Lipton vs. Bebchuk

The problem for Lipton is that while Stout and others such as Vanderbilt University law professor Margaret Blair have fleshed out his views with impressive scholarship, their work may lead to conclusions that run counter to his pro-company perspective. For example, if the directors’ duty is to balance the interests of all corporate stakeholders, should they be given explicit guidance on how to go about doing that? And should they be held liable if they fail to do so in some egregious manner? What happens when a company, even unintentionally, rips off creditors, employees, or the community in a way that enriches its shareholders?

Similarly, Bebchuk’s many admirers may rue where they wind up. Governance reformers in the United States have been led by public and labor pension funds that have invoked shareholder rights to demand more accountability from directors, allowing them to score victories such as Sarbanes-Oxley and majority voting agreements at hundreds of companies. But many have waved the shareholder banner largely out of expediency: After all, the argument for more board accountability to stockholders fits snugly into the reigning ethos that a company’s purpose is to maximize value for its owners.

Yet their true beliefs, certainly prevalent among most union leaders, who ultimately hire and fire the union pension fund managers, lie much closer to the stakeholder view, which was widespread among business antagonists such as the anti-globalism forces of the 1990s. Warns Blair: “The labor and public funds are making a tactical mistake using the shareholder-ownership argument. It’s easy to sell, but they’re not going to like the outcome, which will put more power in the hands of private-equity firms and others who have a short-term interest in a company.”

"Shareholders do not 'own' corporations. They own securities - shares of stock - which entitle them to very limited electoral rights and the right to share in financial returns." --Martin Lipton, Wachtell Lipton

While Lipton’s stakeholder view has been gaining some support in the academic and corporate world, it’s unclear whether it will upend the conventional wisdom that a company is the property of stockowners. Indeed, Bebchuk starts his attack by citing a widely quoted 1988 ruling by the Delaware courts that “the shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests.” He points out that corporate law gives boards the authority to hire and fire management and set the company’s overall direction. But there is a parallel relationship, says Bebchuk, in that directors “are expected to serve as the shareholders’ guardians,” so stockholders in turn must have the power to replace them. “The fear of replacement is supposed to make directors accountable and provide them with incentives to serve shareholder interests,” he says.

Bebchuk’s “Myth of the Shareholder Franchise” article goes on to demonstrate just how infrequently U.S. directors are actually challenged, much less unseated. His conclusion: The franchise that shareholders putatively hold under corporate law is in practice, a myth. The remedy he proposes is more expansive than the proxy- access proposal now before the SEC. To turn shareowner power into a reality, he recommends directors be elected by a secret ballot open to rival candidates nominated by shareholders. To put them on an equal footing with the management slate, challengers should be reimbursed from corporate coffers if they receive a threshold number of votes, perhaps a third of those cast.

While Bebchuk hasn’t fully addressed the stakeholder theory directly, he discusses how his proposals would benefit shareholders in his “Myth” article, which appeared in the May Virginia Law Review issue featuring Lipton’s attack as well as articles by Stout; former Chief Justice of the Delaware Supreme Court, E. Norman Veasey, who is now a senior partner at Weil, Gotshal & Manges; and others. While Bebchuk’s focus on shareholders is certainly the mainstream perspective, Lipton and company advance an alternative view.

A “Team Production”

The stakeholder proponents advance their position by rebutting the notion that shareholders have “ownership” of a public company. They point out that a stock purchase conveys none of the traditional rights that come with conventional property ownership. To support this, they cite the following: Shareowners can’t take possession of the company’s assets, nor can they exclude anyone from company property. They do not even fully control the company’s ultimate fate, since directors have the right to decide whether or not to put a possible sale up for a shareholder vote. In this corporate world view, assets are owned not by investors, but by the corporation itself, a legal entity that stands apart from its many, often shifting stockholders. Further, in the event of a default, it is the creditors who own and decide a corporation’s fate, whereas shareholders are left owning valueless shares.