Another lawyer weighs in Re: Excellent column, but

["Ian Murray" <seamus2001@xxxxxxxxx>]

< http://www.commondreams.org/views02/0119-04.htm >
Published in the January/February 2002 issue of Business Ethics: Corporate Social Responsibility
Report
How Corporate Law Inhibits Social Responsibility
A Corporate Attorney Proposes a 'Code for Corporate Citizenship' in State Law
by Robert Hinkley

After 23 years as a corporate securities attorney-advising large corporations on securities
offerings and mergers and acquisitions-I left my position as partner at Skadden, Arps, Slate,
Meagher & Flom because I was disturbed by the game. I realized that the many social ills created by
corporations stem directly from corporate law. It dawned on me that the law, in its current form,
actually inhibits executives and corporations from being socially responsible. So in June 2000 I
quit my job and decided to devote the next phase of my life to making people aware of this problem.
My goal is to build consensus to change the law so it encourages good corporate citizenship, rather
than inhibiting it.

The provision in the law I am talking about is the one that says the purpose of the corporation is
simply to make money for shareholders. Every jurisdiction where corporations operate has its own law
of corporate governance. But remarkably, the corporate design contained in hundreds of corporate
laws throughout the world is nearly identical. That design creates a governing body to manage the
corporation-usually a board of directors-and dictates the duties of those directors. In short, the
law creates corporate purpose. That purpose is to operate in the interests of shareholders. In
Maine, where I live, this duty of directors is in Section 716 of the business corporation act, which
reads:

...the directors and officers of a corporation shall exercise their powers and discharge their
duties with a view to the interests of the corporation and of the shareholders....

Although the wording of this provision differs from jurisdiction to jurisdiction, its legal effect
does not. This provision is the motive behind all corporate actions everywhere in the world.
Distilled to its essence, it says that the people who run corporations have a legal duty to
shareholders, and that duty is to make money. Failing this duty can leave directors and officers
open to being sued by shareholders.

Section 716 dedicates the corporation to the pursuit of its own self-interest (and equates corporate
self-interest with shareholder self-interest). No mention is made of responsibility to the public
interest. Section 716 and its counterparts explain two things. First, they explain why corporations
find social issues like human rights irrelevant--because they fall outside the corporation's legal
mandate. Second, these provisions explain why executives behave differently than they might as
individual citizens, because the law says their only obligation in business is to make money.

This design has the unfortunate side effect of largely eliminating personal responsibility. Because
corporate law generally regulates corporations but not executives, it leads executives to become
inattentive to justice. They demand their subordinates "make the numbers," and pay little attention
to how they do so. Directors and officers know their jobs, salaries, bonuses, and stock options
depend on delivering profits for shareholders.

Companies believe their duty to the public interest consists of complying with the law. Obeying the
law is simply a cost. Since it interferes with making money, it must be minimized-using devices like
lobbying, legal hairsplitting, and jurisdiction shopping. Directors and officers give little thought
to the fact that these activities may damage the public interest.

Lower-level employees know their livelihoods depend upon satisfying superiors' demands to make
money. They have no incentive to offer ideas that would advance the public interest unless they
increase profits. Projects that would serve the public interest--but at a financial cost to the
corporation--are considered naive.

Corporate law thus casts ethical and social concerns as irrelevant, or as stumbling blocks to the
corporation's fundamental mandate. That's the effect the law has inside the corporation. Outside the
corporation the effect is more devastating. It is the law that leads corporations to actively
disregard harm to all interests other than those of shareholders. When toxic chemicals are spilled,
forests destroyed, employees left in poverty, or communities devastated through plant shutdowns,
corporations view these as unimportant side effects outside their area of concern. But when the
company's stock price dips, that's a disaster. The reason is that, in our legal framework, a low
stock price leaves a company vulnerable to takeover or means the CEO's job could be at risk.

In the end, the natural result is that corporate bottom line goes up, and the state of the public
good goes down. This is called privatizing the gain and externalizing the cost.

This system design helps explain why the war against corporate abuse is being lost, despite decades
of effort by thousands of organizations. Until now, tactics used to confront corporations have
focused on where and how much companies should be allowed to damage the public interest, rather than
eliminating the reason they do it. When public interest groups protest a new power plant, mercury
poisoning, or a new big box store, the groups don't examine the corporations' motives. They only
seek to limit where damage is created (not in our back yard) and how much damage is created (a
little less, please).

But the where-and-how-much approach is reactive, not proactive. Even when corporations are defeated
in particular battles, they go on the next day, in other ways and other places, to pursue their own
private interests at the expense of the public.

I believe the battle against corporate abuse should be conducted in a more holistic way. We must
inquire why corporations behave as they do, and look for a way to change these underlying motives.
Once we have arrived at a viable systemic solution, we should then dictate the terms of engagement
to corporations, not let them dictate terms to us.

We must remember that corporations were invented to serve mankind. Mankind was not invented to serve
corporations. Corporations in many ways have the rights of citizens, and those rights should be
balanced by obligations to the public.

Many activists cast the fundamental issue as one of "corporate greed," but that's off the mark.
Corporations are incapable of a human emotion like greed. They are artificial beings created by law.
The real question is why corporations behave as if they are greedy. The answer is the design of
corporate law.

We can change that design. We can make corporations more responsible to the public good by amending
the law that says the pursuit of profit takes precedence over the public interest. I believe this
can best be achieved by changing corporate law to make directors personally responsible for harms
done.

Let me give you a sense of how director responsibility works in the current system. Under federal
securities laws, directors are held personally liable for false and misleading statements made in
prospectuses used to sell securities. If a corporate prospectus contains a material falsehood and
investors suffer damage as a result, investors can sue each director personally to recover the
damage. Believe me, this provision grabs the attention of company directors. They spend hours
reviewing drafts of a prospectus to ensure it complies with the law. Similarly, everyone who works
on the prospectus knows that directors' personal wealth is at stake, so they too take great care
with accuracy.

That's an example of how corporate behavior changes when directors are held personally responsible.
Everyone in the corporation improves their game to meet the challenge. The law has what we call an
in terrorem effect. Since the potential penalties are so severe, directors err on the side of
caution. While this has not eliminated securities fraud, it has over the years reduced it to an
infinitesimal percentage of the total capital raised.

I propose that corporate law be changed in a similar manner--to make individuals responsible for
seeing that the pursuit of profit does not damage the public interest.

To pave the way for such a change, we must challenge the myth that making profits and protecting the
public interest are mutually exclusive goals. The same was once said about profits and product
quality, before Japanese manufacturers taught us otherwise. If we force companies to respect the
public interest while they make money, business people will figure out how to do both.

The specific change I suggest is simple: add 26 words to corporate law and thus create what I call
the "Code for Corporate Citizenship." In Maine, this would mean amending section 716 to add the
following clause. Directors and officers would still have a duty to make money for shareholders,

... but not at the expense of the environment, human rights, the public safety, the communities in
which the corporation operates or the dignity of its employees.

This simple amendment would effect a dramatic change in the underlying mechanism that drives
corporate malfeasance. It would make individuals responsible for the damage companies cause to the
public interest, and would be enforced much the same way as securities laws are now. Negligent
failure to abide by the code would result in the corporation, its directors, and its officers being
liable for the full amount of the damage they cause. In addition to civil liability, the attorney
general would have the right to criminally prosecute intentional acts. Injunctive relief-which stops
specific behaviors while the legal process proceeds-would also be available.

Compliance would be in the self-interest of both individuals and the company. No one wants to see
personal assets subject to a lawsuit. Such a prospect would surely temper corporate managers'
willingness to make money at the expense of the public interest. Similarly, investors tend to shy
away from companies with contingent liabilities, so companies that severely or repeatedly violate
the Code for Corporate Citizenship might see their stock price fall or their access to capital dry
up.

Many would say such a code could never be enacted. But they're mistaken. I take heart from a 2000
Business Week/Harris Poll that asked Americans which of the following two propositions they support
more strongly:

Corporations should have only one purpose--to make the most profit for their shareholders--and
pursuit of that goal will be best for America in the long run.

--or--


Corporations should have more than one purpose. They also owe something to their workers and the
communities in which they operate, and they should sometimes sacrifice some profit for the sake of
making things better for their workers and communities.
An overwhelming 95 percent of Americans chose the second proposition. Clearly, this finding tells us
that our fate is not sealed. When 95 percent of the public supports a proposition, enacting that
proposition into law should not be impossible.

If business people resist the notion of legal change, we can remind them that corporations exist
only because laws allow them to exist. Without these laws, owners would be fully responsible for
debts incurred and damages caused by their businesses. Because the public creates the law,
corporations owe their existence as much to the public as they do to shareholders. They should have
obligations to both. It simply makes no sense that society's most powerful citizens have no concern
for the public good.

It also makes no sense to endlessly chase after individual instances of corporate wrongdoing, when
that wrongdoing is a natural result of the system design. Corporations abuse the public interest
because the law tells them their only legal duty is to maximize profits for shareholders. Until we
change the law of corporate governance, the problem of corporate abuse can never fully be solved.

Robert Hinkley (rchinkley@xxxxxxxxxxxxxxxxxxx) lives in Brooklin, Maine.