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Yale Law Journal – Corporate Governance Reform and the Sustainability Imperative

abstract. Recent years have witnessed a significant upsurge of interest in alternatives to shareholder-centric corporate governance, driven by a growing sustainability imperative—widespread recognition that business as usual, despite the short-term returns generated, could undermine social and economic stability and even threaten our long-term survival if we fail to grapple with associated costs. We remain poorly positioned to assess corporate governance reform options, however, because prevailing theoretical lenses effectively cabin the terms of the debate in ways that obscure many of the most consequential possibilities. According to prevailing frameworks, our options essentially amount to board-versus-shareholder power, and shareholder-versus-stakeholder purpose. This narrow perspective obscures more fundamental corporate dynamics and potential reforms that might alter the incentives giving rise to corporate excesses in the first place.

This
Feature argues that promoting sustainable corporate governance will require
reforming fundamental features of the corporation that incentivize excessive
risk-taking and externalization of costs, and presents an alternative approach
more conducive to meaningful reform. The Feature first reviews prevailing
conceptions of the corporation and corporate law to analyze how they
collectively frame corporate governance debates. It then presents a more
capacious and flexible framework for understanding the corporate form and
evaluating how corporate governance might be reformed, analyzing the features
of the corporate form that strongly incentivize risk-taking and externalization
of costs, discussing the concept of sustainability and its implications for
corporate governance, and assessing how the corporate form and corporate law
might be re-envisioned to produce better results.

The
remainder of the Feature uses this framework to evaluate the proposals
garnering the most attention today, and to direct attention toward the broader
landscape of reforms that become visible through this wider conceptual lens.
Recent reform initiatives typically rely heavily on disclosure, which may be an
essential predicate to meaningful reform, yet too often is treated as a
substitute for it. The Feature then assesses more ambitious reform initiatives
that re-envision the board of directors, and rethink underlying incentive
structures—including by imposing liability on shareholders themselves, in
limited and targeted ways, to curb socially harmful risk-taking while
preserving socially valuable efficiencies of the corporate form. The Feature
concludes that until we scrutinize the fundamental attributes of the corporate
form and the decision-making incentives they produce by reference to long-term
sustainability, effective responses to the interconnected environmental,
social, and economic crises we face today will continue to elude us

author. Stembler
Family Distinguished Professor in Business Law, University of Georgia School of
Law. For helpful comments and suggestions, thanks to Afra Afsharipour, Martin
Gelter, Virginia Harper Ho, Andrew Johnston, Marc Moore, Beate Sjåfjell, D.
Daniel Sokol, and the editors of the Yale
Law Journal
, particularly Joseph Simmons. Thanks also to Sydney Hamer,
Amanda Milner, Sean O’Donovan, and Jacob Weber for helpful research assistance.

Introduction

Recent years have witnessed a significant upsurge of interest
in alternatives to shareholder-centric corporate governance. In 2019, the
Business Roundtable, an association of CEOs at prominent U.S. companies, issued
a new “Statement on the Purpose of a Corporation,” to which 181 members signed
on.
The document expressed “a fundamental
commitment to all of our stakeholders,” including customers, employees,
suppliers, “the communities in which we work,” and—presumably not least, but
last on the list—“shareholders, who provide the capital that allows companies
to invest, grow and innovate.”

Emphasizing that “[e]ach of our stakeholders is essential,” the signatories “commit
to deliver value to all of them.”
While this rejection of an exclusive
focus on shareholders was not uniformly welcomed across the investment
community
and has prompted considerable
academic deb
ate, signatories included leaders of some
of the largest asset managers in the world—notably, BlackRock’s Larry Fink and
Vanguard’s Tim Buckley,

whose firms manage $9 trillion and $7 trillion in assets, respectively.
Fink has been particularly
outspoken on the topic, concluding in his 2020 letter to CEOs that “a company
cannot achieve long-term profits without embracing purpose and considering the
needs of a broad range of stakeholde
rs.”

It is tempting to minimize such developments as yet another
swing of the corporate governance pendulum, driven in part by a shift in the
broader political economy. The managerialism and stakeholder-centric
perspective of the postwar decades, for example, had much to do with the
political and economic circumstances of the times, including large public
companies’ status as Cold War champions of capitalism, and the combined
capacity for business leaders, a robust labor movement, and the government
itself to function as effective coordinating agents in a period of balanced and
growing prosperity.
This approach gave way, after the
rise of the law-and-economics movement in the 1970s, to the strong-form
shareholder centrism that now prevails.
However, the shift toward
stakeholderism that we witness today may signal a more enduring shift due to
the unique nature of the underlying impetus for reform. Contemporary calls for
corporate governance reform are driven by a growing sustainability
imperative—increasingly widespread recognition that business as usual, despite
the short-term value generated, could undermine social and economic stability
and perhaps even threaten our long-term survival if we fail to grapple with
associated costs.

While discourse on sustainability
remains as susceptible to charged rhetoric as any domain of public policy,
the sustainability
imperative has become impossible to dismiss as mere hyperbole due to the range
of complex and interconnected environmental, social, and economic crises that
we face. The International Panel on Climate Change estimates that we are “more
likely than not” to see global warming of 1.5°C above preindustrial levels by
2040, threatening a range of dire environmental consequences and attendant
social and economic risks, and concludes that it is now “unequivocal that human
influence has warmed the atmosphere, ocean and la
nd.” An interdisciplinary team of
scientists has sought to define Earth’s “planetary boundaries,” quantifying
what the planet can bear in various respects, and has concluded that several of
the identified boundaries have already been exceeded—including climate change
and biosphere integrity, which function as “core” boundaries establishing “planetary-level
overarching systems.”

Some estimates suggest that it would require 1.7 Earths to sustain the global
population’s rate of resource use, and that this figure would balloon to five
Earths if everyone consumed resources at the rate the U.S. population does.

Meanwhile, although the worldwide rate of extreme poverty has
fallen over recent decades—due principally to the economic rise of China and
India
—staggering inequalities persist, and the United States has
hardly been immune. Income has grown dramatically for the wealthy yet stagnated
for most of the U.S. population, and “40% of Americans are living so close to
the edge that they cannot absorb an unexpected $400 expense.”
Extraordinary
concentrations of wealth and resulting inequalities impede further poverty
reduction and more generally undermine social stability in developed and
developing economies alike.

These challenges have only intensified following the onset of the COVID-19
pandemic.

Businesses and capital markets have contributed significantly
to these crises.
Business entities are among the world’s
most significant economic actors, growing in number at an extraordinary rate
and sometimes rivaling even
the largest countries in their economic magnitude and power.
Their operations
significantly impact all dimensions of sustainability.
The transportation,
industrial, and commercial sectors are among the principal emitters of
greenhouse gases, contributing to global
warming.
Economic inequalities, too,
have been exacerbated in recent decades by the redistribution of corporate
gains from labor to capital. That redistribution has been fueled in the United
States by growing shareholder power and activism, which have increasingly
pressured companies “to cut labor costs, resulting in wage reductions within
firms and the ‘fissuring’ of the workpla
ce.” Although such crises cannot be
attributed entirely to big business, it is nevertheless “hard to imagine any
solution to these problems that does not entail a change in corporate behavi
or.”

Many scholars have argued that sustainability is best pursued
through extracorporate regulation such as environmental and labor laws, leaving
corporate governance itself to focus exclusively on shareholders.
But the inadequacies of this reactive
approach are increasingly apparent. As Sarah Light observes, “managers make
decisions with profound environmental consequences long before pollution comes
out of a pipe or smokestack as an externality,” and greater attention to “fields
governing corporate decision-making and market architecture can yield solutions
to enduring problems that traditional federal environmental law has been unable
to solve on its o
wn.”
Notably, this includes “cumulative harms like climate change” that “sit
uneasily within the traditional paradigm of environmental law, which tends to
focus on controlling, reducing, or reporting significant amounts of pollution” but
lacks effective tools to promote changes in harmful day-to-day business
practices that produce large-scale aggregate effects over time.

As a practical matter, there is further reason to doubt that
extracorporate regulation alone could possibly constrain such politically
powerful act
ors.
Even those favoring shareholder-centric corporate governance have conceded that
major corporations’ ability to neutralize external regulations may effectively
undermine attempts to force businesses to internalize the environmental and
social costs associated with their activit
ies. It is thus critical to assess how
decision-making incentives take shape in the first place, and how governance
reforms might render corporate decision-making more sustaina
ble.

Growing awareness of the sustainability imperative has driven
the recent shift away from shareholder-centric corporate governance. The
Business Roundtable statement, for example, cites the importance of “embracing
sustainable practices across our businesses.”
Fink’s letter likewise
states that “sustainable investing is the strongest foundation for client
portfolios” and that a “company’s prospects for growth are inextricable from
its ability to operate sustainably.”
However, prevailing
theoretical lenses on corporate governance effectively cabin the terms of the
debate in ways that obscure many of the most consequential reform options. In
its response to the Business Roundtable statement, for example, the Council of
Institutional Investors objects that the statement “work[s] to diminish
shareholder rights” while “proposing no new mechanisms to create board and
management accountability to any other stakeholder group.”
This exchange reflects the
quandary we face when seeking to apply the familiar terminology and conceptual
frameworks of traditional corporate governance discourse to the novel
sustainability imperative. Options for reform are seemingly limited to
recalibrating board-versus-shareholder power, and shareholder-versus-stakeholder
purp
ose.

Meanwhile, even for those more receptive to a broader
conception of corporate purpose, the range of conceivable reforms appears
limited to tweaked versions of existing capital-market mechanisms. Fink, for
example, narrowly conceptualizes climate change as an “investment risk” and
advocates for expanded corporate disclosures to permit investors to bring this
to bear upon their investment decisions, predicting that “companies and
countries that do not respond to stakeholders and address sustainability risks
will encounter growing skepticism from the markets, and in turn, a higher cost
of capital.”
This approach takes for granted the
sufficiency of such mechanisms for redirecting major corporations toward
long-term sustainable operations.
Although renewed scrutiny of
shareholder-centric corporate governance is a welcome development, such
initiatives are ill-equipped to promote corporate sustainability because they
remain tethered to a conception of the corporate form that obscures the nature
of the underlying problem. Core features of the corporate form, as presently
conceived, are simply unsustainable—environmentally, socially, and
economically.
Promoting sustainable corporate
governance will require reforming features of the corporation that incentivize
excessive risk-taking and externalization of costs onto society.

This Feature interrogates the conceptual binaries that
structure the accepted framework of corporate governance and surfaces more
fundamental corporate dynamics giving rise to corporate excesses in the first
place. To set the stage, Part I canvasses prevailing conceptions of the corporation
and corporate law—specifically, shareholder-primacy theory, nexus-of-contracts
theory, and team production theory. The aim is not to provide a comprehensive
account of their strengths and weaknesses, but rather to analyze how they
collectively frame corporate governance debates. These theories generally focus
exclusively on two conceptual binaries: board-versus-shareholder power, and
shareholder-versus-stakeholder purpose. Accordingly, reform efforts conditioned
by these theories tend to hold constant the underlying features of the
corporate form and associated capital-market structures, and so fail to grapple
with the fundamental forces that drive risk-taking and cost externalization.

We should instead focus on fundamental drivers of corporate
risk-taking and externalization of environmental, social, and economic costs,
and ask how we can alter decision makers’ incentives so as to steer corporate
conduct in a more sustainable direction. Rather than asking which corporate
constituency’s existing incentives represent the least-bad proxy for larger
social goals, we should explore how to adjust their incentives to promote
sustainable modes of corporate governance. Accordingly, in Part II, I present a
more capacious and flexible framework for understanding the corporate form and
evaluating corporate governance reform proposals. I analyze the features of the
corporate form that strongly incentivize risk-taking and externalization of
costs onto society, discuss the concept of sustainability and its implications
for corporate governance, and assess how the corporate form and corporate law
might be re-envisioned to produce better results.

In Part III, I use this framework to critically evaluate the
proposals garnering the most attention today, and to direct attention toward
the broader landscape of reforms that become visible through this wider
conceptual lens. Recent reform initiatives typically employ disclosure-based
strategies, which create the impression of regulatory action, but remain
unlikely to substantially improve matters on their own. Disclosure initiatives
do not directly require corporate actors to change anything about how they
currently operate; do not alter the incentives of shareholders, the predominant
audience, making it unlikely that investor pressures would lead managers to
reform corporate decision-making in any fundamental way; and are often limited
by reference to financial materiality, a narrow concept that is hardly
coextensive with society’s goals. Although such initiatives might support more
robust reform, they too often substitute for it, and are unlikely to produce
sufficient change on their own.

More ambitious initiatives that take direct aim at board
structure—notably, by improving board diversity, and by involving labor in
corporate decision-making—have real potential to promote greater social and
economic sustainability. Environmental sustainability remains another matter,
however, as the Volkswagen emissions scandal illustrates. Although the German
automaker has long had a codetermined board giving labor substantial
representation, the company pursued a strategy of relentless growth that
encouraged harmful, and thoroughly unsustainable, business practices.
Simply put, employees can have bad
incentives too—a reality suggesting that, as important as reforming board
structure may be in advancing social and economic sustainability, it remains an
incomplete response to the broader sustainability imperative.

Reforms taking direct aim at underlying incentive structures
merit real attention. Notably, proposals for imposing varying degrees of
liability on shareholders themselves, in limited and targeted ways, can be
fine-tuned to curb socially harmful risk-taking in particular financial and
economic contexts, while preserving socially valuable efficiencies of the
corporate form. Likewise, in the context of global value chains—where
widespread human-rights abuses and environmental harms have been committed by
subsidiaries and suppliers of consumer-facing companies headquartered in more
affluent jurisdictions—reforms are emerging that could sharpen the incentives
of corporate parents and contractual “lead firms” to monitor more effectively,
to disclose what they find, and to take meaningful action to prevent or
remediate such harms.

These analyses suggest that there is in fact no single
calibration of the corporate form that will promote optimal levels of
risk-taking in all financial and economic contexts. Rather, differing business
realities and risk profiles will require more granular assessment by industry,
and the optimal liability structures and risk incentives in various settings
likely will not be identical. Most critical at this stage is that we begin to
ask the right questions, with an eye toward the corporate form’s flexible
capacities, in order to identify more sustainable governance reforms than those
presently garnering substantial attention. Until we begin to scrutinize the
fundamental attributes of the corporate form and the decision-making incentives
they produce with reference to long-term sustainability, effective responses to
the interconnected crises we face today will continue to elude us.