The Agency Costs of Corporate Political Spending
In response to my last post, Stephen Bainbridge takes issue with my proposal and argues that corporate political spending should be a board prerogative because:
[t]he law in every state is clear that the business and affairs of the corporation are to be conducted by the board of directors and the managers to whom the board delegates authority. Corporate law in this regard is a system of director primacy, not shareholder primacy. Shareholders have no more right to decide where the corporat[ion] spends its lobbying dollars than they do to decide where the corporation builds plants or what products the corporation makes.
I generally agree both with his broad descriptive claim and its normative implication — indeed, in several earlier articles, I am on record as being quite skeptical of shareholder empowerment writ large. However, corporate political activity – by which companies attempt to shape the distributional rules that govern our society – is quite different than deciding where to build a factory, what products to make, or even (to use another commonly-referenced example) corporate charitable contributions. Thus, it’s worth considering whether there are normative justifications for treating it differently as a matter of corporate law. I think there are at least three, which I’ll explain in turn starting with concerns about agency costs.
One normative goal of corporate law is to balance the benefits of centralized, expert management with the agency costs that arise inevitably from the separation of ownership and control that characterizes modern public companies. Management must signal their expertise and trustworthiness to attract investors; once invested, shareholders must monitor their investments; and managers, whose interests may diverge from those of shareholders, may act in ways that fail to maximize shareholder welfare. Corporate political activity implicates potentially substantial agency costs: both pecuniary and what I term “moral agency” costs.
As a threshold matter, at present, such activity is largely opaque to shareholders and the market, and thus imposes substantial monitoring costs on shareholders who wish to ascertain their corporation’s political activities. Shareholders cannot effectively discipline management – even in the standard ways, such as by selling their shares or removing the board – if they are unaware of the problematic conduct. This hurdle could be substantially mitigated through tailored disclosure bylaws. And, in contrast with a mandatory disclosure regime, no disclosure costs would be imposed on firms unless their shareholders are sufficiently interested in this information. Professor Bainbridge suggests that many shareholders are rationally apathetic. That’s probably true (and perhaps even a good thing) with respect to most firm decisions. But it’s not clear to me that shareholders are, or should be, similarly disinterested in how the companies in which they invest play politics. In any event, if shareholders are, in fact, largely apathetic on this issue, bylaw proposals will not obtain the requisite votes. By default, a majority of outstanding shares must be present to constitute quorum, and companies can alter the voting thresholds or quorum requirements in their governing documents (as many already do).
Then, there are potentially serious misalignments of interest between shareholders on one hand, and the board and managers on the other. Managers could employ corporate resources to influence the political process in ways that advance the firm’s best interests. Or, they could co-opt those resources to advance their own political preferences, seek future personal gain, or lobby for changes in corporate or securities laws that redound to their benefit as a class at the expense of other corporate constituencies. These are not just theoretical concerns; while far from conclusive, a growing body of empirical analysis suggests that the connection between political activity and firm value is murky, at best.
Corporate political activity also implicates a second category of agency costs, beyond worries about maximizing shareholder value: shareholders may disagree with the political ends to which the corporation employs its resources. For example, while shareholders generally wish to increase the value of their investment, they may well have boundaries beyond which they are unwilling to go in pursuit of profit. For reasons that I’ll return to, these moral agency costs are dissimilar from the standard concerns arising from disputes about business strategy, dividend policy, risk profiles and the like.
All of that said, the mere existence of agency costs does not automatically mandate legal intervention. There are substantial benefits associated with a centralized management imbued with broad discretion as to corporate affairs, and restricting that discretion comes with its own set of costs. Corporate law seeks, in large part, to strike an appropriate balance between this authority and accountability. Some critics argue that the agency costs associated with corporate political activity are no different than those arising from managerial control over any other aspect of business operations, and thus do not require any special governance rules. I disagree both descriptively and because the standard agency cost controls – litigation, exit, and removal of the board – are either unavailable or problematically costly in this context. Put differently, allowing shareholders a limited right to restrict managerial discretion may be the most efficient way of managing the agency costs associated with corporate political activity. I’ll explain this argument in the next post, and then turn to some important objections.