Corporate Constituency Statutes and Employee Governance

William Mitchell Law Review Volume 30 | Issue 4 Article 1 2004 Corporate Constituency Statutes and Employee Governance Brett H. McDonnell Follow this and additional works at: http://open.mitchellhamline.edu/wmlr Recommended Citation McDonnell, Brett H. (2004) "Corporate Constituency Statutes and Employee Governance," William Mitchell Law Review: Vol. 30: Iss. 4, Article 1. Available at: http://open.mitchellhamline.edu/wmlr/vol30/iss4/1 This Article is brought to you for free and open access by the Law Reviews and Journals at Mitchell Hamline Open Access. It has been accepted for inclusion in William Mitchell Law Review by an authorized administrator of Mitchell Hamline Open Access. For more information, please contact . © Mitchell Hamline School of Law McDonnell: Corporate Constituency Statutes and Employee Governance MCDONNELL-READY.DOC 5/20/2004 7:23 PM CORPORATE CONSTITUENCY STATUTES AND EMPLOYEE GOVERNANCE Brett H. McDonnell† I. INTRODUCTION.................................................................... 1228 II. THE LITERATURE ................................................................. 1230 A. The Statutes............................................................... 1230 B. Arguments Against and For the Statutes ........................ 1232 C. The Effects of Takeovers............................................... 1236 D. Employee Governance.................................................. 1238 III. THE BASIC MODEL ............................................................... 1241 IV. THE THREAT OF A TAKEOVER .............................................. 1244 V. CONSTITUENCY STATUTES AS A SHIELD ............................... 1247 VI. EMPLOYEE GOVERNANCE ..................................................... 1248 VII. CONSTITUENCY STATUTES AS A SWORD ............................... 1250 VIII. DISCUSSION AND CONCLUSION ........................................... 1253 A. Economic models should take into account a variety of stakeholder groups beyond managers and shareholders. .................................................... 1253 B. Although most commentators have concluded that transfers from employees are not an important factor in hostile takeovers, that issue is far from conclusively decided............................................................ 1253 C. There is a redistributive argument in favor of a fiduciary duty favoring employees. .................................... 1254 D. While a revised fiduciary duty and increased employee governance may both help tilt the playing field toward employees, the revised fiduciary duty does so at the cost of lessened discipline of managers, while employee governance provides a new tool for strengthening the discipline of managers...............1255 † Associate Professor, University of Minnesota School of Law. I thank Stephen Bainbridge, Daniel Farber, David McGowan, Lawrence Mitchell, and Paul Rubin for helpful comments on an earlier version of this article. 1227 Published by Mitchell Hamline Open Access, 2004 1 William Mitchell Law Review, Vol. 30, Iss. 4 [2004], Art. 1 MCDONNELL-READY.DOC 1228 5/20/2004 7:23 PM WILLIAM MITCHELL LAW REVIEW [Vol. 30:4 I. INTRODUCTION In whose interests are corporations governed? In whose interests should they be governed? These foundational questions in corporate law have been debated since at least the Berle-Dodd 1 exchange in the 1930s. Most American commentators have asserted a simple answer: the interests of shareholders. The debate flared up in the 1980s as states began to pass corporate constituency statutes. These statutes allow corporate officers and directors to take into account the interests of a variety of corporate stakeholders in carrying out their fiduciary duties to the corporation. The statutes suggest that a corporation should, or at least may, be run in the interests of more groups than just shareholders. The corporate constituency statutes therefore threaten decades of American thinking about the governance of corporations. As a result, many scholarly papers have appeared attacking or defending the constituency statutes. On their face, constituency statutes seem attractive to someone with an interest in employee involvement in corporate governance. However, the statutes were passed in response to the takeover wave of the ’80s, and many commentators have charged that their main intent and effect is to help entrench incumbent managers. This aspect of the statutes is far from attractive (unless you are an incumbent manager). This article tries to sort out these conflicting perspectives. I ultimately conclude that while there are some decent arguments for constituency statutes, and they are not as harmful as many of their opponents feared, they are, all in all, not a good idea. They are a poor substitute for direct employee involvement in corporate governance. This article provides a simple, formal model of the interaction among managers, shareholders, and employees in governing a business organization. Most formal work in corporate governance focuses only on the relationship between managers and shareholders. There has been relatively little formal modeling that includes employees as an important constituency in governance. To ask questions about constituency statutes and employee governance, one must extend that traditional framework. Section II examines the constituency statutes and the scholarly 1. See A.A. Berle, Jr., Corporate Powers as Power in Trust, 44 HARV. L. REV. 1049 (1931); E. Merrick Dodd, Jr., For Whom Are Corporate Managers Trustees?, 45 HARV. L. REV. 1145 (1932). http://open.mitchellhamline.edu/wmlr/vol30/iss4/1 2 McDonnell: Corporate Constituency Statutes and Employee Governance MCDONNELL-READY.DOC 2004] 5/20/2004 7:23 PM CORPORATE CONSTITUENCY 1229 literature on them. It also examines related literature on the effects of takeovers on employees and on employee involvement in corporate governance. Section III presents the basic formal model. A manager chooses how much effort to undertake, which affects both the total output of the firm and benefits personal to the manager. The manager also chooses how much of the total output to allocate to employees rather than shareholders. A variety of mechanisms induce the manager to take into account the effects of output received on both shareholders and employees, but not fully. As a result, the manager tends to set effort too low. Section IV extends the model to add in the effects of a takeover threat. If the amount of firm output allocated to shareholders is lowered, the possibility of a takeover increases, and if a takeover occurs, the manager is punished. As a result, the manager both increases her effort level and allocates a greater fraction of output to shareholders. Shareholders are better off, while the effect on employees is ambiguous. Section V then considers the effect of existing constituency statutes. These statutes allow managers to take defensive (...truncated)