ESG—environmental, social, and governance—has been the new hot topic for the last several years. Yet companies are still trying to come to grips with what it means and how they can address these varying and often competing interests of shareholders and other stakeholders.
Some have questioned how the idea of ESG can be reconciled with the traditional “maximizing value for the shareholder” or “shareholder primacy” theory. But many might be surprised to learn that, long before “ESG” became the acronym du jour, most states had enacted some flavor of a “constituency statute” that allows a board of directors to consider various other constituencies when making decisions on behalf of the corporation.
For instance, Minnesota’s statute provides that directors may consider a broad array of interests, including:
… the corporation’s employees, customers, suppliers, and creditors, the economy of the state and nation, community and societal considerations, and the long-term as well as short-term interests of the corporation and its shareholders including the possibility that these interests may be best served by the continued independence of the corporation.
Minn. Stat. § 302A.251, Subd. 5.
Statutes like this appear to give directors wide latitude and cover for decisions that may not fit the “primacy of the shareholder” model. And indeed, these statutes were enacted at the behest of directors of boards during the 1980s heyday of hostile takeovers—when the barbarians were at the gates, so to speak. Some directors believed that takeovers were not in a corporation’s long-term best interest but feared fiduciary-duty claims if they resisted a hostile takeover that would have provided short-term financial gain to the shareholders.
As a result, directors turned to state legislatures and sometimes threatened to incorporate elsewhere if a constituency statute was not passed in the current state of incorporation. Wanting to keep employers in the state, many state legislators passed these laws—sometimes rather expeditiously. For example, Pennsylvania was the first state to enact such a statute, in 1983, after Scott Paper Company and Gulf Oil Corporation, both facing potential hostile takeovers, threatened to leave the state if the statute was not passed.
That constituency statutes were meant to benefit directors is perhaps best reflected by the fact that none provide an enforcement mechanism for any of the non-shareholder constituencies. Are you an employee or supplier that believes a company’s board is not giving due consideration to how a given decision will affect you? Too bad. Not only are the statutes permissive (the board is not required to give thought to other constituencies), but the statutes have no private right of action and cannot help you. It will only help the director defend against a shareholder who believes its interests must prevail over all others. But some would argue that these laws have done little to benefit directors, either.
And that is because, notwithstanding a majority of states that codified constituency statutes, one state has not: Delaware, the state where the majority of corporations are incorporated. Indeed, Delaware law has established the Revlon standard, which requires that, when a company goes up for sale, the board must maximize the value for the shareholder.
Some have suggested that Delaware has a “quasi-constituency statute” in the post-Revlon case, Paramount Communications v. Time, Inc., where the Supreme Court of Delaware upheld Time’s rejection of a highly profitable tender offer from Paramount to instead merge with Warner Brothers in what the board believed would provide better long-term benefits to the corporation. But, even that case did not address the interests of stakeholders other than shareholders. In sum, Delaware is known for its “primacy of the shareholder” model.
Because of Delaware’s overwhelming influence in corporate jurisprudence, constituency statutes from other states often are overshadowed—or overpowered—by the traditional focus on the interests of the shareholder. Indeed, directors remain reluctant to choose a path financially detrimental to shareholders, even if there may be countervailing benefits to non-shareholder stakeholders. For example, if a company were to put itself up for sale and the highest bidder was an entity with a history of polluting and the next highest bidder promised more environmentally favorable practices, directors in recent years have still been likely to go with the polluting entity, because shareholders can easily quantify their losses and bring a breach-of-fiduciary claim. And directors have been reluctant to rely on constituency statutes when defending fiduciary-duty claims for fear that doing so would result in a lower stock price by suggesting that the company’s shareholders are not paramount. Therefore, despite their prolific presence in statute books throughout the country, constituency laws have rarely been litigated and have done little to bolster the interests of non-shareholder stakeholders.
Somewhat surprisingly, it’s the shareholders who’ve succeeded in getting companies to consider other constituencies. While the term “ESG” first appeared in 2004, it was BlackRock CEO Laurence Fink’s 2016 annual letter to corporate CEOs that catapulted “ESG” into the corporate zeitgeist, where it remains today. Fink argued that boards needed to be more strategic in creating long-term value for their shareholders and less focused on near-term profits. He stated: “Generating sustainable returns over time requires a sharper focus not only on governance, but also on environmental and social factors facing companies today.” And further: “At companies where ESG issues are handled well, they are often a signal of operational excellence. BlackRock has been undertaking a multi-year effort to integrate ESG considerations into our investment processes, and we expect companies to have strategies to manage these issues.”
Going forward, it will be interesting to see if constituency statutes see any revival in light of ESG efforts. Or, as is more likely, will directors instead argue that considering other stakeholders is just another way of providing long-term value to their shareholders?
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