For my whole life, I’ve heard that it is legally required for corporations to make as much profit as possible for shareholders or else they could face repercussions. I’ve seen all kinds of debates on whether this is true or not, but never any actual facts. Is there actually a law that says this? If so, does anyone have an actual citation? If a shareholder actually tried to take a corporation to court for this, what law would they claim was violated? Also, it seems a very difficult thing to define. There is almost literally an infinite number of things a corporation could theoretically/potentially do to produce profit, but many of them are stupid or not in the company’s product line. Could a shareholder take a cookie company to court for failing to pursue profit in making machine parts? Is there any way to really prove whether this meme is true or not? Thanks.
You can prove that it is true by actually providing some proof that it is true. As you state, on its face it is nonsensical, so that might be a good indication on its veracity.
Great question, thank you. I look forward to some discussion…
The board and corporate officers do have a fiduciary duty to the shareholders. That’s basic law and isn’t just a meme.
Now… maximizing profit is different from a fiduciary duty. They are similar, perhaps, but not the same. Fiduciary duty means that you are reasonably managing the assets of another person in accordance with their wishes.
Absolutely maximizing profit is not fiduciary duty. That’s where the meme gets it wrong, I think. If a CEO makes a 3% profit in cookies instead of a 20% profit in machine parts, he’s probably still considered to have fulfilled his fiduciary duties in the context of managing a cookie-making corporation.
Also keep in mind that the shareholders have a variety of ways to direct the company - electing a board of directors and approving or modifying bylaws, for example. Many companies have bylaws that limit the industries or products they’re involved in. More than that, shareholders could write a set of bylaws that says “10% of company assets will go to charity every year, and we only expect enough profit to replace the donated assets.” A CEO who says “Forget charity! Forget cookies! I’ll make you rich instead!” will have also failed in his fiduciary duty. Honestly, doing that would be just about as bad (legally) as stealing all the company’s money.
If you’re looking for more information, just Google “breach of fiduciary duty” and you’ll see tons of links. Just for starters, here is a real lawsuit brought by a shareholder against the management of Groupon.
Besides what ^^he said, such things are generally a matter of civil law, not criminal law. IOW, it’s the kind of thing you’d get sued for, not the kind of thing you go to jail for.
Authorities dealing with this are going to vary depending depending on what jurisdiction you’re dealing with, obviously. There’s a general common-law rule that company directors owe a duty to act in the best interests of the company, “the company” being in many circumstances equated with the shareholders as a whole. In many cases this translates into a duty to maximise the value of the shares, but not always. For instance, it’s not in the best interests of the company that it should break the law, even if doing so would maximise shareholder value.
The Dodge v. Ford decision is the origin of this belief. However, as Wikipedia summarizes:
Yes, I think what you are looking for is the “Business Judgment Rule”. As long as the corporation’s decisions were reasonable under any reasonable definition of “reasonable”, they are not questionable. After all, there are many “stupid” corporate ideas that ended up making lots of money, and plenty of ideas that sounded great on paper (cough Commodore Amiga cough) that didn’t.
There are some rules about this. For example, corporations (somewhat surprisingly) may not build up huge cash reserves unless they actually require that liquidity for an upcoming investment. The directors may all think it would be nice to have a big rainy-day fund, but notwithstanding the business judgment rule courts will order the corporation to disburse the accumulated funds as a dividend, use them to buy back outstanding shares, or to otherwise reinvest them in the enterprise.
This is probably going to be a big issue in the near future, since the largest US corporations are currently hoarding foreign earnings to avoid taxation and eventually large shareholders are going to demand that the money be repatriated so they can get a bigger dividend. Something similar happened in the mid-2000s.
Huh. In certain industries, there’s no guarantee any particular investment will succeed and the cost to develop a new product line is immense. I’m thinking of Apple Computers here. If people all got bored of iphones and Apple has to invent something new, Apple might have to invest 10 billion on 10 different ideas to actually find something people really want.
Sure. And if the board says, “we need this money for R & D on projects X, Y and Z,” they are in the clear. They just can’t hoard cash just because.
The usual application of this rule is - the management or board can’t do things that make them rich at the expense of the other shareholders, or the company’s ongoing financial health. The management team is hired to run the company for the shareholders, and the board is elected by the shareholders to look after their interests.
The management therefore cannot make decisions that make themselves (or friends and cronies) rich at the expense of the shareholders. Borrowing and putting the company heavily in debt to pay the CEO’s exorbitant salary, for example -not good. Buying overpriced real estate from the board’s relatives, creating excessively large number of extra shares for the CEO, etc.
The usual use of this meme is “this is why the company cannot give its money to charity, give a bunch of customers a break on price, etc…” Yes and no. Some charity is normal for companies, it adds to shareholder value by increasing “goodwill”, the value of the company. Giving ALL the profits to charity, even if the CEO does not make himself rich, is likewise not proper work of the company management.
Even if the board on behalf of the shareholders decide to give away the store… the rules for wall street are very strict on protecting the little shareholders. If, say, the 3 large shareholders who don’t need the money decide (since they have a majority) to do something that hurts the multitude of smaller shareholders, they may be sued and may be liable. After all, people bought shares in the company expecting dividends and that the shares hold their value.
So what CAN a management or board do? This is where the court arguments over the word “reasonable” come into play. The board can do what’s reasonable in the circumstances. The usual application of this meme also involves the board and management playing it safe, rather than doing what they feel like and finding out later if the court thinks it was “reasonable”.
Sure, but does Apple really need $200 billion in cash for that?
Lynn Stout takes on this legend in the Shareholder Value Myth (2012). I opened a GD thread on the subject about a year ago:
Right. There are circumstances in which the Board can make a reasonable argument that giving company money away to charity was a reasonable move to enhance long-term shareholder value, for example by positioning the company in the marketplace as a socially-virtuous company. In a sense, they could characterize it as a form of advertising, hoping that future customers will think, “Hey, I can buy from BigCo or SuperInc, but isn’t BigCo that company that builds all of those orphanages in Africa? That’s really great, what has SuperInc done lately except for get caught in accounting scandals? I guess I’ll buy a BigCo product.”
Also worth mentioning are Benefit Corportations which are explicitly about not maximizing shareholder value and hold certain legal protections that allow them to perform a social mission laid out in their charter.
Kickstarter, for example, just recently converted itself into a Benefit Corporation.
Correct. I read the whole thread to jump in at the end to say this. 
That is the basic Business Judgment Rule. As long as what you are doing is reasonable to promote the health of the on-going enterprise, then a court will not invalidate your actions, nor would your actions be considered a breach of a fiduciary duty to shareholders. Yes, the reason for the corporation is to make money for the shareholders. Period. But the idea that a CEO or the board must do absolutely everything (even legal things) to maximize every penny for shareholder wealth is an improper extension of that fact.
There are short term and long term strategies. Many circumstances would dictate that a policy might forego some short term wealth for greater returns in the long term. There is also the idea that part of being a corporation is to act like responsible citizens and participate in local charities, little league teams, and the like, just like society expects but does not require of good citizens.
It not only promotes good will among customers, but says that we are acting like good, responsible citizens, giving back to the community we live in. I think Milton Freedman disputed that idea, but it is a reasonable one. And one I think certainly wouldn’t subject the CEO or the board to a lawsuit.
ETA: Likewise, if the board said “Fuck the Boy Scouts and the Little League team, we want $$$$money$$$!!!” it would also be a proper business judgment.
Not sure it’s a meme. While you set out the legal position, in practice it’s about profits - what is it that gets reported on the news and what is is that the board’s bonuses and dividends are based on? It sure isn’t fulfilling the fiduciary duty.
It’s what goes in pockets that counts.
It was obviously not true when some fashionable companies were divesting from apartheit South Africa. Socially-conscious investors were electing to accept unmaximized profits in exchange for geo-political leverage.
However, the title question of the thread is about whether it is or not a *legal *obligation to maximize profit/share value by any lawful means opportunity provides. And that the question is asked means there IS general misperception that it would be somehow a dereliction to not do so.
What the corporate leadership do in practice or what shareholders demand is a different matter.