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Bested by a comedian?

Remember that discussion a while back about Sen. Franken’s statement about corporations being dangerous because they have to do everything they can to maximize profits? Well, it seemed settled. A bunch of right-wing law professors came out in defense of corporate freedom to act in the interests of whales, trees, hippies, employees, communities, racial interest groups, etc. etc. When this kind of thing happens, when an admirer of Milton Friedman calls him wrong, this is surely a sign of a right answer.

But no. Here comes a trial lawyer I’ve never heard of from Philadelphia in blogosphere smack down. Maxwell S. Kennerly of the Beasley Firm telling us that Franken, Larry Lessig, and others are correct in their demonization of corporations. His basis for this is a fascinating and rich opinion from Chancellor Chandler in the eBay v. Newmark case. (For background on the case, see here.)

Kennerly wrongly concludes from reading the opinion that corporations are legally obligated to be “profit-maximizing zombies who care not for truth, justice, or the American way.” (Careful readers should smell the sophistry.) Nothing could be further from the truth.

Let me say it again: Nothing obligates corporations to maximize profits at the expense of other considerations. For instance, countless firms give lots of money to charity, in some cases 1 or 2 percent of profits, without having to answer to shareholders in court as to why this is the profit maximizing strategy. And how could it be? Do you Google because they do this? Nope. (For an article on the subject, see here.)

Consider also that many states have so-called stakeholder constituency statues that instruct the board that they may consider things other than maximizing profits. Here is one:

?In performing the duties of a director, a director may, in considering the best interests of the corporation, consider the interests of any or all of the following: (1) The corporation?s employees; (2) The corporation?s customers; (3) The corporation?s suppliers; (4) The corporation?s creditors; (5) The economy of the region, state, and nation; (6) The impact on the community; (7) The environment; (8) The long-term, as well as the short-term, interests of the corporation and its shareholders.?

Practically, if shareholders sued a Detroit car company that decided to keep a factory in America instead of moving it to Mexico because it was not the profit-maximizing move, they would surely lose. In part this is because most decisions can be couched in profit-maximizing terms, say over different time horizons or based on different assumptions about the future. (Henry Ford’s problem was that he was embarrassed at being a robber baron and wanted to win the public relations war in his famous suit with the Dodge brothers.) But it is also in part because litigation is a bad way at getting at these questions. Courts generally stay out of these suits because the market will police them well enough. Litigation is likely a deadweight cost that will not improve outcomes. Obviously, cases in which the market will work less well, like in the case of closely held companies, the potential for judicial intervention is higher.

Even then, companies are permitted by statute in most states to give to charity, even anonymously, and no case has held that the directors must prove these contributions are linked with increased profits. See, e.g., the Barlow case, in which a NJ plumbing supply company donated money to Princeton, the CEO’s alma mater, and won. What is the profit-maximizing theory here? None. These cases are losers, and accordingly, firms are policed only by the market when they engage in reasonable levels of philanthropy. Reasonable is the key word here, and one that the Chancellor in the eBay case that has caused all the ruckus focused on. Chancellor Chandler writes:

“The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment.”

The key word in this sentence is “purely.” There are many corporate models spanning from short-term wealth maximizing  to  purely philanthropic, and it is the court’s view that only those at the “purely philanthropic” end of the spectrum raise concerns.

So we are left with everyone here being in violent agreement, I think. We should all agree with the following:

1. A company with a single owner can pursue whatever ends it wants.

2. A company founded to be very philanthropic can attract investors (maybe from a socially responsible investing fund) on that basis and not be sued when it acts that way.

3. A company cannot switch from being a regular company to a “purely philanthropic” one after accepting money from new shareholders. Especially, perhaps, where the company is closely held and market discipline is less.

4. Big, publicly traded companies do not need to defend themselves in court when they make business decisions, like being philanthropic or generous to one group or another, unless there is a potential conflict of interest.

5. Al Franken is engaging in sophistry when he tries to scare people into thinking corporations are evil monsters hell bent on destroying America. Corporations are us, and they reflect our wants and needs. The corporate world, and the corporate law world, is about letting a thousand flowers bloom. We have companies that care about profits only; we have ones that care a lot about philanthropy; and we have everything in between. And, importantly, the law has very little to say about this, absent a bait and switch or some other evidence of games being played, expectations being spoiled, or a story about cheating.

Mr. Kennerly writes that “a team of corporate law professors were bested in their understanding of fiduciary duties by a comedian.” I’ll let our readers decide, but for evidence look to the market. If we see lots of suits challenging, say Google or Patagonia, for being philanthropic without evidence that helping Africans avoid malaria helps earn shareholders more money, then I’ll concede to Mr. Kennerly. Perhaps as a trial lawyer, he should put his partners’ money behind the first suit.

Filed under: truth on the market

Full post as published by Truth on the Market on September 14, 2010 (boomark / email).