In 1919, the Michigan Supreme Court explicitly bound Henry Ford to the notion of shareholder wealth maximization primacy when it held that Henry Ford couldn’t decline to pay the Dodge Brothers special dividends in the pursuit of employing more Detroit auto-laborers.
Henry Ford showed up in court and started talking about the embarrassment of profits that he had made from Ford’s explosion and discussed how it had become time for him to do his part to help “men…build up their lives and their homes.” In testimony, Ford did absolutely nothing to link the desire to employ more people into a belief that greater profits awaited shareholders down the line. For that reason, Ford was ordered to pay a dividend to the Dodge Brothers, as the Court reasoned that the corporate form was not the proper vehicle for advancing ends unrelated to shareholders.
Specifically, the Michigan Supreme Court held: “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.” In other words, Ford had complete authority at Ford Motor Company to determine the strategy for maximizing shareholder wealth, but he did not have the authority to determine whether shareholder wealth should be the purpose of his governance.
If you can come up with any rational link that ties a strategy to increased shareholder wealth, the business judgment rule gets implicated and the management can pursue the strategy. For instance, all Ford had to say was: “By signaling a desire to employ more men in the Detroit area, we believe our brand will be more attractive, thus increasing sales and maximizing shareholder wealth.” It does not take much more than lip service for an executive to get his strategy affirmed by the court, but he does have to say the magic words about how the strategy somehow shares a “rational link” to the maximization of shareholder wealth.
Many in the millennial generation do not recognize this demand upon corporations, as the current social and advertising culture features companies telling you how they’re not interested in money. Ben & Jerry’s runs frequent advertisements about its social responsibilities. McDonald’s ran a campaign in which he offered “hugs” as a payment for free food. Tim Cook, when questioned about the small market size and limited profit ability of making devices geared especially for the blind, said: “When we work on making our devices accessible by the blind, I don’t consider the bloody ROI.” Dow Chemical has heavily allied itself with gay rights. Hershey Chocolate’s capital structure gives large dividends to support its own orphanage. Turn on the TV, and you won’t make it through an advertising string without seeing a corporate advertisement claiming to care about you.
This culture makes it easy to think that corporations are not focused on making money, and instead, would rather take care of some other stakeholder (you, a vulnerable group in the community, etc.)
It is important to understand that this is a facade. The fiduciary duty of every executive is to maximize the wealth on behalf of shareholders (there are some state statutes that permit corporations to become a “benefit corporation” that is allowed to take care of interests of stakeholders other than shareholders, but it is necessary to file as a benefit corporation so that potential investors in the corporation receive the signal that their interests aren’t the exclusive focus of management).
If Tim Cook were ever sued by a shareholder of Apple about his “bloody ROI remarks”, then one of two things will happen: (1) he would show up in court and say that he was spouting his mouth out a bit at that shareholder meeting, and then he would say that doing things that don’t maximize profit like building devices for the blind generates consumer goodwill that maximizes the wealth created through the sale of the mainstream Apple products. He would state that acting like he doesn’t care about profits and instead focusing on niche morality is the strategy for maximizing wealth, and thus, the court would permit Cook to continue running Apple in the exact same manner. The shareholder would lose. Or (2) Tim Cook could stick to his guns, and reiterate that he is not focused on maximizing shareholder wealth when he does thing like make Apple devices for the blind. In this case, the shareholder bringing the lawsuit would lose, and Tim Cook would be ordered to cease the development of Apple devices for the blind.
Sometimes, this reality catches people off guard. Most people don’t know this, but eBay is a major shareholder in Craigslist. As you can imagine, the Newmark family (Craig Newmark, the founder, is the “craig” in craigslist) has very different ideas about how to run a business than eBay. In 2010, he found himself in the Delaware Court of Chancery when he tried to adopt a poison pill that would prevent eBay from ever taking control of the Board of Directors long after he died. The sole purpose of this move was to preserve the corporate culture at Craigslist–there was no rational link between Craig Newmark’s strategy and even lip service to the notion of maximizing shareholder wealth.
This is the most important paragraph from the eBay v. Newmark holding:
“Jim and Craig did prove that they personally believe craigslist should not be about the business of stockholder wealth maximization, now or in the future. As an abstract matter, there is nothing inappropriate about an organization seeking to aid local, national, and global communities by providing a website for online classifieds that is largely devoid of monetized elements. Indeed, I personally appreciate and admire Jim’s and Craig’s desire to be of service to communities. 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. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders. The “Inc.” after the company name has to mean at least that. Thus, I cannot accept as valid for the purposes of implementing the Rights Plan a corporate policy that specifically, clearly, and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders—no matter whether those stockholders are individuals of modest means or a corporate titan of online commerce. If Jim and Craig were the only stockholders affected by their decisions, then there would be no one to object. eBay, however, holds a significant stake in craigslist, and Jim and Craig’s actions affect others besides themselves.”
Sometimes, people hear things about the maximization of corporate wealth and thinks it is an outdated, stodgy notion that is no longer relevant in corporate America. It’s a seductive line of thought, as much advertising and corporate signals to consumers indicate that maximizing profit is far from the mind of the corporation. But this new cultural norm is not a legal norm. With a few statutory exceptions such as benefit corporations, the fiduciary duty of management teams still requires that profit must be maximized on behalf of the shareholders.
This once obvious point has become so obscured that even successful businessmen and lawyers forget to state a rational link between a particular strategy and the shareholder wealth maximization, but the duty remains there. It should also be a reminder to take corporate advertising and the purported strategy of executives with a grain of salt. Even when corporations appear to not care about profit, the management team is still bound by fiduciary principles to pursue profit, and they will certainly state this in court even if it blatantly contradicts what they say to consumers. And, in the few instances when they forget to tie together the loose ends in court, the program gets shut down.
Originally posted 2016-03-18 21:34:28.