By Jerome Gessaroli
June 9, 2022
In Canada, corporate directors have the duty to act in the best interests of the company. This has, until relatively recently, been interpreted as to making decisions for the shareholders’ benefit – that is, wealth maximizing decisions. Yet some within academia, the legal community and advocacy groups have argued that this focus is too narrow. In addition, in two cases since 2000, the Supreme Court of Canada has stated that directors may also consider the needs of other groups when making decisions, explicitly mentioning “employers, consumers, creditors, governments, and the environment.”
In 2019 the federal government amended the Canadian Business Corporations Act and specifically itemized the groups that companies may consider when determining the corporation’s best interest. The amendments may appear innocuous. However, they show a push towards redefining a corporation’s purpose. The topic may be abstract, but its economic consequences are very real.
There are two competing perspectives vying to define a company’s primary purpose: is it to undertake commerce for the benefit of its shareholders – those that set up and finance the company with risk capital – or to conduct business to look after constituencies that have an interest or stake in the company (i.e., the stakeholders, as mentioned above)? In other words, should companies emphasize wealth distribution (the stakeholder) over wealth creation (the shareholder)?
Some political leaders argue that companies should adopt a new corporate purpose that is more inclusive and sensitive to society’s concerns. They believe that the corporate governance model that corporations have used over the past 50 years is misguided, and that managers are forced to make short-term decisions to maximize the company’s share price. By focusing on shareholder wealth maximization, critics argue, corporate leaders are making myopic decisions that will hurt the company and its stakeholders in the long-run.
This argument disregards the reality that competition and voluntary contracting force businesses to cooperate with their stakeholders even if the company’s goal is to maximize shareholder wealth. Suppliers must receive a sufficient return or they will not deal with the company. Employees must receive competitive wages or they will leave for alternative employment. And customers will simply not buy a company’s product unless it is priced competitively, is of sufficient quality, and provides useful benefits.
There is no conclusive evidence of systematic short-termism. If a corporation’s purpose is to maximize its intrinsic value, by its very definition managers must make appropriate short-term and long-term decisions. And if managers treat stakeholders inadequately, it is not because of a flawed corporate purpose, but because of poor managerial decision-making.
Corporate purpose is the driver that meets society’s needs and wants by competing for human, financial, and natural resources and using them as productively as possible. There is strong evidence and history that shareholder primacy works and contributes to the greater good. Replacing shareholder primacy will abrogate the market discipline imperative that forces managers to act competitively and use corporate resources efficiently – the very elements that create wealth, GDP growth, and a flourishing society.