Indiana Law Review


Indiana Laiir Revieir
Volume 24 1991 Number 2

ARTICLES

Redefining Corporate Law
David Millon*

A director may, in considering the best interests of a cor-
poration, consider the effects of any action on shareholders,

employees, suppliers, and customers of the corporation, and
communities in which offices or other facilities of the corporation

are located, and any other factors the director considers perti-
nent. '

Introduction: A Revolution in Corporate Law?
Shareholders have long enjoyed a privileged position at the center

of the corporate law universe. For much of this century, corporate law's
principal function has been to render management accountable to them.
Toward this end, state corporate statutes (supplemented by federal proxy
regulation) provide shareholders with the right to elect directors. In

addition, fiduciary principles specify duties of care and loyalty owed by
management to the shareholders. In contrast, the various nonshareholder

constituencies involved in the corporate enterprise (such as employees,

creditors, suppliers, and customers) are of little concern to corporate

law. Contracts (supplemented by regulatory statutes), rather than fi-

duciary duty or other accountability mechanisms, determine manage-

ment's obligations to these groups. Under this conception of

management's role in the corporation, management must accord primacy

to shareholder interests in exercising its discretion to manage the cor-

poration's business affairs. Management discharges this responsibility by

* Associate Professor of Law, Washington and Lee University. Ph.D., Cornell

University; J.D., Harvard University. The author gratefully acknowledges the critical insights

of Lyman Johnson, the financial support from the Frances Lewis Law Center, Washington
and Lee University, and the research assistance of Ron Ciotti.

1. Ind. Code Ann. § 23-l-35-l(d) (West Supp. 1990). So far, 27 other states
have adopted similar statutes. See statutes cited infra note 76.



224 INDIANA LAW REVIEW [Vol. 24:223

attempting to maximize the company's profits in order to enhance share

values.^

Recent developments challenge the conventional framework. The
catalyst has been the hostile takeover boom of the 1980s. Despite their
undoubted value to target company shareholders,^ highly leveraged **bust-
up'* acquisitions'* by means of tender offer are widely perceived to
threaten jobs, the security of creditors, established customer and suppher

relationships, tax revenues, charitable contributions, and other economic

and social benefits provided by resident companies to local communities.^

Concerns about adverse effects on nonshareholders have resulted in

various judicial and legislative efforts to curb hostile takeovers. State

courts have been increasingly hospitable toward efforts by target company
management to fend off unwelcome takeover bids. This attitude is
illustrated most graphically by the Delaware judiciary's recent blessing

of Time's rejection of Paramount's attempted acquisition, despite its

obvious attractiveness to Time's shareholders.^ At the same time, state

2. I use the term "shareholder primacy" to refer to this conception of manage-

ment's responsibility and also to corporate law's commitment to shareholder welfare as

the primary objective of corporate activity. While it is possible to distinguish between

them, these two ideas are inextricably linked in traditional doctrine. Management's duty

to privilege shareholder interests is based on an underlying assumption about the purpose

of corporate activity; and our system of corporate law assigns to corporate management

the task of pursuing the underlying shareholder welfare objective. There is nothing inevitable

about this linkage: one could imagine a legal system in which some other person or group

ie.g.y a state agency; the shareholders themselves) was responsible for maximizing share-

holder welfare.

3. Premiums paid to shareholders in hostile tender offers have averaged 50% over
market price. Kraakman, Taking Discounts Seriously: The Implications of "Discounted"

Share Prices as an Acquisition Motive, 88 Colum. L. Rev. 891, 892 (1988).

4. So-called "bust-up takeovers" are motivated by an intention to earn profits

by breaking up the acquired corporation and selling off some or all of the constituent

parts. This objective, rather than a desire to continue existing operations under new

management, has been identified as the dominant reason for hostile takeovers during the

1980s. See Coffee, Shareholders Versus Managers: The Strain in the Corporate Web, 85

Mich. L. Rev. 1, 2-7 (1986).

5. See, e.g.. Chairman of the Subcomm. on Telecommunications, Consumer

Protection, and Finance of the House Comm. on Energy and Commerce, 99th Cong.,
2d Sess., Report: Corporate Takeovers: Public Policy Implications for the Economy
and Corporate Governance (Comm. Print 1987), reprinted in L. Solomon, D. Schwartz
& J. Bauman, Corporations: Law and Policy 1149, 1162-63 (2d ed. 1988); Johnson,
The Eventual Clash Between Judicial and Legislative Notions of Target Management

Conduct, 14 J. Corp. L. 35, 67 (1988); Proxmire, What's Right and Wrong About Hostile

Takeovers?, 1988 Wis. L. Rev. 353; see also Edgar v. MITE Corp., 457 U.S. 624, 646
(1982) (Powell, J., concurring).

6. See Paramount Communications, Inc. v. Time, Inc., [1989 Transfer Binder]

Fed. Sec. L. Rep. (CCH) 1 94,514 (Del. Ch. 1989), aff'd, 571 A.2d 1140 (Del. 1990)



1991] REDEFINING CORPORATE LAW 225

legislatures have adopted a potent array of statutory measures designed

to slow the pace of hostile takeover activity.^

By empowering target company management to prevent shareholders
from enjoying the benefits of a robust takeover market, these devel-

opments indicate a willingness to subordinate shareholder financial in-

terests to other values. In this respect, they conflict with corporate law's

traditional commitment to shareholder primacy. Even more dramatic,

however, is the recent wave of statutes expressly redefining corporate

management's duty. Though they differ in detail, in form these new
directors' duty statutes^ authorize management to consider the interests

of various nonshareholder constituencies (typically including employees,

creditors, suppliers, consumers, and local communities) in making busi-

ness decisions. If a particular decision would harm the interests of one
or more of these groups, management need not adopt it, no matter how
beneficial that course of action might be to shareholders. These statutes

abrogate the long-standing shareholder primacy requirement, and most

are not confined to the hostile takeover setting.

The new directors' duty statutes confront corporate law's most basic
premises. If the traditional conception viewed the corporation as an

engine for shareholder wealth maximization and shaped legal doctrine

accordingly, the new statutes suggest a more complex notion of the
corporation's role in society. At the core of this new conception —
vague and tentative as yet — is the recognition that a number of
nonshareholder constituencies depend upon the corporation for their

welfare and are therefore affected directly by the manner in which

management conducts the corporation's affairs. Relentless pursuit of

(refusing to enjoin preliminarily Time's defensive acquisition of Warner despite Paramount's

offer of premium substantially over market price). For discussion of this decision's broad

implications, see Johnson & Millon, The Case Beyond Time, 45 Bus. Law. 2105 (1990)
[hereinafter Johnson &, Millon, Case Beyond Time].

7. See generally Johnson & Millon, Missing the Point About State Takeover
Statutes, 87 Mich. L. Rev. 846 (1989) (discussing motivations behind various forms of

antitakeover statutes) [hereinafter Johnson & Millon, Missing the Point].
8. Because in form they define the manner in which directors should discharge

their duties to the corporation, I term these statutes "directors' duty statutes." Others

have referred to them as nonshareholder (or nonstockholder) constituency statutes or

stakeholder statutes. See Hanks, Non-Stockholder Constituency Statutes: An Idea Whose
Time Should Never Come, 3 Insights 20 (1989); Karmel, The Duty of Directors to Non-

Shareholder Constituencies in Control Transactions—A Comparison of U.S. and U.K.
Law, 25 Wake Forest L. Rev. 61, 66-68 (1990) (referring to stakeholder statutes); Note,
A Framework for Satisfying Corporate Directors' Responsibilities Under State Nonshare-
holder Constituency Statutes: The Use of Explicit Contracts, 138 U. Pa. L. Rev. 1451

(1990); see also A.B.A. Section of Business Law, Committee on Corporate Laws, Other

Constituencies Statutes: Potential for Confusion, 45 Bus. Law. 2253 (1990) [hereinafter

ABA Report].



226 INDIANA LAW REVIEW [Vol. 24:223

profit maximization for their sake can impose substantial costs on non-

shareholders. Corporations are more than just investment vehicles for
owners of financial capital. The new statutes reflect a desire to redefine
management's responsibilities in light of this fact.

Nearly thirty states have adopted various versions of the directors'

duty statutes,^ and more can be expected to do so in the months to
come. Although the new statutes' general thrust is clear enough to have
attracted some critical commentary, '^ they have not yet been subjected

to judicial scrutiny'' or sustained academic analysis.'^ As a result, the
full implications of these terse and, in some ways, distressingly vague
enactments are far from clear. This Essay begins, in Part I, with a

sketch of the background from which the new statutes emerged. This
is intended to furnish the context necessary to appreciate the statutes'

apparently sharp break with the past, as well as the circumstances that

led to their passage. An understanding of the statutes' background is
necessary if we are to make sense of their mandate. Part II offers a
description of the statutes' content, drawing attention to what is new
as well as to what is not. Part III then considers, in detail, doctrinal

implications with respect to shareholder primacy. By analyzing the sta-
tutes' abrogation of the shareholders' right to hold management ac-
countable for deviations from profit maximizing strategies, this section

deals with what might be termed the negative aspect of the statutory

agenda. Part IV then takes up the separate question of the extent to

which the directors' duty statutes affirmatively oblige management to
protect nonshareholder interests. Initially, two interpretations of non-

9. See statutes cited infra note 76.

10. An American Bar Association committee has published its analysis of the
directors' duty statutes, undertaken to determine whether the Revised Model Business

Corporation Act should be amended. ABA Report, supra note 8. The report is critical
of the statutes and recommends against amendment, but the committee's conclusion

apparently was not unanimous. Id. at 2254. For a briefer and sharper critique written

by a respected lawyer for an audience of practicing lawyers and business executives, see

Hanks, supra note 8.

11. Directors' duty statutes have been referred to in two decisions, but in neither

did the court explain the relation between statute and outcome, if any. See Amanda
Acquisition Corp. v. Universal Foods Corp., 708 F. Supp. 984 (E.D. Wis.) (citing Wisconsin

statute), aff'd, 877 F.2d 496 (7th Cir.), cert, denied, 110 S. Ct. 367 (1989); Baron v.

Strawbridge & Clothier, 646 F. Supp. 690 (E.D. Pa. 1986) (citing Pennsylvania statute).
12. Paul Cox considers the Indiana directors' duty statute in the context of an

insightful analysis of that state's broad array of antitakeover legislation. See Cox, The

Indiana Experiment in Corporate Law: A Critique, 24 Val. U.L. Rev. 185 (1990). A
student author offers useful suggestions about strategies available to management for

satisfaction of its responsibilities to nonshareholders under the new statutes, but only

briefly discusses the statutes themselves. Note, supra note 8.



1991] REDEFINING CORPORATE LAW 227

shareholder rights under the new statutes (the **no new rights'* and
**minimal protection" interpretations) are suggested. Under either of

these, protection of nonshareholders would depend on management's

willingness to use its discretionary power for nonshareholders' benefit.

However, it turns out that various incentives make it highly unlikely
that this will occur. Accordingly, if the statutes are to have any mean-

ingful effect, a stronger interpretation is needed. This is also presented

in Part IV, and consideration of some objections then follows.
Corporate law is in a state of conceptual turmoil. Fundamental

questions that seemed firmly settled a generation ago — about the
appropriate aims of corporate law and about corporate purpose itself
— no longer command consensus. This is nowhere more apparent than
in the directors' duty statutes. One commentator has referred to them
as a

*

'revolution in corporate law."'^ Whether this judgment is accurate

must await more judicial and academic attention than the statutes have
yet received. Their language is in fact quite malleable. Nevertheless,

there is little doubt that the directors' duty statutes present a serious

challenge to fundamental assumptions. As a response to broadly shared
concerns about the role of the business corporation in our society, they

demand to be taken seriously. At the very least, these statutes invite us
all — as lawyers, academics, judges, and concerned citizens — to engage
in the dialogic process that will determine the direction of corporate

law in the years to come.

I. The Shareholder Primacy Principle

The directors' duty statutes are the boldest in a series of recent
efforts to reconsider management's role in the corporation. They an-

nounce that management, previously accountable to the shareholders by

the fiduciary principle, may weigh a broad range of shareholder and
nonshareholder interests in making decisions about deployment of the

corporation's resources. Before considering these statutes in detail, '"* this

section sketches their context, including a discussion of the conventional

understanding of the shareholders' position in the corporation,^^ and

then of developments that initially signalled a willingness to revise that

understanding.^^

A. The Conventional Understanding

1. Shareholder Primacy.—Corporate management's responsibility typ-
ically has been stated in terms of a duty owed to the corporation. Thus,

13. Hanks, supra note 8, at 22.

14. See infra pts. II-IV.

15. See infra pt. 1(A).

16. See infra pt. 1(B).



228 INDIANA LAW REVIEW [Vol. 24:223

for example, the American Law Institute's restatement of the common
law duty of care identifies **the best interests of the corporation'* as

the objective of managerial decision-making.'^ If one thinks of the

corporation as an entity embracing a variety of nonshareholder, as well

as shareholder, interests, to designate the corporation as the beneficiary

of management's activities is potentially vague. How is management
supposed to promote a wide variety of possibly conflicting interests?

Which is (or are) to have priority?
Corporate law has avoided such puzzles by, for the most part,

equating the duty to the corporation with a duty to act in the best

interests of its shareholders.'® Delaware jurisprudence makes this identity

explicit by describing management's duty as a duty owed simultaneously
**to the corporation and its shareholders."'' In practice, the view that

management is supposed to act in the shareholders' best interests means
that it should pursue maximization of the entity's profits in all but

exceptional situations; shareholders will benefit in the form of enhanced

share values.^® Thus, under the conventional view, management's duty

to act in **the best interests of the corporation" actually means a duty

to promote shareholder welfare through profit maximization.^'

2. Historical Background.—Corporate management's responsibility
has not always been defined in terms of shareholder primacy. During

much of the nineteenth century, various statutory and common law rules
limited management's powers to accumulate wealth for the benefit of

the shareholders.^^ The modern view of the corporation as an engine

17. Principles of Corporate Governance: Analysis and Recommendations §
4.01(a) (Tent. Draft No. 4, 1985) [hereinafter ALI PrinciplesI; see also Revised Model
Business Corporation Act § 8.30(a) (1984).

18. "[The] phrase ['best interests of the corporation'] is an expression of that

component of the duty of loyalty involving the corporate director's primary allegiance.

As the shareholders' designee, the corporate director is in a position of stewardship for
the owners of the enterprise, whose interests are interchangeably merged with the interests

of the corporate entity." A.B.A. Section of Corporation, Banking and Business Law,

Corporate Director's Guidebook, 33 Bus. Law. 1591, 1601 (1978) [hereinafter Corporate
Director's Guidebook]', see also ALI Principles, supra note 17, § 2.01 (corporate objective
stated as "enhancing corporate profit and shareholder gain"); ABA Report, supra note
8, at 2255 ("With few exceptions, courts have consistently avowed the legal primacy of

shareholder interests when management and directors make decisions.").
19. See Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985); Aronson v. Lewis,

473 A.2d 805, 811 (Del. 1984); Guth v. Loft, Inc., 23 Del. Ch. 255, 5 A.2d 503, 510

(1939), aff'd, 25 Del. Ch. 363, 19 A.2d 721 (Del. 1941).

20. This is because the corporation's shareholders, whose claims against corporate

assets are residual, are entitled to whatever is left after the fixed claims of the corporation's

various creditors have been paid.

21. See R. Clark, Corporate Law 17-19 (1986).
22. See Millon, Theories of the Corporation, 1990 Duke L.J. 201, 205-11 [here-

inafter Millon, Theories of the Corporation].



1991] REDEFINING CORPORATE LAW 229

for shareholder wealth maximization is of relatively recent vintage, con-

nected with changes in thinking about the role of corporations in Amer-
ican society. These changes occurred around the turn of this century,

as traditional hostility to corporate accumulation of wealth rapidly

eroded.^^ This development was most graphically apparent in the statutory

revisions — heralded by New Jersey in 1888^^ — that facilitated the
creation of vast holding companies. Thus, it was only during the early

years of the twentieth century that the gigantic business corporation

assumed its place as a welcome fixture in the American commercial

landscape.

As corporations grew in size and share ownership became much
more widely dispersed than it had been in the days of smaller, closely-

held companies, a class of professional managers emerged who were
hired for their special expertise and who typically held minimal stock
positions in the firms they managed. Realization of a growing distance

between the owners of the corporation and those who managed it first
prompted serious attention to the question of management's relation to

the corporation's shareholders. This separation of ownership and control

raised the danger that corporations might not be managed in the best
interests of those who had contributed their capital and were likened
to its **owners." The threat was exacerbated by changes in practice that

effectively enlarged managerial discretion.^^ In addition, the courts vitiated

doctrinal barriers that traditionally had been relied upon to limit cor-
porations to narrow, defined ranges of profit-seeking activity.^^

Adolf Berle and Gardner Means articulated these concerns with
striking force in their classic work published in 1932.^"^ They argued that
shareholders were owners of property that deserved legal protection.

Because of the lack of identity between managerial and shareholder

23. For discussion of Americans' traditional hostility to concentrations of economic

power, see Millon, The Sherman Act and the Balance of Power, 61 S. Cal. L. Rev.

1219 (1988). For fuller consideration of changes in thinking about corporations and

corporate law that occurred around the turn of this century, see Millon, Theories of the

Corporation, supra note 22, at 211-16; Millon, State Takeover Laws: A Rebirth of
Corporation Law?, 45 Wash. & Lee L. Rev. 903, 905-18 (1988).

24. Act of Apr. 4, 1888, ch. 269, 1888 N.J. Laws 385; Act of Apr. 7, 1888, ch.

295, 1888 N.J. Laws 445 (allowing corporations to hold stock in other corporations).

Removal of traditional statutory limits on capitalization also played an important part in

these changes. See Millon, Theories of the Corporation, supra note 22, at 212.

25. Corporate statutes increasingly allowed incorporators to describe corporate

purposes and powers in unlimited terms, rather than by means of specific definition. See

Millon, Theories of the Corporation, supra note 22, at 208-09, 219.

26. See id. at 212 (demise of ultra vires doctrine).

27. A. Berle & G. Means, The Modern Corporation and Private Property
(1932 & reprint 1948).



230 INDIANA LAW REVIEW [Vol. 24:223

interests, such protection depended on effective legal mechanisms for

constraining management's use of its discretion in ways that harmed
shareholders.^*

Berle and Means' analysis took for granted that shareholders, as

property owners, were entitled to management's undivided loyalty. By
1932, corporate law had already endorsed the view that shareholder

financial interests should guide managerial decision-making without re-

gard to competing, nonshareholder claims. As early as 1919, in the oft-
quoted Dodge V. Ford Motor Co. case,^^ the Michigan Supreme Court
repudiated Henry Ford's desire to benefit employees and consumers by
sacrificing corporate profits. The court stated a general principle:

A business corporation is organized and carried on primarily
for the profit of the stockholders. The powers of the directors

are to be employed for that end. The discretion of directors is
to be exercised in the choice of means to attain that end and

does not extend to a change in the end itself, to the reduction

of profits or to the nondistribution of profits among stockholders
in order to devote them to other purposes. ^°

It was this idea — shareholder primacy in managerial decision-making
— that lay at the heart of Berle and Means' influential book.

The history of corporate law since Berle and Means' elaboration of

the shareholder primacy idea has consisted largely of efforts to fashion

doctrinal solutions to the accountability problem they articulated so

forcefully. Such efforts have vacillated between relatively strict and loose

responses. Apparent laxity has been the product of judicial and legislative

reluctance to second-guess management's expertise^' and, more recently,

to put faith in market forces as more effective policing mechanisms than

legal rules.^^ Nevertheless, the underlying premise of the central impor-

tance of shareholder welfare has remained unchallenged within main-

stream thinking about corporate law.

3. Justifications.—There have been two primary theoretical foun-
dations for the shareholder primacy principle. Traditionally, as Berle

and Means contended," notions of property suggested that shareholders.

28. Id.

29. 204 Mich. 459, 170 N.W. 668 (1919) (assessing management policy to use
corporate revenues to improve wages and working conditions and to offer the company's

product to the public at a lower than profit-maximizing price).

30. Id. at 507, 170 N.W. at 684.
31. For discussion of this justification for managerial discretion, see Frug, The

Ideology of Bureaucracy in American Law, 97 Harv. L. Rev. 1277 (1984).

32. See infra text accompanying notes 35-41.

33. A. Berle & G. Means, supra note 27.



1991] REDEFINING CORPORATE LAW 231

as the corporation's owners, were entitled to certain legal protections.

Along the same line, Berle had earlier described the relation between

shareholders and management as a trust relationship, with management
holding the shareholders' property in trust for their benefit.^'* The property
idea provided a conceptual basis for articulation of rules focusing man-
agement's attention on shareholder welfare. The trust analogy was es-
pecially apt because, while it referred to the trustee's common law
obligation to guard the interests of the beneficiary, it implied broad

discretionary powers toward achievement of that objective.

More recently, scholars influenced by neoclassical economic analysis
have offered a different explanation for corporate law's requirement that

management maximize shareholder financial interests. These scholars have
discarded the property notions on which the trust analogy was grounded,

finding the ownership idea unhelpful in analyzing the relations among
the various participants in the corporate enterprise. Instead, they see the

elaborate web of relations that constitutes the large corporation as
essentially similar to the relations among actors in a market.^^ Accord-
ingly, the rights of the various participants, including shareholders,

managers, and nonshareholders, are better thought of as governed by

contractual ordering.^^

In pursuing their interests through complex arrangements with other

suppliers of "inputs," shareholders of large corporations have no choice

but to act through professional managers. However, shareholders face

the ever-present danger that managers, as agents, will fail to act as

diligently as a principal would if acting on his or her own behalf. For
shareholders to maximize returns on their investments under these cir-

cumstances, the costs of managerial shirking and other forms of mis-

behavior must be minimized. These costs, together with the costs involved

34. Berle, Corporate Powers as Powers in Trust, 44 Harv. L. Rev, 1049 (1931).

35. For an overview, see Butler, The Contractual Theory of the Corporation, 11

Geo. Mason U.L. Rev. 99 (1989). The seminal economic analyses include Alchian &
Demsetz, Production, Information Costs, and Economic Organization, 62 Am. Econ. Rev.
777 (1972) and Jensen & Meckling, Theory of the Firm: Managerial Behavior, Agency
Costs and Ownership Structure, 3 J. Fin. Econ. 305 (1976). Examples from the legal

literature include Baysinger & Butler, Anti-Takeover Amendments, Managerial Entrench-
ment, and the Contractual Theory of the Corporation, 71 Va. L. Rev. 1257 (1985);
Fischel, The Corporate Governance Movement, 35 Vand. L. Rev. 1259 (1982); Ribstein,

Takeover Defenses and the Corporate Contract, 78 Geo. L.J. 71 (1989); Symposium:

Contractual Freedom in Corporate Law, 89 Colum. L. Rev. 1395 (1989). For critical

commentary, see Bratton, The "Nexus of Contracts" Corporation: A Critical Appraisal,
74 Cornell L. Rev. 407 (1989); Brudney, Corporate Governance, Agency Costs, and the

Rhetoric of Contract, 85 Colum. L. Rev. 1403 (1985); Johnson, The Delaware Judiciary

and the Meaning of Corporate Life and Corporate Law, 58 Tex. L. Rev. 865 (1990).
36. For this reason, this approach to corporate law is often referred to as "the

contractual theory of the corporation." See, e.g., Butler, supra note 35.



232 INDIANA LAW REVIEW [Vol. 24:223

in reducing inefficient behavior, are termed *' agency costs. "^^ Market

forces will tend to reduce agency costs to an efficient level by aligning

the interests of shareholders and management,^^ but legal rules also have

a role to play because market mechanisms may be insufficient. Thus,
various legal doctrines, including the fiduciary duties of care and loyalty,^^

form part of the **standard form contract" between shareholders and

management that is supplied by corporate law."^ From this perspective,
management's legal duty to prefer shareholder over other interests is

37. See Jensen & Meckling, supra note 35.
38. According to the contractual theory, various market phenomena will have this

effect. For example, product market competition will tend to discipline inefficient man-

agement. Further, inefficiency will increase capital costs and, because inefficiency will be

reflected in share prices, it will invite hostile takeovers in order to install new management

that will maximize asset value. See generally Butler, supra note 35, at 110-20 (discussing

these and other market factors). For a vigorous argument against the efficacy of market

forces in reducing agency costs, see Eisenberg, The Structure of Corporation Law, 89

COLUM. L. Rev. 1461, 1488-1514 (1989).

39. See Butler, supra note 35, at 119-20.

40. Id. at 119. Several prominent scholars are engaged in a lively debate over the

appropriate character of corporate law rules. Some contractualists argue that corporate
law rules should represent a standard-form contract governing management's conduct.

Shareholders may choose to adopt these rules as a low cost alternative to negotiating and
drafting a contract from scratch; however, it is argued, they should also be free to override

these rules when they find it in their interest to do so. In other words, corporate law

rules should be default or suppletory provisions. See, e.g.. Haddock, Macey & McChesney,
Property Rights in Assets and Resistance to Tender Offers, 73 Va. L. Rev. 701, 736

(1987); McChesney, Economics, Law, and Science in the Corporate Field: A Critique of
Eisenberg, 89 Colum. L. Rev. 1530, 1535-37 (1989). In contrast, others argue that

mandatory rules (i.e., rules that shareholders may not contract around) are necessary to
protect shareholders from agency costs. See Eisenberg, supra note 38.

To the extent this debate is interesting, its appeal is purely academic. First, no one
denies that corporate law has always contained mandatory rules (as well as default rules)

and there is no sign of any inchnation among state legislators to reject the view that
mandatory rules are an appropriate part of corporate law. Second, the argument over

the desirability of mandatory rules is an argument between camps that share an underlying

commitment to shareholder welfare as corporate law's primary objective. The argument

is over which approach to corporate law better serves that goal. The mandatory-suppletory

debate has nothing to say about why maximization of shareholder welfare (as opposed
to some other norm that tempers commitment to that objective in order to accommodate

other values) ought to be management's function. The adoption of the new directors'

duty statutes indicates the extent to which state legislators are unimpressed with these

academic disputations. In most cases, the statutes are mandatory, in the sense that

shareholders lack the freedom to avoid their coverage. But cf infra note 103 (discussing

**opt-in" statutes). In this regard, corporate law retains the mandatory character it has

always had and has never shown any signs of discarding. However, the new statutes'

objective is not unalloyed shareholder welfare, but instead some measure of protection

for nonshareholder interests in situations in which those interests conflict with shareholders'.

In this regard, the new statutes reject the underlying premise on which the proponents

of mandatory and suppletory approaches are in accord.



1991] REDEFINING CORPORATE LAW 233

obviously a central element in this implicit bargain. Thus, the new
economic theory of the firm replaces older trust and property law ideas

as a theoretical explanation for shareholders' legal right to insist on

management's exclusive fidelity to their interests/'

B. Initial Inroads

I. Hostile Takeovers.—Although it appeared to be firmly established,
recent events have generated misgivings about shareholder primacy as

the fundamental postulate of corporate law. The catalyst has been the
immense public policy controversy generated by the proliferation of

hostile takeovers during the 1980s. In a typical hostile takeover, the

aggressor (or bidder) appeals directly to the target company's share-

holders, offering to buy a controUing block of the target's stock at a

premium substantially over market price."^^ The great attraction of the
hostile takeover by means of tender offer is the bidder's ability to do

an *'end run" around target company management, who would be
expected to resist the bid in order to keep their jobs. An offer's success
does not require management approval because the target shareholders
possess the power to decide a takeover bid's fate simply by virtue of

their right to decide whether to tender their stock to the bidder.

The well-pubUcized hostile takeovers of the 1980s were, of course,
a boon for target company shareholders, who found themselves the
beneficiaries of the bidders' remarkable largesse. Takeover premiums,

often paid for by readily available junk bond financing, were substantial.
Averaging as high as fifty percent,'*^ premiums in excess of one hundred

41. As a normative assertion about the appropriate content of corporate law, the

contractualist theory of the corporation rests on a belief in efficiency as the criterion by

which legal rules should be evaluated. According to the proponents of the efficiency norm,

self-interested bargaining will maximize aggregate wealth in the absence of impediments

(market failures or legal rules) to freedom of contract. See generally R. Posner, Economic

Analysis of Law 11-15 (3d ed. 1986) (discussing efficiency in terms of bargained-for
exchange). In the context of corporate law, nonshareholders and shareholders (acting

through management, which operates under the shareholder primacy mandate) should

pursue their respective interests through private ordering. Unless shareholders agree, legal

rules that allow management to temper its commitment to profit maximization with other

considerations will threaten efficiency. The directors' duty statutes' apparent rejection of

this normative vision and the assumptions on which it is based is discussed infra pt. IV(D)(2).

42. For general discussions of the mechanics of hostile takeovers, relevant law,

and the attendant poHcy controversies, see R. Hamilton, Fundamentals of Modern
Business 381-414 (1989); L. Solomon & A. Palmiter, Corporations: Examples and
Explanations 533-44, 551-89 (1990).

43. See supra note 3.



234 INDIANA LAW REVIEW [Vol. 24:223

percent were not uncommon.^ Moreover, economic theorists argued that
all shareholders — even those whose corporations were never pursued
by hostile bidders — benefitted in another less dramatic, but no less
significant, way from a robust market for corporate control. The looming
threat of a hostile takeover spurs corporate managers to eliminate slack

and otherwise increase corporate profitability: Management's failure to

maximize the value of the firm's assets will be reflected in depressed

stock prices, which will invite a takeover by someone eager to install

a more efficient management team."^^
In the public's eyes, the dark side of these impressive gains for

shareholders has been the adverse effects on nonshareholders. The use
of enormous amounts of credit to finance these acquisitions creates

strong pressures to cut costs, and, in some cases, prompts asset Hqui-

dations and plant closings. Particularly with regard to bust-up takeovers,'^

it is often assumed that dramatic employee layoffs will follow. Given

the usual unavailability of a right to compensation, layoffs of employees,

who have invested years of their lives in their jobs, are widely perceived
to frustrate legitimate expectations of employment security.^^

The economic theory of implicit labor contract provides a useful

perspective on this problem. According to this theory, entry-level em-

ployees starting a new job typically agree to work for less than the full
value of their contribution to the firm in exchange for an implicit promise

of job security and increased compensation in the future. In return for

undertaking to reduce the risk of unemployment facing the employee,

the employer can better encourage the employee to make firm-specific
investments of human capital (such as acquisition of specialized skills)
that he or she otherwise would be reluctant to make because they are
not readily transferrable to a new job in the event of layoff. The deferred
aspect of the compensation arrangement also motivates the junior em-

ployee to work diligently in the expectation of future pay-offs. These

mutual undertakings are implicit elements of the contractual bargains

struck between employees and employers, but they are not explicitly

articulated and therefore not legally enforceable. Accordingly, the value

44. Stout, Are Takeover Premiums Really Premiums? Market Price, Fair Value,

and Corporate Law, 99 Yale L.J. 1235, 1259 n.l26 (1990).
45. See Fischel, Efficient Capital Market Theory, the Market for Corporate Control,

and the Regulation of Cash Tender Offers, 57 Tex. L. Rev. 1 (1978); Manne, Mergers

and the Market for Corporate Control, 73 J. Pol. Econ. 110 (1965).
46. See supra note 4.

47. For discussion of the problem of plant closings and an extended argument in

favor of legal protection from job losses, see Singer, The Reliance Interest in Property,

40 Stan. L. Rev, 611 (1988). Singer argues for recognition of rights growing out of

reliance on relationships, as opposed to the traditional limitation of reliance-based recovery

to reliance on promises. See id. at 663-701.



1991] REDEFINING CORPORATE LAW 235

of these expectations to the employee depends on the employer's will-

ingness to honor them. Although employers may generally be disinclined
to breach this trust (for reputational and employee morale reasons),

shareholders whose corporation is the subject of a hostile tender offer

are able to behave opportunistically toward the firm's employees by

selling the firm to a bidder that will cut costs by reneging on implicit

contracts. Thus, layoffs in the wake of a takeover may represent re-
pudiation of legitimately relied upon expectations of continued employ-

ment for which no compensation is available.*^

Employees are not the only nonshareholder constituency believed to

suffer unfairly from hostile takeovers. Customers and suppliers may have
made investments whose value depends on the continuation of legitimately
expected long-term relationships, and increased indebtedness places pre-

existing creditors in a more precarious position than they were in before
the takeover. Local communities in which corporate divisions have op-

erated for years may lose tax revenues and charitable contributions on
which they have come to depend, and find themselves saddled with
costly public works projects Gike roads, schools, or hospitals) undertaken

in the expectation of the corporation's continued presence in the com-

munity. Even when companies avoid being taken over by resorting to
radical financial restructuring, the increased debt burden may result in
all of these various nonshareholder groups sustaining losses similar to

those that follow successful takeovers.

2. Judicial and Legislative Responses.—Public perceptions about the
harmful effects of hostile takeovers on nonshareholders have encouraged

a series of assaults on the shareholder primacy principle in the takeover

context. State courts have been increasingly willing to allow target com-

pany management to block unwelcome takeover bids, even when the bid
might be lucrative enough to appeal to target shareholders. In some

cases, courts have allowed target management to justify such measures
by claiming to protect shareholder interests. Even though this sort of

paternalism prevented shareholders from deciding for themselves whether

48. Though senior executives may enjoy "golden parachute" arrangements, rights
to severance payments are uncommon for lower-level employees. For discussions of the
implicit contract idea and its relevance to the issues discussed here, as well as citations

to the economic literature, see Coffee, supra note 4; Macey, Externalities, Firm-Specific

Capital Investments, and the Legal Treatment of Fundamental Corporate Changes, 1989

Duke L.J. 173; O'Connor, Restructuring the Corporation's Nexus of Contracts: Recognizing
a Fiduciary Duty to Protect Displaced Workers, forthcoming in N.C.L. Rev. (1991). It

has been argued that takeover premiums paid to target company shareholders derive at
least in part from bidders' ability to renege on implicit promises of long-term job security.

See A. Schliefer & L. Summers, Breach of Trust in Hostile Takeovers, Nat'l Bureau of
Economic Research Working Paper No. 2342 (August 1987).



236 INDIANA LAW REVIEW [Vol. 24:223

to tender their stock,'^^ courts at least paid lip service to shareholder

primacy. In the important Unocal case,'° however, the Delaware Supreme

Court suggested that shareholder primacy may not be the rule in the
hostile takeover setting. In that case, the court stated that a board of

directors deciding whether to block a hostile bid might justify defensive

measures by taking into account **the impact [of the takeover] on
* constituencies' other than shareholders (i.e., creditors, customers, em-

ployees, and perhaps even the community generally)."^' Delaware's ju-
diciary has since reiterated this idea," and courts in other jurisdictions

have made similar pronouncements." Nevertheless, the extent to which
courts in Delaware and elsewhere are willing to allow target management

explicitly to subordinate shareholder to nonshareholder interests has been

unclear. In the only case squarely presenting the issue, the Delaware

Supreme Court held that under the circumstances, management's sole

responsibility was to maximize share value. ^"^

49. See, e.g., Moran v. Household Int'l, Inc., 500 A.2d 1346 (Del. 1985) (allowing

management's deployment of poison pill designed to protect shareholders from unfair

tender offer bids). Although it purports to rest on an underlying commitment to shareholder

welfare, the shareholder protection rationale for management defensive action differs from

a shareholder autonomy interpretation of shareholder welfare because an autonomy ap-

proach would leave shareholders with the power to define their welfare for themselves.

For discussion of shareholder protection and shareholder autonomy as alternative and

potentially conflicting interpretations of shareholder welfare in the context of target man-

agement defensive measures, see Johnson & Millon, Misreading the Williams Act, 87
Mich. L. Rev. 1862, 1882-86 (1989) [hereinafter Johnson & Millon, Misreading the Williams
Act].

50. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

51. Id. at 955.

52. In Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del.
1986), the court referred to the board's prerogative to consider nonshareholder interests,

but added that
*

'there must be some rationally related benefits accruing to the stockholders."

Id. at 176; see also Mills Acquisition Co. v. MacMillan, Inc., 559 A.2d 1261, 1282 n.29

(Del. 1987). However, in Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334,
1341-42 (Del. 1987), the court reiterated Unocal's declaration of the relevance of non-

shareholder considerations in hostile takeovers, without Revlon*s qualification. More re-

cently. Chancellor William Allen has written that "directors in pursuit of long run corporate

(and shareholder) value may be sensitive to the claims of other 'corporate constituencies.'"
TW Services, Inc. v. SWT Acquisition Corp., [1989 Transfer Binder] Fed. Sec. L. Rep.
(CCH) 1 94,334, at 92,178 (Del. Ch. 1989).

53. For statements endorsing management consideration of nonshareholder interests,

see Herald Co. v. Seawell, 472 F.2d 1081, 1091 (10th Cir. 1972); Baron v. Strawbridge

& Clothier, 646 F. Supp. 690, 697 (E.D. Pa. 1986); GAF Corp. v. Union Carbide Corp.,
624 F. Supp. 1016, 1019-20 (S.D.N.Y. 1985); Enterra Corp. v. SGS Assoc, 600 F. Supp.
678, 689 (E.D. Pa. 1985).

54. See Revlon, 506 A.2d 173 (holding that situation required target company

management to auction the company to the highest bidder in order to maximize share

value); cf. City Capital Assocs. v. Interco, 551 A.2d 787 (Del. Ch. 1988) (requiring



1991] REDEFINING CORPORATE LAW 237

Although state courts have exhibited ambivalence about the legitimacy

of explicitly decentering shareholder interests in takeover contests, the

Delaware judiciary seemed particularly sympathetic to that objective in

the recent widely publicized Paramount Communications, Inc. v. Time,
Inc. case" — though, ironically, the supreme court's opinion purported
to endorse shareholder primacy. The judgments in Time approved Time
management's efforts to fend off Paramount's unwelcome bid by re-

structuring a negotiated merger with Warner in a manner that denied

Time shareholders a right to vote.^^ The object of this tactic was to
foreclose the likely possibility that Time's shareholders would vote against

the merger in order to accept Paramount's tender offer premium, which

started high and soon exceeded one hundred percent.^^ Time's projections

for the value to its shareholders of the Time-Warner combination were

strong, though necessarily vague and highly speculative.^^ In addition,

Time management emphasized the importance of a distinctive 'Time
culture" of editorial independence and journalistic integrity,^^ said to be

crucial to the magazine's role in the cultivation of an informed, politically

astute citizenry. An acquisition by Paramount would have placed **Time
culture" in jeopardy.^

The Delaware Supreme Court affirmed the trial court's refusal to

enjoin preliminarily the Time-Warner combination, purportedly on the

management redemption of poison pill to allow shareholders to choose whether to accept

noncoercive tender offer; no reference to possible harm to nonshareholder constituencies).

For a thoughtful commentary on the Delaware judiciary's vacillating commitment to

shareholder primacy in the takeover setting, see Johnson, supra note 35, at 910-33.

55. Paramount Communications, Inc. v. Time, Inc., [1989 Transfer Binder] Fed.

Sec. L. Rep. (CCH) 1 94,514 (Del. Ch. 1989), aff'd, 571 A.2d 1140 (Del. 1990).
56. Id.

57. Paramount's initial offer, to buy all outstanding shares at $175, was later

increased to $200. At the time of the first announcement, Time stock was trading at

$126. Time, 571 A.2d at 1147-49.

58. Time's advisers offered the following ranges: between $106-$188 for 1990, $159-

$247 for 1991, $230-$332 for 1992, and $208-$402 for 1993. In Chancellor Allen's words,

the last range in particular was one "that a Texan might feel at home on." T/me, [1989
Transfer Binder] Fed. Sec. L. Rep. (CCH) 1 94,514, at 93,273.

59. See Time, 571 A.2d at 1143 n.4; see also Time, [1989 Transfer Binder] Fed.

Sec. L. Rep. (CCH) 194,514, at 93,267-69.
60. Time director Matina S. Horner, then president of Radcliffe College, described

the public interest aspect of "Time culture" in these terms:

I am very concerned about the need to preserve Time's editorial freedom. I
believe that editorial freedom free from political or other kinds of intervention

is absolutely essential if members of our society are to be enlightened enough

to form wise judgments and fulfill their responsibilities as citizens. I believe

that the need to foster a literate citizenry is the sine qua non of this nation's

and the company's future.

Time, [1989 Transfer Binder] Fed. Sec. L. Rep. (CCH) 194,514, at 93,269.



238 INDIANA LAW REVIEW [Vol. 24:223

ground that Time's management was legitimately seeking to serve share-
holder interests. ^^ However, because the long-term financial benefits of

the Warner agreement were uncertain and the shareholders could be
presumed to have preferred the short-term alternative of a Paramount

acquisition, the facts did not present a strong instance of blocking tactics

undertaken to protect shareholder welfare. The court did refer to Time
management's duty to protect its shareholders from harmful tender offer

bids, but the asserted threats to shareholder welfare were so inconse-

quential that it is hard to take seriously shareholder protection as the

dominant justification for the court's holding."

Although purporting to rely on conventional shareholder primacy

rhetoric, the broad power to block unwelcome takeovers that Time

endorses instead suggests a very different justification for the result.

Shareholders effectively lose the benefits of an active takeover market

in exchange for the Delaware Supreme Court's authorization of broad

managerial prerogative to chart the corporation's course. Thus, the court

spoke approvingly of management's discretion to prefer long-term cor-

porate strategies over short-term shareholder gains.^^ Because the court

is silent, we are left to speculate about what underlying values legitimate
management's authority to pursue such long-range strategies. Shareholder

welfare itself would not seem to be among those values because the
premise underlying the case was Time shareholders' preference for the

short-term gains offered by Paramount. The references to corporate

benefit and denigration of short-term shareholder gains suggest instead

that the beneficiary of the court's decision is supposed to be the corporate

enterprise as a whole, distinct from its shareholders. Beneath this con-

ception may be a continued adherence to the importance of profit
maximization, but only so long as it is pursued through preservation

of stable relations among the firm's various constituencies." Further,
the *Time culture" idea may suggest the legitimacy of the public's
interest in the preservation of corporate independence when necessary
to protect legitimately valued business policies."

61. Time, 571 A.2d at 1142.

62. Because Paramount's bid was an all-cash, all-shares offer, the threat of share-

holder coercion presented by a two-tier bid was not present. Nor was the bid obviously

too low. Instead, the court referred to the danger that Time shareholders might be ignorant

or confused about the respective merits of the alternatives before them and that the

conditions attached to the offer would make it hard to evaluate. See id. at 1153. Needless

to say, the same might be said about most hostile tender offers.

63. Id, at 1150.

64. For a reading of the Time opinions that analyzes their destabilizing effects on

existing legal doctrine, see Johnson & Millon, Case Beyond Time, supra note 6.
65. For a reading of Time that discusses the nonshareholder considerations —



1991] REDEFINING CORPORATE LAW 239

Alongside these common law developments, most states have enacted
statutes that restrict hostile takeovers in various ways.^ After the United

States Supreme Court struck down Illinois's takeover regulation statute
on commerce clause grounds in 1982,^^ state legislatures returned to the

drawing board in order to develop new strategies. The result has been
various forms of antitakeover statutes that are packaged as instances of

the states* traditional jurisdiction over corporate internal affairs.^^ One
such statute, the control share acquisition statute, passed constitutional

muster in CTS v. Dynamics Corp. of America^^ and has been widely
adopted.^° The more potent business combination statute also has survived

constitutional challenge.^' The aim of these and other legislative efforts

is to protect the interests of those nonshareholders who must bear the
costs of unrestricted takeover activity. ^^ While the judiciary has exhibited

an ambivalent stance toward restriction of shareholder rights in hostile

takeovers, the state legislatures have acted much more fortbrightly.

particularly a public interest idea — that may lie beneath its conventional rhetoric, see
Millon, Theories of the Corporation, supra note 22, at 251-61. Professor Johnson argues

that judges confronting important corporate law questions inescapably do so from a public

policy perspective. See Johnson, supra note 35.

66. For a general discussion of the various species of antitakeover legislation, see

Johnson, supra note 5, at 61-88. The Investor Responsibility Research Center Inc. publishes

an up-to-date record of state antitakeover legislation. P. McGurn, S. Pamepinto & A.
Spector, State Takeover Laws (1989 & Supp. June 30, 1990) [hereinafter IRCC, State
Takeover Laws].

67. Edgar v. MITE Corp., 457 U.S. 624 (1982).
68. For discussion of this "corporatization" strategy, see Johnson & Millon, Mis-

reading the Williams Act, supra note 49, at 1873-82.

69. 481 U.S. 69 (1987).

70. Control share acquisition statutes condition a hostile bidder's voting rights on

approval by the target company shareholders. For an up-to-date listing, with citations,

see IRCC, State Takeover Laws, supra note 66.

71. Amanda Acquisition Corp. v. Universal Foods Corp., 877 F.2d 496 (7th Cir.
1989) (upholding Wisconsin's business combination statute), cert, denied, 110 S. Ct. 367

(1989); RP Acquisition Corp. v. Staley Continental, Inc., 686 F. Supp. 476 (D. Del. 1988)
(Delaware's statute); Vernitron Corp. v. Kolhnorgen Corp., No. 89 Civ. 241 (S.D.N.Y.

1989) (New York's statute). Several states besides Delaware, New York, and Wisconsin
have adopted business combination statutes. See IRCC, State Takeover Laws, supra

note 66. Business combination statutes restrict a hostile bidder's rights to engage in certain

significant post-takeover transactions unless target company management previously ap-

proved the acquisition or the transaction.

72. For a discussion of the motivations behind state takeover legislation, see Johnson

& Millon, Missing the Point, supra note 7. But see Booth, The Promise of State Takeover
Statutes, 86 Mich. L. Rev. 1635 (1988) (analyzing benefits to shareholders of control

share acquisition statutes); Romano, The Political Economy of Takeover Statutes, 73 Va.
L. Rev. Ill (1987) (arguing that management interests are primary motive force behind

antitakeover legislation).



240 INDIANA LAW REVIEW [Vol. 24:223

The effectiveness of judicial and legislative efforts to halt the takeover
boom is still uncertain. Other factors, such as the withering junk bond
market, may bring about that result on their own.^' Nevertheless, these
efforts are significant for what they tell us about the security of the

shareholder primacy principle. They indicate a willingness to subordinate

shareholder financial interests to the interests of nonshareholders and

of the corporate entity's longer-term viability, at least in the hostile

takeover context. Explicit rhetoric, implicit motivation, and actual results

make this interpretation unmistakable. Though these efforts are thus far
limited to the specific context of hostile takeovers, it is important to

see that the takeover market is perhaps the single area in which share-

holder primacy is most important. After all, that is where shareholders

stand to reap the rewards of windfall premiums, as well as the less

dramatic benefits to be derived from enhanced managerial diligence.

Thus, the states' judicial and legislative willingness to place restrictions

on the market for corporate control represents an important prelude to
the frontal assault on shareholder primacy apparent in the directors'

duty statutes.

II. The Directors' Duty Statutes

A. The Statutes

Although recent judicial and legislative restrictions on hostile take-

overs suggest at least a partial willingness to subordinate shareholder to

nonshareholder interests, the proliferation of state statutes redefining

management's duties reveals this policy much more graphically. In various
forms, these statutes authorize management^'* to consider shareholder as

well as nonshareholder interests in formulating corporate policies. On
their face, the statutes appear to deny shareholders the right to insist

on management's undivided devotion to their financial welfare, and may
also acknowledge nonshareholders' right to management's attention.^^

73. A respected commentator has stressed the importance of junk bond financing
to the takeover boom. See Lipton, Corporate Governance in the Age of Finance Cor-
poratism, 136 U. Pa. L. Rev. 1, 11-13 (1987).

74. Most of the statutes refer to directors' duties. As such, they apply to senior
officers who sit on the board as well as to outside directors. A few also apply to officers
who are not directors. See, e.g., III. Ann. Stat. ch. 32, ^ 8.85 (1989), as amended by
Pub. Act 86-126, 1989 111. Legis. Serv. 1314 (West); Me. Rev. Stat. Ann. tit. 13-A, §
716 (Supp. 1989); Wis. Stat. Ann. § 180.305 (West Supp. 1989).

75. These questions are considered in detail infra pts. Ill & IV.



1991] REDEFINING CORPORATE LAW 241

Nearly thirty states have adopted some form of this new directors' duty
statute.

^^

As discussed previously, management's duty to the corporation has
been defined in terms of a duty to maximize corporate profits for the

benefit of the shareholders.^^ Until the hostile takeover boom, it was
rarely necessary to consider situations in which the interests of the

corporate entity (including the various participants in the corporate

enterprise) and those of the shareholders alone might diverge.^^ For the

most part, one could safely assume that corporate profitability would

benefit nonshareholders as well as shareholders. Especially in times of

general prosperity, larger pies imply larger servings for all. Accordingly,

there have been very few cases in which courts have been called upon

to consider whether, if profit maximization threatens nonshareholder

interests, management might lawfully choose to temper its devotion to
shareholder welfare.^^

Yet the legal description of management's duty as a duty owed to
the corporation^^ contains a potential ambiguity. Although this duty has

been interpreted as synonymous with a duty to maximize share values,^'

76. Ariz. Rev. Stat. Ann. § 10-1202(A) (1990); Conn. Gen. Stat. Ann. § 33-

313(e) (West Supp. 1990); Fla. Stat. Ann. § 607.111(9) (West Supp. 1990); Ga. Code
Ann. § 14-2-202(5) (1989); Haw. Rev. Stat. § 415-35(b) (Supp. 1990); Idaho Code §
30-1602 (Supp. 1990); III. Ann. Stat. ch. 32, 5 8.85 (Smith-Hurd Supp. 1990), as amended

by Pub. Act 86-126, 1989 111. Legis. Serv. 1314 (West); Ind. Code Ann. § 23-1-35-

l(d)(0(g) (West Supp. 1990), as amended by Pub. Law 227-1989 (approved Feb. 23, 1989);
Iowa Code Ann. § 490.1108 (West 1990); Ky. Rev. Stat. Ann. § 27 IB. 12-210(4) (Michie/
Bobbs-Merrill Supp. 1990); La. Rev. Stat. Ann. § 12:92(G) (West Supp. 1991); Me.

Rev. Stat. Ann. tit. 13-A, § 716 (Supp. 1990); Mass. Gen. Laws Ann. ch. 156B, § 65
(West Supp. 1990); Minn. Stat. Ann. § 302A.251(5) (West Supp. 1991); Miss. Code
Ann. § 79-4-8.30 (Supp. 1990); Mo. Ann. Stat. § 351.347 (Vernon Supp. 1991); Neb.
Rev. Stat. § 21-2035(1) (Supp. 1988); N.J. Stat. Ann. § 14A:6-14(4) (West Supp. 1990);
N.M. Stat. Ann. § 53-ll-35(D) (Supp. 1989); N.Y. Bus. Corp. Law § 717(b) (McKinney
Supp. 1991); Offlo Rev. Code Ann. § 1701.59 (Anderson Supp. 1989); Or. Rev. Stat.

§ 60.357(5) (1989); Pa. Cons. Stat. Ann. §§ 511(d),(e),(g) & 1721(e),(f),(g) (Purdon Supp.
1990); R.I. Gen. Laws § 7-5.2-8 (Supp. 1990); S.D. Codified Laws Ann. § 47-33-4
(Supp. 1990); Tenn. Code Ann. § 48-35-204 (Supp. 1988); Wis. Stat. Ann. § 180.305
(West Supp. 1990); Wyo. Stat. § 17-16-830 (1989). Notable among the states that have
not adopted directors' duty statutes are Delaware and California. IRCC, State Takeover

Laws, supra note 66, continuously monitors legislative activity and is a good source for

locating additional statutes enacted since this Essay went to press.

77. See supra pt. 1(A)(1).

78. See generally Johnson, Corporate Takeovers and Corporations: Who Are They
For?, 43 Wash. & Lee L. Rev. 781 (1986).

79. For notable exceptions, see supra text accompanying notes 29-30 (discussing

Ford case) and infra note 119 (discussing Wrigley case).

80. See supra text accompanying note 17.

81. See supra text accompanying notes 18-21.



242 INDIANA LAW REVIEW [Vol. 24:223

there has always been the latent possibility that the duty to the corporation

might be interpreted as a duty to consider the welfare of the enterprise

as a whole, including all of its constituent participants, rather than as

a sharply focused duty to promote shareholder welfare to the exclusion

of other considerations. The hostile takeover explosion fractured the
complacently assumed unity of interest between the corporate entity and

shareholders. As shareholders reaped unprecedented returns, lost jobs
and other costly, highly publicized side effects focused attention on the

fact that shareholder welfare did not necessarily imply corresponding

benefits for nonshareholders. Indeed, the opposite might be the case.

Accordingly, state courts and legislatures have been forced to define

management's duty with more precision.^^ This process began with the
judicial" and legislative*"* developments traced above and finds its most

direct expression in the new directors' duty statutes.
In form, the directors' duty statutes specify the interests that directors

may legitimately weigh in performing their managerial functions. Iron-
ically, they do this while, for the most part, clinging to the traditional

formulation of management's duty as owing to the corporation or even

to the corporation and its shareholders. Nevertheless, the new statutes
clearly reject shareholder primacy as the guiding principle. For example,

Maine's statute refers to the responsibility to make business decisions
according to **the best interests of the corporation and of its

shareholders"*^ but then specifies that directors may **consider the effects
of any action upon employees, suppliers and customers of the corpo-

ration, communities in which offices or other establishments of the

corporation are located and all other pertinent factors."*^ Other statutes

similarly refer to the standard duty to the corporate entity and its

shareholders, but add that **long-term" considerations as well as non-

shareholder interests are also relevant:

82. Recently, Delaware Chancellor William Allen lucidly stated the ambiguity latent

in the board's duty to "the corporation and its shareholders":

The knowledgeable reader will recognize that this particular phrase masks the

most fundamental issue: to what interest does the board look in resolving conflicts

between interests in the corporation that may be characterized as "shareholder
long-term interests" or "corporate entity interests" or "multi-constituency in-

terests" on the one hand, and interests that may be characterized as "shareholder
short-term interests" or "current share value interests" on the other?

TW Services, Inc. Shareholders Litigation, [1989 Transfer Binder] Fed. Sec. L. Rep. (CCH)
1194,334, at 92,178 n.5 (Del. Ch. 1989).

83. See supra text accompanying notes 49-65.

84. See supra text accompanying notes 66-72.

85. Me. Rev. Stat. Ann. tit. 13-A, § 716 (Supp. 1990).
86. Id. For a similar formulation, which is limited to hostile or friendly corporate

combinations, see La. Rev. Stat. Ann. § 12:92(G) (West Supp. 1991).



1991] REDEFINING CORPORATE LAW 243

In discharging his [or her] duties, a director may consider such
factors as the director deems relevant, including the long-term

prospects and interests of the corporation and its shareholders,

and the social, economic, legal, or other effects of any action

on the employees, suppliers, customers of the corporation or its

subsidiaries, the communities and society in which the corporation

or its subsidiaries operate, and the economy of the state and
nation. ^^

According to statutes Uke this one, directors are not only free to consider

the listed nonshareholder interests, they may also decline to take action
that would be immediately profitable to shareholders in order to pursue

possible longer-term benefits.^* Presumably, shareholders need not be

the primary beneficiaries of these longer-term strategies. Yet another

statutory approach characterizes management's duty simply as a duty

owed to the corporation as an entity, but includes shareholder interests
as only one among a longer list of relevant considerations.^^

All directors' duty statutes share the apparent objective of allowing

management to consider nonshareholder interests in running the cor-

poration. In this respect, they reject the traditional principle that man-

agement's attention should focus solely on shareholder financial welfare.

However, the statutes typically offer little, if any, guidance about how
management is to exercise this new power. This feature raises important
questions: Is there any duty to consider shareholder interests at all? Can
management make decisions bearing on nonshareholder interests with
complete disregard for shareholder welfare? Or, alternatively, can man-

agement choose to ignore nonshareholder interests in order to promote

the traditional objective of shareholder welfare? If management chooses

to weigh both shareholder and nonshareholder interests, what weight is

each to receive in cases of conflict?

Ohio's statute is one of the few that expressly makes consideration

of shareholder interests mandatory:

[A] director, in determining what he [or she] reasonably believes

to be in the best interests of the corporation, shall consider the

87. Fla. Stat. Ann. § 607.111(9) (West Supp. 1990).
88. See Conn. Gen. Stat. Ann. § 33-3 13(e) (West Supp. 1990); Haw. Rev. Stat.

§ 415-35(b) (Supp. 1990); Idaho Code § 30-1602 (1989); Iowa Code Ann. § 490.1108
(West 1990); Ky. Rev. Stat. Ann. § 271B. 12-210(4) (Michie/Bobbs-Merrill 1990); Mass.

Gen. Laws Ann. ch. 156B, § 65 (West Supp. 1990); Minn. Stat. Ann. § 302A.251(5)
(West Supp. 1989); N.M. Stat. Ann. 53-11-35(D) (Supp. 1989); N.Y. Bus. Corp. Law
§ 717(b) (McKinney Supp. 1991); Or. Rev. Stat. § 60.357(5) (1989).

89. Ind. Code Ann. § 23-l-35-l(d),(f),(g) (West Supp. 1990), as amended by Pub.
Law 227-1989 (approved Feb. 23, 1989); Wis. Stat. Ann. § 180.305 (West Supp. 1990).



244 INDIANA LAW REVIEW [Vol. 24:223

interests of the corporation's shareholders and, in his [or her]

discretion, may consider any of the following:
(1) The interests of the corporation's employees, suppliers,

creditors, and customers;

(2) The economy of the state and nation;

(3) Community and societal considerations.^

In most other cases, there is no explicit requirement that management
assign any significance to shareholder interests. Thus, most of the di-

rectors' duty statutes apparently confer broad discretion on management

to decide whether to take shareholder interests into consideration at all.^'

In contrast, Connecticut's statute is the only one that makes con-

sideration of nonshareholder interests mandatory:

[A] director . . . shall consider, in determining what he [or she]

reasonably believes to be in the best interests of the corporation,

(1) the long-term as well as the short-term interests of the

corporation, (2) the interests of the shareholders, long-term as

well as short-term, including the possibility that those interests

may be best served by the continued independence of the cor-
poration, (3) the interests of the corporation's employees, cus-

tomers, creditors and suppliers, and (4) community and societal

considerations including those of any community in which any

office or other facility of the corporation is located. A director
may also in his [or her] discretion consider any other factors
he [or she] reasonably considers appropriate in determining what

he [or she] reasonably believes to be in the best interests of the

corporation.^2

90. OfflO Rev. Code Ann. § 1701.59 (Baldwin Supp. 1989); see also Conn. Gen.
Stat. Ann. § 33-313(e) (West Supp. 1990); N.M. Stat. Ann. § 53-ll-35(D) (Supp. 1989).

91. A few statutes refer to the interests of the corporation as an entity and of
various nonshareholder constituencies, but actually omit any direct reference to shareholders

in specifying management's responsibility. See III. Ann. Stat. ch. 32, 1 8.85 (Smith-

Hurd Supp. 1990), as amended by Pub. Act 86-126; Mo. Ann. Stat. § 351.347 (Vernon

Supp. 1990). Tennessee's law is phrased as an exemption from Hability for good faith

consideration of enumerated nonshareholder interests and therefore says nothing about

shareholder interests. Tenn. Code Ann. § 48-35-204 (1988). Despite the absence of direct

references, however, it seems highly unlikely that these legislatures intended actually to

exclude shareholder interests from the realm of legitimate management discretion; these

would no doubt be included among unspecified "pertinent factors" or be subsumed within

the reference to the interests of the corporate entity.

92. Conn. Gen. Stat. Ann. § 33-313(e) (West Supp. 1990). Arizona's statute,

Ariz. Rev. Stat. Ann. § 10- 1202(A) (1990), does not explicitly refer to nonshareholder

constituencies but does require directors to consider the "long-term as well as short-term

interests of the corporation and its shareholders." This reference might be interpreted as

a requirement that management consider effects on nonshareholders as well as shareholder

interests in short-term gains.



1991] REDEFINING CORPORATE LAW 245

The rest would appear to leave management free to give no weight to
nonshareholder interests and instead attend solely to shareholders.

Questions concerning what the directors* duty statutes allow or

require of management are complicated and will be discussed below in

detail.^^ For now, it is enough to note that, on their face, the statutes

appear to confer extremely broad discretion. Most of them seem to

allow management to decide which among the array of potentially relevant
shareholder and nonshareholder interests should guide decision-making.

There is no express requirement that either shareholder or nonshareholder

considerations be taken into account in any particular case. This suggests

that management may legitimately choose to focus its attention on one
or the other. Likewise, management may be free to concern itself with
only one or a few nonshareholder constituencies, to the exclusion of

other conflicting nonshareholder interests. The statutes' only apparent
substantive limitation on management's freedom to choose the benefi-

ciaries of its decision-making is an implicit one, and would require that

management seek to further some statutorily enumerated shareholder or

nonshareholder interest, as opposed to the interest of some nonshare-

holder constituency (such as management's self-interest) beyond the range

of interests articulated by the statute.

Superficially, at least, this broad freedom (to decide which interests

to consider) seems to imply further that management also has the dis-
cretion to decide the respective weight to be accorded the various share-

holder or nonshareholder interests it chooses to consider. If a statute

implies that no constituency can insist on being considered at all, it may
also imply that none may demand that it receive priority should man-
agement choose to consider it. Two statutes appear to contain clear
language to this effect. Indiana's statute expressly provides that in con-

sidering the best interests of the corporation, directors are free to take

into account effects on enumerated nonshareholder constituencies as well

as on shareholders.^'^ It goes on to state that ** directors are not required

to consider the effects of a proposed corporate action on any particular

corporate constituent group or interest as a dominant or controlling

factor. "^^ Pennsylvania recently has amended its directors' duty statute

to include similar language.^^ Though lacking express provision to this

93. See infra pts. Ill & IV.
94. Ind. Code Ann. § 23-l-35-l(d) (West Supp. 1990), quoted supra in text

accompanying note 1.

95. Id. § 23-1-35-1(0.

96. "[T]he board of directors . . . shall not be required ... to regard any corporate

interest or the interest of any corporate group as a dominant or controlling interest or

factor." Pa. Cons. Stat. Ann. § 511(b) (Purdon Supp. 1991); cf. N.Y. Bus. Corp. Law
§ 717(b) (McKinney Supp. 1990) ("Nothing in this paragraph shall create any duties owed



246 INDIANA LAW REVIEW [Vol. 24:223

effect, it may be possible to read most of the directors' duty statutes^^
as implying the same idea.

The broad powers granted to management by the directors' duty
statutes extend, in most cases, across the entire spectrum of managerial

decision-making.^* A few apply only to takeovers or other change of
control transactions,^^ reflecting the background against which they were

adopted. Others, however, include references to the takeover context,

but clearly indicate that they apply generally to director decision-making.

Illinois's statute, for example, authorizes directors to consider the effects

on nonshareholders **of any action (including without limitation, action

which may involve or relate to a change or potential change of control
of the corporation)."*^ Similarly, Indiana's statute, while speaking in

general terms about the directors' authority to consider shareholder as

well as nonshareholder interests, '^^ also includes an explicit statement

disaffirming any duty to act or decline to act in the interest of any

shareholder or nonshareholder constituency
*

'solely because of the effect

such action might have on a proposed acquisition of control of the

corporation or the amounts that might be paid to shareholders under

such an acquisition. "'^^ Most of the remaining statutes say nothing about

takeovers or any other specific contexts to which they might apply. '°^

by any director to any person or entity to consider or afford any particular weight to

any of the foregoing [specified nonshareholder constituencies.]").

97. That is, all but those that expressly make consideration of either shareholder

or nonshareholder interests mandatory. See supra notes 90 & 92 and accompanying text.
98. In a few cases, coverage is limited to publicly held corporations, defined

according to stated criteria. See Conn. Gen. Stat. Ann. § 33-3 13(e) (West Supp. 1990);
Idaho Code § 30-1602 (Supp. 1990).

99. See Conn. Gen. Stat. Ann. § 33-3 13(e) (West Supp. 1990); Iowa Code Ann.

§ 490.1108 (West Special Pamphlet 1990); La. Rev. Stat. Ann. § 12:92(G) (West Supp.

1990); Mo. Ann. Stat. § 351.347 (Vernon Supp. 1990); Or. Rev. Stat. § 60.357(5) (1989
& Supp. 1990); Tenn. Code Ann. § 48-35-204 (Supp. 1990).

100. III. Ann. Stat. ch. 32, f 8.85 (Smith-Hurd Supp. 1990); see also Ky. Rev.

Stat. Ann. § 2718.12-210(4) (Michie/Bobbs-Merrill Supp. 1989 & Supp. 1990); Mo. Ann.
Stat. § 351.347 (Vernon Supp. 1990); N.J. Stat. Ann. § 14A:6-14(4) (West Supp. 1990);
N.Y. Bus. Corp. Law § 717(b) (McKinney Supp. 1991).

101. IND. Code Ann. § 23-l-35-l(f) (West Supp. 1990).
102. Id.

103. See Fla. Stat. Ann. § 607.111(9) (West Supp. 1990); Haw. Rev. Stat. §
415-35(b) (Supp. 1990); Me. Rev. Stat. Ann. tit. 13-A, § 716 (1981 & Supp. 1990);
Mass. Gen. Laws Ann. ch. 156B, § 65 (West Supp. 1990); Minn. Stat. Ann. § 302A.251(5)
(West Supp. 1991); Neb. Rev. Stat. § 21-2035(1) (Supp. 1988); Omo Rev. Code Ann.
§ 1701.59 (Anderson Supp. 1989); Pa. Cons. Stat. Ann. § 511(b) (Purdon Supp. 1990).

All but a few of the statutes apply automatically. None allows shareholders (or
nonshareholders for that matter) to agree to waive (or "opt out" of) the statutory

authorization to consider nonshareholder interests and substitute a shareholder primacy

rule instead. In this sense, although most do not require management to protect non-



1991] REDEFINING CORPORATE LAW 247

B. The Structure Of Corporate Governance

Despite their apparent iconoclastic ambitions, the statutes leave un-

touched some basic features of existing corporate legal structure. Most
obviously, management remains at the top of the corporation's decision-

making hierarchy. If state legislatures were motivated by solicitude for

nonshareholders, they conceivably might have established a quite different

governance structure. For example, nonshareholders might be given the

right to participate directly in high level decision-making, at least with

respect to matters in which they have an immediate interest. Toward
this end, corporations might be required to set aside particular seats on

the board of directors for representatives of various nonshareholder

constituencies.'^ Or, more radically, one might revise the customary
decision-making hierarchy by diffusing power downward from manage-
ment into the hands of particular nonshareholder constituencies most

likely to be affected by particular decisions. The statutes do not seek

to promote nonshareholder interests in these ways.

Furthermore, the directors' duty statutes do nothing to alter the

existing electoral system. In this respect, management remains accountable
only to the shareholders. This may seem surprising: If the legislatures
expected management to look after nonshareholder interests, one might

have thought the statutes would attempt to achieve accountability by

providing nonshareholders with the right to participate in the annual

election of the board of directors. '^^ This, of course, is the rationale

behind shareholder voting rights. Yet the directors' duty statutes say

nothing about voting rights for nonshareholders.'^

shareholders, the new statutes are "mandatory." See supra note 40. A few, however,
merely allow corporations to "opt in" by including a new directors' duty provision in

the articles of incorporation. See Ga. Code Ann. § 14-2-202(5) (1989); Tenn. Code Ann.

§ 48-35-204 (1988). Because articles amendments typically require shareholder approval,

"opt-in" directors' duty statutes seem odd: Would rational shareholders ever agree to
such provisions if given the chance to vote against them? In fact, at least two such

proposals, both involving Georgia corporations, have been adopted. ABA Report, supra
note 8, at 2263 n.35. While these events may be explained by management's control of
the proxy machinery, it would be wrong simply to assume that management seeks to

further its own self-interest in such situations. It is conceivable that management desires
the broader powers conferred by the directors' duty provisions because they better comport

with management's views about responsible conduct of corporate operations.

104. See, e.g., R. Nader, M. Green & J. Seligman, Taming the Giant Corporation
(1976).

105. Compare German corporate law, which mandates employee participation (with
shareholders) in election of the board of directors. See generally Summers, Codetermination

in the United States: A Projection of Problems and Potentials, 4 J. Comp. Corp. L. &
Sec. Reg. 155 (1982).

106. See infra pt. IV(B) for further discussion of this and related issues.



248 INDIANA LAW REVIEW [Vol. 24:223

To the extent the statutes do attempt to protect nonshareholder
interests, they rely on a traditional conception of the role of corporate

management. That is, just as management has been the vehicle for
achievement of the goal of shareholder welfare, now, as the objective

apparently changes to embrace nonshareholder welfare as well, man-

agement takes on that responsibility. Facially, the statutes leave open

the question of management's status as fiduciary. Is it still appropriate

to conceive of management as owing a fiduciary duty, albeit qualified,

to the corporation's shareholders? Is management's new responsibility
to nonshareholders fiduciary in nature? Before these questions can be

addressed, it is necessary to consider in more detail how the new statutes
alter existing shareholder and nonshareholder rights.

III. Decentering Shareholders

The new directors' duty statutes appear to allow management to
consider the impact of its decisions on nonshareholder interests and, if

deemed appropriate, to choose courses of action that are inconsistent

with traditional notions of shareholder primacy. Decentering the share-

holder in this manner might be termed the negative aspect of the statutory

agenda: The directors' duty statutes take away a basic right — shareholder
primacy in managerial decision-making — previously provided by cor-
porate law.'°^ But what sort of legal regime do the statutes contemplate

instead? What new rights do nonshareholders gain? What is management
supposed to do with its newly minted discretion? Postponing for the

moment consideration of such questions, which we might call the af-
firmative side of the new directors' duty statutes, ^'^^ this section analyzes
their negative aspect.

107. In referring to the statutes' "negative" aspect, I do not mean to imply an

evaluative judgment. Rather, my point is to distinguish between, on the one hand, the
way in which they diminish or reduce existing legal protection for shareholders and, on

the other, enhance or increase the status of nonshareholders. The latter is what I mean

by the statutes' "affirmative" agenda, considered in Part IV below. Professor Johnson

has analyzed both the negative and the positive aspects of judicially imposed restrictions

on shareholders' right of access to tender offers in terms of redefinition of the attributes

of corporate stock. That is, protection for nonshareholders has been achieved by cutting

back existing shareholder "property" rights rather than by articulating new rights (based

on property, contract, or tort, for example) on behalf of nonshareholders. See Johnson,

supra note 35, at 888 n.86; see generally Johnson, Sovereignty Over Corporate Stock,

forthcoming in Del. J. Corp. L. (1991). Considering the question beyond the specific

context of hostile takeovers, I argue below that adequate protection for nonshareholders

cannot be achieved solely through restriction of shareholder rights; instead, affirmative

responsibilities must be imposed on management to protect nonshareholder interests. See

infra pts. IV(B), (C). For discussion of the property-based critique of the directors' duty

statutes, see infra pt. IV(D)(1).

108. See infra pt. IV.



1991] REDEFINING CORPORATE LAW 249

In order to assess the negative impact of the directors' duty statutes,

it is necessary to understand how the new statutes alter shareholders'
rights to challenge objectionable management decisions. Under traditional
doctrine, management is subject to common law fiduciary duties of
loyalty and care. The duty of loyalty mandates that a director ** should

not use his [or her] corporate position to make a personal profit or
gain other personal advantage. "*°^ The idea is that, as fiduciaries, di-

rectors (and senior officers too) owe a duty of undivided loyalty to their
principal, the corporation. Most of the legal doctrine in this area is

concerned with various species of conflict of interest transactions. '"^

According to a typical formulation of the duty of care, a director

should **perform his [or her] functions in good faith, in a manner that

he [or she] reasonably believes to be in the best interests of the cor-

poration, and with the care that an ordinarily prudent person would

reasonably be expected to exercise in a like position and under similar

circumstances. "•'^ The duty covers both negligent failure to act and

decisions taken without appropriate care, including decisions reached

without sufficient information regarding the matter at issue. In addition,

director action may be challenged on the ground that, from an objective
standpoint, it could not rationally have been deemed to be in the

corporation's best interests. Thus, for example, a decision that amounts

to waste of corporate assets cannot be justified on the ground that it

was disinterested and the result of a reasoned decision process. ^'^

Shareholders have traditionally enjoyed the right to enforce the

fiduciary duties of care and loyalty through litigation."^ However, the

practical significance of this right has always depended in large part on

the so-called '^business judgment rule," which insulates managerial de-

cision-making from shareholder (and judicial) scrutiny. Thus, before it

is possible to determine how the directors' duty statutes affect the
common law duties of care and loyalty, it is first necessary to consider
the business judgment rule in light of the new statutes.

109. Corporate Director's Guidebook, supra note 18, at 1599.

110. See generally R. Clark, supra note 21, at 141-89.

111. ALI Principles, supra note 17, § 4.01(a).
112. In this respect, the duty of care can be said to require substantive as well as

procedural due care. W. Cary & M. Eisenberg, Cases and Materials on Corporations
541 (6th ed. 1989).

113. In form, the challenge is usually by means of the shareholders* derivative

action, in which particular shareholders sue on behalf of the corporation to obtain a

remedy for past or threatened financial harm to the corporation. The typical case is one

in which managerial negligence or self-dealing has resulted in a financial loss to the

corporation. In contrast to derivative suits are direct actions, in which a shareholder (or

a class of shareholders) asserts a claim based on an injury suffered by the shareholder

as such. Examples include efforts to enforce voting rights or to compel payment of

dividends. See generally R. Clark, supra note 21, at 639-74.



250 INDIANA LAW REVIEW [Vol. 24:223

The business judgment rule has been expressed in different ways in

different jurisdictions, but the basic idea is the same.''"* Courts will not

allow shareholders to challenge exercises of managerial business judgment

if, at the time of the decision, three prerequisites were satisfied. The

decision in question must have been the product of (i) disinterested and

(ii) informed judgment, and (iii) an objectively rational effort to further

the corporation's best interests.''^ Accordingly, the business judgment

rule requires a shareholder seeking to challenge a board decision to show

that the directors were subject to a conflict of interest with respect to

the matter at issue, ^'^ failed adequately to inform themselves prior to

reaching the decision, ''^ or, from an objective point of view, could not

rationally have beheved that the decision was in the corporation's best

interests."^ An allegation of irrationality requires a court to evaluate
the substantive merits of the decision in question. Here, under traditional

doctrine, the shareholder primacy principle comes into play. Absent some

demonstration of likely long-term financial gain to the corporation, a

decision to sacrifice profits solely to benefit employees or other non-

shareholders would not enjoy the protection of the business judgment

rule. Even if the directors were fully informed and had nothing to gain

personally from the decision, it would fail the rationality test because

of its inconsistency with shareholder financial interest.''^

Only if the disgruntled shareholder can demonstrate that at least

one of these three conditions (conflict of interest, inadequate information,

irrationality) is present will he or she be allowed to proceed with a

114. For extended analysis of the variations, see ALI Principles, supra note 17,
at 58-76 (comment and reporter's note to § 4.01(c)).

115. One area in which formulations of the business judgment rule differ is with
respect to the rationality element. Some jurisdictions have used a reasonableness standard
instead. See ALI Principles, supra note 17, at 67-68. Some jurisdictions also add a
requirement of good faith.

116. See R. Clark, supra note 21, at 138.

117. See, e.g.. Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
118. See, e.g., ALI Principles, supra note 17, § 4.01(c)(3).
119. For example, in Shlensky v. Wrigley, 95 111. App. 2d 173, 237 N.E.2d 776

(1968), a shareholder sought to challenge a corporate policy (no lights at Wrigley Field)

alleged to be inconsistent with profit maximization. According to the plaintiff, management

was motivated by a conviction that baseball is a "daytime sport" and concerns that night

baseball would lead to deterioration of the neighborhood surrounding the ballpark, rather

than by "interest in the welfare of the corporation." The appellate court affirmed dismissal

of the complaint not because such a policy was entitled to the protection of the business

judgment rule but rather because the plaintiff had failed to allege adequately that man-

agement's motives "are contrary to the best interests of the corporation and its stock-

holders" and that the policy might not in fact be related to legitimate financial objectives.

As a decision about proper pleading, the opinion is hyper-technical and thoroughly

disingenuous.



1991] REDEFINING CORPORATE LAW 251

lawsuit alleging management misconduct. Thus, the business judgment

rule is designed to shield directors from judicial scrutiny if they acted

properly at the time of the conduct at issue — even though their decision
later proves harmful to the corporation. ^^° In addition, because the

shareholder bears the burden of proving that at least one of the pre-

requisites to business judgment rule protection was not satisfied, the

business judgment rule also furnishes a presumption that directors act

in a disinterested, informed, and rational manner when they make man-
agement decisions. '^^ Only if a shareholder can overcome this presumption

will he or she be able to challenge the merits of management's conduct.

Thus, whether the business judgment rule blocks a particular shareholder

claim and the merits of the claim itself are actually two distinct questions.

To appreciate the impact of the new statutes on shareholders' ability
to challenge management decision-making, it is necessary first to consider

how the statutes alter traditional business judgment rule analysis. There
does not seem to be any change with respect to the requirement of

disinterest. Although the new statutes allow management to deviate from
relentless pursuit of profit maximization, they offer no basis for an

argument that management's own self-interest is an acceptable justifi-
cation for such deviations. Some statutes include a residual catch-all
category among the listing of specified nonshareholder considerations
that justify management's subordination of shareholder welfare (such as

'* other pertinent factors"'^^). However, even if this category were in-

terpreted to extend beyond the listing of specific nonshareholder con-

stituencies that appear to be the statutes' intended beneficiaries, there

is no warrant for adding management's own interests to the list of
legitimate considerations. The directors' duty statutes authorize man-

agement to use its discretion to protect nonshareholders at the expense

of shareholders, but do not allow management to transfer corporate
wealth to itself. So, a shareholder seeking to challenge a management

decision still should be able to avoid the business judgment rule by

arguing that the decision in question was tainted by conflict of interest.

In addition to cases of conflict of interest, it still should be possible

to challenge a decision on the ground that management failed adequately

to inform itself beforehand. For example, in cases of decisions that

relinquish profit maximization out of solicitude for nonshareholders, a

120. The reason for this is the beUef that, on the one hand, managers are chosen

for their business expertise and require a fair measure of discretion if they are to do

their jobs effectively, while, on the other, courts are poorly qualified to second guess

business decisions after the fact. See Corporate Director's Guidebook, supra note 18, at

1603-04.

121. See, e.g., Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

122. See, e.g., supra note 86 and accompanying text.



252 INDIANA LAW REVIEW [Vol. 24:223

shareholder might claim that the board failed adequately to evaluate the

respective costs and benefits to all affected constituencies (shareholders

as well as nonshareholders) of the options before it. Absent such an

evaluation, the business judgment rule's presumption of prudent, delib-

erate decision-making should not apply. Additionally, it might be argued

that the board had no informed basis for believing, on the one hand,

that a profit-maximizing option would harm identifiable nonshareholder
constituencies and, on the other, that the decision actually taken would

benefit those nonshareholders or at least avoid harming them. Thus,

acting on inadequate information should remain a basis on which a
shareholder seeking to challenge a management decision can overcome
management's invocation of the business judgment rule.

Because they expressly authorize management to make decisions that
take nonshareholder interests into account, the new statutes presumably
have the effect of revising what counts as a rational decision under the

business judgment rule. A decision that trades off shareholder gain
against nonshareholder benefits may now be construed as rational. For
example, the owners of a professional baseball franchise need not attempt

to justify their refusal to install lights for night games on the ground

that doing so will actually enhance the club's profitability by preventing

deterioration of the surrounding community; they could simply rely on

their desire to be good neighbors. ^^^ Iowa's statute attempts to address

this issue expressly. After specifying the nonshareholder interests that a

director may consider, the statute goes on to state the following:

Consideration of any or all of the community interest factors

is not a violation of the business judgment rule or of any duty

of the director to the shareholders, or a group of shareholders,

even if the director reasonably determines that a community
interest factor or factors outweigh the financial or other benefits

to the corporation or a shareholder or group of shareholders. '^'^

Even in the absence of such language, however, the logic of the directors'

duty statutes should preclude a shareholder from arguing against business

123. Cf. Shlensky, 95 111. App. 2d 173, 237 N.E.2d 776 (affirming dismissal of

shareholder complaint because of failure to establish harmful financial impact of man-

agement's refusal to install lights to facilitate night baseball).

124. lowA Code Ann. § 490.1108(2) (West Special Pamphlet 1990) (coverage re-
stricted to "acquisition proposals"). Though the passage's meaning is clear, its reference

to "violation of the business judgment rule" is an unfortunate malapropism. The business

judgment rule is both an exemption from liability and a rebuttable presumption that

directors exercise proper business judgment in making decisions. See supra notes 120-21

and accompanying text. It is not a substantive liability norm that can be violated. What
the legislature meant was that consideration of nonshareholder interests does not provide

a sufficient basis for denial of business judgment rule protection.



1991] REDEFINING CORPORATE LAW 253

judgment rule protection simply on the ground that a management

decision prefers nonshareholder over shareholder interests.

If this is so, under what circumstances might a shareholder argue

against invocation of the business judgment rule on the ground that a

particular decision was objectively irrational? Although it seems sensible

to assume that the statutes are not designed to eliminate entirely the

distinction between objectively rational and irrational managerial decision-

making, the content of the distinction is no longer clear. An obvious
example of objectively irrational behavior not entitled to business judg-

ment rule protection would be a decision that, at the expense of the

corporation's shareholders, conferred a benefit on some third party not

legitimately entitled to management's largesse. An example might be a
gratuitous cash payment to the surviving spouse of a recently deceased

senior officer of the corporation. Another less obvious possibility might

be a case in which management chose to forego a certain and very

substantial benefit to shareholders in order to achieve a much more
speculative and less substantial benefit for nonshareholders. The argument

would not be that management acted irrationally by preferring non-

shareholders over shareholders (the statute allows this), but rather that

under the circumstances the balancing judgment was so sharply skewed

against the shareholders and of so little benefit to nonshareholders as

to be objectively irrational.

To sum up the analysis thus far, the directors' duty statutes alter
the grounds available to shareholders for overcoming the business judg-

ment rule's presumption in favor of management. Shareholders should

retain the right to challenge management decisions tainted by self-interest.
In cases of decisions that benefit nonshareholders at the shareholders'

expense, shareholders should be able to argue in appropriate cases that

such decisions were based on inadequate information, but should no

longer be allowed to argue that any decision sacrificing profit maxi-

mization for the sake of nonshareholder interests is objectively irrational

for that reason alone. In this respect, the new statutes significantly
restrict shareholders' rights to hold management accountable.

If a complaining shareholder is able to overcome the business judg-

ment rule's hurdle to judicial scrutiny of managerial decision-making,

he or she must still prevail on the merits of the underlying claim. In

this regard, the duties of care and loyalty should be much the same as
under traditional doctrine. ^^^ One important difference must be noted.

125. As already noted, the duty of loyalty proscribes management decision-making

on the basis of self-interest. See supra text accompanying notes 109-110. The new statutes

authorize deviation from shareholder primacy only for the sake of specified nonshareholder



254 INDIANA LAW REVIEW [Vol. 24:223

however. A management decision to sacrifice shareholder interests in
order to benefit nonshareholders no longer amounts to a per se violation

(such as waste of corporate assets). '^^ For example, even a clearly stated

management policy to use corporate revenues to improve wages and
working conditions and to offer the company's product to the public

at a lower than profit-maximizing price would not, without more, appear

to be a basis for liability or injunction. '^^ In this regard, several directors'

duty statutes provide expressly that management shall be exempt from
personal liability for decisions taken pursuant to the statutory author-

ization to consider nonshareholder interests. '^^

interests; they do not allow managerial self-dealing.

The duty of care requires management to act "with the care that an ordinarily

prudent person would reasonably be expected to exercise in a like position and under

similar circumstances." ALI Principles, supra note 17, § 4.01(a). This implies a requirement
that management be adequately informed before deciding to protect nonshareholders at

the shareholders' expense. Indiana's statute makes this clear: A disinterested decision,
reached after consideration of nonshareholder interests, "shall conclusively be presumed

to be valid unless it can be demonstrated that the determination was not made in good
faith after reasonable investigation." Ind. Code A^fN. § 23-l-35-l(g) (West Supp. 1990)
(emphasis added). This relevant information should include evaluations of the likely costs

and benefits of a particular decision to all affected constituencies, including shareholders

and nonshareholders.

It should be apparent that the evidence bearing on liabiUty in such cases (lack of

adequate information) is the same as the evidence that a shareholder would cite in order

to overcome the business judgment rule's presumption. This will not always be the case,

however. For example, if the claim is conflict of interest, the plaintiff must first estabhsh

the existence of a legally sufficient conflict to rebut the business judgment rule's presumption

and, if successful, will then have to litigate a different issue, the substantive fairness of

the transaction at issue. See, e.g., Del. Code Ann. tit. 8, § 144(a) (1989).
126. A disgruntled shareholder might try to characterize such a decision as a violation

of the duty of loyalty (on the ground that management acts disloyally when it favors the

interests of some particular constituency), but the duty of loyalty has traditionally been

interpreted in terms of illegitimate managerial efforts to promote self-interest rather than

the interests of third parties.

Alternatively, a plaintiff might attempt to frame such a challenge in terms of the

duty of care, on the theory that the duty of care includes a substantive element recognizing

that certain decisions (however prudent they may appear to be from a procedural point
of view) are objectively irrational. See supra text accompanying note 118. However, the

mere fact that management has chosen to prefer nonshareholder interests over those of

shareholders would be insufficient to demonstrate irrationality because the statutes allow

management to act in this way.

There may still be something left to the rationality requirement, but it is unclear
how helpful it would be to shareholders who object to policies favoring nonshareholders.
One possible example of irrationality might be a decision that sacrificed very substantial

shareholder gains for trivial nonshareholder benefits.

127. Cf. Dodge v. Ford Motor Co., 204 Mich. 459, 170 N.W. 668 (1919) (ordering

payment of dividend when management sought to retain earnings to pursue policies contrary

to shareholder financial interests).

128. See Conn. Gen. Stat. Ann. § 33-313(e) (West Supp. 1990); Haw. Rev. Stat.



1991] REDEFINING CORPORATE LAW 255

From the shareholders' viewpoint, the principal doctrinal effect of
the directors' duty statutes is to deny them the right to hold management

accountable for decisions that renounce their interest in profit maxi-

mization in order to protect nonshareholders. The fact that a management

decision has that objective no longer provides a sufficient basis for

overcoming the business judgment rule's presumption of propriety or

for proving a substantive violation. By revising traditional doctrine in
this way, the directors' duty statutes allow management to protect non-

shareholder interests without fearing Hability to shareholders for their

decisions. The effect is to decenter shareholders by abrogating the tra-

ditional shareholder primacy principle. It should be stressed, however,

that the changes discussed here are purely doctrinal. Whether they will

be of any practical importance to shareholders depends on the extent

to which management actually chooses to exercise its authority to dis-
regard shareholder welfare. In other words, as long as management
pursues shareholder welfare, the loss of a right to challenge deviations

from that norm will be unimportant. Thus, the practical significance of
the changes discussed in this section will depend on how management
behaves. That, in turn, will depend on whether the new statutes are
interpreted as imposing affirmative responsibility on management to

protect nonshareholders, as discussed in the next section.

IV. The Rights of Nonshareholders

We have seen that, in their negative aspect, the directors' duty
statutes sharply curtail shareholder opportunities to challenge management
decisions that sacrifice their interests to those of nonshareholders. ^^^ Yet,

because the statutes are mostly phrased in permissive rather than man-

datory terms, the extent to which management will exercise its new
powers — and therefore the extent to which shareholders will suffer
and nonshareholders benefit — is unclear. To approach the question of
whether the new statutes incorporate an affirmative agenda entitling
nonshareholders to management's soHcitude, it is necessary to determine

the circumstances under which nonshareholders can hold management
accountable for decisions nonshareholders deem harmful to their interests.
The first part of this section addresses that question, suggesting two

possible interpretations. One would leave nonshareholders entirely rehant
on management's discretion, while the other would acknowledge some

§ 415-35(b) (Supp. 1990); Idaho Code § 30-1602 (1989); Ind. Code Ann. § 23-l-35-l(d)
(West Supp. 1990); Mass. Gen. Laws Ann. ch. 156B, § 65 (West Supp. 1990); N.M.
Stat. Ann. § 53-ll-35(D) (Supp. 1989); Or. Rev. Stat. § 60.357(5) (1989); Pa. Cons.

Stat. Ann. § 511(b) (Purdon Supp. 1990).
129. See supra pt. III.



256 INDIANA LAW REVIEW [Vol. 24:223

minimal rights with respect to management's consideration of nonshare-

holder interests. '^^ It will then be suggested that either of these readings

would likely be of slight value to nonshareholders.'^^ Accordingly, if the

directors* duty statutes are to be taken seriously, a stronger interpretation

of nonshareholder rights is needed. '^^ After presentation of such an

interpretation, some objections to it will be addressed.^"

A. Defining Management's Responsibility To Nonshareholders

1. No New Rights.—A superficially appealing answer to the question
of nonshareholder rights under the new statutes is to deny that they
provide anything. We might term this the "no new rights** interpretation.
This answer stresses that virtually all statutes make consideration of
nonshareholder interests optional but not mandatory. That being the

case, nonshareholders gain nothing from these statutes beyond what

directors choose to give. This interpretation appears to be all the more
forceful when the statute expressly states that no single group's interests
shall be deemed controlling by the board. ^^"^

If courts were to interpret the directors' duty statutes in this manner,

the effect would be to expand management discretion substantially.
Management would enjoy the freedom to decide whether shareholder or
nonshareholder interests should receive priority in particular situations.

Decisions to favor nonshareholders could not be challenged by share-

holders; ^^^ and nonshareholders could not challenge management decisions

designed to promote shareholder interests at substantial cost to affected

nonshareholder constituencies. In other words, the manner in which

management chose to exercise its broad powers would be largely immune
from judicial review.

It would be a mistake to adopt the no new rights interpretation of
the new statutes. Courts should be reluctant to read them in a manner

130. See infra pt. IV(A).

131. See infra pt. IV(B).

132. See infra pt. IV(C).

133. See infra pt. IV(D).

134. See supra notes 95 & 96 and accompanying text. Even when consideration of
nonshareholder interests is required by the directors' duty statute {i.e., Connecticut), nothing

is said about how shareholder and nonshareholder interests are to be weighed against each

other. Accordingly, once the board has assessed the relevant nonshareholder interests, it

apparently is free to accord them whatever weight (including none) it wishes. Here, at

least, a nonshareholder could sue management for simply ignoring his or her interest in

the decision in question. But determining the remedy might be problematic, because it

would be difficult, if not impossible, to show that compliance with the duty to consider

might have resulted in a different management decision. Cf. infra note 137.

135. At least not as long as they were disinterested, adequately informed, and

rational. See supra pt. III.



1991] REDEFINING CORPORATE LAW 257

that creates such expansive and unaccountable power, while at the same

time denying any meaningful role for the judiciary in policing the manner

in which that power is exercised. Furthermore, if the statutes are read

as leaving nonshareholder protection entirely to management's discretion,

a variety of incentives will discourage management from using its powers

to protect nonshareholder interests, a point discussed more fully below.

This interpretation would therefore result in the statutes having virtually

no effect at all. If that is so, the no new rights interpretation would
amount either to judicial nullification of the directors' duty statutes or

to imputation to the legislatures of empty intentions. However, before

considering these incentives and the need for a stronger interpretation

of nonshareholder rights under the new statutes, it is first necessary to
examine how the no new rights interpretation conflicts with basic notions
of management's responsibility to act with due care and should be rejected

for that reason alone.

2. Minimal Protection.—An alternative to the no new rights inter-
pretation of the directors' duty statutes would recognize limited oppor-

tunities for nonshareholders to challenge management decision-making.

This reading — a **minimal protection" interpretation — is based on
the traditional requirement of managerial due care. We have seen that
directors are now empowered to sacrifice (or at least temper) devotion
to shareholder wealth maximization when they decide that other values
so merit. Decisions about how to weigh shareholder financial interest
against nonshareholder considerations may now qualify as proper ex-
ercises of business judgment. Even here, however, the usual requirement

that management exercise due care — with its attendant requirement of
adequate information — would seem to apply. ^^^

At the very least, nonshareholders should be able to challenge a

decision adversely affecting them on the ground that it was uninformed.

In this context, nonshareholders might contend that the board failed

accurately to assess the impact of the decision in question on an affected

nonshareholder constituency. As a result, its decision to adopt a policy
harmful to that constituency was not the product of careful, reasoned

deliberation. In other words, the statutes should be interpreted to require

management to give adequate consideration to possible adverse effects

on particular nonshareholder constituencies before deciding on a course

of action designed to benefit shareholders. This implies that management

needs to be both aware of possible adverse effects and adequately

informed about their likely magnitude. Only then will management be
in a position to deliberate about the significance of these costs in relation

to expected shareholder benefits. Thus, this interpretation would ac-

136. See supra pt. III.



258 INDIANA LAW REVIEW [Vol. 24:223

knowledge that management has the discretion to pursue profitable
transactions despite harmful effects on nonshareholders, but would allow

it to do so only after having assembled and considered relevant infor-

mation about such effects.

This does not seem too much to ask. As a general matter, the law's
willingness to delegate power to make substantive choices need not imply
lack of concern for the manner in which choices are made. To the
contrary, the very act of delegation ordinarily implies an expectation

that the power conferred will be exercised with reasonable care. This

principle is reflected in corporate law's traditional requirement that

management exercise its discretion to manage the corporation on the
basis of adequate information and with appropriate deliberation. Under

the directors' duty statutes, these discretionary powers are enlarged to

include an authorization to take into account harmful effects on non-

shareholders. It seems only reasonable to continue to require management

to exercise its powers of choice in light of adequate consideration of

the relevant options. Thus, delegating to management the power to
protect nonshareholder interests impHes a duty to ascertain whether and

to what extent those interests are likely to be affected by particular

decisions.

If so, a nonshareholder's claim that a decision was not based on

adequate information should be sufficient to avoid management immunity

based on the business judgment rule, just as it would be if a shareholder

were attempting to challenge a decision on the same ground. In addition,

if proved, lack of due care ought to be grounds for relief in suits by

nonshareholders and shareholders alike. This interpretation would there-

fore acknowledge management's discretionary powers to choose between

shareholder and nonshareholder interests, requiring only that those powers

be exercised with knowledge and circumspection.

If the analysis offered here is sound, the new statutes should at
least be interpreted to confer certain limited rights on nonshareholders,

allowing them to formulate challenges to harmful management decisions

on the ground that management's decision was uninformed. '^^ However,

137. Even if this interpretation is accepted, there is a potentially vexing question

of causation in such cases. When the claim is that management failed adequately to inform
itself about effects on nonshareholders (or failed to consider nonshareholder interests at

all), aggrieved nonshareholders would presumably have to show that, had management

acted with adequate information, it would not have taken the objectionable decision. This

may be extremely difficult to prove. Nevertheless, perhaps a court should not be too
hesitant about granting prospective injunctive relief in appropriate cases. Such a judgment

would amount to an order to reconsider the matter at issue, paying adequate attention

to relevant nonshareholder interests, and would not involve personal liability for money
damages. As such, it would be an endorsement of the value of the dehberative process,



1991] REDEFINING CORPORATE LAW 259

the question still remains whether nonshareholders have standing to bring

suit under the new statutes. The statutes themselves are silent on this
question, but courts should not deny rights of action to nonshareholders.

One obvious reason is the standard one for implying private rights of
action under statutes that neither confer nor deny such rights. As the
statutes' intended beneficiaries, nonshareholders ought to be able to

enforce whatever rights they gain under them. This argument is all the

more forceful in situations, like this one, in which there is no reason

to expect public authorities (or others) to vindicate the beneficiaries'

interests by suing on their behalf.

There is a further reason for allowing nonshareholders to bring suit.

The apparent goal of the statutes is to encourage, or at least allow,

managerial attention to nonshareholder interests in cases in which ex-

clusive devotion to profit maximization would be harmful. Under the

minimal protection interpretation, management would be permitted, but
not required, to exercise this power. It is therefore especially important

to minimize significant disincentives for management to do so.^^^ From
the nonshareholders' perspective, there is concern that management will

fail adequately to consider nonshareholder as well as shareholder welfare.

Shareholders will have an incentive to challenge decisions that sacrifice

their interests for the sake of assertedly offsetting benefits to nonshare-

holders. Thus, if management chooses a course of action that sacrifices

shareholder interests for the sake of nonshareholders, there is at least

some likelihood that it will be sued by a disgruntled shareholder. How-
ever, if management chooses to promote shareholder welfare instead,

and adversely affected nonshareholders have no right of action, there

rather than an assertion that management would necessarily have reached a different

conclusion under hypothetically altered circumstances. However, when the harmful effects

of a decision have already occurred, it may be harder to make a compelling case for
monetary relief. Perhaps it should be enough to say that, if the relatively mild prohibition

on management decisions that harm nonshareholders inadvertently or carelessly is to mean
anything, courts will need to avoid overly scrupulous insistence on proof of causation.

Two further grounds for relief should also be mentioned, though these may be
relatively unimportant. First, nonshareholders should be able to challenge decisions to

benefit shareholders that are tainted by management's self-interest, as, for example, if a

majority of the board members owns substantial blocks of stock. Second, even if a decision

to benefit shareholders at a cost to nonshareholders is disinterested and adequately informed,

it should be possible to claim that the decision is objectively irrational. However, as in

the case of shareholder suits, the rationality requirement is likely to be relevant only in

a relatively small range of cases. One category might include decisions designed to benefit
shareholders that will result only in slight gains even if things work out as hoped, but

will produce substantial detriment to a particular class of nonshareholders. Another would

be cases of waste, in which management confers a benefit on some person or group

having no legitimate claim.

138. See infra pt. IV(B) for further discussion of related issues.



260 INDIANA LAW REVIEW [Vol. 24:223

is little if any reason to fear litigation challenging adverse impact on

nonshareholders. Surely shareholders would not be expected to sue man-

agement because a financially beneficial decision also happens to impose

costs on nonshareholders. So, unless nonshareholders can assert their

rights under the statutes, the threat of suits by shareholders may en-
courage management to disregard nonshareholder considerations, and

choose the safer course of preferring shareholder wealth maximization

over competing nonshareholder interests. Such a result would, of course,

render the statutes meaningless as a device for protecting nonshareholders.

Thus, the availability of a right of action for shareholders suggests a

reason for a corresponding right for nonshareholders. ^^^

Even with a right of action, the interpretation of nonshareholders'

rights under the new statutes offered in this section is far from generous.
It only establishes a right to relief in cases in which management either

entirely ignored affected nonshareholder interests or chose to subordinate

such interests to shareholder welfare without first having adequately

informed itself of relevant costs and benefits. If management is disin-

terested and adequately informed prior to making a decision, there is

virtually no basis on which nonshareholders might sue management for

choosing to pursue shareholder interests despite significant costs to non-

shareholders. ''^^ Thus, although this interpretation is more generous than

the no new rights interpretation discussed above,*"*' it is still quite minimal.
Whether it is at all adequate to the statutes' apparent objective of

protecting nonshareholder welfare is considered next.

B. Incentives

Of the two interpretations of the new statutes discussed in the
previous section, the minimal protection interpretation would at least

require informed, disinterested evaluation of the impact of particular

decisions on nonshareholder constituencies. Assuming a right of action

were available, nonshareholders would be entitled to challenge manage-

ment decisions on grounds that the decisions are based on inadequate

information, tainted by conflict of interest, or substantively irrational.

139. In form, nonshareholder challenges of the type discussed above might be deemed

direct actions (as opposed to derivative, see supra note 113), because the injury complained

of is a harm to a particular nonshareholder constituency, rather than to the corporation

as a whole. Alternatively, however, if a decision to protect a particular nonshareholder

group is conceived of as an effort by management to discharge a duty owed to the

corporation, the action could be characterized as derivative, even though the beneficiaries

of a judgment are only a single nonshareholder constituency.

140. The sole exception would be those odd-ball cases in which management's decision

could be construed to be substantively irrational. See supra note 126.

141. See supra pt. IV(A)(1).



1991] REDEFINING CORPORATE LAW 261

This is a more generous interpretation than the no new rights reading,
but it does not require that management protect nonshareholder interests
under any defined circumstances. As long as management collects and
digests the necessary information, it would be free to pursue profit

maximization without regard to adverse effects on nonshareholders.

If protection is Hmited to that provided by either the no new rights
or minimal protection interpretations, and even assuming that nonshare-

holders enjoy a right of action, the statutes will have little if any beneficial

effects for nonshareholders. Instead, various incentives will encourage

management to focus its energies on shareholder welfare, for the most

part leaving its newly minted discretionary powers on the shelf. '"^^ This

is so for several reasons.

First, as noted previously, the new statutes do not extend voting
rights to nonshareholders. The power to elect the corporation's board

of directors therefore remains in the hands of the shareholders. However
weak this power may be (because of management's control over the
proxy machinery'"^^), voting rights still represent a potentially meaningful

check on the way in which management exercises its powers. Especially
as large institutional shareholders take on an increasingly vocal monitoring

role, managers who wish to retain their jobs and avoid controversy must
be wary of disappointing the corporation's shareholders. In contrast,

there would be little reason to fear the nonshareholders, at least as long

as management does its homework well enough to minimize the likeHhood
of a successful lawsuit. This means that in cases in which management
must choose between promoting shareholder welfare at a cost to non-

shareholders or protecting nonshareholders at the shareholders' expense,

the existence of shareholder voting rights encourages management to
prefer the former option.

Existing executive compensation schemes that discourage management
from tempering a commitment to profit maximization are another dis-

incentive to regard for nonshareholders. This is obvious when bonus
payments are tied to profitability. In addition, if grants of stock or of

stock options are an important part of the compensation package, man-

agement will have an incentive to maximize share values. The long-term

security of executive pension plans may also be perceived to depend in
part on the corporation's financial performance.

Besides the voting rights disparity and the character of existing

executive compensation schemes, several market-based incentives consti-

tute a third factor discouraging regard for nonshareholders. These in-

142. The argument is not that management will be more attentive to shareholder

welfare if the new statutes are interpreted minimally than it would be if there were no

statutes at all. Rather, it will not be any less so.

143. See M. Eisenberg, The Structure of the Corporation 97-136 (1976).



262 INDIANA LAW REVIEW [Vol. 24:223

centives are based on management's interest in ensuring that the

corporation compete effectively with the other firms in its markets.

Failure to do so would result in declining market shares and, ultimately,

bankruptcy. As with voting rights and executive compensation, man-
agement's financial welfare, job security, professional reputation, and

self-esteem are at stake. Even if such considerations do not guarantee

that management will do everything in its power to pursue profit max-
imization, they still generate systemic pressures that lead management

away from costly poHcies beneficial to nonshareholders.

One such market-based incentive is the existence of product (or
service) market competition. Competition from other sellers in the same

market will encourage management to trim costs. This objective can
translate into losses for nonshareholders. For example, in a case in which

maintaining operations at an older facility constitutes a productively

inefficient use of the corporation's assets, management will feel pressured

to close the plant. Failure to do so may disadvantage the corporation
vis-a-vis its competitors. Thus, the need to minimize production costs

creates an incentive for management to pursue efficiency rather than

nonshareholder welfare.

Competition among corporations for debt financing may also have
that effect. To the extent that lenders perceive an uncertain commitment
to profit maximization as a threat to the corporation's financial stability,

borrowing costs should be higher. These will be out-of-pocket costs in

the form of higher interest rates, and may therefore impair the cor-
poration's ability to compete. Accordingly, there is an incentive to pursue

strategies that will facilitate lower-cost borrowing.

Capital market pressures may also be relevant. Sub-optimal per-
formance is likely to increase the cost of raising capital through sale

of equity; investors in newly issued stock who are asked to settle for
a lower rate of return can be expected to demand a larger quantity of
stock in return for their capital contribution. The higher cost of such

stock offerings is not an additional out-of-pocket expense affecting the

corporation's ability to compete in the product market.''*^ Nevertheless,

the greater the amount of stock to be issued, the greater the likelihood

that existing shareholders will object that the percentage share of the

corporation's total equity to be held by the new investors is too great
in relation to the amount of their capital contribution. The result may
be lawsuits by existing shareholders or dissatisfaction registered at the

annual meeting. ""^^ Thus, the fact that corporations must compete with

144. Eisenberg, supra note 38, at 1500-01.

145. Nevertheless, the significance of the higher capital cost factor should not be

overstated. Most publicly held corporations do not depend on public offerings of stock



1991] REDEFINING CORPORATE LAW 263

each other to obtain equity financing may also encourage profit mgix-
imization, despite negative effects on nonshareholders.

Finally, it should be recalled that only some corporations are subject

to the new directors' duty statutes. Some states — notably Delaware
and California — have not enacted them; presumably shareholder primacy
(however diluted) will continue to be the governing norm for firms
incorporated in these states. Thus, management of a corporation subject

to a directors' duty statute may have to compete against companies for
which adoption of policies designed to favor nonshareholders would be

illegal. This factor could therefore compound the significance of the
various market forces discouraging deviation from profit maximization. '"^^

All these reasons taken together suggest that there will be substantial

incentives for management to pursue profit maximizing options even

when it is aware of foreseeable, substantial negative effects on particular
nonshareholder constituencies. ^'^^ If the statutes are interpreted as re-

quiring nothing more than disinterest, adequately informed decision-

making, and rationality, they can be expected to be of little benefit to

nonshareholders. Critics of the directors' duty statutes have focused on

management's broad discretion to choose between shareholder and non-

shareholder interests, apparently unconstrained by guidelines about how
this discretion is to be exercised. •'** Under this view, managers wield

unprecedented power not only over questions of business policy but over

the question of corporate purpose itself. However, the analysis offered

above suggests that these critics may have little to fear. If there is no

to generate needed capital, relying on retained earnings instead. Stout, The Unimportance

of Being Efficient: An Economic Analysis of Stock Market Pricing and Securities Reg-
ulation, 87 Mich. L. Rev. 613, 648 (1988).

146. This discussion raises the possibility that states adopting directors' duty statutes

could put their domestic corporations at a competitive disadvantage (vis-a-vis firms in-

corporated in other states) if the statutes were interpreted as requiring management to

take nonshareholder interests into account. If the disadvantage were severe enough, the

result might be reincorporation in a state (such as Delaware) that lacks such a statute.

Before that possibility is taken too seriously, however, one would want to see some

empirical evidence that the detrimental effect of management's conduct is sufficient to

make a difference in the corporation's competitive position. Even if there is a noticeable
effect, there may be other considerations (taxes or convenience, for example) that militate
against reincorporation.

147. One market factor that may be of relatively limited significance is the market
for corporate control. Such a market encourages management to maximize returns on

corporate assets in order to deter potential hostile acquirers. See generally Manne, supra

note 45. However, the combination of judicial decisions and antitakeover legislation,

discussed in Part 1(B)(2) above, have sapped the takeover market of much of its vigor.
Another cause has been the withering of the junk bond market on which the takeover

market depended in large part.

148. See Hanks, supra note 8, at 24-25; ABA Report, supra note 8, at 2269.



264 INDIANA LAW REVIEW [Vol. 24:223

legal requirement that management protect nonshareholders, it is unlikely
that it will do so.

One response to this analysis is to point out that management's
dedication to profit maximization depends on its perception that such

a course of action is in its self-interest. There may be situations in which
self-interest will dictate use of the statutory power to disregard shareholder

welfare. In other words, the interests of management and nonshareholders

may be aligned under certain circumstances, and the incentives ordinarily
encouraging promotion of shareholder welfare may not apply. In those
cases, even a weak interpretation of the statutes will be sufficient to
protect nonshareholders.

This observation may be accurate in the relatively isolated situations
in which promotion of shareholder interests threatens management's job

security. The obvious example is the hostile takeover. When nonshare-
holder interests are also threatened, management can use its authority
under the directors' duty statutes to take whatever defensive actions are

needed. In such cases, the statutes may work in the nonshareholders'
favor even if management's responsibility to them is wholly discretionary.

However, even in the hostile takeover situation, management and share-

holder interests may be aligned, as for example, if generous golden
parachute provisions apply. In any event, hostile takeovers are increas-

ingly rare and represent only one among the many possible situations
in which nonshareholders may be adversely affected by pursuit of share-
holder welfare. They are also unique in presenting the likelihood that

management will lose its job. Most other situations involving a choice

between shareholder and nonshareholder interests (plant closings unrelated

to changes in control, for example) involve no such threat. Thus, the

cases in which management and nonshareholder interests will coincide
will be relatively rare, and are not nearly frequent enough to justify

confidence that management will use its statutory powers to protect

nonshareholders on more than an occasional basis.

Under either the no new rights or minimal protection interpretations,
the directors' duty statutes do not present as serious a threat to share-

holder primacy as their critics fear. From a doctrinal viewpoint, the
statutes would prevent shareholders from challenging management de-
cisions that sacrifice shareholder interests for the sake of nonshareholder

welfare. However, it is likely that they will fail to benefit nonshareholders

because management will be reluctant to exercise its powers on non-

shareholders' behalf. If the statutes are interpreted to impose only min-

imal requirements on management, they will have only minimal effect.

Therefore, the need is to decide whether to read the statutes in a manner

that trivializes and effectively nullifies them or, instead, to try to un-

derstand them as meaningful legislative efforts to protect nonshareholders

from the harmful side-effects of overly zealous commitment to profit

maximization.



1991] REDEFINING CORPORATE LAW 265

C. Taking the Directors* Duty Statutes Seriously

If the directors* duty statutes are to have any significant effect, they

must impose requirements on management that extend beyond minimal
requirements of disinterest, adequate knowledge, and rationality. As part
of a larger effort by the states to protect vulnerable nonshareholders

from the excesses of exclusive devotion to shareholder welfare, the

directors' duty statutes should be read in light of their political context.

An interpretation that in effect renders the statutes vacuous ignores the
magnitude of the problem they address and vitiates the legislatures'

attempt at a solution. It also leaves corporate management with greatly
expanded discretionary power, without any likelihood of meaningful

benefits to the statutes' intended beneficiaries. The statutes therefore
need to be interpreted in a way that mandates protection for nonshare-
holder interests under defined circumstances.'"*^

This section suggests three broad principles governing management's

exercise of its powers under the new statutes. These principles apply
both within and outside of the hostile takeover context and are based

on an understanding of the context out of which the statutes emerged.

Before outlining the principles, it is necessary to revisit a few key points

about that context. As discussed above, '^° the immediate occasion for
the directors' duty statutes was the hostile takeover explosion. Before

then, management's duty to the corporation could be interpreted as a

duty to the shareholders because the interests of shareholder and non-

shareholder participants in the corporate enterprise were assumed to be

largely congruent.'^' So long as management pursued long-term strategies,
all participants stood to gain. Profits would flow from investment in

research and development and gradual expansion and adjustment of

production in response to market conditions. Management promoted the
firm's interest by supervising employee, supplier, creditor, and customer

149. Statutory language apparently disclaiming the right of any corporate constituency

to insist that its interests receive priority should present no obstacle to such an interpretation.

See supra text accompanying note 95 (quoting Indiana's statute); see also Pa. Cons. Stat.

Ann. § 511(b) (Supp. 1990) (quoted supra note 96); c/. N.Y. Bus. Corp. Law § 717(b)
(McKinney Supp. 1990). The purpose of this language is not to deny rights to nonshare-

holders, but rather to state explicitly that shareholders are no longer entitled to the primacy

they enjoyed under traditional corporate law principles. The Indiana statute seems to make
this clear. Immediately following the sentence denying priority, the statute addresses

shareholders' rights to tender offer premiums, explaining in effect that Indiana law does

not require directors to promote shareholder interests in hostile takeover situations. See

Ind. Code Ann. § 23-l-35-l(f) (West Supp. 1990). Thus, it would be a mistake to read
such provisions as precluding efforts to interpret management's obligations to nonshare-

holders in a meaningful manner.

150. See supra pt. 1(B)(1).

151. See supra text accompanying notes 78-79.



266 INDIANA LAW REVIEW [Vol. 24:223

relationships in ways that minimized unexpected, uncompensated dis-

ruption.

Hostile takeovers presented a highly visible and dramatic instance

in which shareholder interests and those of the other participants in the

corporate enterprise diverged. Target company shareholders possessed
the power to decide unilaterally whether particular hostile bids would

succeed by virtue of their power to decide whether to tender their stock

to the bidder. They could and did wield this power without regard to
how changes in management and in corporate policy might affect non-
shareholders. As a result, shareholders' desires for immediate gains often
brought immediate costs to nonshareholders. Despite the absence of

express contractual commitments by the corporation, many of these
nonshareholders had legitimate expectations of long-term relationships

with the corporation, built on impHcit understandings and reliance.'"

By allowing shareholders to sell the company to the highest bidder,
tender offers interfered with target company management's ability to
pursue longer-term strategies in accordance with nonshareholder expec-

tations, even when these might be to the ultimate benefit of target
shareholders as well. Takeovers therefore focused attention on the dis-

tinction between short-term shareholder gain and attendant nonshare-

holder losses, on the one hand, and, on the other, the possible longer-

term benefits to both shareholders and nonshareholders of the continued

independence of the corporation.

The new directors' duty statutes, as a part of the broader judicial
and legislative response to the harmful effects of hostile takeovers,'"

should be read as an effort to deny shareholders the power to realize

short-term profits at the expense of management's discretion to pursue

longer-term strategies from which both shareholders and nonshareholders

might benefit. Because most of these statutes apply beyond the hostile

takeover context, it seems entirely reasonable to conclude that they seek

a similar goal beyond that context. Accordingly, the first principle that

should guide interpretation of the directors' duty statutes is this: Man-
agement should not seek or allow short-term shareholder gains if frus-

tration of legitimate nonshareholder expectations will result.

For example, it would be presumptively improper for management

to adopt a policy that would result in the swift, unexpected layoff of

large numbers of workers or the closing of a plant in a community in

which that facility is an important citizen, even if the immediate financial

benefit to the corporation would be significant. (This decision would

only be presumptively improper because it might be justified under certain

152. See supra text accompanying notes 47-48.

153. See supra pt. 1(B)(2).



1991] REDEFINING CORPORATE LAW 267

circumstances by reference to the third principle, discussed below.) The

first principle would also embrace situations in which management must

intervene to prevent shareholder profit-taking from harming nonshare-

holders. The most salient example would be a threatened bust-up takeover
that would result in a large premium for shareholders but a substantial
disruption of existing nonshareholder relationships. In other words, this

principle is an explicit rejection of the view that management's duty is

to promote short-term shareholder financial interests when significant
harm to nonshareholder constituencies would follow.

Although the first principle would interpret the statutes as empow-
ering management to disregard short-term shareholder gains in order to
avoid nonshareholder losses, there is no basis for interpreting the statutes

as authorizing management to disregard the profit motive altogether. It
would be surprising to read so radical a message into these terse en-

actments, and there is no need to do so. Accordingly, the second principle

requires management to pursue profit-seeking strategies that aim to
harmonize the shareholders' financial interest and nonshareholder inter-

ests in stable relationships with the corporation.

This objective implies that management should run the corporation
with an eye toward a longer horizon. That suggests a policy of patient

attention to profit maximization through gradual, prudent adjustment

to market circumstances, rather than radical, disruptive reactions mo-
tivated by a desire to shore up current profits. Some statutes refer
expressly to the relevance of **long-term" considerations to managerial

decision-making. ^^"^ The decline of a robust takeover market, together

with the empowerment to block destructive bids that the directors' duty
statutes themselves provide, should give management the freedom needed

to pursue such strategies.

As long as management adheres to the first and second principles,
sharp conflicts of interest between shareholders and nonshareholders may
be relatively infrequent. Long-term strategies can be formulated that

minimize disruption of nonshareholder relationships. However, there will

be times when preservation of existing relationships appears to be either
impossible or so costly as to threaten the well-being of the enterprise

as a whole. Plants will have to be replaced; suppliers may prove unable
to trade at competitive prices. Under such circumstances, management's

duty to respect existing nonshareholder relationships implies a larger

duty to promote the welfare of the enterprise as a whole; after all, if

the corporation collapses, all fall with it. Accordingly, the statutes should

not be read as entitling nonshareholders to permanent relationships with

the corporation under all circumstances. However, in cases of conflict

154. See supra text accompanying note 87 and statutes cited supra note



268 INDIANA LAW REVIEW [Vol. 24:223

between the interests of the enterprise in maintaining profitable operations

and those of a particular nonshareholder constituency in continuing a

valuable relationship, the latter need not be sacrificed with impunity.

Keeping their context in mind, the directors* duty statutes clearly reveal

a concern about abrupt, unfair disruption of relations between the

corporation and vulnerable nonshareholder constituencies. Accordingly,

a third principle seems appropriate: In managing the company in a
manner that pays due regard to profit maximization over the long-term,

management should honor the legitimate expectations of nonshareholder
constituencies if abrogation of existing relationships is necessary to serve

the larger interests of the corporate enterprise as a whole.

A duty to consider the interests of particular nonshareholder con-
stituencies therefore does not mean that plants can never be closed or
suppHer relationships terminated. It does mean, however, that manage-

ment should conduct such transitions in a manner that minimizes losses

to the affected parties. Substantial advance notice would seem to be a

basic entitlement. In the case of employees, job transfer and retraining

opportunities may also be appropriate. If losses resulting from disruption
of legitimate expectations cannot be avoided, the objective should be

full compensation for losses resulting from breach of commitments im-

plicitly undertaken by management. If computation of such awards proves

to be too difficult, it may be desirable to spell out these rights ahead
of time by contract as, for example, through adoption of so-called **tin

parachute" severance payment provisions.'"

The interpretive principles offered here are admittedly very general.

Even those who are sympathetic may find them too vague to be helpful.
Terms like **legitimate expectations" and distinctions like

*

'long-term"

versus
*

'short-term" are notoriously manipulable. If this is all that can

be made of the statutes, some will conclude that it is not enough. (And
those who are implacably hostile to the entire enterprise will find another
reason to object.) In its defense, this approach relies on necessarily loose

normative guidelines and, in effect, invites courts to develop a new body
of common law in this area. The virtue of the common law method
has always been its adaptability to new information and changing cir-
cumstances. This seems all the more suitable in a situation that involves

factually and conceptually difficult issues, troubling political questions,

and a sharp break with traditional legal doctrine. Perhaps the meaning

of the general principles sketched here is best worked out in the context

of concrete cases. '^^

155. Protection might also include successorship requirements binding subsequent

acquirers. For discussion of the use of tin parachutes and successorship requirements in

these contexts, see Note, supra note 8, at 1473-84.

156. For example, what counts as legitimate nonshareholder expectations entitled to



1991] REDEFINING CORPORATE LAW 269

Surely a comparatively more cautious, less ambitious approach is

preferable to an effort to specify a large number of detailed, narrow

rules. It would be an act of foolish hubris to reject nearly a century

of accumulated legal development and, simultaneously, offer what pur-

ports to be a fully articulated replacement. Whatever wisdom and clarity

such a project might appear to offer would be largely illusory because

it is sure to require adjustment and creative interpretation in light of

future problems now only dimly perceived. In any event, the statutes
themselves speak in such general terms that a more finely textured
interpretation seems inappropriate.

The interpretation suggested above implies a new conception of
management's responsibilities to shareholders and nonshareholders. One
might ask whether under this interpretation the new statutes extend the
fiduciary principle from the management-shareholder nexus to the re-

lations between management, on the one hand, and all the various

corporate constituencies (shareholder as well as nonshareholder), on the

other. '^^ The problem with this conceptualization is that it implies that
management owes fiduciary obligations to a wide range of beneficiaries

whose interests will inevitably conflict from time to time. Used in this

manner, the fiduciary idea, with its implication of undivided loyalty,

does not seem very helpful.

One alternative is to continue to think of the shareholders as the
beneficiary of management's fiduciary obligation, but to appreciate that

the obligation is hemmed in by statutory responsibilities to nonshare-

protection is best decided on a case-by-case basis. Even if legitimate expectations are

defined more precisely (such as those growing out of relied upon, implicit understandings

of long-term employment, as evidenced by firm-specific investments made in anticipation

of long-term returns), the justice of a nonshareholder group's claim will depend on the

factual circumstances, including the nature and history of the relationship with the cor-

poration, the extent and character of the nonshareholders' rehance, the reasonableness of

their expectations under the circumstances, the amount of compensation, and other factors.

The difficulty of such evaluations would not be eliminated by expressing legal principles

in the language of economic theory. For example, to state management's responsibility

as a requirement that significant poHcy decisions be Pareto efficient with respect to

nonshareholders as well as shareholders (/.e., no one should be made worse ofO would

simply raise a new set of interpretive difficulties. General economic concepts are no more

determinate than ordinary legal ones.

157. For an extended argument in favor of recognition of a fiduciary duty owed

by management to the corporation's employees, see O'Connor, supra note 48. Though

the existence of the new directors' duty statutes is one element on which O'Connor draws

in support of her position, her argument is not presented as an interpretation of these

statutes. Rather, she advocates creation of a common law fiduciary duty analogous to
the nonstatutory fiduciary obligations traditionally owed by management to shareholders.

See also McDaniel, Bondholders and Stockholders, 13 J. Corp. L. 205 (1988) (advocating

fiduciary protection of bondholders).



270 INDIANA LAW REVIEW [Vol. 24:223

holders. After all, there have always been limits on the shareholders'

right to demand that management promote their interests. Most obvious
is the traditional requirement that management act within the bounds
of the law.'^^ In addition, fraudulent conveyance principles restrict man-
agement's freedom to benefit shareholders at the expense of creditors. '''

Interpreted in the manner suggested above, the directors' duty statutes
simply supplement existing restrictions on over-zealous pursuit of share-
holder primacy.

Perhaps, however, it is preferable to think about management's

fiduciary obligation as a duty to the corporation as such, rather than

to any particular constituency. The directors' duty statutes invite us to
jettison the traditional conflation of management's duty to the corpo-

ration with a duty to the shareholders. Doctrinally this was never accurate;

management is an agent of the reified corporate entity rather than of
its shareholders. Nevertheless, the conflation was long acceptable because

both descriptively and normatively, it didn't seem to make much dif-
ference. Corporate and shareholder interests were perceived to be con-

gruent and generally unthreatening to the various nonshareholder

constituencies. How we conceptualize the nature of the corporation may
have limited practical significance in any large sense, but it can nev-

ertheless help us to clarify our thinking about particular normative

questions. •^ By formulating management's duty as a duty to the corporate
enterprise, we emphasize that management's responsibility to look after
nonshareholders arises in the context of a more general duty to further
the success of the corporation as a whole, conceived as a complex

network of shareholders and nonshareholders. This idea rests on a

normative perspective that rejects the notion that corporations exist solely

to serve as investment vehicles for shareholders. This is only one of

their functions. They also play a vital role in our society as employers,

customers, suppliers of goods and services, and valued members of local
communities. By redefining management's responsibility as a duty to the
corporate entity, comprising nonshareholders as well as shareholders,

corporate law acknowledges this fact.

D. Objections

The stronger interpretation of the directors' duty statutes offered

above defines limitations on management's discretion that are designed

to require protection of nonshareholder interests under certain circum-

158. See, e.g., ALI Principles, supra note 17, § 2.01.
159. See generally R. Clark, supra note 21, at 40-52.

160. For discussion of the role of theories of the corporation in legal and political

discourse, see Millon, Theories of the Corporation, supra note 22, at 240-51.



1991] REDEFINING CORPORATE LAW 271

Stances. This interpretation would confer enforceable rights on non-

shareholders to challenge particular management decisions. Definition

and enforceability are necessary to overcome the incentives that will

discourage management from exercising its powers to protect nonshare-
holders. The result will be restriction on management's ability to pursue
shareholder welfare through profit maximization. This fact suggests one

objection to the stronger interpretation: its damaging impact on share-

holder property rights. If interpreted in the manner suggested here, the

statutes will also interfere with shareholders' ability to structure their

relations with nonshareholders through private ordering. In that respect,

the statutes threaten efficiency. Both these objections are considered

below.

/. Shareholder Property Rights,—By restricting management's ability
to pursue shareholder welfare, the strong interpretation would have an

adverse effect on shareholder property rights. Ownership of a share of

stock would no longer imply a right to have management exercise its
stewardship of the corporation in order to maximize the share's value.

Of course, the new statutes do not authorize managerial self-dealing,
sloth, or other forms of deliberate or negligent injury to shareholder

financial interest.'*^' Nevertheless, under certain circumstances, manage-

ment would be required to put shareholder interests to one side in order

to protect the interests of nonshareholders.'^^ Because shareholders would

have to settle for less than optimal financial performance, stock in

corporations subject to the new statutes would presumably be worth less
than before. '^^

161. See supra pt. III.

162. Because nonshareholders would realize corresponding benefits, the statutes have

been characterized as authorizing transfers of wealth from shareholders to nonshareholders

and have been criticized on that account. See Hanks, supra note 8, at 24 (referring to

management's power to allocate "stockholders' wealth" to other groups). However, what

counts as shareholders' wealth depends in part upon how the shareholders' entitlements
are defined by corporate law. While the enactment of the statutes may be said to have
a negative impact on shareholder wealth, management decisions pursuant to the statutes

would not involve Wealth transfers unless there was a pre-existing entitlement involved.

However, the new statutes redefme the shareholders' status in a way that redefines their

entitlements. Thus, it is inaccurate to characterize management's power in terms of the

power to transfer wealth.

163. It is possible that the stock market would assign a relatively small negative

value to the new statutes. The magnitude of the effect would depend in large part upon

their practical effects. It may be that these will be only occasional; if management is still
able effectively to pursue profit maximization most of the time, the impact on share

values may be insubstantial. In any event, the extent to which stock prices respond to
apparently signiflcant changes in the law is not clear. See Weiss & White, Of Econometrics
and Indeterminacy: A Study of Investors' Reactions to "Changes" in Corporate Law, 75
Calif. L. Rev. 551 (1987) (analyzing effect of seven important judicial decisions on stock

prices and finding no significant correlation).



272 INDIANA LAW REVIEW [Vol. 24:223

As a legal argument, this objection is weak. Legal transitions do
not present serious legal difficulties simply because they cause incidental,

uncompensated diminution of share values. Shareholders have always

been on notice that states can change the law governing their corporations.

Taking the lead from Justice Story's opinion in Trustees of Dartmouth

College V. Woodward,^^ state general incorporation laws routinely include
provisions reserving the right of amendment and announcing their po-
tentially retroactive force. *^^ It might even be said that shareholders

tacitly consent to such changes in advance by buying stock under these

circumstances.

Shareholders cannot fruitfully respond that the shareholder primacy

principle is somehow embedded or inherent in the essence of corporate
stock. State legislatures define the content of these property rights. By
redefining them, the legislatures are simply exercising a prerogative that

has always been theirs. *^^ For example, the one-share, one-vote principle,

which may seem so fundamental as to be timeless, was by no means
a universal feature of nineteenth-century corporate law.^^^ So too, it has

not been long since state legislatures eliminated the individual share-

holder's veto power over fundamental corporate changes by doing away
with the requirement of unanimous shareholder approval. '^^ In short,

there is no '*ideal type'* that defines the transcendental essence of stock.

One can respond that, however legally justified the state's redefinition
of stock ownership rights might be, the change would be bad policy.

Investors will find stock in corporations subject to the new directors'
duty statutes less attractive relative to other investment opportunities,

including stock in corporations not subject to the statutes. As a result,
it will be more costly for some companies to raise needed capital, and

potentially disastrous economic consequences will follow. *^^ It might even

come to pass that the very nonshareholders the state legislatures seek
to protect will find themselves victims of bankruptcies and resultant

plant closings.

Why might it make sense to interpret the statutes in a way that
could lead to such results? For one thing, the empirical validity of these

claims is unknown; the dire consequences may be overstated. '^° Even if

164. 4 Wheat. 518 (1819).

165. See, e.g., Del. Code Ann. tit. 8, § 394 (1989).
166. See generally Johnson, supra note 107.

167. See E. Dodd, American Business Corporations Until 1860 with Speclal

References to Massachussets 326 (1954).

168. See Horwitz, Santa Clara Revisited: The Development of Corporate Theory,

in Corporations and Society: Power and Responsibility 13, 35-37 (W. Samuels & A.
Miller eds. 1987).

169. See Hanks, supra note 8, at 25.

170. See supra note 163.



1991] REDEFINING CORPORATE LAW 273

the effect on share prices were significant, however, offsetting consid-

erations might justify it. Courts and state legislatures first placed new
obstacles in the way of ahenability (restricting shareholder opportunities
in the hostile takeover context) in response to public policy concerns

about the adverse effects of takeovers on nonshareholders. Then, in the

directors' duty statutes, the states have taken the potentially much bolder
step of effecting a general redefinition of management's responsibilities.

The justification for statutes that are likely to impose costs on share-

holders (and perhaps some nonshareholders too) is the political judgment
that the intended benefits to nonshareholders are worth that price.

The manner in which shareholder property rights are defined is a
manifestation of the states' general power to specify the content of

property rights in order to promote justice or utility. So-called private

property rights always exist in order to give expression to public values;

the survival of a given property law regime depends ultimately on its

social utility.
*^^ Once a particular legal doctrine is thought of as obsolete,

it can and will be replaced with a new one. The directors' duty statutes
are an example of this process at work.

2, Efficiency.—An interpretation of the directors' duty statutes that
qualifies management's responsibility to maximize profits could also be

criticized on efficiency grounds. ^^^ Instead of a firm structured as a

network of bargained-for relationships among shareholders (acting
through management) and nonshareholders, management would find itself

obliged to make decisions that are designed to benefit nonshareholders
at the shareholders' expense. To the extent that management acts in this
way, one result may be less productive utilization of corporate assets.
Corporations would be less efficient in the sense that fewer goods and

services would be produced than would have been had management

pursued profit maximization without regard to nonshareholder consid-

erations. According to the proponents of economic efficiency, society

as a whole will suffer if assets are not put to optimally productive uses.

From this perspective, the directors' duty statutes impede efficiency
because the manner in which corporate assets are deployed and wealth

is shared among the participants in the corporate enterprise would cease
to be determined through private ordering according to economic self-

171. The legal realists made this point forcefully. See Cohen, Property and Sov-
ereignty, 13 Cornell L.Q. 8 (1927); Hale, Bargaining, Duress, and Economic Liberty,

43 CoLUM. L. Rev. 603 (1943). For a more recent analysis of this and related aspects of

legal realism, see Singer, Legal Realism Now, 76 Calif. L. Rev. 465 (1988).
172. See ABA Report, supra note 8, at 2268 (deviation from corporate law's

traditional commitment to shareholder primacy "could undermine the effectiveness of the

system that has made the corporation an efficient device for creation of jobs and wealth").



274 INDIANA LAW REVIEW [Vol. 24:223

interest. *^^ Nonshareholders would no longer be left to their own devices
to identify and protect their interests through the bargaining process,

while shareholders would lose the right to insist on profit maximizing

strategies. Management interventions on behalf of nonshareholders are
therefore likely to leave shareholders worse off than they would have

been under the traditional corporate law regime. Additionally, non-

shareholders might find themselves parties to relationships with the cor-

poration that they themselves would have chosen to structure differently.

For example, instead of protection through the directors' duty statutes,

some employees might prefer that management relentlessly pursue cor-

porate profit maximization as long as they receive higher wages and

contractually tailored job security provisions in return. Thus, the new
statutes might result in wealth sharing arrangements that nonshareholders

as well as shareholders regard as less than optimal.

It is possible to take the efficiency critique a step further. In place

of a regime based on private ordering, the new statutes would establish
an ** oligarchy" in which corporate management decides how resources
will be allocated and corporate wealth distributed within the relatively

loose constraints of the directors' duty statutes.'^'* *Tublic" or *'politicar'

questions of wealth distribution would thus be committed to the discretion

of private individuals rather than the impersonal workings of the

market.'"'^

While the strong interpretation of the directors' duty statutes would

redefine the parties' ability to use private ordering to structure their

relationships, that fact alone does not render the interpretation inde-

fensible. It can be justified on grounds that reject the basic premises

on which the efficiency critique rests. As interpreted here, the directors'
duty statutes reflect a deep distrust of the efficiency model's bargain

paradigm. According to this perspective, private ordering is an inequitable

process for structuring relationships between parties of unequal wealth

and information. These disparities can generate significant bargaining

disadvantages, and substantially impede the ability of the less powerful

to protect their interests adequately through contract. Where the con-

173. Note that this criticism implies that, but for the directors' duty statutes,

corporate relationships are a product of private ordering. In fact, of course, private

ordering takes place within an environment that includes many mandatory legal elements.
One might say that, even if the directors' duty statutes are interpreted as suggested here,
private ordering will still predominate. The rules of the game will be different, and

therefore outcomes will be too, but it is incorrect to contrast a state of pure bargain

with a state of pure regulation. At most, these are questions of more or less.

174. See Cox, supra note 12, at 209-12.

175. See ABA Report, supra note 8, at 2270.



1991] REDEFINING CORPORATE LAW 275

servative economist sees voluntariness, bargaining, and wealth-increasing

exchange, the critic sees coercion and severely limited choice. '^^

Seen in this Hght, a commitment to private ordering in the context

of corporate law is^itself "oligarchical."*^^ Rather than an impersonal

mechanism for wealth allocation through individual activity (to be con-

trasted with the arbitrary private power of corporate management), the

market represents an opportunity for shareholders to impose their will

on workers and others who lack the abihty to protect themselves fully
through contract. These nonshareholders find themselves dependent on

management's good will for their well-being, but management must

respond to the wholly self-interested hunger for short-term profits that

drives an increasingly small number of arbitrageurs and institutional

investors. *^^ Under these circumstances, nonshareholders' inability to ob-

tain fully specified contractual protection leaves them victim to oppor-

tunistic disregard of their interests. Market decision-making is thus no

less oligarchical than the regime that would be inaugurated by the strong

interpretation of the directors' duty statutes. The difference is in who
will decide and, more importantly, in whose interest.

Distrust of the fairness of private ordering as a process is not the

only reason for rejection of the efficiency norm. Commitment to effi-
ciency as the central value in a normative system presupposes the justice

of the existing distribution of wealth. If one views that distribution as

unfair, individual pursuit of wealth maximization through bargaining

will not correct the unfairness, however fair one might consider the

bargaining process to be. Instead, existing disparities are likely to be

repHcated and perhaps intensified through the market. '^^ This perspective

on efficiency as a normative criterion therefore provides a further jus-

tification for legal intervention.*^^

176. See supra note 171 and sources cited therein.

177. Cf. supra text accompanying note 174.

178. See Lipton, supra note 73, at 7-9.

179. See J. Coleman, Markets, Morals and the Law 319-20 (1988).
180. Though I prefer to read the statutes as a rejection of the efficiency norm and

its premises, it is still possible to construct a defense of the new statutes on efficiency

grounds. One might view the statutes as grounded on a belief that the traditional share-

holder-management relationship, with its requirement that management maximize share-

holder wealth, imposes significant externalities on identifiable nonshareholder constituencies.

These nonshareholders are unable to protect themselves adequately through contract because

transaction costs, such as severe informational disparities, stand in the way of effective

contracting strategies. For example, the traditional legal duty to maximize shareholder

interests threatens to cause lost jobs, disruption of other valuable economic relationships,

and imposition of costs (such as unemployment benefits) on the general public. However,

because employees often lack access to information about the likelihood of future layoffs

and other plans to improve productive efficiency, employees are unable to insist on contract



276 INDIANA LAW REVIEW [Vol. 24:223

The difference between this justification for nonshareholder protec-
tion and the views of the efficiency proponents is thus quite a bit wider

than a disagreement about how to apply economic analysis to corporate
law. A strong interpretation of the directors' duty statutes would reflect
a rejection of basic positive and normative premises of neoclassical

economic orthodoxy. It would reflect a willingness to interfere with

efficiency in order to promote a program that restructures the power

relationships within the corporation. Corporate law has always shaped

those relationships. The new structure proposed here would redistribute
power (and therefore wealth) from shareholders to nonshareholders

through the mechanism of managerial supervision of the relations among
shareholders and nonshareholders. If that is to be the statutes' meaning,

it makes little sense for conservatives to criticize them on efficiency

grounds. They should instead focus their efforts on the much more
difficult task of persuading the pubUc that theirs is a normative vision

worthy of broad appeal.

Conclusion: Toward A New Definition Of Corporate Law

It is not enough simply to analyze the new statutes' negative doctrinal

implications for the shareholder primacy principle. Even if shareholders

lose the right to insist that management privilege their interests, it is by
no means clear that management will use its statutory powers to protect

nonshareholders at the expense of shareholders. Unless the statutes are

interpreted as imposing affirmative obhgations on management, there

are good reasons to believe that nonshareholders will derive little benefit.

So, if the directors' duty statutes are to have any significant meaning,

it is necessary to make something constructive out of them. That has
been the principal focus of this Essay.

The directors' duty statutes are not intended to provide a blueprint

for a new vision of the corporation. Their thrust is as yet largely negative:
The states wish to curb existing management tendencies to prefer the

terms that are well-tailored to their interests. Difficulties may be even greater in situations
in which actors (such as local governments) make firm-specific investments in the expectation

of a long-term corporate presence but are not in contractual privity with the corporation.

Accordingly, statutory protection may be necessary in order to give nonshareholders the
rights they would have bargained for in the absence of transaction costs. However, as a

justification for the strong interpretation of the new statutes, the suggestion that it aims

to mimic the outcomes of private ordering is probably of limited utility. For one thing,

the statutes themselves offer no obvious suggestion that they are designed to correct market

failure. Further, defenders of protection for nonshareholders would probably make a
serious strategic mistake if they limited themselves to defending intervention solely on

grounds of efficiency. It probably makes more descriptive and strategic sense to interpret

the new statutes as rejecting, for political reasons, the efficiency perspective.



1991] REDEFINING CORPORATE LAW 277

short-term financial interests of shareholders despite the often substantial

costs to nonshareholders. In so doing, they reject the orthodox share-

holder primacy principle. Yet this negative aspect inevitably implies an

affirmative one. By decentering the shareholder, the statutes also reject
corporate law's traditional fixation with the shareholder-manager rela-

tionship and thrust nonshareholders into the limelight as legitimate objects

for corporate law's attention. This in turn seems to be based on a

conception of corporate purpose that is much more complex than profit
maximization and shareholder welfare. Although these changes imply a

fundamental reorientation of corporate law, the statutes speak tentatively

and the contours of the new order are as yet uncertain.

It is conceivable that the directors' duty statutes herald the beginnings

of a radically different understanding of corporate law and corporate

purpose. If they are manifestations of a deeper design to enhance the

status of nonshareholders within the corporate enterprise, several lines

of development are possible. One could imagine greater nonshareholder
involvement in the decision-making process, through voting rights, for

example. More radically, we might revise our notion of corporate gov-
ernance so as to replace the present hierarchical structure with one in

which significant decision-making authority spreads downwards, from

management into the hands of those most directly affected. And if
nonshareholders are to have powers of control, perhaps new ownership
structures should be considered as well.

The directors' duty statutes will not provide the vehicle for such

developments. Nevertheless, these statutes raise fundamental normative

questions about the appropriate aims of corporate law and about cor-

porate purpose itself. In defining management's responsibilities to share-

holders and nonshareholders, courts will face choices. As we have seen,
it is possible to interpret the directors' duty statutes in ways that ef-

fectively trivialize them. To do so would be a mistaken attempt to shore
up a crumbling status quo that no longer rests on a firm foundation

of societal consensus. Alternatively, the courts can participate in the

dialogic process — involving concerned citizens, legislators, and aca-
demics, as well as judges — by which society redefines corporate law
and the meaning of the corporation itself. The directors' duty statutes

challenge the courts to engage in this conversation. Whether these statutes

prove to be as revolutionary as their critics suggest will depend on what

we make of them.