business judgement rule

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Yesterday, Prof. Bainbridge annotated my “creed” on corporate governance, and I appreciated his take. In fact, many of his chosen sources would have been mine.

In a later footnote, he noted that he was not sure what I meant by my statement: “I believe that public companies should be able to plan like private companies . . . .” I thought I’d try to explain. 

My intent there was to address my perception that there is a prevailing view that private companies and public companies must be run differently.  Although there are different disclosure laws and other regulations for such entities that can impact operations, I’m speaking here about the relationship between shareholders and directors when I’m referencing how public and private companies plan. 

Public companies generally have far more shareholders than private companies, so the goals and expectations of those shareholders will likely be more diverse than in a private entity. Therefore, a public entity may need to keep multiple constituencies happy in a way many private companies do not.  However, that is still about shareholder wishes, and not the public or private nature of the entity itself.  A private company with twenty shareholders could crate similar…

Prof. Bainbridge yesterday posted about The Modern Corporation Statement on Company Law.  The statement has ten fundamental rules, of which number ten is:

Contrary to widespread belief, corporate directors generally are not under a legal obligation to maximise profits for their shareholders. This is reflected in the acceptance in nearly all jurisdictions of some version of the business judgment rule, under which disinterested and informed directors have the discretion to act in what they believe to be in the best long term interests of the company as a separate entity, even if this does not entail seeking to maximise short-term shareholder value. Where directors pursue the latter goal, it is usually a product not of legal obligation, but of the pressures imposed on them by financial markets, activist shareholders, the threat of a hostile takeover and/or stock-based compensation schemes.

Prof. Bainbridge is with Delaware Chief Justice Strine in that profit maximization is the only role (or at least only filter) for board members.  As he asserts, “The relationship between the shareholder wealth maximization norm and the business judgment rule, . . . explains why the business judgment rule is consistent with the director’s “legal obligation to maximise profits for…