The Efficiency of Corporate Political Speech Bylaws
posted by Jay Kesten
Nearly half a century ago, Albert Hirschman formalized two ways in which members of organizations could express their displeasure: exit and voice. Exit is market-based expression, and is typically quiet, impersonal and cheap. Voice, by contrast, is political expression — it is usually loud, messy, and expensive. From an efficiency perspective, exit is thus generally favored as a matter of institutional design.
Corporate law largely track Hirschman’s theory. Shareholders’ voice rights are, by default, quite constricted, and the business judgment rule imposes an important limitation on seeking judicial remedies. In most cases, unhappy shareholders’ only practical method of expressing their discontent is to exit the firm by selling their shares.
But Hirschman warns that in certain circumstances, such as where the barriers to exit are sufficiently high, it is preferable to adjust institutional design to facilitate or strengthen members’ voice rights. Corporate political activity presents exactly such a case, because the standard shareholder remedies – suing, voting for the board of directors, and selling their shares – are either unavailing or exceptionally costly. I treat this range of options in more detail elsewhere, but below I will briefly describe these problems with a focus one key area in which corporate political activity differs markedly from other types of corporate action, and then turn to an important objection.
Litigation is problematic because the many of the harms associated with unwanted corporate political activity are unremediable. Even if a shareholder succeeded in a derivative suit, the remedy (reimbursement to the company of the improperly spent funds) would not undo the effects on public discourse. Moreover, corporate law’s standard response to activities that raise this sort of inherent conflict-of-interest is to set aside the business judgment rule and impose a heightened standard of judicial review. However, unlike mergers or other fundamental transactions in which heightened scrutiny applies, which occur only rarely in the life of a corporation, political spending is a regular occurrence for some companies. In this context, private ordering, which requires a broad consensus among shareholders, may thus be preferable to a flood of costly litigation, which can be initiated by a single malcontent shareholder with idiosyncratic views as to the corporation’s political activity.
Board removal is also inadequate and inefficient due to a bundling effect. Leaving aside the costs of proxy contests and the practical difficulties posed by staggered boards, presumably incumbent management and the board are chosen for their expertise, business judgment, and firm-specific knowledge. It may be extremely difficult, if not impossible, to find similarly situated actors who are in all respects equivalent managers, except willing to abide by shareholders’ political activity preferences. Plus, absent a way of directly constraining managerial conduct, there is no guarantee that the newly elected board would abide by shareholder preferences.
Most importantly, exit is highly problematic. Unlike shareholders exiting undesirable firm-specific financial circumstances, a selling shareholder cannot exit from the societal effects of having funded unwanted political speech. Further, there are real costs associated with exit, such as transaction costs and potential risks associated with a loss of diversification. Diversification also plays another, under-appreciated role. Fiduciary obligations and securities laws protect shareholders from the most egregious forms of managerial misconduct: fraud, self-dealing, and the like. What remains are largely firm-specific circumstances or business decisions that meet with shareholder disapproval: investments in risky projects, unfavorable dividend policies, lazy managers, poor product-market decisions and so on. As to these matters, though, the board is (quite correctly, in most circumstances) protected by the business judgment rule. One key justification for this rule is that rational shareholders would themselves agree to such a rule ex ante in order to maximize the value of their portfolios. Why? Because they can diversify away the vast majority of these firm-specific financial risks. But shareholders cannot diversify away moral agency costs. Absent pure happenstance, investing in a portfolio of companies is unlikely to produce offsetting political speech. Thus, there is no clear reason to assume that shareholders would implicitly bargain away their expressive rights, especially in light of the exogenous shock of Citizens United.
That said, one might nevertheless challenge the existence of meaningful expressive/moral agency harms in this context because a majority of public company stock is held by institutional investors, such as mutual funds or pension funds, and not retail investors. To be sure, this layer of intermediation currently presents a real practical impediment. Fund managers may be able to monitor and potentially constrain financial agency costs arising from corporate political speech, but are unlikely to do the same concerning moral agency costs. Yet, if we take the Supreme Court at its word — that corporate political expression should reflect human shareholders’ collective political will — we should think carefully about whether there are low-cost methods of aggregating and communicating individual investor preferences.