NARRATOR: Thanks for joining this episode of the No. 86 lecture series, where we discuss basic principles and applications of Corporate Law along with landmark cases. Today’s episode features Seth Oranburg, who is an Associate Professor at the University of New Hampshire Franklin Pierce School of Law. Professor Oranburg also co-directs the Program on Business, Organization, and Markets at the Classical Liberal Institute at New York University School of Law. As always, the Federalist Society takes no position on particular legal or public policy issues; all expressions of opinion are those of the speaker. PUBLIUS: In this episode, I want to discuss the role of corporations in society. There is a lot of talk about corporate responsibility. What are they responsible for, or to whom? Should they use their money and influence to improve their community? What is the purpose of a corporation? PROFESSOR ORANBURG: Over time, this debate has unfolded into two camps. One of which is most clearly articulated by Milton Friedman, who wrote an article in the 1970s in the New York Times, effectively to the title that the only purpose of a corporation is to make profits for its shareholders, period. That's the social value of a corporation. I think he even went to even say that that was its duty or that's its social virtue. Whereas others, most notably Chancellor Strine, who was chancellor of the Delaware Supreme Court, and for that matter, many others, have argued that corporations have a role beyond profit maximization known as environmental and social governance. That they have some role to govern as stewards of the environment, society and other social interests. Kind of doing good by doing well or doing well by doing good philosophy that since corporations get certain special status by virtue of their limited liability, they're protected from their investors or protected from certain risks at society's expense. Therefore, we are justified in asking them, demanding that they give back and consider other interests. This debate has become important again recently. There was a period where the Milton Friedman side of things seemed to be winning out and corporations were being taken over by hedge funds and other activist investors whose role was to unlock value. Who said that, "This corporation is wasting its money. It has divisions that aren't necessary. It's paying certain people too much. It's not investing enough in research and development or investing too much in research and development. It's not engaging in the right sort of things in order to make profits. So we're going to take it over, we're into strip it down, divest assets that aren't profitable and boost the bottom line." This strategy worked in terms of really streamlining corporate activity, but it changed how people interfaced with corporations. It meant that you couldn't guarantee a corporate job for life because corporations were going to fire people that were underperforming now, which, quite frankly, there were businesses that if you got a job for them in the '60s you, at that point, might reasonably expect you'd stay there until the '90s when you got a pension. That's changed. People move from job to job much more quickly and fluidly now. Corporations are more apt to terminate people and, in fact, entire lines of business that are not profitable. Some people are upset with this and saying that corporations need to return to that role of creating some stability in society. For that matter, creating stability in our environment, in our ecosystem. We're now at a point where there are some very fundamental questions to ask again about looking at the modern world, what's the role of the modern corporation? How does it best serve its social purpose? Is it to return to the Milton Friedman doctrine or is it to explore a broader range of activities that corporations are authorized to, and maybe legally required to engage in that provide something other than profits for shareholders? PUBLIUS: Let’s talk more about that. Do corporations have obligations to anyone besides shareholders? PROFESSOR ORANBURG: There's a debate today about whether corporations owe obligations only to their shareholders or whether they owe obligations to stakeholders. Now, corporations exist because of law and they actually externalize certain risks onto society. Limited liability means that if you invest in a corporation, you can't lose more than you put in. What happens if a corporation commits a crime or a tort or [01:08:30] doesn't honor a contract, and the harm caused by that action is more than the corporation has? Well, again, since in general, the harmed party can't take from the corporate owners, the harmed party is not going to get fully redressed. Some of that harm is not going to be resolved in litigation because there is protections to the shareholders for some of that liability in excess of what the corporation had. This is called externalization and it happens in many forms. And as a result, society has some corporations owe some duties back to society because they create some risk to society and the question is how much, and what should corporations be doing to fulfill that obligation? Milton Friedman most famously said that the duty of corporations is to earn profits for shareholders. That's how they give back to society because in that way, they create the best products [01:09:30] at the best value and engender the most wealth for shareholders who then can go and give it to charity or perform their functions, or what have you. There's a movement right now called ESG, or environmental and social governance, which is demanding corporations not to focus on profits, but to actually lose profits in order to pursue other social objectives so asking coal plants to shut themselves down, or to install expensive scrubbers to reduce carbon emissions, even when that reduces profits. When we talk about fiduciary duties and we talk about obligations, the traditional conversation was what duties do directors and officers owe to shareholders and that duty was limited to making profits for those shareholders. The scope of litigation really was I, shareholder, have been harmed financially by you, director or officer, who made a bad business decision or acted disloyally, and as a result, calls the corporation to lose value and therefore I lost stock value. That's the classic argument. There's a new argument that says, "I, a stakeholder, a supplier, a neighbor, someone who can smell the paper factory from down the street, an employee, or maybe someone from some other part of the world who is simply subject to rising sea levels as a result of carbon emissions," or what have you, those people are now saying, "We have rights to sue directors and officers," and there is a concept then of stakeholder liability, liability to stakeholders of officers and directors. And there's an ongoing conversation about whether or not our existing models of corporate liability and governance function in a world of stakeholder liability, of liability to stakeholders. It's not at all clear that we've worked this one out just yet, and it's not at all clear where it's going to land, but it's certainly a very interesting debate to listen to right now because we're asking some fundamental questions about what is the purpose of corporations in society and to whom do they owe duties? PUBLIUS: What is the environmental, social, and governance movement (usually known as ESG)? Who is setting these goals for corporations and monitoring them? PROFESSOR ORANBURG: It's a demand that corporations do not maximize profits when certain conditions are met. For example, maximizing profits by taking advantage of loose offshore drilling restrictions would be considered a good business model prior to ESG. I mean, if offshore drilling is profitable and the regulations are lax so it's not expensive, you'd expect companies to go and drill offshore and to do that profitably. The solution to these problems of, for example, environmental catastrophe because of off drilling was to tighten the regulations, but some regulations are hard to tighten. International waters aren't really regulated in the same kind of way that domestic ones are. Deep water offshore drilling, such as what happened with the BP Horizon disaster it's very hard to regulate. There's now been a push that corporations need to regulate themselves and simply not engage in these profit maximizing behaviors where they're too potentially harmful to society or the environment in one or another way. Why are corporations listening to this? Why would they be forgoing profits? Well, there's a couple reasons for that. One, is that some of the investment funds, like BlackRock, are trying to attract investors into their funds by saying, "We're not going to invest BlackRock funds into companies that are engaged in environmental bad stuff." Bad stuff is hard to define. I guess it's in the eye of the beholder. That's a question. What kind of stuff is that? But as a result, BlackRock, which has $7 trillion under management, overwhelmingly the bazillion-pound gorilla in the New York Stock Exchange room, can really throw its weight around and cause a lot of change in corporate behavior. By BlackRock saying, "We're not going to invest our funds in companies like Chevron because they're in a dirty industry," that's going to really change corporate decision making. Whether that's for good or for bad is to be determined. But, that's the push. The push is for companies to stop looking at the bottom line and look at other factors as well. It's not clear that they can do this legally today because as the law stands, corporations have an obligation to maximize profits to shareholders, unless they're a B corporation and they've chartered otherwise. Some of these behaviors will probably result in shareholder lawsuits because they could constitute a breach of fiduciary duty to maximize profits. On the other hand, many states are now trying to impose statutory requirements that corporations engage in various social exercises. California, for example, requires gender diversity on boards, regardless of whether it enhances profits. It's just a matter that California by statute has declared that boards have to have gender diversity. Although ironically, it seems to be counted only in terms of not having enough females. The Victoria's Secret board, Victoria's Secret makes exclusively or predominantly women's under clothes, the board is entirely female. There's no diversity on that board from a gender perspective. But again, the laws at this point are not necessarily looking for equality, but some type of equity. They're trying to achieve these equitable outcomes now through statutory mandates that may require boards to do things that are not profit maximizing, putting boards in a position of conflict where they must not break the law, but they must maximize profits. If they can't do both at the same time, then directors have to make a decision are we going to be liable for suit by not following a statute, are we going to be liable for suit by shareholders by not maximizing profits? It's a very delicate situation because our system is not really designed for corporations to pursue these other ambitions, at least not without shareholder consent. There could be liability that results from this on both sides. It's not clear if the experiment in enforcing corporations to be more socially responsible will work. PUBLIUS: Why would a corporation voluntarily adopt these standards? Do most corporate management teams believe that the social impact outweighs the potential profit loss? PROFESSOR ORANBURG: I'll start with the BlackRock piece. I mean, BlackRock is a for-profit enterprise. They're one of the wealthiest corporations that's ever existed. They control a vast amount of the stock market. What's behind BlackRock's push toward investing only in companies, or purportedly only in companies, that support ESG. Well, one reason may be that this is attractive to large states. Large states have large funds, pension funds, that need to be invested in companies like BlackRock. Right now, two of the largest states in America are New York and California. California, in particular, has a huge economy, is larger than many countries in the world and certainly carries its own weight. This California economy has been recently dominated by some environmental social thinking that has led that government to want to invest in more socially-responsible funds. Maybe BlackRock is just following the money, in other words, and simply trying to be more and more attractive to the Californias and New Yorks of the world. That's a business strategy. Another thought, which is perhaps a little bit more sinister, is that BlackRock can charge more fees for actively-managed funds than passive ones. If BlackRock is simply putting money into an index, just like everybody else does, they're only going to get a few basis points, a few fractions of a percentage for managing that fund because it's, quite frankly, very simple. They just run a computer algorithm that's going to trade automatically. It's not particularly complicated. These funds were invented in the '70s and are very well understood in the 2020s. You don't pay people a lot of money to manage index funds. You pay them to manage active funds, which are going to go in there and try to select the right companies and then affect change at the management level. You can actually earn a lot more fees by having an ESG fund because you can claim that it's active. Then instead of getting a few basis points, a few decimals of a percentage point, you can charge what's called the two and 20, which is you receive 2% of all the assets under management as a management fee and 20% of the profits, which is a dramatic amount more money. It may very well be that BlackRock is simply creating products that are more profitable for them. The question then becomes why are states willing to do this? Why would a state choose to invest in a BlackRock ESG fund, even though ESG funds return less money and they're paying higher fees? They're effectively giving up, let's say 5% of their returns. Why would a person rationally choose to give away 5% of their money? This is a harder question to answer, but when we actually look at who's making these decisions, we have to understand that the people deciding to give away 5% of the money aren't giving away their own money. These are elected officials or appointed persons who are in charge of large organizations, often outside of the public ambit. They're making decisions with other people's money that other people, like teachers and firefighters who depend on these streams of investment for their pension funds, can do with less so that others have more. That is a decision that's being made. I don't know how public it's being made because I'm sure there are some teachers and firefighters that would prefer to receive higher distributions in their pension and then make their own decisions about what charity they want to donate it towards, as opposed to it going toward a generalized concept up of ESG, which, well, it could mean different things to different people. The other challenge with ESG is what are we measuring? What is the good? If we all agree the corporation's role is to maximize profits, then we can work towards that goal empirically. We can look and see whether profits went up or went down. We have some tools now in accounting that do a pretty good job of measuring profit. But, how do you measure environmental impact? How do you measure social impact? Is it the number of transgender people on staff? Is it the number of dollars of donations given to children in an underprivileged region? What's the metric? What is the good? There isn't really a consensus around that right now. In fact, different groups might argue for different things. Some groups would argue that the good is gender diversity on boards. Others would argue that the good is access to funds or medical resources provide contraception. Others would advocate that it would be in infertility treatments. Others would argue more medical fees for changing gender. Others might argue that we should put the money into buying carbon credits or others might argue that we should install better safety equipment at various plants and protect workers above and beyond what OSHA requires. These are worthwhile conversations, but which one of these things is right? We clearly can't do them all. Who decides? How do we decide? If we get into a world where corporate managers are required to maximize these things, what does that mean exactly? How do we measure that? Who decides what metrics we look at? These questions need to be answered if we're going to have a mandate for ESG because if we don't know what it means, it's very hard to know if we're accomplishing it. There are many charities that are worth giving towards. There are many people that are in need right now. Is the corporation the best vehicle to be making those choices or should the corporation be providing money to investors and workers so that they can make their own decisions about how to improve society? I think there's a general frustration among environmentalists that government has not done enough. Since government has failed to enact and follow through with environmental protocols, we'll go to the next biggest source, which is corporations. Maybe we can use corporations to bring about the world we want to see. But it may be that you just can't force people to do this. What you need to do is really make the case to individuals that they should be making different choices. ESG takes that choice away from people and it gives it to managers. The problem with doing that is those managers have their own personal incentives. They're going to be incentivized to do things that improve their own wellbeing. It's just human nature. There are some real questions about whether we're going to get a better world by requiring corporations to make the decisions about what is good and what is worth investing in as opposed to allowing people their own choice as to where they put their time and effort for charity. PUBLIUS: How do ESG priorities affect the day to day business at a corporation? Are these mostly high level goals amongst management? Or do they impact workers and production? PROFESSOR ORANBURG: ESG manifests itself in every step of the corporate process. First off, there are ESG funds. There are investors that are looking to put their money where their morals are, which is to say they're going to invest in companies that may not have the same kind of profit returns, but are going to generate some good that they value. One way that it manifests is investors making choices. But then once you invest in a company and the company has some money, someone in the company needs to decide how it's going to fulfill that ESG mission. Some companies like TOMS shoes are going to give away a pair of shoes for every one they sell or something like that. Other companies are simply going to spend more on carbon scrubbers on their power plants than are required by law or are going to buy carbon credits or plant trees or perform some other kind of function. But those decisions are going to be made usually at the CEO or someone in that kind of level. The decisions they make will be based significantly, at that point, on their priors and preferences, or maybe their sense about what will keep them their jobs. Remember that CEOs want to keep their jobs, otherwise they can't continue doing the good work, and for that matter, earning the high salaries and stock. They're going to be trying to do ESG activities that both help them look good, but potentially, maybe make it harder to measure. Because if you can't measure someone's performance, you can't really say they're not doing very well. Some of these ESG initiatives seem to be going into fuzzy areas that don't have measurable outcomes. That may be because management has a personal benefit from making it hard to figure out if they're doing ESG well or poorly. Of course, it also manifests in hiring decisions and a number of other things as well. That's in part because people who work at companies are demanding it. It's in part because laws are putting pressure on companies to show it. But a lot of it comes down to the finance, major finance operations are saying, "If you don't engage in this sort of ESG activity, we're simply going to make it harder for you to access cash." Since cash is the lifeblood of business, that means that you simply have to comply with the requirements or at least the standards that the banks and investors are imposing. PUBLIUS: Even before the ESG movement, there was talk about “corporate social responsibility.” Are they the same concept with different names? PROFESSOR ORANBURG:The old debate was framed as shareholder wealth maximization versus corporate social responsibility. The term corporate social responsibility seems to have morphed into environmental and social governance, ESG. It seems that these concepts, corporate social responsibility and environmental social governance, really are along the same line of thinking, just a slightly more extreme version of the social responsibility piece because it, of course, includes not just society, but the environment. That has been a big focus of corporate activity is corporate requirements to prevent global warming climate change and mandating that companies do this through ESG proposals and principles. But, this isn't new. Shareholders have always been concerned about corporations doing evil things. Corporations that make bombs, for example, have a history of shareholders protesting and especially pacifists who would purchase shares in the company only so they could have a voice in trying to stop the production of weapons and napalm during various wars. This is nothing new, but it's more aggressive than usual. The ESG moniker on it has helped it gain in popularity. It seems to have moved past what used to be a fairly academic debate between pretty wonky corporate governance scholars who would argue about whether ESG or CSR would result in net social welfare. But that conversation with ESG seems to have changed a bit and people are no longer asking so much about net social welfare. They're not even thinking about things economically. It's more about thinking of them equitably. That corporations simply have too much power. We should begin taking it from them, mandating that they act differently. It doesn't really matter if this results in a net social welfare increase. At this point, there's enough pressure that we simply need a wealth transfer in society, away from corporations and towards these other purposes. That's where I see the ESG and the CSR movement deferring. The CSR movement, again, was able to have conversations with the SWM movement. The corporate social responsibility movement and the shareholder wealth maximization movement were in conversation. The ESG movement tends to step aside from that and says, "Look, conventional economics have not produced the society we want. We haven't achieved equality through these principles. It's time to try something new. Let's move toward an equity-based model. That should justify governments actually taking from wealthy shareholders and wealthy corporations and distributing that to society and the environment because that's how we're going to get the results that we want." That won't necessarily result in a larger pie, which was really the debate that the older generation had. How do we increase the overall social pie through shareholder wealth maximization or through corporate social responsibility with some profit in it? Now it seems like we're talking about how do we redistribute the pie, even if that results in it shrinking a little bit because some people are eating too much of it. PUBLIUS: Proponents of ESG insist that eventually corporations will have improved profits from embracing these values. Shareholders and consumers will choose to put their money in a socially responsible business. Has that been true? Are corporations doing better (profit-wise) after implementing these strategies? PROFESSOR ORANBURG: Aside from lowering cost of capital, because people seem to want to give money to ESG-motivated companies, the preliminary empirics show that ESG does not increase profits. Profit maximization increases profits. That's not to say that you can be blind toward the needs of the world and expect your corporation to go on forever, especially in a world of social media where don't be evil is an important part of being successful.] Both morally, as well as I'm saying just rationally on the basis of profit maximization, evil corporations will be boycotted, will be protested against, will have more headwinds. There's good reason to do good even for profit motivations. But so far the data show that ESG doesn't produce more profit. It's a cost. It's a redistribution of wealth from shareholders to someone else, to environment and society, to the E and S in the ESG. Again, the jury is still very much out. We're still early on in this process. It's not even clear if we can measure who's doing ESG because no one can agree what it is. I don't even know how we'd arrive at some authentic empirics about how well ESG is bettering society, but in terms of bettering shareholders, no, shareholders do better in companies that focus on fundamentals. Interviewee: I mean, ESG's design is wealth redistribution. I mean, it comes from a school of thought which is more Marxist than capitalist. Again, we should be revisiting and having these conversations, I'm not putting a stake in the ground, but I think we need to understand the critical difference between these arguments. There is an argument that we should be motivated to work because we're going to earn profits based on our success. There's a different school of thought that we should each take according to our needs and give according to our abilities. Those assertions are based on different assumptions about human nature. That's the conversation we need to have. I don't think we can continue pretending that we're having a conversation about how to improve capitalism. The question is more do we still want capitalism or do we want to moderate it with some Marxism and socialism? This ESG movement, in the sense that it is designed to redistribute wealth from shareholders, capitalists, if you will, toward other purposes because they have more than they need, we need to force them to take less so they take what they need and others have more, we should just have those conversations using well-understood terms and concepts so that we can really, as a society, figure out where we are and what we value. But it is definitely a redistribution. If people freely choose that, I think that's excellent. I think it's wonderful for people to have that choice. I mean, you could also donate your money. Don't forget that. Before we go on the whole ESG thing, I mean, you can invest in ESG firms, but you could also make money and then give it to charity. I mean, there's lots of ways that we can improve the world. ESG is one way that sort of, I don't know, maybe it's a way of investing while feeling good. You give a little bit, but you should you think of it as partly charity because the goal of ESG investing is not to earn the maximum return on profit, by definition. By definition, the goal is to earn some suboptimal return on profit and for some of that money to be going toward a social purpose or at least not towards [01:00:00] an anti-social purpose at the expense of profits. So long as that's a personal choice that people are making, that's one thing. But once the government starts mandating it, that's effectively a sort of wealth redistribution. We should have policy conversations about that. The emergence of ESG funds and the focus of, especially BlackRock, on not investing in certain businesses that have good fundamentals, should open the market up for some funds that return to fundamentals. Not everyone is interested in giving their money away towards specific causes that someone else has determined. Some of us want to keep our money and others want to donate it to causes that we choose, as opposed to some general principal of what ESG is. Although there's a current move toward mandating ESG and the resulting shift or transfer in wealth from shareholders toward whoever are the recipients of that policy, there is likely to be some type of backlash where there are a number of people that would rather have personal control over their financial success, and for that matter, would like to use that money for charitable purposes, but toward things that they consider valuable. Given that we have a tradition here in America of being very charitable and a tradition here of entrepreneurship and success through hard work, I think there's going to be an emergence in the next several years of funds that are going to return to fundamentals and make promises to investors that they're going to be careful stewards of their money and that investors then have the power and authority to do good, I suppose we could say. The investors can take the profits from having done good in the markets and use it to do well by others. Remember that some of our most storied institutions are charitable contributions from successful entrepreneurs. I mean, Stanford University, among them. Leland Stanford was a railroad baron. I think we're going to see a resurgence in some of that. I hope we continue to see the charitable spirit of the American people who I believe are going to continue supporting good causes, whether or not they're mandated to. Maybe they'll even support those causes more if at the end of the day, they have more in their bank account that they can use to give to food banks and to help the local homeless and to give to their local communities. Again, that's a little bit more traditional in terms of how America is used to thinking about wealth transfer, it being a part of our free choice. I see there at least being some room for those to become popular, at least among some. NARRATOR: Thank you for listening to this episode of the No. 86 Lecture series on Corporate Law. The spirit of debate of our Founding Fathers animates all of the No. 86 content, encouraging discussion and critical reflection relative to how each subject is widely understood and taught in law schools and among law students. Subscribe to the No. 86 Lecture series on your favorite podcast platform to have each episode delivered the moment it’s released. You can also go to no86.fedsoc.org for lectures and videos on Federalism, Contracts, Jurisprudence and more. Thanks for listening. See you in class!