There exists a commonly held misconception that the law in the United States and the United Kingdom requires public companies to maximise shareholder value. This article debunks this myth.
The myth’s origins
The myth that the law requires company directors to maximise financial value for shareholders can be traced back to the Michigan Supreme Court’s 1919 decision in Dodge v Ford Motor Company. Horace and John Dodge, minority shareholders at Ford Motor Company, had started a rival car manufacturing company called Dodge Brothers Company. The Dodge brothers needed money to expand their competing business. Aware of their plans, Henry Ford, majority shareholder at Ford Motor Company, decided against paying dividends to shareholders, seemingly in order to offer lower prices to consumers and higher wages to employees. The Dodge brothers sued. The Michigan Supreme Court ruled against Henry Ford and ordered him to pay dividends to the minority shareholders. The Court made the following remark: “… a business corporation is organised and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end”.
This is the remark most commonly relied on by advocates of the shareholder primacy model. In terms of legal significance, the remark is mere “dicta”; it is incapable of creating legal precedent. Furthermore, Ford Motor Company was, at the time, a closely held (private) company, not a public company. Company law treats public and private companies differently. The case concerned the duty a controlling majority shareholder owes to minority shareholders. It was not a judgement pertaining to corporate purpose, nor directors’ duties. Delaware courts, the leading American jurisdiction on matters of corporate law, have never cited Dodge v Ford in judgements dealing with the question of corporate purpose.
Judicial interpretation in the US
In fact, courts have consistently refused to hold directors liable for failing to maximise shareholder value. The “Business Judgement Rule” affords directors the discretion to act in the manner they deem most appropriate, provided their actions are not tainted by personal conflicts of interest. In Shlensky v Wrigley, a famous American case, the firm that owned the Chicago Cubs baseball team refused to hold games at night, even though this would have increased profits and value. The director, Mr Wrigley, argued that installing lights for the games would disturb the peace of the surrounding environment. Mr Shlensky filed a derivative action against the director. The court ruled that, notwithstanding the alleged increase in shareholder value, it was not the role of the court to make business judgements when no evidence of fraud, illegality or conflicts of interests was present.
In the Delaware case of Air Products Inc v Airgas Inc., the directors of Airgas refused a lucrative takeover bid by Air Products, even though that would have increased the value of the company’s share significantly. The Delaware court maintained that it is to the directors’ discretion to decide what is in the company’s best interests in the long term, and that no obligation exists in law to maximise shareholder value in the short term.
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The exception that proves the rule
Advocates of the shareholder primacy model often cite the case of Revlon Inc v MacAndrews & Forbes Holdings Inc, where a Delaware court held the board of directors liable for failing to maximise shareholder value. On close inspection, this case is the exception that proves the rule. Revlon, a public corporation, had decided to go private, meaning that existing shareholders would have to give up their shares. The Delaware court ruled that, under these circumstances i.e. when there is no public corporation whose interests the directors may balance, the business judgement rule no longer applies. The directors must make sure to achieve the best possible price for their shares. The court maintained that so long as directors aim to remain public, they will be protected by the business judgement rule. Only when directors have decided to go private, must they attend to shareholders’ interests above all else. It is wrong to suggest the existence of a general duty to put shareholders first.
In 2014, the United States Supreme Court voiced its position in no uncertain terms. In Burwell v Hobby Lobby Stores Inc., the Supreme Court stated that “Modern corporate law does not require for profit corporations to pursue profit at the expense of everything else”.
The UK approach
The UK, under its enlightened shareholder value model, has placed no statutory duty on directors to maximise shareholder value. In fact, Section 172 of the Companies Act 2006 provides that directors must promote the success of the company for the benefit of its members as a whole whilst considering the interests of a number of stakeholders such as employees and suppliers. In Shepherd v Williamson, the High Court upheld the business judgement rule by explaining that directors are afforded the discretion to resolve conflicts that arise when corporate decisions may benefit certain stakeholders but harm others.
The above analysis has shown that, contrary to the commonly held belief, directors of public companies are not under a legal obligation to maximise shareholder value, neither in the US nor in the UK.