The debate about stakeholder capitalism should seek to learn from our experience with constituency statutes, which authorized corporate leaders to take into account stakeholder interests in considering a sale of the company. We document how, over the past two decades, these statutes utterly failed to produce the hoped-for stakeholder benefits: Corporate leaders used their bargaining power to secure benefits for shareholders, executives, and directors, but made little use of it to obtain protections for stakeholders.

Editor’s note: To mark the 50-year anniversary of Milton Friedman’s influential NYT piece on the social responsibility of business, we are launching a series of articles on the shareholder-stakeholder debate. Read previous installments here.

A critical question within the heated debate about stakeholder capitalism and stakeholderism is whether, if corporate leaders are granted discretion to give weight to the interest of non-shareholder constituencies (stakeholders), they can be expected to actually do so. 

In our new study For Whom Corporate Leaders Bargain, we put forward novel empirical evidence that can contribute to resolving this key question. We discussed these findings in the presentation of a companion study by two of us, The Illusory Promise of Stakeholder Governance, during the Stigler Center’s Political Economy of Finance conference at the end of last week. 

Although stakeholderism has enjoyed unprecedented levels of support in recent years, in the 1980s and the 1990s many states already adopted “constituency statutes”—which are still in place today—that embrace an approach similar to that advocated by modern stakeholderists. Proposed as a remedy to eliminate or reduce the adverse effects of acquisitions on employees and other stakeholders, these statutes accord corporate leaders the power to give weight to the interests of stakeholders when considering a sale of their companies. 

The current debate should be informed, we argue, by the lessons that can be learned from the results produced by this large-scale experiment in stakeholderism.

We therefore set out to investigate empirically whether constituency statutes actually delivered protections for stakeholders as was hoped for. Although constituency statutes have long been a common topic in corporate law textbooks, as well as the focus of many law review articles, thus far there has been no direct study of the terms of acquisition agreements negotiated in the shadow of such statutes. Using hand-collected data on a large sample of such agreements from the past two decades, we put forward novel empirical evidence on the subject.

We document that corporate leaders selling their companies to private equity buyers obtained substantial benefits for their shareholders as well as for themselves. By contrast, corporate leaders made little use of their power to give weight to the interests of stakeholders. Our review of the contractual terms of these deals finds very little protection provided to stakeholders from the risks posed by private equity control.

We conclude that constituency statutes have failed to deliver their promised benefits. These conclusions have implications not only for the long-standing debate on constituency statutes but also for the general debate on stakeholder capitalism. Our findings cast substantial doubt on the wisdom of relying on the discretion of corporate leaders, as stakeholderism advocates, to address concerns about the adverse effects of corporations on their stakeholders.

The debate on stakeholderism to which we seek to contribute seems to have reached a critical juncture. In this ongoing debate, stakeholderists and their opponents strongly disagree on how corporate leaders are likely to use discretion to give independent weight to stakeholder interests. We believe that, to help resolve this disagreement, it is worth examining the performance of constituency statutes in protecting stakeholders.

“Our findings cast substantial doubt on the wisdom of relying on the discretion of corporate leaders, as stakeholderism advocates, to address concerns about the adverse effects of corporations on their stakeholders.”

Our empirical analysis focuses on private equity acquisitions of public companies. Because these transactions move assets to the hands of managers with powerful incentives to maximize financial returns, such transactions often pose significant risks to stakeholders that corporate leaders who care about stakeholders may seek to address.

We analyze each of the private equity acquisitions of public companies of significant size that were incorporated in a state with a constituency statute during the 20-year period of 2000 through 2019. For each of these transactions, we hand-collected and analyzed detailed information about the process leading to the transaction and the full set of terms negotiated by the parties.

We find that the acquisitions were commonly the product of a long negotiation process that produced substantial benefits for both shareholders and corporate leaders. Shareholders enjoyed sizable premiums over the pre-deal stock price. In addition to the gains made on their own equity holdings, corporate leaders also frequently secured additional payments in connection with the transactions, and often obtained commitments for continued employment after the acquisition.

At the same time, however, corporate leaders made little use of their bargaining power to negotiate for any constraints on the power of the private equity buyer to make choices that would adversely impact stakeholders. Although concerns about layoffs and downsizing induced labor unions to support constituency statutes, we document that in 95 percent of cases corporate leaders did not negotiate for any restrictions to the freedom of the private equity buyers to fire employees, and that even in the handful of cases in which such restrictions were found, the deal terms denied employees any power to enforce these constraints.

Furthermore, we find that corporate leaders generally did not negotiate any constraints on buyers’ post-deal choices that could pose risks to several other notable stakeholder groups—consumers, suppliers, creditors, or the environment. In a very small minority of cases, we found buyer pledges to retain the location of company headquarters or to continue some local investments or philanthropy, but our analysis of the legal terms indicates that these rare pledges were rather “soft”: unlike commitments to shareholders or corporate leaders, these pledges were vague and under-specified and, importantly, denied potential beneficiaries any enforcement rights.

To be sure, many stakeholders, such as employees, customers, suppliers, and creditors, typically have contractual arrangements with the company. These contractual arrangements might provide them with some protection in the event of an acquisition even if the corporate leaders negotiating the deal with the private equity buyer do not bargain for stakeholder protections during the negotiations over the acquisition. Thus, for example, employment agreements might entitle some employees to certain benefits if they are fired, and supply agreements might entitle some suppliers to specified benefits in the event the company terminates the supply relationship.

However, the premise of constituency statutes was (as the premise of modern stakeholderism currently is) that the contractual arrangements of some stakeholders, such as employees, customers, and suppliers, do not protect them sufficiently from being adversely affected by acquisitions. Constituency statutes therefore sought to enable corporate leaders to seek stakeholder protections that could address the remaining concerns. For this reason, our analysis focuses on whether corporate leaders negotiating in the shadow of constituency statutes used their power to obtain such stakeholder protections, and it concludes that they did not.

“We document that in 95 percent of cases corporate leaders did not negotiate for any restrictions to the freedom of the private equity buyers to fire employees, and that even in the handful of cases in which such restrictions were found, the deal terms denied employees any power to enforce these constraints.”

The evidence we have put together enables reaching a clear conclusion on the performance of constituency statutes: they failed to deliver the promised and hoped-for benefits for stakeholders.

Because constituency statutes had stakeholderist justifications and goals, everyone involved in the ongoing stakeholderism debate should seek to learn from the experience with these statutes. In particular, stakeholderists must wrestle with the failure of these statutes, identify the factors that caused this failure, and examine whether these factors would also undermine their current proposals.

As for why constituency statutes failed to deliver stakeholder protections, we extend our empirical evidence in order to evaluate possible explanations. Our analysis indicates four explanations that might be suggested for the failure of constituency statutes that are unlikely to drive our findings: uncertainty about what the statutes authorized; the shadow of the Delaware Revlon doctrine; the need to obtain shareholder approval for the acquisition; and the influence of shareholder-centric norms on corporate leaders.

Our analysis leads us to conclude that the most plausible explanation can be found in the incentives of corporate leaders. Although the interests of corporate leaders do not perfectly align with the interest of shareholders, they are substantially linked to them. Because of the pay arrangements of executives and directors, and the dynamics of the labor and control markets, corporate leaders often benefit when they enhance shareholder value.

By contrast, there is no significant link between the interests of corporate leaders selling their companies and the post-sale interests of stakeholders. In fact, to the extent that stakeholder protections would constrain the buyer and thus be costly to it, the inclusion of such protections in the deal could result in somewhat lower gains for the shareholders and/or the corporate leaders. Thus, corporate leaders had no incentives to use their bargaining power—and indeed had incentives not to use their bargaining power—for the purpose of negotiating protections for stakeholders.

The conclusions of our analysis indicate that considering the incentives of corporate leaders is crucial for assessing the promise of stakeholderism. As the supporters of constituency statutes, supporters of stakeholderism have commonly assumed that corporate leaders would substantially use discretion to protect stakeholders for this purpose. Our evidence indicates that, in the case of constituency statutes, this assumption was unwarranted. Stakeholderists, and all those concerned about stakeholders, should be wary of relying on such an assumption in assessing the promise of stakeholderism. As George Santayana warned in The Life of Reason a century ago, “Those who cannot remember the past are condemned to repeat it.”

Our study is available here, and comments would be most welcome.