What the Law Allows

Author: Gentile, Mary C.
Source: The Aspen Institute Center for Business Education's Corporate Governance and Accountability Project
Year: 2005

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Abstract:

This collection was prepared by Dr. Mary Gentile, Associate of and Consultant to the Aspen Institute Business and Society Program.
Click here for Teaching Questions that guide this module.
Click Here to view a comprehensive and detailed table of contents for this collection, or see below for a brief version.

In 2003, The Aspen Institute Business & Society Program embarked upon a research initiative on Corporate Governance and Accountability to learn more about the prevailing models of corporate governance and theories of the firm, as they are understood, researched and taught by business school faculty.

To that end, we interviewed and convened a group of faculty from leading business schools who identified a number of topics, or “teachable questions,” which they believed could or should usefully be introduced into the business curriculum, given appropriate teaching materials. Accordingly, we have developed this and other Teaching Modules on Corporate Governance and Accountability.

This module – What the Law Allows – was created because some faculty mentioned how it is often assumed that managers and directors are required to take actions that serve shareholders by maximizing short term share price. They wanted to examine those areas where the law allows managers and directors to consider other stakeholders and the firms' longer term well-being. Accordingly, this module focuses on the question:
What does the law actually allow (and forbid), with regard to managerial discretion in balancing the objectives of shareholders and other stakeholders, and in trying to manage “for the long term” – an often stated but rarely defined objective for business leaders?

What the Law Allows
Sometimes students, business practitioners and even faculty argue that legal constraints in the United States prevent managers and directors from making decisions that might enhance the long-term value of the firm and/or benefit some of its stakeholders, if such long-term results come at the risk of a lower short-term share price.

On the other hand, it is often argued that the duty to maximize shareholder value (i.e., the shareholder primacy model of corporate governance) is the best means to maximize long-term firm value, precisely because the legal and institutional context in which it is applied reflects the preferences of societal stakeholders and prevents market excess.

But the question arises: just what does the law require of executives and directors when it comes to shareholder value maximization? The default position, often explicitly or implicitly presumed, is that short-term shareholder primacy rules.

A closer look reveals more room – and need – for explicit attention to non-shareholders than often assumed. Scholars bandy the guidance of Delaware courts regarding this question back and forth; cases that allow for greater board discretion can be pitted against those that do not. Although some scholars argue that these courts are moving to provide even greater shareholder protection in the wake of recent scandals, others suggest that this attention may grow out of a commitment to better hold directors accountable for their duty of care and duty of oversight, as opposed to a narrowly defined commitment to short-term shareholder value.

Some scholars argue that U.S. law is not necessarily based on a shareholder primacy model, with directors not being bound to pay dividends in most cases, for example, nor being prohibited from using funds for various business development investments or even for philanthropic purposes. Managers' hands may not necessarily be as firmly tied to short-term share price optimization as is often assumed.

Given the need for managers to understand the law, both as a prerequisite to compliance and as one of the foundations for effective market functioning, this Teaching Module of teaching materials on “What the Law Allows” provides both full length case studies and shorter case examples, supplementary student readings, background faculty readings and teaching topics that may be inserted into courses on Business Law, Strategy, Finance, General Management and Leadership.

Click here for Teaching Questions that guide this module.
Click Here to view a comprehensive and detailed table of contents for this collection, or see below for a brief version.

READINGS FOR STUDENTS – WHAT THE LAW ALLOWS
- “The Fiduciary Responsibility: A Legal Perspective” by Lynn Sharp Paine
- “When companies put shareholder second" by Michael Skapinker
- “M&A Legal Context: Basic Framework for Corporate Governance” by Carliss Y. Baldwin, Constance E. Bagley, and James W. Quinn
- “The Devil Made Me Do It: Replacing Corporate Directors' Veil of Secrecy with the Mantle of Stewardship” by Constance E. Bagley and Karen L. Page
- “The Social Responsibility of Boards of Directors and Stockholders in Change of Control Transactions: Is There any “There” There?” by Leo Strine
- “Reforming Corporate Governance: What History Can Teach Us” by Margaret M. Blair
- “Bad and Not-So-Bad Arguments for Shareholder Primacy” by Lynn A. Stout
- “Shareholder Value, Corporate Governance, And Corporate Performance: A Post-Enron Reassessment of the Conventional Wisdom” by Margaret M. Blair
- “Managerial Duties and Business Law” by Jerry Useem and Joseph L. Badaracco Jr.
- “Deception in Business: A Legal Perspective” by Lynn Sharp Paine and Christopher M. Bruner

CASE – TAKEOVER SITUATION
- “Veridian: Putting A Value on Values” by Rakesh Khurana, Joel Podolny, and Jaan Elias
- "Share Price as a Poor Criterion for Good Corporate Law" by Lynn Stout
- "A Team Production Theory of Corporate Law" by Lynn Stout and Margaret Blair
- "When the Existing Economic Order Deserves a Champion: The enduring Relevance of Martin Lipton's Vision of the Corporate Law" by Leo Strine and Bill Allen
- "First the Merger, Then the Mess," by Steven Pearlstein

CASE EXAMPLE – TAKEOVER SITUATION
- “Shareholders should not always come first” by Lynn Stout
- “Verizon Wins Bidding for MCI: Qwest Drops Out As Industry Consolidates, Higher Rates Are A Worry: A Governance Test Case” by Jesse Drucker and Almar Latour
- “MARKETPLACE: As Maytag Chooses a Suitor, It's Not All About the Money” by Andrew Ross Sorkin

READING WITH EMBEDDED CASE EXAMPLE – NON-TAKEOVER SITUATION
- “Corporate Conduct That Does Not Maximize Shareholder Gain: Legal Conduct, Ethical Conduct, the Penumbra Effect, Reciprocity, The Prisoner's Dilemma, Sheep's Clothing, Social Conduct, and Disclosure” by Melvin Aron Eisenberg

CASE EXAMPLE WITH SUPPLEMENTARY READING FOR STUDENTS – PENSION INVESTORS AND THE FIDUCIARY RESPONSIBILITY
- “Institutional Investors Find Common Ground with Social Investors” by Timothy Smith
- "UNEP Finance Initiative: Innovative Financing for Sustainability" by Freshfields, Bruckhaus, Deringer
- “Investing in Socially Responsible Companies is a Must for Public Pension Funds – Because There is no Better Alternative” by S. Prakash Sethi
- “California PERS (A, B) James E. Sailer and Katharina Pick
- “The Social Responsibility of Boards of Directors and Stockholders in Change of Control Transactions: Is There any “There” There?” by Leo E. Strine Jr.

CASE EXAMPLE WITH FACULTY BACKGROUND READING – CORPORATE PHILANTHROPY
- “Tsunami: the backlash. A troubling paradox about corporate philanthropy has surfaced. Is such largess even legal?” by Malcolm Maiden - “A Contractarian Defense of Corporate Philanthropy” by Margaret Blair
- “Corporate Conduct That Does Not Maximize Shareholder Gain: Legal Conduct, Ethical Conduct, the Penumbra Effect, Reciprocity, The Prisoner's Dilemma, Sheep's Clothing, Social Conduct, and Disclosure” by Melvin Aron Eisenberg

Click here to view a comprehensive and detailed table of contents for this collection, or see below for a brief version.