Brian A. SchneiderSpring 2015
Sustainable Corporations
Professor Alan Palmiter
The Lasting Impact of Dodge v. Ford:
Balancing the Business Judgement Rule, Shareholder Wealth Maximization, and Corporate Integrity
Abstract
The core principles of corporate law are the duties of trust and confidence, the fiduciary duties owed by those who manage the corporation to those who nominally “own” the corporation (namely, the shareholders). Among the first things anyone schooled in law or business thinks of when considering the loci that is “corporate law” are Shareholder Wealth Maximization and the Business Judgement Rule. Within the hallowed halls of academia, and amongst the well traversed hallways of corporate America, professors, students, and executives are ensconced in this view of business law and corporate responsibilities. The problem is, the entire system is a myth; a figment created from the ephemera by a trial that was not about what it seemed.
The responsibilities and duties of corporate executives and board members as we know them today stem from the decision rendered in Dodge v. Ford. As this paper will explore, however, that decision is as it appears. Perhaps it is time to re-imagine the world of corporate law. New views on corporate integrity, and the sustainable corporation movement, bring forward thoughts and ideas for how we might view the corporation in the 21st century and beyond, and how that might differ from the corporate model established in the early 20th century.
The Lasting Impact of Dodge v. Ford:
Balancing the Business Judgement Rule, Shareholder Wealth Maximization, and Corporate Integrity
Table of Contents
1.Introduction
2.Dodge v. Ford Motor Co.
A.Background
B.Beneath the Surface
C.Business Judgment Rule
D.Shareholder Wealth Maximization
E.Conflicting Interests
3.Corporate Integrity
A.Organizational Commitment
B.Leadership and Motivation
C.Tying it all Together
4.Lynn Stout’s Statement on Company Law
A.Stout’s Statement
B.Strine’s Rebuttal
C.Reconciling the Two
5.Thoughts for the Future
1.Introduction
The core principles of corporate law are the duties of trust and confidence, the fiduciary duties owed by those who manage the corporation to those who nominally “own” the corporation (namely, the shareholders).
Among the first things anyone schooled in law or business thinks of when considering the loci that is “corporate law” are Dodge v. Ford Motor Co. (hereinafter, “Dodge v. Ford”), Shareholder Wealth Maximization (“SWM”), and the Business Judgement Rule (“BJR”). Within the hallowed halls of academia, and amongst the well traversed hallways of corporate America, professors, students, and executives are ensconced in this view of business law and corporate responsibilities. Law schools teach it to upcoming lawyers, and business schools teach it to future executives; thus has it been and thus it remains. The problem is, the entire system is a myth; a figment created from the ephemera by a trial that was not about what it seemed, a court that wanted to make a political statement, and a generation of academics who went along with it because it seemed to make sense.
Corporate America, business law, and the responsibilities and duties of corporate executives and board members as we know it today stems from the decision rendered in Dodge v. Ford. As this paper will explore and examine, however, that decision is not all that it appears to be on the surface. Additionally, as times have changed and new ideas have been created, perhaps it is time to re-imagine the world of corporate law. New views on corporate integrity, and the sustainable corporation movement, bring forward thoughts and ideas for how we might view the corporation in the 21st century and beyond, and how that might differ from the corporate model established in the early 20th century. As part of that examination, this paper will take a look at Lynn Stout’s Statement on Company Law, in which she promotes and advocates a series of guidelines, and lens through which to view the modern corporation.
2.Dodge v. Ford Motor Co.
A.Background
Founded in 1903, the Ford Motor Company was and is a model of American business enterprise. Henry Ford was and remains one of this country’s most successful and influential businessmen, alongside more modern counterparts like Jack Welch and Steve Jobs. The Ford Motor Company was so sensationally successful, that in 1911 it paid a regular annual dividend of $1.2 million. Furthermore, between 1913 and 1915, the company paid out special dividends in amounts ranging from $10 million to $11 million.
In 1916, however, Henry Ford, the majority shareholder of the company, declared that he would not pay the special dividend, and instead use that cash to fund a new factory at River Rouge which would greatly enhance the company’s production capacity. Ford also planned to increase employee salaries while reducing the price of Ford automobiles.
The Dodge brothers, who were amongst the original investors in the Ford Motor Company brought suit against the company, in essence demanding that Ford pay the special dividend and to enjoying Ford from constructing the River Rouge Factory [Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919)]. The trial court found in favor of Dodge on both issues. The Michigan Supreme Court, however, while upholding the lower Court’s finding that Ford was required to pay the dividend, did reverse the injunction against construction of the River Rouge Factory, which remains to this day one of the nation’s largest.
In upholding the requirement that Ford pay the special dividend, the Court stated the following about the purpose of a business corporation:
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 non-distribution of profits among stockholders in order to devote them to other purposes.
From this statement, a generation of business school academics and future M.B.A’s derived the notion of SWM. The problem, of course, if that the same Court completely contradicts itself both before and after making this statement. It is also worth noting that the above-quoted passage is dicta, and not part of the ruling; and yet it inspired a century’s worth of corporate leadership and guidance.
Earlier in the same opinion, the Court quoted that “[i]t is a well-recognized principle of law that the directors of a corporation, and they alone, have the power to declare a dividend of the earnings of the corporation, and to determine its amount.” The Court continues to state that, absent fraud, misappropriation, or “such an abuse of discretion as would constitute a fraud, or breach of that good faith which they are bound to exercise towards the stockholders” courts of equity should not interfere if the corporation refuses to declare a dividend. Later on, the Court continues by stating:
We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. [… T]he ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture. The experience of the Ford Motor Company is evidence of capable management of its affairs. [emphasis added]
The Court seemed to justify itself, or to address this seeming contradiction, by stating that since “[i]t had been the practice, under similar circumstances, to declare larger dividends...a refusal to declare and pay further dividends appears to be not an exercise of discretion on the part of the directors, but an arbitrary refusal to do what the circumstances required to be done.” (emphasis added)
B.Beneath the Surface
Underlying the decision in Dodge v. Ford, however, was a vortex of political sub-currents. The Dodge Brothers had intended to use the 1916 special dividend to finance their own new car company, which was meant to compete directly with the Ford Motor Company. Ford’s decision to not pay the special dividend was seen as an attempt to forestall competition, and the benefits that such competition would have had on the Michigan automobile industry. Thus, the real issue at stake in Dodge v. Ford was one of anti-trust violations. Unfortunately, plaintiff’s brought the action in State Court, and could not win on a federal antitrust claim. Instead, they relied on twisted logic to persuade an antagonistic Michigan Court to side against Ford.
Under the guise of corporate law, the court used its opportunity to advance a political agenda. Due to Ford’s, perhaps unwise, public persona and statements made to the press and on the public record, the Court was able to paint Ford as an anti-shareholder altruist, and declare his refusal to pay a dividend “arbitrary” and grossly against the interests of the corporation, despite going out of their way to stress the importance of the idea that “judges are not business experts” and that the “experience of the Ford Motor Company is evidence of capable management of its affairs,” presumably by Mr. Ford.
Thus, while this case served as the basis of a century’s worth of legal and business education and scholarship on SWM and the concordant duties of corporate managers, it was actually a case that declared that courts had no place second guessing business decisions, and actually hinged on the fears of the Michigan Court of Ford Motor Company’s, and, more specifically, Henry Ford’s rapidly growing power and influence.
C.Business Judgment Rule
In the aftermath of Dodge v. Ford, and the generations of MBAs and scholarship that followed, it has become standard ideology to accept that public corporations are “owned” by their shareholders, that corporate managers owe fiduciary duties to those shareholders under agency theory, and the shareholder primacy dominates; thus, SWM has become the rule by which corporate managers live.
In The Problem of Corporate Purpose,[1]Lynn A. Stout questions whether the maxims of SWM and shareholder primacy have lived up to their expected billing. Stout suggests that the embrace of SWM, especially over the past two decades, should have resulted in vastly improved performance by the business sector. Instead, however, Stout says that business has “have suffered a daisy chain of costly corporate scandals and disasters, from massive frauds at Enron, HealthSouth, and Worldcom in the early 2000s, to the near-collapse of the financial sector in 2008, to the BP Gulf oil spill disaster in 2010.”
Contrary to the popular opinion and routine over the past decades to cite Dodge v. Ford as mandating a policy of SWM, the actual corporate law states no such thing. Dodge v. Ford, as discussed above, was a farce of a case; a charade played out on legal grounds. Modernly, the corporate code of Delaware, where the majority of U.S. corporations are incorporated, states simply that “corporations can be formed for any lawful purpose.” This, along with the actual holding from Dodge v. Ford, results in what today is known as the Business Judgment Rule.
The business judgment rule essentiallystates that aspersonal conflicts of interest, fraud, or willful lack of knowledge, courts will not second-guess managerial decisions about what is best for a corporation—even if those decisions predictably reduce profits or share price. In Air Products, Inc. v. Airgas, Inc. Air Products sought to acquire Airgas at a $30 per share premium. Airgas’ board refuse, and an action was brought to require the sale arguing that Airgas was forced to consider the interests of its shareholders. The Delaware Court failed to find that argument persuasive, and stated that the Airgas Board “was not under any per se duty to maximize shareholder value in the short term.” Here, the Delaware Court uses the BJR to declare that corporations, while operating in the realm of creating profit for shareholders, is not bound to create immediate returns in the near term, but rather, absent fraud or conflict of interest, is free to consider longer term implications.
D.Shareholder Wealth Maximization
Contrary to Stout’s arguments regarding the BJR, Leo Strine continues to argue the merits of SWM. In Our Continuing Struggle with the Idea that For-Profit Corporations Seek Profit,[2]Strine suggests that “any for-profit corporation that sells shares to others has to be accountable to its stockholders for delivering a financial return.” While Strine agrees that Dodge v. Ford stands for the creation of the BJR, he seems to argue that discretion is limited by the “well-motivated, non-conflicted fiduciary.” Thus, Strine argues that the fiduciary, or the executive of board of directors, “be motivated by a desire to increase the value of the corporation for the benefit of the stockholders.”
Strine seems to have some justification for his arguments. In a 2010 case pitting eBay against Craigslist, a similar thread to what first appeared in Dodge v. Ford appeared. Here, Craig Newmark and Jim Buckmaster, the controlling stockholders of Craigslist, created a poison pill—a provision which would have diluted eBay’s ownership should their ownership position increase in any way. Newmark and Buckmaster argued that their action was designed to prevent the disruption of Craigslist’s “corporate culture.” Chancellor Chandler, of the Delaware Court, however, ruled that “[d]irectors for a for-profit Delaware corporation cannot deploy a rights plan to defend a business strategy that openly eschews stockholder wealth maximization—at least not consistently with the directors' fiduciary duty under Delaware law.” This holding seems to be at odds with Stout’s definition of the BJR.
E.Conflicting Interests
Contrarily, however, Stout continues to argue that shareholder primacy, and the principles of SWM, may not, in fact, be all that they seem. This results from the fact that there is no single “shareholder value.” Stout argues that “different shareholders have different needs and interests depending on their investing time frame, degrees of diversification and interests in other assets, and perspectives on corporate ethics and social responsibility.”
Stout’s most interesting observation is in the discrepancy between potentially harmful short-term thinking and long term strategic planning that such theories of SWM hold. Stout states quite eloquently:
Shareholder value ideology focuses on only a narrow subgroup of shareholders, those most short-sighted, opportunistic, willing to impose external costs, and indifferent to ethics and others’ welfare. As a result shareholder value thinking can lead managers to focus myopically on short-term earnings; to harm employees, customers, and communities; and to lure companies into reckless and socially irresponsible behaviors. This ultimately harms most shareholders themselves—along with employees, customers, and communities.
Kent Greenfield also weighs in on the problem of short-term earnings as it relates to management. In The Puzzle of Short-Termism,[3] Greenfield talks about one of the problems of the “sustainable corporation” being the nature of corporations to produce externalities. The most usual and obvious externalities produced by corporations are current externalities, such as avoiding environmental regulation, or laying off employees. These current, or short-term, externalities must be balanced against future externalities, which affect the sustainability of the corporation. The problem, as Greenfield puts it, is that “[c]urrent shareholders may prioritize present returns over future returns, and current shareholders may not expect to be future shareholders at all.” This creates an incentive upon managers to please current shareholders at the potential expense of future shareholders, which, in turn, leads to short-termism. In numerous studies conducted, corporate managers admit that they have made decisions expected to be harmful to the corporation in the long-term in order to maximize short-term earnings. And as Greenfield notes, “[i]n 2006, both the Conference Board and the Business Roundtable, two of the nation's most prominent business organizations, issued reports “decrying the short-term focus of the stock market and its dominance over American business behavior.”
How then to handle the conflict between the BJR and SWM; between short-term profits and long-term sustainability?
3.Corporate Integrity
Thus far we have examined the BJR and SWM; how they relate, how they seem to be at odds with one another, and how some have tried to reconcile the two. We’ve also discussed how both came to be more as a result of common perception and scholarship than actual legal machination. It seems like it might be hopeless to try to reconcile these two ideologies independently. However, a third ideology exist, currently separate from the BJR and SWM, but one that may be able to bridge the gap between the two.
Corporate Integrity is a way of looking at the corporate body that is different from either the BJR or SWM. It’s more psychologically and behaviourally based than business or legally; but these fields are not mutually exclusive, and, in fact, should be fused together.