Tuesday, March 06, 2012

Edward Waitzer on Fiduciary Duty and Corporate Social Responsibility; Are Benefit Corporations a Step in the Right Direction?

Edward Waitzer is a professor and director of the Hennick Centre for Business and Law at York University’s Osgoode Hall Law School and the Schulich School of Business and a senior partner of Stikeman Elliott LLP.
Professor Waitzer has recently written an opinion piece worth careful consideration, Edward Waitzer, The next generation gap: equity and fairness, The Globe and Mail (Toronto, Ont.),  Feb. 21, 2012.  

The subject of the article is sustainability and fiduciary duty, and consequently on welfare maximization and the mechanics of legal, social and financial standards for the exercise of the fiduciary duty of corporate principals.
In the not-too-distant future, we will look back at existing governance frameworks (public as well as private) and think of them as having been, at best, quaint. How did we allow privatized returns to become so untethered from socialized risks? How did we allow the severe imbalances that are likely to preoccupy policy-makers for coming generations? Most agree that we need to find new models to collaboratively address these challenges at a global level. What emerges must focus on addressing inequalities, including those between current and future generations.  (Edward Waitzer, The next generation gap: equity and fairness, supra.).
The social risks are great--the sort of social instability that can lead to political, social, and civil unrest.  (Ibid.).  Professor Waitzer is not alone in this assessment.  Both the Chinese and Norwegian states, coming from very different starting points, have arrived at the same conclusion, which have been applied in the operaitons of their respective sovereign wealth funds.  Both understand the need to frame the context in which corporate decisions are made within the larger imperative of social, political and civil stability.  But the Chinese approach this as a political issue that might be ameliorated through economic policy and the Norwegians see this as an economic issue that must be managed through political policy.Both emphasize a long time horizon for investment decisions.  The Norwegian approach suggests the way in which public and private policies are harmonized in the operating norms of the Norwegian SWF:

The GPFG is a state-owned fund, and is dependent on the trust of the general public in order to achieve a good management of the Fund capital. Accordingly, emphasis must be given to securing broad-based political support for the Fund’s investment strategy, transparency about all aspects of management, and responsible investment practices that take account of good corporate governance and environmental and social factors. Moreover, the Fund depends on legitimacy with other market participants to secure good, stable framework conditions over time. (From Norwegian Ministry of Finance, Report No. 15 (2010-2011): The Management of the Government Pension Fund in 2010, Boks 2.1 Special features of the Government Pension Fund Global).

 (From Edward Waitzer, The next generation gap: equity and fairness, supra.)
Professor Waitzer points to a different cause--irrationality in the service of short term exploitation.
How is it, for example, that the Big Three auto makers were driven to build far more vehicles than the market demanded in the runup to the auto bailouts? One study argues they did so to compete on the hours-per-vehicle metric widely used by investment analysts as an indicator of efficiency. Increasing production also allowed them to keep the costs of excess capacity off their income statements and on the balance sheet in the form of inventory. All in spite of the obvious damage to sustainable performance (and reputation). A recent Bank of England study found that “investment choice, like other life choices, is being returned to a shorter wavelength,” leading to irrational decisions – particularly with respect to projects of longer duration that often yield the highest private (and social) returns. (Edward Waitzer, The next generation gap: equity and fairness, supra.).
Ironically, this critique mirrors, in part, that made by Fidel Castro almost a decade ago in his indictment of the foundations of economic globalization.  Those foundations, Castro suggested, were grounded in part on principles of deliberate overproduction and the cultivation of irrational consumerism with the purpose of reducing the price of goods below their real costs in the developed world and shifting the difference between that price and real costs to the developing world.   The result is a global plantation system maintained through the manipulation of the economic concept of rationality in the service of a particular ideology.  See, e.g.,  Backer, Larry Catá, Ideologies of Globalization and Sovereign Debt: Cuba and the IMF. Pennsylvania State International Law Review, Vol. 24, 2006. Available at SSRN: http://ssrn.com/abstract=880967. For alternative perspectives on globalization and its effects, and particularly on its sustainability, see, Backer, Larry Catá, Economic Globalization Ascendant: Four Perspectives on the Emerging Ideology of the State in the New Global Order. University of California, Berkeley La Raza Law Journal, Vol. 17, No. 1, 2006. Available at SSRN: http://ssrn.com/abstract=917417.
(From Craig Berry,  Which generation should pay for long-term care? Inequalities, April 19, 2011 ("The Dilnot Commission was appointed by Britain’s coalition government in July 2010 to finally deliver a settlement on care funding. . . . "A recognition of inequalities within generations, and of the scale of intergenerational transfers and support within families, is central to the forensic and landmark analysis of intergenerational equity offered by David Piachaud, John Macnicol and Jane Lewis. Piachaud et al also show that intergenerational conflict has a very long history. Inevitably, there will always be a degree of misunderstanding between age cohorts; while different terminology may have been used in the past, since the birth of mass society tension and occasional antipathy have been features of intergenerational relations.))
Rather than focus solely on political equity, Professor Waitzer usefully focuses on a factor that deserves far more attention:
 A key focus in searching for durable solutions must be on intergenerational equity. One reform, discussed at the World Economic Forum in Davos last month, is the need for new leadership norms (in both the political and economic spheres) – striking a balance between older generations and youth.

While our legal systems are infused with the notion of equity and fairness between contemporaries, we have yet to embrace the notion that justice should be facilitated between members of different generations. One exception has been in environmental law. For example, many of the provinces and the federal government have enacted “sustainable development” legislation, designed to improve environmental decision-making. The statutes define “sustainable development” as meeting present needs without compromising the ability of future generations to meet their own needs. (Edward Waitzer, The next generation gap: equity and fairness, supra.).
The problem, Professor Waitzer suggests, is structural: "How can we expect better, longer-term decision-making processes when our legal frameworks are still largely reactive and short-term focused? " (Ibid.).  Consequently, the solution requires restructuring of the assumptions and structures of law, especially in the context of protecting business decisions against claims for breach of the duty of managers and directors.
 One possibility may be to breathe new life into legal norms that have fallen out of favour over time. For example, the fiduciary duty of trustees includes a duty of impartiality, which should require them to balance short-term and long-term considerations. How many today could defend themselves from a claim that future generations are being dealt with in a less than evenhanded manner? Can they demonstrate that they have identified and impartially considered the conflicting interests of beneficiary groups – present and future? Just as law- and regulation-making must generally be accompanied by cost-benefit analysis and “notice-and-comment” procedures, perhaps the time has come to develop a more applied principle of intergenerational equity – requiring legislatures, judges, pension fund trustees and, yes, corporate CEOs and boards of directors to consider and be held accountable for the impact current decisions have on future generations’ interests – each in their particular contexts. (Edward Waitzer, The next generation gap: equity and fairness, supra.).
There it is. Currently, directors and officers may comply with their fiduciary duties when they make decisions that are in the interests of the corporation or its shareholders.  I will not suggest the interesting new efforts to distinguish between duty to shareholders versus duty to entity that is currently being fashioned in some academic circles, other than to note that while the results should be similar in both cases, in the case of a pure duty-to-entity it may be possible to more easily justify decisions that are detrimental to shareholders but advantage the entity.  If that is the case, it is then further argued, directors might embrace a stakeholder maximization model grounded in avoidance of adverse social, cultural, human rights and environmental impacts to the extent that such a model can be justified as advancing the interests of the entity.  
In any case, directors and officers still retain the flexibility to determine which fiduciary model they will invoke to justify their decisions and to avoid liability for breach of their duty.  What Professor Waitzer suggests, in effect, is not the abandonment of fiduciary duty as the basis of managing director and officer conduct, but rather that the flexibility inherent in the concept as currently enforced be narrowed.  Right now, directors and officers can choose short over long term time horizons for making decisions, they may also choose to value the interests of current shareholders over the entity. Directors, though might also consider the long term best interests of shareholders as a class or of the entity, by balancing short and long term considerations.   
Professor Waitzer suggests that what is discretionary be made mandatory; a small modification with potentially substantial effects. "Such a principle would not necessarily put the interests of future generations ahead of our own, but should make those interests more explicit. In doing so, it might generate deeper sensitivity and serve as an effective antidote to the demographic imbalances and broader short-term orientation that challenge us all."  (Edward Waitzer, The next generation gap: equity and fairness, supra.). That future may already be here.  
Yesterday, New York became the 7th state to pass into law legislation that allows the formation of a new and different type of corporation, one that is required to create benefit for society as well as shareholders: The Benefit Corporation. I heard about this from my friend Barb, whose husband's company will apply immediately to be one of NY's first benefit corporations. . . . According to Kyle Westaway, a lawyer who studies corporate forms and represented Launcht, the first company to file and officially become a Benefit Corporation in Vermont, this new class of corporation is a milestone for two reasons:  The law, he says, "broadens the goals of the corporation from [just] profit to: profit, people and planet. Secondly, the Benefit Corporation increases transparency and accountability, by using an independent third party to verify that a business is acting in a socially and environmentally conscious fashion."Another big reason why a Benefit Corporation designation makes a huge difference is that it allows its owners to weigh factors other than just money, should it later be sold. (From Occupying the Future: Benefit Corporations now opening shop in NY, six other states, Daily Kos, Dec. 14, 2011).
It is thus not only possible to realize the approach realized by Professor Waitzer, a number of states in the U.S. have already begun to create the legal architecture to make that possible.  Though it is as yet only an option for those seeking to engage in economic activities, it might provide a step in the direction Professor Waitzer envisions.  For more on benefit corporations: 

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