There are two serious defects that ail today’s corporate governance, that is, the system that governs decision-making authority in corporations. First, the bulk of voting power has been taken out of the hands of individual shareholders and given to institutional shareholders, that is, mutual funds and other wealth management investors. This has eroded shareholder democracy and has practically denied a voice to the actual owners. Thus, we face an economy beset by the dual concentration of market power and voting rights in the hands of, respectively, fewer firms and voting entities. Second, women and minorities are still poorly represented on corporate boards, thus leaving more diverse and important perspectives with weak influence on corporate decisions.
There is, though, a third cause for concern in relation to how corporate boards are structured. Specifically, they fall far short of assuring us how they uphold the social responsibility principles they claim or are expected to care for.
For most of its life, the corporation has functioned to serve economic efficiency, and in particular the economic interests of its shareholders. The rationale for this was that the shareholders bore the ultimate risk of the enterprise and, hence, they should have ultimate authority over its management.
But then in the middle of the “greed is good” hype of the Eighties, business academics and practitioners realized that subordinating the interests of other parties to those of the shareholders could damage the economic efficiency of the firm and hurt shareholders. Thus, the stakeholder theory of the firm was born. To achieve long-term survival and prosperity firms were advised to pay fair consideration to the interests of stakeholders (like debtors, workers, customers, and suppliers) not just to those of shareholders. This alignment of the shareholders’ interests with the interests of the firm’s other stakeholders was still a call for economic efficiency, and thus, still consistent with shareholder ultimate decision-making authority.
What has happened since the Nineties, though, is that the range of stakeholder interests has been broadened to include the interests of local communities, climate and environmental concerns, diversity, and social justice. This expansion of the stakeholder concept comes from our recognition that firms do not operate in a vacuum, but instead they can generate risks and harmful conditions to be borne by all and not only by the traditional stakeholders.
The new class of stakeholder interests falls into the realm of social responsibility. Whereas the traditional board structure remains effective in managing decisions related to the economic efficiency of the corporation, it is time to ask: Is this board structure still effective in managing decisions that satisfy the social responsibility of the corporation? That is, we have to ask: Can shareholders consider the interests of a community in a relocation decision? Can shareholders consider the workers’ interests in acquisitions that result in downsizing the labor force? Can the shareholders consider ecological and environmental risks if it means lower profits? Can the shareholders give a fair chance to women and minorities of color to participate on boards and executive positions?
There are usually two ways to nudge firms toward certain behavior. One is to rely on market forces. Thus, debtors can refuse to lend untrustworthy firms. Consumers can refuse to buy from unscrupulous firms. The same way, we can argue the public could shun firms with a poor social responsibility record. But that would require we have reliable and verifiable information about hundreds, thousands of firms the public deals with. It would also require that the public has reasonable choices if it is to discriminate across good and bad corporate actors – not exactly an easy matter in a world of growing concentration in many important markets. (How many have abandoned Facebook in light of its recent bad publicity?)
Another way to discipline firms is through laws and regulations. But this approach also has limitations. It is often the case that society’s preferences in favor of stronger environmental protection or greater diversity are not countenanced by the political powers that are. The point is that discipline from the outside, whether the market or the government, is not enough to bear on corporations when it comes to matters of social responsibility.
But there is a third way. The right to board participation can be expanded to parties that represent the interests of communities, workers, diversity and ecological sustainability. This board reform is most crucial for large corporations that have a big and heavy footprint on communities, workers, the ecology and social justice issues. To the purists of the shareholder model this reform may be an anathema. But we have to acknowledge the corporation is not the creation of natural laws. It is a human innovation, a legal construct, that gave a solution to the aggregation of large sums of capital with less personal risk. Over time, the law, the regulatory authorities (e,g,. the Securities and Exchange Commission), and stock exchanges have seen the need to enforce various representation rules in order to safeguard the integrity of corporate governance.
Now we have entered a phase of reckoning with our responsibility to the wellbeing of communities and workers, gender equality, social justice and our threatened ecosystem. Today’s corporations dwarf in size the corporations of the past and impact important aspects of human and natural life with unprecedented consequences.
Two years ago, the Business Roundtable (an association of CEOs) revised the purpose of the firm to include the responsibility for stakeholder interests beyond those of the shareholders. It is time to acknowledge that these interests cannot be effectively served without proper representation. Reforming the representational rules of corporate boards will better integrate economic, social, and ecological interests and serve the common good.
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