The emergence of new corporate forms

Most debates about corporate responsibility narrowly define a stark choice between government regulation and free markets. A US-based organisation called Corporation 20/20 advocates a third path: system redesign. While the corporate responsibility and governance movements have achieved some notable progress, they argue that a more systemic, integrated transformation is both needed and plausible at this moment in history. The following article is an edited extract of a paper given at the ‘Summit on the future of the Corporation‘, hosted by Corporation 20/20 in Boston, November 2007.

Many believe that the prevailing corporate form focuses on maximizing profit for
stockholders at the expense of other stakeholders – specifically employees, the community in which it operates, and the natural environment. Even corporations that strive to integrate corporate social responsibility (CSR) into their operations face constraints on their ability to pursue deep social responsibility, primarily as a result of the fiduciary obligations of their boards of directors.

The inadequacy of the rigid line between for-profit corporations and tax-exempt
organizations has been highlighted by two different movements which have gained  momentum in the last decade. For-profits are beginning to pursue social missions like nonprofits, and nonprofits are taking on profitable subsidiaries much like for-profits.

The emergence of these two movements raises questions about the adequacy of
existing corporate forms. Are there significant limitations to for-profit and nonprofit models that prevent organizations from successfully blending profit making with social mission?

There are many proposals being floated and experiments underway today. As yet, it is unclear whether any of the proposals can create large-scale change quickly.

On the nonprofit side, the various types of hybrids do work. However, social enterprises are hobbled by many legal constraints, including a seemingly arbitrary designation of what is considered tax-exempt revenue, and the labyrinth of legal rules that regulate their activities. In addition, nonprofits are required to articulate a fairly narrow public purpose in their articles. They also lack access to financial markets, relying instead on philanthropy.

Incorporating more for-profit business principles into certain types of
revenue-generating nonprofit models will serve the nonprofit community well. Yet nonprofits on the whole remain a very small percentage of the overall economy and will never have the power to effect widespread change.

On the for-profit side, the problems inherent in new voluntary or mandatory charters could frustrate their effectiveness. Proposed new forms – incorporating profit-making with social mission – may work for small-scale for-profits. Yet the ‘legacy problem’ represents one of the great challenges of retaining that social mission over time. Many socially oriented for-profits find that their social mission is dependent on founders’ fervor, and when founders retire or sell, their social legacy is often lost as more traditional owners and managers take over.

Federal or state governments could offer a possible solution by passing a law to create a new corporate form which would embed social purpose into the DNA of future corporations. This new form could be structured as either a for-profit charity, a socially conscious corporation, or some combination of both. Such hybrid models have both strengths and weaknesses.

One example of of this approach is the model proposed by the Minnesota State Legislature in 2006 through the Minnesota Responsible Business Corporation Act. Under the act, a corporation would have the ability to designate itself as a Socially Responsible Corporation, using the letters ‘SRC’ after its corporate name rather than the standard letters ‘Inc.’ The aim of the legislation is to create a design that integrates a dual focus on both financial success and social responsibility.

The legislation includes the following features:

(a) In determining the best interests of the corporation, directors and officers must consider (in no particular order of importance), the interests of the corporation’s stockholders, employees, customers and creditors; the ‘public interest’; and the long-term as well as short-term interests of the corporation and its stakeholders.
(b) Employees will elect 20 percent of the board of directors, and an additional 20 percent of seats will be reserved for public interest directors (who are also required to balance the interests of all stakeholders).
(c) If publicly traded, corporations will be required to issue an annual ‘Public Interest Report’ along with their annual report.
(d) The board is required to provide opportunities for stakeholders to provide advisory input at regular stakeholder meetings and through a web site or email listserve.
(e) The corporation is required to train its officers, directors, and employees regarding the special duties to stakeholders.
(f) To prevent courts from overriding the legislation, the law explicitly carves out the application of the common law of agency, under which the officers and directors are required to act almost solely in the interests of the stockholders by maximizing the corporation’s profits.

Despite its benefits, companies that chose the new form may face a lack of flexibility, possible conflicts with future business plans, and more limited access to capital markets. Also, an external regulation (even one that is voluntary) may require greater ongoing enforcement costs.

None of the various forms or legislation proposed so far will serve as a viable option for the multinational corporations that are the most powerful forces in the world
today. New hybrids and social enterprises are likely to be used primarily to expand the nonprofit community.

Where the business case for CSR is compelling, the operations of larger, for-profit corporations can be transformed significantly by the adoption of CSR principles. In
addition, we must be optimistic that boards and management (with court approval and guidance) will exercise their business judgment in expansive ways that embrace the concerns of stakeholders, broadening company mission beyond a sole focus on return on investment for stockholders.

However, there are two fundamental issues with sole reliance on the existing corporate tools. First, Corporate Social Responsibility initiatives are not likely to  stimulate change fast enough to address the major issues facing us today. The current fiduciary duties have evolved though legislation and judicial activism over the past 100 years. Second, given that CSR has only recently been embraced fully by certain large multinational corporations, it is too early to tell if an increased emphasis on employees, community, and the environment can serve to change the fundamental way a corporation operates – primarily because the stockholder remains the sole legally recognized stakeholder.

What changes may serve to effect the greatest transformation of
the corporation most quickly?

First, instead of relying on modifications of charters or the creation of hybrids,
legislation should create new fiduciary duties – covering both public and private corporations – that favor employees, the community, and the natural environment. The legislation must be federal or adopted nationwide, although one or two states could serve as pilots for the new regime.

The largest obstacle will be creating a means for the board and management to weigh the different and often diverging interests of stakeholders effectively when making decisions.

To ensure accountability, the legislation must include clear metrics to measure the impact of the corporate actions on various stakeholders. One proposal is the analytic hierarchy process developed by Thomas Saaty, which would create a matrix decision-making tool to help in balancing financial and non-financial stakeholder interests.

Second, governments should take action to increase corporate disclosure and accountability on environmental issues. Universal disclosure requirements should be adopted by the world stock exchanges, with NASDAQ, NYSE, AIM and the Tokyo Stock Exchange taking the lead. The effect of a corporation’s actions on all stakeholders – including the local and world community, employees, and the natural environment – clearly should be included in the definition of ‘materiality’. Stockholders would then be able to evaluate such factors, the expanded impact would be understood more widely, and connections between social impact and long term profitability would become clearer. Enforcement would be critical.  Corporations would need to face real and substantial penalties for failure to disclose according to the new guidelines. Fortunately, such a disclosure framework already is being developed through the Global Reporting Initiative sustainability reporting guidelines.

Third, it is vital to recognize that redesigned corporate forms are not the only route to creating corporate responsibility, particularly when quick change is
needed. Also needed are new government regulations, particularly to address environmental degradation and climate change. Governments should regulate the
environmental impact of all economic actors (including government and quasi-governmental entities), not just private corporations. And they should impose a  uniform burden on all companies operating in the U.S., to minimize the likelihood that firms will re-incorporate off-shore to avoid compliance (recognizing that the
extra-territorial extension of U.S. laws will not be well received on the international stage and will face enforcement complexities.)

The challenges presented by the inadequacies of current corporate legal forms can
and must be solved, for the 21st century will require corporate forms that incorporate a responsibility to a wide range of stakeholders, not just to stockholders alone. There is a clear case to be made for the creation of new corporate forms, yet the complete answer to the puzzle is not yet fully in hand. Many promising alternatives are already in play, but the ferment of existing experimentation needs to continue, as new ways of thinking about innovative corporate designs continue to evolve.

Leave a Comment