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Does Dodge v Ford Motor Co Remain Canon?

My friend and UCLAW colleague Lynn Stout has posted to SSRN a provocative paper: Why We Should Stop Teaching Dodge v. Ford:

Among non-experts, conventional wisdom holds that corporate law requires boards of directors to maximize shareholder wealth. This common but mistaken belief is almost invariably supported by reference to the Michigan Supreme Court’s 1919 opinion in Dodge v. Ford Motor Co.

This Essay argues that Dodge v. Ford is bad law, at least when cited for the proposition that maximizing shareholder wealth is the proper corporate purpose. As a positive matter, U.S. corporate law does not and never has imposed a legal obligation on directors to maximize shareholder wealth. From a normative perspective, options theory, team production theory, the problem of external costs, and differences in shareholder interests all suggest why a rule of shareholder wealth maximization would be bad policy and lead to inefficient results.

Courts accordingly treat Dodge v. Ford as a dead letter. (In the past three decades the Delaware courts have cited the case only once, and then on controlling shareholders’ duties to minority shareholders). Nevertheless, legal scholars continue to teach and cite it. This Essay suggests that Dodge v. Ford has achieved a privileged position in the legal canon not because it accurately captures the law - it does not - or because it provides good normative guidance - it does not - but because it serves professors’ need for a simple answer to the question, What do corporations do? Simplicity is not a virtue when it leads to misunderstanding, however. Law professors should mend their collective ways, and stop teaching Dodge v. Ford as anything more than an example of how courts can go astray.

Lynn’s article should be read in companion with Todd Henderson’s piece, Everything Old is New Again: Lessons from Dodge v. Ford Motor Company, which argued that:

Dodge is often misread or mistaught as setting a legal rule of shareholder wealth maximization. This was not and is not the law. Shareholder wealth maximization is a standard of conduct for officers and directors, not a legal mandate. The business judgment rule protects many decisions that deviate from this standard. This is one reading of Dodge. If this is all the case is about, however, it isn’t that interesting.

But Dodge is a part of the corporate law canon because it is about much more than this. This essays shows that what the Michigan Supreme Court did was actually an elegant solution to a complex legal and policy issue. The history of case and the parties also shows how many prominent aspects of corporate law and practice have long and under-appreciated histories.

and Gordon Smith’s piece The Shareholder Primacy Norm, which argued that:

Corporate directors have a fiduciary duty to make decisions in the best interests of the shareholders. This aspect of fiduciary duty is often called the shareholder primacy norm. Legal scholars generally assume that the shareholder primacy norm is a major factor considered by boards of directors of publicly traded corporations in making ordinary business decisions and that changing the shareholder primacy norm would have an effect on the substance of those decisions. This Article challenges this view and argues that the shareholder primacy norm was never equipped to mediate conflicts between shareholders and nonshareholder constituencies of a corporation. The origins and development of the shareholder primacy norm suggest that it was introduced into corporate law to perform a much different and somewhat surprising function: the shareholder primacy norm was first used by courts to resolve disputes among majority and minority shareholders, and over time this use of the shareholder primacy norm evolved into the modern doctrine of minority oppression. This application of the shareholder primacy norm seems incongruous today because minority oppression cases involve conflicts among shareholders, not conflicts between shareholders and nonshareholders. Nevertheless, when early courts employed rules requiring directors to act in the interests of all shareholders (not just the majority shareholders), they were creating the shareholder primacy norm. Once used to resolve minority oppression cases, the shareholder primacy norm easily found its way into cases involving publicly traded corporations because courts did not routinely distinguish closely held corporations from publicly traded corporations until the middle of this century. But the application of the shareholder primacy norm to the ordinary business decisions of publicly traded corporations is muted by the business judgment rule. As a result, even though the shareholder primacy norm is closely associated with debates about the social responsibility of publicly traded corporations, it’s impact on the ordinary business decisions of such corporations is extremely limited.

I don’t buy it. From my article Director Primacy: The Means and Ends of Corporate Governance:

To what extent should the fiduciary duties of corporate directors permit them, or even require them, to consider nonshareholder interests when making corporate decisions? Corporate law’s classical answer famously was articulated in Dodge v. Ford Motor Co. [FN138] In this case, Henry Ford embarked on a plan of retaining earnings and lowering prices, while improving quality *575 and expanding production within his firm. At trial, Ford’s testimony left the court with the impression that Ford believed “the Ford Motor Company has made too much money, has had too large profits, and that, although large profits might be still earned, a sharing of them with the public, by reducing the price of the output of the company, ought to be undertaken.” [FN139] Ford further explained that his “ambition” was “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. To do this we are putting the greatest share of our profits back in the business.” [FN140] The plaintiff Dodge brothers therefore contended that an improper altruism towards his workers and customers motivated Ford. The court agreed, strongly rebuking Ford:

A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes. [FN141]

Consequently, “it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others.” [FN142] Dodge’s theory of shareholder wealth maximization has been widely accepted by courts over an extended period of time. Almost three quarters of a century after Dodge, the Delaware Chancery Court similarly opined: “It is the obligation for directors to attempt, within the law, to maximize the long-run interests of the corporation’s stockholders.” [FN143] Although*576 some scholars claim that directors do not adhere to the shareholder wealth maximization norm, the weight of the evidence suggests the contrary. [FN144] First, shareholder wealth maximization is not only the law, but also is a basic feature of corporate ideology. A 1995 National Association of Corporate Directors (NACD) report stated: “The primary objective of the corporation is to conduct business activities with a view to enhancing corporate profit and shareholder gain.” [FN145] A 1996 NACD report on director professionalism set out the same objective, without any qualifying language on nonshareholder constituencies. [FN146] A 1999 Conference Board survey found that directors of U.S. corporations generally define their role as running the company for the benefit of its shareholders. [FN147] The 2000 edition of Korn/Ferry International’s director survey found that when making corporate decisions, directors most frequently ranked shareholder interests as their primary concern, although it also found that a substantial number of directors feel a responsibility towards stakeholders. [FN148]

[FN138]. 170 N.W. 668 (Mich. 1919).

[FN139]. Id. at 683-84.

[FN140]. Id. at 683.

[FN141]. Id. at 684.

[FN142]. Id.

[FN143]. Katz v. Oak Indus., 508 A.2d 873, 879 (Del. Ch. 1986). For an interesting interpretation of Dodge that the shareholder wealth maximization norm originated as a means for resolving disputes among majority and minority shareholders in closely held corporations, see D. Gordon Smith, The Shareholder Primacy Norm, 23 J. Corp. L. 277 (1998). I am skeptical of Smith’s interpretation. In the first instance, the court’s own analysis in Dodge is not limited to close corporations. Smith places considerable emphasis on the sentence immediately preceding the court’s statement of the shareholder wealth maximization norm. See id. at 319 (using italics for emphasis). In that sentence, the court draws a distinction between the duties Ford believed he and his fellow stockholders owed to the general public “and the duties which in law he and his codirectors owe to protesting, minority stockholders.” Dodge, 170 N.W. at 684 (emphasis added). On its face, the duty to which the court refers is that of a director rather than the duties of a majority shareholder. (Admittedly, both the specific passage in question and the opinion in general are sufficiently ambiguous to permit Smith’s interpretation.) In the second instance, whatever Dodge originally meant, the evolutionary processes of the common law have led to Dodge being interpreted as establishing a basic rule for boards of directors, namely, that the board has a duty to maximize shareholder wealth. In Long v. Norwood Hills Corp., 380 S.W.2d 451 (Mo. Ct. App. 1964), for example, the court observed:

Plaintiff cites many authorities [including Dodge] to show that the ultimate object of every ordinary trading corporation is the pecuniary gain of its stockholders and that it is for this purpose the capital has been advanced.... All of these cases involve either banking, commercial or manufacturing corporations and in most of them alleged misappropriation of the assets of the corporation or misconduct of the majority stockholders or boards of directors have been alleged.

Id. at 476 (emphasis added). The court further stated that it had “no quarrel with plaintiff insofar as the rules of law stated therein govern the actions of majority stockholders and the boards of directors of corporations.” Id. (emphasis added). As Smith himself concedes, moreover, his interpretation departs from the “consensus” of most corporate law scholars. Smith, supra, at 283.

[FN144]. See, e.g., Blair & Stout, Team Production Theory, supra note 26, at 286; Smith, supra note 143, at 290-91.

[FN145]. Nat’l Ass’n of Corporate Dirs., Report of the NACD Blue Ribbon Commission on Director Compensation: Purposes, Principles, and Best Practices 1 (1995) (noting, however, that “long-term shareholder gain” requires “fair treatment” of nonshareholder constituents).

[FN146]. See Nat’l Ass’n of Corporate Dirs., Report of the NACD Blue Ribbon Commission on Director Professionalism 1 (1996).

[FN147]. Conference Bd., Determining Board Effectiveness: A Handbook for Directors and Officers 7 (1999).

[FN148]. Korn/Ferry Int’l, 27th Annual Board of Directors Study 33-34 (2000).

Update: To be clear, when I said “I don’t buy it,” I did not intend to single out Gordon Smth’s important contribution to the debate. To the contrary, I had in mind Stout as much as Smith.

In any case, as I observed on Gordon’s site:

Two thoughts. First, Daniel Boorstin observed that “Disagreement produces debate but dissent produces dissension. ... People who disagree have an argument, but people who dissent have a quarrel.” I trust that we have an argument rather than a quarrel.

Second, Dodge reminds me of Charles Dickens’ infamous case of Jarndyce and Jarndyce: “This scarecrow of a suit, has, in course of time, become so complicated that no man alive knows what it means. The parties to it understand it least; but it has been observed that no two Chancery lawyers can talk about it for five minutes, without coming to total disagreement as to all the premises.”