Chapter 4. Corporate Social Responsibility

ADW DRAFT 9/3/11

AP edits 9/5/11

Chapter 4. Corporate Social Responsibility

Primary Sources Used in this Chapter

• Ohio Revised Code § 1701.59
• ALI Principles of Corporate Governance. § 2.01
• MBCA § 302
• IRC § 170
• ABA Model Rules of Professional Conduct, Rule 2.1
• ALI Principles of Corporate Governance, §2.01
• Dodge v. Ford Motor Co
• Theodora Holding Corp. v. Henderson
• Kahn v. Sullivan, 594 A.2d 48 (Del. 1991)

Concepts for this Chapter

• Who does the corporation serve?

• Classic answer: Dodge v. Ford Motor

– Meaning of case

– Other constituency statutes

• Modern answer: corporate charity

– Corporate law

– Who should decide?

• Role of directors and lawyers

– Choices in takeover

– Choices in offshore operations

A. Who Does the Corporation Serve?

Question: Is the purpose of the corporation to serve as private property or as a social institution?

Answer: This is an overarching question in corporate law, and the tension exists both in corporate law and in business reality.

What are the implications of the corporation as property? What social responsibility isthere beyond seeking to make money while complying with law?If a corporation is a social institution, how should the tension between shareholders andother corporate stakeholders be mediated? Profit maximization remains crucial, but thelimits of its pursuit are no longer just business and legal limits. Additional concerns—from living wages to environmental sustainability—come into play.

Question:Who should decide this debate?

Answer: The board of directors(management) is given virtually all authority to manage the business and affairs of thecorporation. Does management have discretion to consider the corporation’s impact onsociety and account for those considerations in doing business? Can the corporation servemultiple masters?

The modern debate between advocates of “shareholder primacy” and proponents of what is now known as “corporate social responsibility” (CSR) can trace it roots to the period following the 1929 Stock Market Crash, when the United States focused on the role of the corporation (including Congressional hearings).

Consider the following description by Professor Lynn Stout:

In 1932, the Harvard Law Review published a debate between two preeminent corporate scholars on the subject of the proper purpose of the public corporation. On one side stood the renowned Adolph A. Berle, coauthor of the classic The Modern Corporation and Private Property. Berle argued for what is now called "shareholder primacy" - the view that the corporation exists only to make money for its shareholders. According to Berle, "all powers granted to a corporation or to the management of a corporation, or to any group within the corporation ... [are] at all times exercisable only for the ratable benefit of all the shareholders as their interest appears."
On the other side of the debate stood esteemed professor Merrick Dodd of Harvard Law School. Dodd disagreed vehemently with Berle's shareholder primacy thesis. He argued for "a view of the business corporation as an economic institution which has a social service as well as a profit-making function." Dodd claimed that the proper purpose of the corporation (and the proper goal of corporate managers) was not confined to making money for shareholders. It also included more secure jobs for employees, better quality products for consumers, and greater contributions to the welfare of the community as a whole.

Lynn Stout, Lecture and Commentary on the Social Responsibility of Corporate Entities: Bad and Not-So-Bad Arguments for Shareholder Primacy, 75 S. Cal. L. Rev. 1189 (2002) (citations omitted).

Question: What is the argument in favor of the corporation as private property?

Answer: After Berle,Milton Friedman emerged as a leading proponent of the shareholders primacy doctrine. Friedman argued:

When I hear businessmen speak eloquently about the "social responsibilities of business in a free-enterprise system," I am reminded of the wonderful line about the Frenchman who discovered at the age of 70 that he had been speaking prose all his life. The businessmen believe that they are defending free enterprise when they declaim that business is not concerned "merely" with profit but also with promoting desirable "social" ends; that business has a "social conscience" and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact they are–or would be if they or anyone else took them seriously–preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.

The discussions of the “social responsibilities of business” are notable for their analytical looseness and lack of rigor. What does it mean to say that "business" has responsibilities? Only people can have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but "business" as a whole cannot be said to have responsibilities, even in this vague sense

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[T]he doctrine of "social responsibility" taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book Capitalism and Freedom, I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

Milton Friedman,The Social Responsibility of Business Is to Increase Its Profits,The New York Times Magazine, September 13, 1970.

Delaware Chancellor William T. Allen has noted that this model of the corporation as existing to generate shareholder wealth implies that the corporation is a form of privately held property. Chancellor Allen described the view of the corporation as a nexus of contracts as “incomplete,” noting that the directors have duties to the corporation itself as an entity, not merely to the corporation’s shareholders:

The law and economics paradigm offers a highly coherent conception of corporation law as a system of rules facilitating wealth maximization through contracts, explicit or implicit. This is, to a substantial extent, an idealized version of the corporation law in action. Like much of neoclassical economics, the law and economics account of corporation law is at bottom not empirical description, but normative prescription. It means to tell us how people would act with respect to formation of legal rules concerning corporations if people acted rationally (as they sometimes, if imperfectly, do).

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The idealized law and economics version of corporation law makes a tremendous contribution to our understanding of the nature of the firm, but it is not complete. My own understanding, which is, I confess, incomplete as well, acknowledges the power and utility of much of the law and economics story, but recognizes as well the pressures on rule-creating agencies to view corporate directors as men and women with obligations of loyalty which will be evaluated ex post on a fairness standard. Courts have felt and responded to these pressures for over two hundred years. To whom director duties of loyalty are owed can and has sustained earnest debate in legislative chambers, in the press, and in the academy. Thus, either a descriptive account or a normative account of corporation law that I might advance would include a powerful element of wealth maximization, but it would inescapably include as well a political-moral component. Corporation law is a system of rules, principles and roles and a process by which they are defined, redefined in legally significant interactions, and enforced. In that process the law, or legal agents, mediate, pursuant to the processes of law, between the wealth maximizing value and the ex ante analytical style of the liberal model and the fairness value and the ex post analytical style of equity.

William T. Allen, New Directions in Corporate Law: Contracts and Communities in Corporation Law, 50 Wash. & Lee L. Rev. 1395, 1404-5 (1993) (citations omitted)

Question: What are some of the arguments in favor of corporate citizenship and responsibility?

Answer: Some possible answers to this question are:

• CSR advances the corporations long-term interests/sustainability
• Consumers demand CSR
• Shareholders demand CSR
• Ethical reasons
• Public relations

Professor Merrick Dodd made the case for what we now consider CSR in 1932:

That the duty of the managers is to employ the funds of the corporate institution which they manage solely for the purposes of their institution is indisputable. That that purpose, both factually and legally, is maximum stockholder profit has commonly been assumed by lawyers. That such is factually the purpose of the stockholders in creating the association may be granted. Nevertheless, the association, once it becomes a going concern, takes its place in a business world with certain ethical standards which appear to be developing in the direction of increased social responsibility. If we think of it as an institution which differs in the nature of things from the individuals who compose it, we may then readily conceive of it as a person, which, like other persons engaged in business, is affected not only by the laws which regulate business but by the attitude of public and business opinion as to the social obligations of business. If business is tending to become a profession, then a corporate person engaged in business is a professional even though its stockholders, who take no active part in the conduct of the business, may not be. Those through whom it acts may therefore employ its funds in a manner appropriate to a person practising a profession and imbued with a sense of social responsibility without thereby being guilty of a breach of trust.

E. Merrick Dodd, Jr., For Whom Are Corporate Managers Trustees, 45 Harv. L. Rev. 1145,1161 (1932)

The Corporate Social Responsibility movement is not without its critics. See for example, Professor Aneel Karnani’s August 2010 article in the Wall Street Journal, The Case Against Corporate Social Responsibility.

Question: Does the board of directors have the discretion to decide whether the corporation should exclusively maximize shareholder value, or instead pursue a different agenda?

Answer: Maybe. In fact, many state corporate statutes specifically recognize the discretion of the board to consider the interests of the corporations other stakeholders. Consider as an example § 1701.59 of the Ohio Revised Code governing the Authority of Directors (reprinted on p. 99). The Ohio provision authorizes the directors to consider:

• the corporation’s employees, suppliers, creditors and customers,
• the economy of the state and the nation
• community and societal considerations, and
• the long-term and short-term interests of the corporation and the shareholders.

This seems like a very broad authorization.

B. CSR in Two Legal Contexts

1. The “Classic” Case

The classic CSR conflict in corporate law concerns the proper role of the corporation, and the conflict between CSR and a strict adherence to a shareholder primacy doctrine.

Dodge v. Ford Motor Co. addresses the question “who does the corporation serve?” and presents the classic private property vs. social institution debate. In its mixed ruling, the court first required a payment of dividends (despite Ford’s view that his business plan and cutting of dividends would raise the lives of employees and customers), but then the court chose not to stop his expansion plans (accepting that judges are not business people). In the process the court seemed to both rebuke and exalt Ford’s business plans.

Dodge v. Ford Motor Co., 204 Mich. 459. 170 N.W. 668 (1919)

Facts: Ford. Motor Company was organized in 1903 with an initial capital of $150,000. At the time of this case, the company’s capital had grown to $2,000,000. After distributing special dividends from 1911-1915, in 1916 Henry Ford haddeclared it to be the policy of the company to cease paying any special dividends(other than the regular dividend) and instead put that money back into thebusiness for the development of the company and good of its workers. Thisdecision came after years of loyalty to the shareholders—steady growth anddividend distribution.

On its face, Ford’s new plan certainly did not appear an act solely in service of theshareholders. Ford was taking into account the business’ effect on others, namelythe employees and potential employees, to the point of depriving shareholders ofwhat they believed were profits they were entitled to.

The Dodge brothers, who had begun to manufacture cars in competition withFord, brought suit as two minority shareholders (they owned 22% of thecompany’s stock) against the Ford Motor Company to compel payment of adividend, to enjoin construction of the Ford company’s River Rouge plant, and forother relief. The Dodges needed Ford’s special dividends to finance a plannedexpansion of their manufacturing operations. In addition, a decision by Ford toreduce the selling price of its cars further threatened the Dodges operationsthrough increased competition.

For what purpose was Ford reducing special dividends and putting money backinto the company? Ford had ambitious plans for an unprecedented expansion.

First, he was considering vertically integrating the stages of production requiredto build automobiles—mining the company’s own iron ore, building its own shipsto transport the ore, and building smelters to make steel.

Second, Ford planned to reduce the price of cars from $440 to $360. At thisprice, the court found, Ford had no intention of making the business moreprofitable; its only effect would be to diminish the value of shares and returns toshareholders.

Third, Ford sought to continue the corporation not as a business institution but asa “semi-eleemosynary” (charitable) institution. Henry Ford’s vision, he said, was“to employ still more men, to spread the benefits of this industrial system to thegreatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of the profits back in the business.” The hope of his vision was to bring global peace through consumerism.

Question:What was the realpurpose of his plan?

Answer: Perhaps Ford had a brilliant trick up his sleeve to maximize the company’s profitability in hatching his expansion project.

Just what was going on at Ford’s corporate offices? We know Ford wanted to help put people to work, but in what way was he reimagining the industrial landscape? Was Ford’s sense of corporate social responsibility still subservient to earning profits? Or was something bigger in place than just helping folks find jobs?

Maybe Henry Ford had a vision of his corporation beyond serving shareholders. Ford saw not just a responsibility owed by the corporation to society, but the potential for collaboration between the two. The corporation and society, Ford believed, functioned in a symbiotic relationship. To this end, he hoped to use industry to increase trade and spur international peace. Ford’s sense of corporate social responsibility, in short, was global.

Question: How did Ford plan to finance the expansion? How are corporate expansions usually financed?

Answer: This is a good place to introduce general principles of debt and equityfinancing and the limited options a corporation has in financing itself and its projects.

Unlike more traditional methods of debt and equity financing, Ford planned to financethe expansion internally. Ford planned to terminate the company’s history of generousspecial dividends and use that money to fully self-finance the expansion. This was verymuch consistent with his general business philosophy of maintaining proud independence and self-reliance.

Question: What is product pricing? Why was Ford product pricing by reducing prices of cars from $440 to $360?

Answer:Product pricing is part of any business strategy. Prices should covercosts, maintain and grow a customer base, and maximize profits. Ford’s product pricingreduced prices from $440 to $360 – to increase the customer base and perhaps the Ford Motor workers. The method also helped Ford workers afford to buy the cars theywere making.

Question: Was this contrary to profit maximization?

Answer: The Dodge brothers arguedFord’s plan was not one of profit maximization but instead to transition the company into a “semi-eleemosynary” institution—a private enterprise that put customer interests andjob creation over profitability. But maybe this was a way of becoming dominant –ultimately a highly profitable monopolist!

Question: For what purpose was Ford seeking to employ “still more men” at $5.00 a day?

Answer:Fordsought to employ more and more people out of a sense of corporate social responsibility– or so he said. As the Prometheus of American industry, he sought to share its benefitswith everyone. He saw his corporation as bringing industry and social need together. Ford believed he could pay more and more people a living wage if he reinvested Ford’sstaggering profits back into the company. But not all workers made above-market wages– only white men who lived proper family lives. Many other workers earned marketwages. These higher wages allowed his workers to buy cars, crating pressure for asystem of highways – just like the “networks” that Microsoft sought to create with itscomputer software.