Max Sternberg

As corporate social responsibility becomes a more prominent and permanent interest of a significant portion of U.S. consumers,[1] the Benefit Corporation could become a more attractive investment vehicle, and more Benefit Corporations may begin to go public. A Benefit Corporation is a legal structure that allows for-profit corporations to consider the interests of outside stakeholders in addition to shareholders, and have social purposes that go beyond maximizing share price.[2] In other words, a Benefit Corporation allows a for-profit business to pursue social goods without necessarily breaching fiduciary duties to maximize profits for shareholders. Benefit Corporations are distinguished from nonprofits for many reasons, including the ability of a Benefit Corporation to have shareholders and strive for profits.[3]

In 2017, Laureate Education became the first Benefit Corporation to go public.[4] The idea of a public Benefit Corporation, and now the reality of it, raises a number of issues. For example, how are fiduciary duties applied? In a normal for-profit corporation the corporation’s purpose is to increase profits and maximize value, and there are duties of care and loyalty to the shareholders.  However, the invent of dual purposes muddies the duties that are owed. The duty to protect shareholders and shareholder interests is broader and less clear in a Benefit Corporation due to the additional interests and duties to stakeholders. Even if, as some have argued, the fiduciary duties owed in a Benefit corporation are not significantly different from those owed in a normal for-profit corporation,[5] it is an area that needs to be litigated and fleshed out as more Benefit Corporations go public.

Another potential issue for public Benefit Corporations is the difficulty of avoiding mission drift.[6] It may be difficult to maintain the non-financial mission once public shareholders are allowed to invest in the corporation. While the founders and owners of a corporation may want to pursue a social good, the shareholders who have decided to invest may not share the same vision. Shareholders may push to pursue profits over the social goal of the corporation.[7] By going public the founders give up some control over their vision, and even if shareholders originally invested because of the social mission, there may be drift over time towards a more traditional for-profit goal and purpose structure, especially in the face of shareholder activism.

Not only is there concern that management won’t be able to pursue the social goals of the corporation due to mission drift, but on the either side of the spectrum a Benefit Corporation might weaken shareholders ability to control management, and thus the corporation, through the vote.[8]The corporate voting mechanism relies on shareholders having common, homogenous goals—without a common goal the voting mechanism collapses.[9] This idea was demonstrated by Kenneth Arrow. To illustrate the point here, imagine there are three shareholders with voting rights. Shareholder 1 prefers, in this order, route X, Y, and then Z; Shareholder 2 prefers Y, Z, and then X; and Shareholder 3 prefers Z, X, and then Y. If there is a shareholder vote, and the shareholders vote on X vs. Y, then Shareholder 1 will vote for X, Shareholder 2 will vote for Y and Shareholder 3 will vote for X (her second choice after Z) and X will win 2-1. If the shareholders vote on X vs. Z, Shareholder 1 will vote for X, Shareholder 2 will vote for Z (her second choice after Y) and Shareholder 3 will vote for Z and Z will win 2-1. If the vote is Y vs. Z then Shareholder 1 will vote for Y (her second choice), Shareholder 2 will vote for Y, Shareholder 3 will vote for Z and Y will win 2-1.[10]

 

  Shareholder 1 Shareholder 2 Shareholder 3 Preference 1 X Y Z Preference 2 Y Z X Preference 3 Z X Y

 

As demonstrated, any of the three options could win, depending on the matchup. This means that the group running the agenda can manipulate the vote in order to secure its preferred outcome. If management is running the agenda and wants X to win, they would first put to vote Y vs. Z, which would result on a Y win. The vote would then go to X vs. Y, which X would win. If management wanted Z to win, they would first vote on X v. Y, in which case X would win, and then X vs. Z in which case Z would win. When there is more than one preference the vote becomes meaningless, as it is circular and can be controlled. A vote with multiple interests does not necessarily demonstrate the majority preference, and it becomes an inefficient method for monitoring management.[11]

In a typical for-profit corporation shareholders have the common goal of maximizing share price.[12]This makes shareholders in a typical for-profit efficient managers, because their vote reflects the common goal, even if individual shareholders may disagree on the best way to achieve that goal. Management is held accountable for failure to achieve the goal of maximizing share price. A Benefit Corporation on the other hand can have multiple goals,[13] and may attract investors with divergent interests—shareholders may not share a common goal. Some shareholders may value maximizing the share price, others might value maximizing an environmental goal, and others still might value another social missions of the corporation. As such, a shareholder vote will not accurately reflect shareholders belief in whether a course of action taken by management is the correct action, both because the presence of heterogeneous preferences can be manipulated and because even if multiple options are voted on at once, a majority of 34% does not accurately demonstrate the collective will.

The addition of multiple goals also complicates matters for management, who may become unsure which course of action shareholders will prefer. For example, in a typical for-profit the CEO can be confident that if the share price goes up that is a positive sign for which they will be rewarded. However, in a Benefit Corporation, an increase in share price might not be rewarded by shareholders, especially if it comes at the cost of the social goal. Management may therefore be unsure which goal to pursue in order to please shareholders, creating hesitancy on the part of management.[14] The result may be inefficiencies from management, and increased principle agent costs.

Perhaps as means to avoid the voting issues discussed, Laureate Education issued dual-class stock.[15] Such a method may be effective in solving the issues surrounding voting.[16] This method allows Laureate to raise capital on the market while holding onto voting rights in order to avoid mission drift. This method also helps solve inefficiencies that may occur due to confusion from management on what goal to more actively pursue. Furthermore, assuming the owners and founders who maintain the class with voting rights, this method also may help insure that voting shareholders have the same goals for the corporation as management.

[8] Agency costs and issues of shareholder control are not unique to Benefit corporations (see generally Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305 (1976).

[9] Kenneth J. Arrow, Social Choice and Collective Values (2d ed. 1963); Frank Easterbrook & Daniel Fischel, Voting in Corporate Law, 26 J.L. & Econ. 395, 403 (1983)(“ It is well known, however, that when voters hold dissimilar preferences it is not possible to aggregate their preferences into a consistent system of choices. If a firm makes inconsistent choices, it is likely to self-destruct.”).

[10] Kenneth J. Arrow, Social Choice and Collective Values (2d ed. 1963).