The Shareholder Primacy Myth

I used to hold a common misconception about corporations in the United States that I’ve seen commonly shared by friends and strangers online. I believed that the executive leadership of corporations was legally mandated to prioritize and maximize profit for shareholders, putting this duty above all other considerations. I’ve since learned that this misapprehension is, at best, controversial, and at worst, outright false and dangerous.

The doctrine of prioritizing shareholder interests above all others is called shareholder primacy. It appears to have been promulgated in particular by theorist Milton Friedman (an economic theorist who advised U.S. President Reagan and UK Prime Minister Thatcher, espousing free-market policies with minimal government interference).1

The initial notion of shareholder primacy in the U.S. seems to come from a misinterpretation of a case called Dodge v. Ford Motor Company. That took place back in 1919, when Henry Ford wanted to take surplus profits from his publicly shared company and, rather than continuing dividends, reinvest those into his factories and workforce. Shareholders took him to court, and the court forced him to pay dividends.

The judgment in this case, its interpretation, and its context are more complex than I feel willing to stretch as a non-lawyer. However, I understand most definitely—based on that case and case law afterward, which states unambiguously what limits courts have to interfere in business decisions—that Dodge v. Ford Motor Company did not establish the shareholder primacy doctrine as it lives, in myth, today. In that case, the court ruled that (emphasis mine),

courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds, or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud, or breach of that good faith which they are bound to exercise towards the stockholders.

Subsequent case law has only underscored the original intent. Case law has evolved into a doctrine called the “business judgment rule” in many common law countries, including the U.S.2 It gives corporate business leaders generous autonomy in making business decisions, even ones that sacrifice short-term profit or reduce shareholder value, so long as those decisions aren’t outright profligate, fraudulent, and so on. Duty to the shareholders is grounded in dealing fairly, not submissively.

The business judgment rule allows that, “in making business decisions not involving direct self-interest or self-dealing, corporate directors act on an informed basis, in good faith, and in the honest belief that their actions are in the corporation’s best interest.”3

So it seems clear that the shareholder primacy myth was predicated on, charitably speaking, a misunderstanding of case law. If there were any doubt about the interpretation of the judgment in Dodge v. Ford Motor Company, there are subsequent cases which have provided clear precedent and tests of the court’s powers in matters of executive decision making.

The next time someone tells you that corporations exist only, or first and foremost, to serve the shareholders, you know now that belief has no basis in law, if not reality. Where CEOs and boards hold themselves to the standard of conduct that shareholder primacy implies—always capitulating to shareholder whims, prioritizing share price and profit in every decision—they are imposing their own independent values and beliefs on corporate governance. Shareholder primacy is itself a leadership decision, not a law.