Professor Bainbridge on Fiduciary Responsibility

Professor Bainbridge bangs a drum I’ve been beating here for some time and writes on corporate fiduciary responsibiliy, his area of academic research:

General welfare laws designed to deter corporate conduct through criminal and civil sanctions imposed on the corporation, its directors, and its senior officers are more efficient than stakeholderist tweaking of director fiduciary duties. By virtue of their inherent ambiguity, fiduciary duties are a blunt instrument. There can be no assurance that specific social ills will be addressed by the boards of the specific corporations that are creating the problematic externalities.

When you insist that corporate directors’ fiduciary responsibilities be extended to address all sort of social goods, the good of society as a whole, while absolving legislators and regulators from any responsibilities whatever, you arrive at a destination very much along the lines that we see now. Large corporations do pretty much whatever they care to, with a confidence rooted in experience that they’ll be allowed to skate on their responsibilities, small companies will either have their doors closed by regulators or close their doors themselves because they can’t compete under a set of regulations that were written with the biggest companies in mind, entrepeneurs will be discouraged from forming new companies, and regulators will look the other way at the most egregious offenses of the largest companies, not wanting to threaten their prospects for future employment.

Contrariwise, I agree with Professor Bainbridge:

The social obligation of business is to sustainably maximize long-term profits for shareholders. Nothing more. Nothing less.

that businesses whose managers can’t live up to these fiduciary responsibilities should be allowed to fail, and that regulators’ incentives should be aligned in such a way that they are more likely to satisfy their own fiduciary responsibilities.

22 comments… add one
  • steve Link

    I tried yesterday to make it through his series on this topic. Too much for me. I think he is correct that we should not expect moral behavior from business, just maximizing profits for shareholders. The part I wish he would have addressed more is what happens when corporations, especially banks, instead maximize short term profits. What happens when they maximize returns for management? I think that when people have a stunted internal moral compass, (ever read Snakes In Suits?) it makes external constraints more important.

    I did make it through Bill Black’s work on the GSEs, which covers some of the same issues, but in a more narrow way. A good example of maximizing short term gains for the gains of management.

    http://neweconomicperspectives.blogspot.com/2011/02/wallison-is-far-too-kind-to-fannie-and.html

    Steve

  • The part I wish he would have addressed more is what happens when corporations, especially banks, instead maximize short term profits. What happens when they maximize returns for management? I think that when people have a stunted internal moral compass, (ever read Snakes In Suits?) it makes external constraints more important.

    I could not agree with this more, Steve. That’s why I keep harping on the importance of the incentives and behavior of the regulators.

    And IMO corporate governance is an extremely important issue. When stock values are rising rapidly, buoyed by a generally rising stock market, top management has too frequently found short term returns from sales of stock irresistibly tempting. But it’s not managing—it’s a form of looting.

  • Maxwell James Link

    “If we make America the best place to do business, businesses should make their mark in America. They should set up shop here, and hire our workers, and pay decent wages, and invest in the future of this nation. That’s their obligation.”

    Clearly your blog has had an influence on me, because I took one look at that statement and thought “That’s not corporate social responsibility, that’s Fordism.”

  • Yes, it is. 😉

    One of my persistent complaints is that American politicians, Republican and Democratic, are mired in the 1950s, at least in their thinking about business, economics, and organization structure.

  • Drew Link

    Well, well, well.

    As a small businessman, the paragraph that starts “When you insist that corporate directors’ fiduciary responsibilities be extended to address all sort of social goods” couldn’t sum up my views any better. I applaud you, Dave. And to put an exclamation point on it, we now have Obama and Immelt doing the wild thing – admittedly in a high class hotel – just as I often lament. What could go wrong?

    However, the inevitable co-point always seems to be missed. This is why government intervention and regulation must be minimized as much as possible. This is anathema to the left, who want to control/punish business through govt intervention at every turn without ever considering they are simply setting up the mechanism for the worst of business – Big Business – to rig the game.

    Its a sad, but fascinating, dynamic to watch. So now we have Obama – the archetypal master planner – trying to fix things with………The General???!!!???

  • sam Link

    Yeah, well, as I said over at OTB, when businesses stop rent-seeking, I’ll entertain the idea that they don’t have a social responsibility.

  • I don’t think you see the problem with that statement, sam, so let me try to explain it to you. Rather than using jargon and buzzwords, let’s use plain English. Rent-seeking is simply corporate management looking out for the best interests of the company or, unfortunately, sometimes their own best interests at the expense of the company.

    When you re-phrase it that way it becomes “when businesses stop looking out for their own best interests, I’ll entertain the idea that they don’t have a social responsibility” which is obviously nonsense. It’s absurd to demand of corporate managers that they abandon their fiduciary responsibilities in favor of the political whim of the moment.

    Here’s what I favor: align the incentives of managers, politicians, and regulators so that they’re all doing what we want them to do. Simple to say, much harder to do.

    Companies will always seek rents and the bigger the company the more successful it will be in extracting them. Expecting them not to do so is trying to change human nature.

  • sam Link

    I was using the term ‘rent-seeking’ in the sense of getting government to grant them all manner of tax breaks, subsidies, depletion allowances, writeoffs, and what not. That kind of rent-seeking.

  • So was I. If a manager can secure a tax break, subsidy, etc. that benefits his company, it’s his fiduciary responsibility to do so. Expecting him not to do so is expecting him to act against the company’s interests.

    Who determines what social responsibility entails? My answer is that

    1. We encode the minimum requirements for socially responsible managers into law.
    2. Regulators enforce it.
    3. Anything that’s not encoded into law or enforced is optional.

    Failure to execute the first is a failure of the Congress and failure to execute the second is a failure of the executive branch. What’s the alternative? Guess? Hope?

  • sam Link

    My point is, to the extent the companies are able to extract rents from the government, to that extent they have a responsibility to those who underwrite the rents extracted, that would be us. How this responsibility, social if you want, is discharged is debatable. That the responsibility exists is, I think, not debatable.

    And don’t get me wrong, I do agree that they will always try to extract rents in the sense you and I agree on. I said over at OTB, and sincerely mean it, there is is a sense in which one can argue that the US Constitution is the most elegant response to rent-seeking in the history of mankind. There has always been a business-government nexus in our country. There always will be. It’s how the country was set up. It was no accident that the first piece of substantial legislation passed by the first congress was a tariff act. I have no problem at all with this. I only have a problem with those who think that rent-seeking is aberrational, that in the natural order, government and business would be walled off from one another, no benefits asked, none granted. Never, ever, gonna happen.

  • My point is, to the extent the companies are able to extract rents from the government, to that extent they have a responsibility to those who underwrite the rents extracted, that would be us. How this responsibility, social if you want, is discharged is debatable. That the responsibility exists is, I think, not debatable.

    Without a mechanism that’s just wishful thinking.

    What I think you’re missing is that managers have a hierarchy of responsibilities and their highest responsibility as managers is to the company and its stockholders.

  • Maxwell James Link

    Dave,

    If a manager can secure a tax break, subsidy, etc. that benefits his company, it’s his fiduciary responsibility to do so.

    I agree in principle, but that opens a can of worms. Because corporations – especially large ones – don’t just operate within the law, but influence its passage. One could easily argue that it then becomes management’s duty to lobby the government to rewrite the legal code in a way that most benefits the corporation.

    And companies or industries which do that tend to become those which become the most enmeshed with government, and thereby the most problematic to a functioning capitalist economy. That’s a pretty major negative externality they create in so doing.

    I’m not suggesting I know what the solution to this is, although I suspect, like you, that it is more the responsibility of the law than of good corporate behavior. But it makes me pretty skeptical of rhetoric like Bainbridge’s, who on the one hand places all responsibility on the legislator and regulator, but on the other hand argues for a broad notion of corporate personhood. And who himself expresses a lot of skepticism about the value of regulation in pretty much all other instances.

    I’ll also add that I suspect part of the reason “corporate social responsibility” has come into vogue in the past two decades is because of the decline of the Fordist compromise. Something had to move into its place, and that’s what we got.

  • sam Link

    “Without a mechanism that’s just wishful thinking.”

    It’s a moral argument, Dave.

    “What I think you’re missing is that managers have a hierarchy of responsibilities and their highest responsibility as managers is to the company and its stockholders.”

    Surely that’s not an empirical conclusion. It has to be the conclusion of a moral argument, and I’ve yet to see such an argument.

  • steve Link

    ” This is why government intervention and regulation must be minimized as much as possible.”

    If they function as Bainbridge wrote, then they need few regulations, as long as we are really talking about small business. Banks need lots of regulation as they have repeatedly (Lord Acton anyone?) shown they cannot or will not behave in a sustainable, long term manner. The rest of business is somewhere in between.

    I would even favor true partnerships having virtually no regulations. Since the partner face personal liability, there is much less need for regs. For LLCs, we need to provide for negative externalities.

    Steve

  • Yeah, well, as I said over at OTB, when businesses stop rent-seeking, I’ll entertain the idea that they don’t have a social responsibility.

    This is foolish because firms engage in rent seeking when the government has discretionary power to intervene on their behalf. Remove that power and there is no incentive for rent seeking. Expecting firms to not engage in rent seeking when there is the opportunity is to expect firms to not engage in activities that are in the firm’s best interest, which as Dave points out is not reasonable. Upper management at each firm will be thinking, “If we don’t do it the competition will then we are screwed.”

    Further, rent seeking is not a good strategy in that it can hamper long term economic growth, could lead to bad investments and possibly even bubbles since it distorts various price signals. In other words, rent seeking is more than simply transferring income from one group to another, it is reduced economic efficiency and growth.

    With the Progressive movement and the ever expanding interpretation of the Commerce Clause we’ve basically ensured that rent seeking is a viable way for firms to behave. In short, if Progressives are bemoaning rent seeking they have only themselves to blame.

    Maxwell,

    I agree in principle, but that opens a can of worms. Because corporations – especially large ones – don’t just operate within the law, but influence its passage. One could easily argue that it then becomes management’s duty to lobby the government to rewrite the legal code in a way that most benefits the corporation.

    Absolutely. You don’t think this happens today? Where do you think Larry Summers will toddle off too when he is done with the Obama Administration? Back to Wall Street and his multi-million dollar/year job? That’s my guess.

    And companies or industries which do that tend to become those which become the most enmeshed with government, and thereby the most problematic to a functioning capitalist economy. That’s a pretty major negative externality they create in so doing.

    Quite so. The economy in the U.S. is not really capitalist, but more like corporatist. The goals of government and big business become intertwined. Example: the bailouts for financial firms under Bush, and Obama’s bailout of GM and Chrysler. And yes, look around at the current problems…pretty major negative externality, IMO.

    I’m not suggesting I know what the solution to this is, although I suspect, like you, that it is more the responsibility of the law than of good corporate behavior. But it makes me pretty skeptical of rhetoric like Bainbridge’s, who on the one hand places all responsibility on the legislator and regulator, but on the other hand argues for a broad notion of corporate personhood. And who himself expresses a lot of skepticism about the value of regulation in pretty much all other instances.

    Don’t forget the market is a regulator as well. Fail to generate profits or at least cover costs and the market will regulate you right out of existence. Now we have a government that prevents that from happening if you are big enough to be able to get their attention, and one way to get big is via rent seeking.

    And you are right the solution is not obvious because when you get right down to it, it would require politicians to give up power that they have used and benefited from. Case in point,

    Following his election defeat, Daschle took a position with the lobbying arm of the K Street law firm Alston & Bird. Because he was prohibited by law from lobbying for one year after leaving the Senate,[27] he instead worked as a “special policy adviser” for the firm.[28][29]

  • sam Link

    @Verdon
    “This is foolish because firms engage in rent seeking when the government has discretionary power to intervene on their behalf. Remove that power and there is no incentive for rent seeking.”

    Did you miss the part of my comment wherein I said our system of government was created in such a way as to ensure rent-seeking?

    See my February 7, 2011 at 2:34 pm

  • PD Shaw Link

    steve, individuals in a corporation aren’t shielded from personal liability for misconduct they were actively involved in. That notion is in the first sentence of the excerpt from Bainbridge. Doctors don’t get to escape personal liability for malpractice by pleading they were working for a corporation.

    I believe the perceived limitations on personal liability are three: (1) Wrongdoing in a large business is usually diffused and often lies most closely to lower level employees. This upsets people who want to hang the guy making seven figures, but he’s not usually actively involved in any one thing. (2) The liability risks are insured over. This is often required by laws, that value compensation to the victims over the risk of moral hazard. I also suspect that if we prohibited insurance, we would end up with less qualified people, but I think prohibitions on insurance where specific damage-wielding victims are not apparent is worth considering. (3) The rules aren’t clear in many areas, and I don’t think they can be. Most rules are only written clearly to avoid an historic problem and for future problems tend to be written as “thou shall take reasonable steps to avoid X.” Such a general prohibition by nature is going to diffuse responsibility and make enforcement difficult.

  • PD Shaw Link

    I admit I couldn’t chug through the Bainbridge piece. The premise seemed odd. First, Obama is reaching out to all business, not just corporations. The immediate conflation of business with corporations seems part of a larger problem.

    Second, fiduciary responsibilities are owed in all kinds of relationships, partner to partner, doctor to patient, lawyer to client. (Look at wikipedia for the entire list) And while the precise duties differ, the basic construct I believe is that a person in a superior position has an obligation to avoid benefiting themselves to the inferior’s detriment. Since this is arguably a question of judgment, imposing additional duties on the relationship gives the person in trust more leeway to work out the different angles to his or her benefit. That, I believe is the problem with monkeying with notions of fiduciary responsibility.

  • john personna Link

    I think when all is said and done, this modern recognition of wider “stakeholders” is just a recognition that what goes around, comes around.

    What may seem in shareholder interests now, may actually destroy shareholder equity 10 or 20 years later, as citizens notice … well, what’s in their drinking water, for instance.

    We dress it up in the short term, or decry it as an unfair burden in the short term, but the harsh reality is that none of these corporations would look beyond shareholder value … if they thought they could truly pull it off.

    Why does Apple care about the plight of Chinese workers? Well, they only care to the extent that they think it might swing around and clobber them.

  • steve Link

    PD- Let me clarify. I am less concerned about fraud, though I think corporate CEOs get away with that also, than I am with risk management. Management can concentrate on short term profits, benefitting themselves, while harming the corporation and others. They are immune to attempts to recoup those losses unless you can actually prove fraud. The corporation gets sued, but the perps walk. I was in a partnership for a year before we incorporated. We were very aware of what other partners did and aware of risk.

  • Did you miss the part of my comment wherein I said our system of government was created in such a way as to ensure rent-seeking?

    Actually it wasn’t. Judicial activism on the part of FDR, the New Deal and the progressive movement created that problem. Now there is nothing the government cannot regulate and given that big business and government are more entwined than ever, guess what that kind of bone headed thinking has set up….a situation where regulations favoring big business can be implemented via rent seeking.

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