{"id":1253240,"date":"2023-11-16T13:07:03","date_gmt":"2023-11-16T12:07:03","guid":{"rendered":"https:\/\/www.ie.edu\/insights\/?post_type=articles&p=1253240"},"modified":"2023-12-15T09:48:33","modified_gmt":"2023-12-15T08:48:33","slug":"board-as-sovereign-steward-not-shareholders-agent","status":"publish","type":"articles","link":"https:\/\/www.ie.edu\/insights\/articles\/board-as-sovereign-steward-not-shareholders-agent\/","title":{"rendered":"Board as Sovereign Steward not Shareholders\u2019 Agent"},"featured_media":1253242,"template":"","meta":{"_has_post_settings":[]},"schools":[],"areas":[481],"subjects":[416],"class_list":["post-1253240","articles","type-articles","status-publish","has-post-thumbnail","hentry","areas-leadership","subjects-business-and-finance"],"custom-fields":{"wpcf-article-leadin":["Sovereign boards of directors that use their judgment to understand an organization's best interests are key to generating credibility, write Mikko Ketokivi and Liisa V\u00e4likangas."],"wpcf-article-body":["Those in positions of power must not use their positions to serve their own interests. This principle applies to the governance of both corporations and sovereign nations. To think that shareholders appoint the board mainly to prioritize shareholder interests is similar to the misconception held by President Trump when he assumed that because he appointed the Attorney General, the Attorney General worked for him and served his personal interests.\r\n\r\nIt is surprising how persistently we think of board membership in terms of representing particular interests, whether those of shareholders, employees, lenders, the government, etc. However, just like the Attorney General represents the people of the United States, the board of directors represents the corporation as a whole. Corporate law compels all decisions to be made in the \u201cbest interests of the corporation<\/a>.\u201d\r\n\r\nWhile it may be difficult to prove and take legal action against a board that is serving interests other than those of the entire corporation, it behooves all board members to understand the corporation\u2019s primacy as a legal entity unto itself. No, shareholders do not<\/em> own the corporation. Instead, they own shares that the corporation has issued to assign specific decision-making rights and residual rights after the corporation has met all its legal and contractual obligations, such as salaries, invoices, interests on loans, taxes, etc. It is important to note that shareholders do not have ownership over the corporation\u2019s assets, which are the property of the separate legal entity.\r\n\r\nEven if we conceded that shareholders owned the corporation and, consequently, their interests were a top priority in board decisions, the notion of shareholder interests<\/em> would remain fundamentally problematic because shareholder interests are not uniform. Examples are numerous: (1) the interests of majority and minority shareholders are often in tension (this is why minority shareholders\u2019 rights are written into corporate law); (2) conflicts between common shareholders and preferred shareholders may be so profound they must be litigated; and (3) the interests of private equity funds differ significantly from those of mutual funds.\r\n\r\nAs an example of the tension between common and preferred shareholders, consider Trados, a U.S. software company that was sold to a larger incumbent in 2005 for $60 million. In the deal, Trados executives received $8 million, preferred shareholders $52 million, and common shareholders nothing. When common shareholders sued the board for an alleged breach of fiduciary duty, both the Delaware trial court and the Supreme Court ruled that the transaction was \u201centirely fair<\/a>\u201d even though it did not benefit the common shareholders.\r\n\r\nCorporate law, principles of good governance, and the Trados case jointly suggest that the idea of the corporate board serving primarily shareholder interests is painfully oversimplified and inoperational.\r\n\r\nCorporations raise funds by attracting investors, not donors. Therefore, the idea of seeking to increase shareholder wealth is more or less inherent: You don\u2019t attract an investor without offering the potential of a return on their investment. However, there is nothing\u2014either in law or otherwise\u2014that compels the corporation or its directors to privilege shareholders, let alone try to maximize the returns on their investment. In short, the objective of shareholder wealth maximization is simply a myth<\/a>. Furthermore, corporate law is not the only legislation that applies to corporations. Being employers and contracting parties means they also have to comply with numerous labor laws and contract laws.\r\n
A board that takes instructions from shareholders breaches its fiduciary duty to the corporation.<\/blockquote>\r\nA growing perspective in today\u2019s corporate law literature describes the board as a mediating hierarch<\/a>.<\/em> This (a) emphasizes the board\u2019s role as the organization\u2019s steward, a trustee whose task is to function as an arbiter of only partially overlapping and sometimes conflicting stakeholder interests, and (b) points to the board\u2019s independence as the top decision maker in the organization (the \u201chierarchy\u201d).\r\n\r\nTo be considered independent, a board member must not have financial or other connections to the corporation or its influential shareholders. Establishing independence is not a check-the-boxes activity. Instead, the board must thoroughly assess each of its members and explicitly declare the independence of each of its directors transparently and affirmatively.\r\n\r\nWhile independence considerations are patently essential, it\u2019s important to also focus on the related but distinct matter of the board\u2019s sovereignty. Even though shareholders appoint the board, a board that takes instructions from shareholders breaches its fiduciary duty to the corporation and, in so doing, breaks the law. The board chairperson is particularly key in this situation, as influential shareholders may seek to affect board decision-making.\r\n\r\nThe foundational principle of limited liability asserts that a corporation\u2019s liabilities are the sole burden of the organization, not its constituencies or stakeholders. By this principle, it is thus the corporation itself, through its board of directors, that makes the central decisions. These decisions should not be the exclusive domain of any individual constituency, no matter how much power that constituency may wield within the corporation. Building on the premise that the ability to exert influence on a governance decision can be just as significant as the formal authority to decide in the first place, corporate law might impose a fiduciary duty not only on the board of directors but on any constituency with de facto<\/em> power in the organization. Consequently, fiduciary duty may be extended to influential shareholders<\/a> as well.\r\n\r\nThe board\u2019s sovereignty is unproblematic if the board acts in the best interest of the corporation as the law compels. But this implies that the board neither is a stakeholder nor represents one. Moreover, because the board is the corporation\u2019s sovereign ruler, shareholders must exercise utmost care in selecting this sovereign. Once the board has been appointed, shareholders must step aside and let the board exercise its independent judgment. While it might be unsettling for shareholders that the board does not follow their instructions, appointing a corporate sovereign\u2014instead of one\u2019s own \u201cagent\u201d\u2014to the board may ultimately be in the shareholder\u2019s best interest<\/a>. Come to think of it, the proposition should not be too controversial: While equity financing is an indispensable part of value creation, it is hardly the only part. A board that emphasizes the interests of just one value-creating constituency immediately jeopardizes the organization's credibility in the eyes of everyone else. Focusing primarily on the interests of one constituency may jeopardize the viability of the organization.\r\n\r\nMany shareholder-focused approaches are problematic because they tend to be based on one-size-fits-all thinking that fails to consider the fact that equity plays a more crucial value-creating role in some organizations than in others, effectively creating a continuum. At one end of this continuum, there are organizations such as private equity firms whose entire business model, as the name suggests, is based on investments in equity. Therefore, the best interest of the organization readily aligns with the interests of private equity investors; although even here it must be noted that not all private-equity investors want the same thing.\r\n\r\nAt the other end of the continuum, we find professional service organizations that do not need to raise equity to finance their operations. Because the organization is revenue-financed and revenue is created by professionals (lawyers, accountants, consultants, and other experts), the best interest of the organization links more strongly to the company\u2019s employee base, not shareholders. Finally, industrial firms fall somewhere between the two ends, as value is created through a combination of people, technology, and capital.\r\n\r\nAs mediating hierarchs, boards must conduct a comparative analysis of all value-creating factors and prioritize accordingly. Consider the prioritization protocols used in the delivery of Covid-19 vaccines. The rationale behind vaccinating essential workers before non-essential ones was to protect the collective interest. Analogous prioritization in governance decisions is justified as long as the focus remains on the best interests of the entire organization, rather than just those being prioritized.\r\n\r\nActing as an effective mediating hierarch requires that board members use their judgment to understand the best interests of the organization in its specific context, and then prioritize accordingly. Because every context is at least partly idiosyncratic, boards must not rely on general prescriptions to guide their way.\r\n\r\nIn conclusion, appointing a genuine sovereign to lead the corporation is a vital step toward establishing and maintaining the organization\u2019s credibility in the eyes of all its constituencies. More generally, credible, and viable corporations serve as an integral part of a functioning society.\r\n\r\n \r\n\r\nThis article is based on and partially elaborates on an <\/em>op-ed published by the same authors, in Finnish, in the Finnish Kauppalehti magazine<\/em><\/a>.<\/em> In addition, Mikko Ketokivi acknowledges\u00a0 his joint work with <\/em>Joseph T. Mahoney<\/em><\/a> of the University of Illinois and <\/em>Leon Anidjar<\/em><\/a> of Vanderbilt University on the topic.<\/em>\r\n\r\n \r\n\r\n\u00a9 IE Insights."],"wpcf-audio-article":[""],"wpcf-article-extract":["Sovereign boards of directors that use their judgment to understand an organization's best interests are key to generating credibility, write Mikko Ketokivi and Liisa V\u00e4likangas."],"wpcf-article-extract-enable":["1"]},"_links":{"self":[{"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/articles\/1253240","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/articles"}],"about":[{"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/types\/articles"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/media\/1253242"}],"wp:attachment":[{"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/media?parent=1253240"}],"wp:term":[{"taxonomy":"schools","embeddable":true,"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/schools?post=1253240"},{"taxonomy":"areas","embeddable":true,"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/areas?post=1253240"},{"taxonomy":"subjects","embeddable":true,"href":"https:\/\/www.ie.edu\/insights\/wp-json\/wp\/v2\/subjects?post=1253240"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}