The limited responsibility company, or the tale of the unnatural revolutionary

“If companies do not focus on making sustainable profits by selling useful products and services, and treat their workforce well, our economy will not work fairly for everyone.”

Companies are at risk of losing their connections to the real world. It is some 200 years since the creation of the first limited liability companies in something close to the form that we now know them. The risk now is that some businesses are seeking to be limited responsibility companies.

This is the unwritten thesis between the lines of a radical set of proposals from a remarkably conservative source. Leo Strine does not strike one as a natural revolutionary. Most recently chief justice of the Delaware Supreme Court, he has spent more than 20 years as a judge in that state’s courts — the most important for corporate law because diminutive Delaware made its corporate framework attractive enough that over half of the US’s publicly traded companies are incorporated there. Strine has consistently been a careful jurist who has maintained the status quo more often than move the law forwards. For example, he has consistently reinforced the ‘business judgment rule’ which essentially frees US company directors from challenge to the bulk of their decision-making.

And yet now, Strine is questioning US business’s collective judgment — as the quote that heads this post indicates. Indeed, he is proposing something that for US culture at least amounts to little less than a revolution. This is in a paper published in his last month in office before his recent retirement, for the consistently challenging John Olin Center for Law, Economics and Business at Harvard. In it, Strine puts forward “A Comprehensive Proposal to Help American Workers, Restore Fair Gainsharing between Employees and Shareholders…” and several other things besides. 

The paper is called Toward Fair and Sustainable Capitalism. Naturally, I like the title.

Strine puts forward what he claims to be no less than a new model for capitalism. For this, he adopts the acronym EESG, adding ‘employees’ to the start of the usual ‘environmental, social and governance’. Let’s set aside the issue that employees are central to most people’s understanding of what the ‘social’ in ESG means — perhaps the fact that this is not understood by so smart and thoughtful a commentator as Strine indicates just how much change is needed to US corporate culture. Setting that misunderstanding aside, the proposals are more than worthy of careful consideration.

It is a broad-based manifesto, only some of which I will seek to address this time around. Strine’s proposals include:

• requiring operating companies to give appropriate consideration to and make fair disclosure of their policies regarding EESG issues;
• giving workers more leverage by requiring large companies to have board level committees charged with ensuring fair treatment of employees, enabling works’ councils, and reforming labour laws to facilitate wider union membership and bargaining for fair wages and working conditions;
• changing accounting rules to treat investments in human capital like other long-term investments and require more disclosure of human capital investment;
• that if a company provides quarterly earnings guidance, it must also provide a broader context considering longer-term factors such as EESG;
• requiring institutional investors also to have due regard to EESG, and explain how their policies and practices deliver on this requirement;
• closing loopholes on disclosure of company ownership so that activists must disclose their economic positions in companies promptly and honestly;
• reforming the corporate voting system in a number of ways that Strine suggests are supportive of sustainable business practices and long-term investment; these include transforming the vote on pay from up-to-annual to every four years, making it harder to submit shareholder proposals, and requiring the disclosure of the economic interests in the company of any investor making a shareholder proposal or soliciting proxies;
• improving the tax system to encourage longer-term investment and discourage speculation — not least by extending the holding period for capital gains taxation, ensuring carried interest is taxed at the same rate as other income and establishing a financial transactions tax — with the resulting proceeds being used to green US infrastructure and tackle climate change; and
• reforming corporate political spending and forced arbitration, to level the playing field for workers, consumers, and ordinary investors.

So is Strine right? First, it is fair to say that Strine reserves some strident criticism for institutional investors as well as urging them to put EESG at the core of their work (clearly, he has seen no evidence that they do so already). I will perhaps return to this criticism of investors in a later blog. Second, it is important to note that Strine’s criticism of capitalism is focused exclusively on the US, and it is fair to say that capitalism in the US is very much an outlier, particularly in the area of Strine’s greatest focus, the treatment of employees (workforce may be a better term given that one of the issues with the current version of US capitalism is that some companies carefully structure themselves and their contractual relationships so that the bulk of their workers are not in fact employees). 

The US is an outlier. Much of what Strine proposes in relation to EESG looks very much like the standards expected of UK companies through the modern interpretation of directors’ duties under s172 of the Companies Act. In particular, the Corporate Governance Code now insists that boards in some way ensure that the voice of the workforce is heard at board level, offering ways in which this may be done including by having worker representatives on the board itself, or having a designated non-executive director with the specific role of liaising with staff. Clearly much of this — not least worker representatives on boards — is already in place in much of Europe, and some UK voices are pressing hard for this particular solution to be taken forwards here. Strine’s proposals would only amount to a partial catching up with these approaches.

In part, the US hesitancy over taking account of stakeholder interests in a way similar to that called for in s172 reflects the ongoing misunderstanding that US law insists that corporate boards must focus on shareholder interests alone. This is not actually what US law requires. And US companies make much less disclosure than others on ESG (or EESG) matters, fearing greater exposure to legal action than necessary if they report more than the Securities and Exchange Commission (SEC) strictly requires of them.

In theory, the major US companies have now asserted their belief that stakeholders matter. Through August’s Statement on the purpose of a corporation, 181 US corporate leaders asserted that other stakeholders are as important as shareholders to their businesses. Yet this statement from the Business Roundtable has not been followed by any substantive changes in business approach. Indeed, it has become apparent that those same corporate leaders continue to pursue business as usual; for example it was within days of the issuance of the statement that Amazon (led by signatory Jeff Bezos) decided that its newly acquired Wholefoods should move to withdraw healthcare coverage from hundreds of part-time workers. So much for providing workers with important benefits and for stakeholders more generally (see also Demanding Supply).

Amazon is not alone. Apple, probably the most lauded company of recent years, has prospered by outsourcing its manufacturing, denying much of the responsibility for the lives of those in its supply chain by putting its business at contractual arm’s length from ongoing allegations of mistreatment of workers by, among others, Hon Hai Precision Industry (usually known as Foxconn). Uber has in effect outsourced its whole driver workforce, seemingly absolving it of all responsibility for their earnings or welfare. A couple of years ago I had the privilege of sitting on the panel alongside an anonymised Tesla worker who risked his job by making allegations that the company was irresponsibly risking the health and safety of its workforce in a rush to meet accelerating production targets.

This corporate denial of responsibility to those who create their products and provide their services has to be recognised as wholly irresponsible. 

With the development of such limited responsibility companies, no wonder there is a sense that the corporate world has become disconnected from society. In a very deliberate way, too many companies have sought to be so, cutting the ties that earth them. The company, an invention of law which is really just a nexus of relationships with actors in the real world, is in some cases at risk of morphing into a pure fiction drifting free of all reality. 

Perhaps it is therefore no wonder that the unnatural revolutionary Strine feels the need to rework US capitalism to put workers back at its centre. His proposals offer an interesting step towards reinjecting responsibility into US business, reconnecting companies with the factors that make them part of the real world — most importantly by reconnecting them much more fully with their workforce. His is a lengthy set of prescriptions, but it may be a long journey back from the world of the limited responsibility company.

Toward Fair and Sustainable Capitalism

Accountable Capitalism, Governance

Statement on the purpose of a corporation, Business Roundtable