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Properly Understanding the Relationship Between the BJR and CSR

Crooked Timberite Daniel posts on the shareholder wealth maximization norm, commenting in part that:

In real life, the business judgement rule protects more or less anything that the Creative Capitalism gang [a corporate social responsibility outfit] might want businesses to do. Even the paradigm example used by Posner – of a corporate chief executive making charitable donations and specifically saying that they weren’t doing it for PR purposes and that they didn’t run the company in the interests of the shareholders – doesn’t actually necessarily give rise to a situation which would fail the business judgement test, because that’s pretty much the story of Body Shop, and if the only way that a company can secure the services of a talented and energetic cosmetics executive like Anita Roddick is to give away money without regard for shareholders, then that’s in the interests of shareholders. There is, of course, a cottage industry in business school cases and the funnies pages of the Economist in proving that instances of corporate philanthropy are actually in the interests of shareholders in the long term.

He’s mostly right, of course. As I explained in The Bishops and the Corporate Stakeholder Debate, however, it’s important to understand why the business judgment rule does so:

[C]urrent law in fact allows boards of directors substantial discretion to consider the impact of their decisions on interests other than shareholder wealth maximization. This discretion, however, exists not as the outcome of conscious social policy but rather as an unintended consequence of the business judgment rule.  To be sure, some scholars find an inconsistency between the business judgment rule and the shareholder wealth maximization norm.  I concede that the business judgment rule sometimes has the effect of insulating a board of directors from liability when it puts the interests of nonshareholder constituencies ahead of those of shareholders, but deny that that is the rule’s intent.  Instead, as the Delaware supreme court has explained:

Under Delaware law, the business judgment rule is the offspring of the fundamental principle, codified in [Delaware General Corporation Law] § 141(a), the business and affairs of a Delaware corporation are managed by or under its board of directors.... The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors.

The business judgment rule thus operationalizes the intuition that fiat— i.e., centralization of decisionmaking authority—is the essential attribute of efficient corporate governance.  As Nobel laureate economist Kenneth Arrow explains, however, authority and accountability cannot be reconciled:

[Accountability mechanisms] must be capable of correcting errors but should not be such as to destroy the genuine values of authority. Clearly, a sufficiently strict and continuous organ of [accountability] can easily amount to a denial of authority. If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B and hence no solution to the original problem.

The business judgment rule prevents such a shift in the locus of decisionmaking authority from boards to judges. It does so by establishing a limited system for case-by-case oversight in which judicial review of the substantive merits of those decisions is avoided. The court begins with a presumption against review.  It then reviews the facts to determine not the quality of the decision, but rather whether the decisionmaking process was tainted by self-dealing and the like.  The questions asked are objective and straightforward: Did the board commit fraud? Did the board commit an illegal act? Did the board self-deal? Whether or not the board exercised reasonable care is irrelevant, as well it should be.  The business judgment rule thus erects a prophylactic barrier by which courts pre-commit to resisting the temptation to review the merits of the board’s decision.

The business judgment rule, however, has no application where the board of directors is disabled by conflicted interests.  In such cases, concern for director accountability trumps protection of their discretionary authority. In corporate takeovers, for example, a well-known conflict of interest taints target company director decisionmaking.  Not surprisingly, therefore, the law denies directors discretion to consider the interests of nonshareholder constituencies in the takeover setting.  To be sure, the interests of shareholders and nonshareholder may be consistent in takeover fights, just as they are in many settings. In light of the directors’ conflict of interest, however, we can no longer trust them to make an unbiased assessment of those competing interests. The conflict between management and shareholder interests requires skepticism when management claims to be acting in the stakeholders’ best interests. A board decision to resist a hostile offer may have been motivated by concern for potentially affected nonshareholder constituencies, but it may just as easily have been motivated by the directors’ and managers’ concern for their own positions and perquisites. Selfish decisions thus easily could be justified by an appropriate paper trail of tears over the employees’ fate. Consequently, in the takeover setting, rigorous application of the shareholder wealth maximization norm properly becomes the standard of judicial review.

This then is the major failing of the Bishops’ support for a multi-constituency conception of corporate directors’ duties. “Any social order that intends to endure must be based on a certain realism about human beings and, therefore, on a theory of sin and a praxis for dealing with it.” Here, the sin in question is that of self-interest. While the Bishops’ proposal would empower honest directors to act in the best interests of all the corporation’s constituents, it also would empower dishonest directors to pursue their own self-interest. There is a very real risk that directors and managers given discretion to consider interests other than shareholder wealth maximization will use stakeholder interests as a cloak for actions taken to advance their own selfish interests.