Fuente: Harvard Law School Forum on Corporate Governance
Autor: Joseph E. Bachelder, McCarter & English LLP
Today’s post discusses the meaning of “corporate purpose” for a business corporation and the role long-term incentive compensation plays in achieving that purpose. (Each business enterprise, of course, will have its own goals and strategies to attain its corporate purpose in its own specific business or businesses.)
The dominant purpose of a business corporation is to create long-term value for its shareholders. Recent commentators have sought to reconcile this corporate purpose with the needs of other “stakeholders”—the corporation’s employees, its suppliers, its customers, its environment and the communities in which it exists. The problem with many of these commentaries is that they confuse the need for good corporate behavior with the fundamental purpose of the business corporation to provide long-term value to its shareholders. Members of a community—whether individuals or entities—are expected to be good citizens of that community. A business corporation is obligated to constituencies of that community based on employment, business and other relationships. But these obligations to such constituencies should not be confused with the fundamental purpose of a business corporation: to provide sustained growth in value for its shareholders.
Business Roundtable Proposes Redefinition of Corporate Purpose. On Aug. 19, 2019, the Business Roundtable issued a statement (signed by over 180 corporate CEOs) regarding the purpose of a corporation as follows:
“Since 1978, Business Roundtable has periodically issued Principles of Corporate Governance that include language on the purpose of a corporation. Each version of that document issued since 1997 has stated that corporations exist principally to serve their shareholders. It has become clear that this language on corporate purpose does not accurately describe the ways in which we and our fellow CEOs endeavor every day to create value for all our stakeholders, whose long-term interests are inseparable.
We therefore provide the following Statement on the Purpose of a Corporation, which supersedes previous Business Roundtable statements and more accurately reflects our commitment to a free market economy that serves all Americans. This statement represents only one element of Business Roundtable’s work to ensure more inclusive prosperity, and we are continuing to challenge ourselves to do more.”
In its new statement of corporate purpose, the Business Roundtable lists what it describes as five “commitments” by a business corporation:
(1) Delivering value to customers.
(2) “Investing” in employees.
(3) Dealing fairly and ethically with suppliers.
(4) Supporting the communities in which a business corporation operates, which includes protecting the environment.
(5) Generating long-term value for shareholders (and committing to “transparency and effective engagement” with them).
In an Aug. 19, 2019 press release, the Council of Institutional Investors responded to the Business Roundtable’s revised statement on corporate purpose. It stated:
“The Council has a productive relationship with BRT [the Business Roundtable] that has included discussion on corporate “stakeholder” obligations, but we respectfully disagree with the statement issued by the BRT earlier today. The BRT statement suggests corporate obligations to a variety of stakeholders, placing shareholders last, and referencing shareholders simply as providers of capital rather than as owners.
CII [the Council] believes boards and managers need to sustain a focus on long-term shareholder value. To achieve long-term shareholder value, it is critical to respect stakeholders, but also to have clear accountability to company owners.
Accountability to everyone means accountability to no one.”
In an article published in 2015, former Delaware Supreme Court Justice Leo Strine commented on stockholder welfare relative to other interests in a business corporation. His comments included the following:
“For Delaware courts to declare that boards of directors have leeway to subordinate stockholder welfare to other interests would involve them making a policy determination jarringly inconsistent with the structure of our law, which has remained focused on stockholders. As an example, when the [Delaware] General Assembly wished to provide an option that would allow for the consideration of multiple interests, it adopted a specific new form of corporation, the benefit corporation, which may be formed for the purpose of putting non-stockholder ends—such as the environment or its workers—on a footing equal to stockholders as ends. (Leo E. Strine Jr., “The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law,” Wake Forest Law Review, Vol. 50, 761, 785 (2015).)”
In the article, former Justice Strine also states:
“If we believe that other constituencies should be given more protection within corporation law itself, then statutes should be adopted giving them enforceable rights that they can wield. The benefit corporation is a modest, but genuine, example of that kind of step forward. Even more, if interests such as the environment, workers, and consumers are to be protected, then what is required is a revival of effective externality regulation that gives these interests more effective and timely protection. (Id. at 792-93.)”
In subsequent commentary, former Justice Strine has discussed the need to protect the interests of constituencies other than shareholders. In fact, he has put forth proposals for changes in the legal system that he thinks would protect those interests. See, e.g., Leo E. Strine Jr., “Toward Fair and Sustainable Capitalism: A Comprehensive Proposal to Help American Workers, Restore Fair Gainsharing between Employees and Shareholders, and Increase American Competitiveness by Reorienting Our Corporate Governance System Toward Sustainable Long-Term Growth and Encouraging Investments in America’s Future,” U of Penn, Inst for Law & Econ Research Paper No. 19-39, Harvard John M. Olin Discussion Paper No. 1018 (October 2019).
In 2013 Delaware amended its General Corporation Law, as noted above, to provide for the creation of for-profit corporations that include as part of their principal purpose the provision of a public benefit, or benefits, to constituencies beyond shareholders. Sections 361-368 of Subchapter XV of Chapter 1, Title 8 of the Delaware Code. In doing that, Delaware established a form of for-profit corporation, a “public benefit corporation,” that formally declares a public benefit, or benefits, as part of its principal purpose. As of the writing of this column, over 30 states have passed similar laws.
The creation in the Delaware General Corporation Law of this new corporate form—a “public benefit corporation”—underscores that business corporations that are not chartered as public benefit corporations (or as other special purpose corporations authorized by statute or regulation) have as their purpose the creation of long-term value for their shareholders and other commitments should be subject to the achievement of that purpose.
Role of Long-Term Incentive Compensation in Supporting Corporate Purpose. Long-term incentive plans (LTIPs) typically include a statement that the goal of the plan is to create long-term value for shareholders. For example, following is a provision in the Cisco Systems 2005 Stock Incentive Plan (as amended and restated effective on Dec. 11, 2017): “The purpose of the Plan is to promote the long-term success of the Company and the creation of shareholder value by offering Key Employees an opportunity to share in such long-term success by acquiring a proprietary interest in the Company.”
By the 1950s, the two most prevalent forms of long-term incentive awards were shares of stock and stock options. Both forms of award usually had time-vesting features. Variants of these forms of stock-based awards were stock unit awards and stock appreciation rights.
In the early 1970s, performance targets were introduced to stock awards (but not to stock options). These performance targets were generally based on financial and/or operational targets. Financial targets typically are based on growth in earnings per share (EPS) or growth in revenues.
More recently (starting in the 2000s) performance targets based on growth in stock value have been introduced to stock awards. An example is total shareholder return (TSR). TSR generally represents the change in stock price plus dividends paid during the performance period.
A weakness in many LTIPs and practices is that they are not truly “long term.” Most “long-term” awards vest and are earned out or paid out within a period of three to four years following the date of the award. Stock options typically vest in the three- to four-year period noted but provide rights to exercise that go for a longer period (a full option term is typically 10 years). The author suggests that a period of five to eight years (as some British companies have done) is a more appropriate period for vesting, performance-based earn-out (if there is one) and required holding period (if there is one) once stock has vested and/or been earned out.
Following are elements that should be associated with an LTIP to encourage its successful contribution to long-term growth in shareholder value.
(1) Clear statement of its purpose. An example of such a statement is that provided by Cisco Systems in its 2005 Stock Incentive Plan and quoted above.
(2) Clear statement as to the components making up the desired corporate performance. As discussed above, underlying components of effective long-term growth in shareholder value include effective management of employees, productive relationships with suppliers and customers and effective interaction with the environment and the communities of which the company is a part. Communities include the governments under whose jurisdictions the corporation exists.
(3) Design and management of LTIP. A Board of Directors, including its Compensation Committee, should be given appropriate tools to incentivize management to attain the various commitments noted above. These tools include guidelines as to size of awards, terms of awards, review and adjustments of earn-outs and pay-outs based on performance.
Conclusion
It is well established under Delaware law that the fundamental purpose of a business corporation is to create long-term value for its shareholders. An exception is made for a business corporation such as a public benefit corporation created under state law or regulation to include as part of its principal purpose the provision of a public benefit, or benefits, to constituencies beyond shareholders.
Business corporations make use of LTIPs for the purpose of providing long-term value for their shareholders. The Business Roundtable, as discussed above, announced in August 2019 that it would include in future statements of corporate purpose a number of commitments. These include commitments to customers, employees, suppliers and communities in which the corporations operate (which include the environment and the governments to whose jurisdictions the corporations are subject). The Business Roundtable puts generating long-term value for shareholders last on this list. This is a mistake. LTIPs should continue to be designed and implemented to support the primary corporate purpose of generating long-term value for shareholders. The other commitments noted above need to be given attention and responded to by business corporations in order to be responsible members of their communities. But these other commitments should not be conflated with the corporate purpose of generating long-term value for shareholders.
