses may become more efficient in the long term.

But all of this is going to be an experiment – and the results of an experiment cannot be pre-determined. Things can always go horribly wrong. So, the horse and its rider pursuing such radical reforms may be thrown into the sea… or not. While there are other reasons which justify John’s work on human rights and business and an abandoning of the Draft Norms, I am not sure an argument against the readjustment of corporate law systems is as strong as it was, at least post-covid. The shareholder model prevails on paper, but corporate pragmatism far exceeds it – and company law reforms around the world should start thinking of how to attune company law to suit the new direction companies are beginning to chart for themselves.