Not Everything is About Investors: The Case for Mandatory Stakeholder Disclosure

Courtesy of Ann Lipton

Businesses that operate in the United States are constantly required to disclose information. Both state and federal law require merchants to disclose product and service information to consumers.  Federal law requires employers to disclose workplace hazards to employees.  Data on the racial and gender makeup of a firm’s workforce must be disclosed to the Equal Employment Opportunity Commission, and detailed financial information must be disclosed to the IRS. These disclosures, however, are specific and targeted for particular purposes; many are made exclusively to government agencies and are not available to the public.

There is, however, one regulatory sphere that requires a holistic set of disclosures for public consumption: the federal securities laws.  Whenever a company seeks to raise capital through the public sale of securities, the U.S. Securities and Exchange Commission (“SEC”) requires that it file a detailed description of its business and financial condition, periodically updated with new information about its profits, revenues, assets, and general business activities.  These disclosures are intended for investors, but they are available to anyone; as a result, regulators, competitors, employees, journalists, and members of the community have all grown to depend on securities disclosures to provide a working portrait of the country’s economic life.

Today, that system is breaking down.  Congress and the SEC have made it easier for companies to raise capital without becoming subject to the securities disclosure system, allowing modern businesses to grow to enormous proportions while leaving the public in the dark about their operations.  Meanwhile, even if the public demands information about firms’ environmental impact, treatment of workers, political activity, and the use of customer data, corporations are under no obligation to provide it absent a showing of relevance to an investor audience.  The result is an informational vacuum that benefits investors at the expense of the surrounding community.  For that reason, in my article Not Everything is About Investors: The Case for Mandatory Stakeholder Disclosure, forthcoming in the Yale Journal on Regulation, I argue for a mandatory corporate disclosure system designed specifically for stakeholder, i.e., non-investor, audiences.

One common critique of today’s system of corporate regulation is that corporate managers are encouraged to maximize the wealth of shareholders, even at the expense of other groups with which the corporation interacts. Shareholders vote for directors – which permits them to oust those who do not pursue their interests with sufficient vigor – and corporate pay packages reward managers for increasing company stock prices.  This system, the argument goes, incentivizes managers to exploit workers and consumers in pursuit of profit.

But that portrait is incomplete. Myriad regulatory and market systems penalize antisocial corporations while rewarding the ones that engage in prosocial behavior.  Environmental law, antitrust law, consumer protection law, antidiscrimination law, labor law, and the like, all impose financial costs on corporations found to have harmed nonshareholder constituencies.  Meanwhile, in order to be successful, corporations not only have to produce goods and services that attract customers, but also must generate enough reputational capital to maintain relationships with suppliers, employees, and other critical stakeholders.  Corporations that develop poor reputations – for creating harmful products, mistreating their workforce, or overcharging clients – will find it more difficult to function, cutting into corporate profits and ultimately diminishing shareholder wealth.  In this manner, then, the external disciplining mechanisms of both the law and the market ensure that shareholder interests are aligned with the well-being of the broader society in which the corporation operates.

The catch is that these disciplining mechanisms require a baseline level of transparency.  For example, public disclosures provide counterparties, like employees, with information about wages and working conditions that they can use for negotiating leverage.  Disclosure allows competitors to identify areas of weakness and opportunities to expand their own market share.  Disclosure exposes antisocial practices, which may then become the subject of community protest or regulatory action.

Yet currently, corporations are required to make generalized disclosures only to the extent such information is relevant to an investing audience.  And the needs of investors are systematically different than the needs of the general public.

First, investors and the public are concerned about different companies. Though Congress and the SEC have increasingly decided that investors do not require mandatory disclosures when a company raises capital from a small group of wealthy institutions, these companies – startups like WeWork and AirBnB, or private-equity backed firms that provide infrastructural services like corrections facilities and water and sewerage – may be enormously important to the people who interact with them.

Second, investors and the public are concerned about different topics. Investors are mainly interested in matters that concern a company’s financial condition or results of operations, but the general public also wants to know about matters relevant to corporate social performance, including political spending, diversity efforts, and legal compliance, even when these matters do not impact the corporate bottom line.

Finally, investors and the public operate on a different scale.  Subsidiary operations of very large companies may have great significance to society, even if they have minimal relevance to their corporate parents.  YouTube presents a case in point.  Despite its obvious influence on the internet, YouTube is wholly-owned by Google’s parent company, Alphabet, and Alphabet insists that the details of YouTube’s financial performance are not necessary to investors’ understanding of Alphabet’s business.  As a result, that information remains concealed from both investors and the public alike.

In sum, a disclosure system geared only to investors leaves the general public without crucial information necessary to protect its interests, and yet this is the system that prevails in the United States.

It is worth noting that America is an outlier in this regard.  Europe, for example, requires most limited liability companies to disclose basic financial information, with larger companies subject to more expansive reporting obligations.  Recently, the European Union adopted a new directive requiring the largest companies – usually, though not always, publicly traded – to disclose information about social performance for the benefit of non-investor audiences. Yet in America, disclosure remains stubbornly tethered to the needs of the investing class.

As my research shows, America’s peculiar system of tying generalized corporate disclosure obligations exclusively to public investment is the result of a series of historical compromises.  Both in the Progressive Era, and again during the 1970s, activists, scholars, and politicians sought to enact corporate disclosure schemes in order to make businesses more accountable to society at large.  Each time, these efforts were redirected towards investor audiences, in the expectation that investors could serve as a proxy for the broader society.

That compromise carried with it the seeds of its own destruction.  The more that investors are granted a governmentally-conferred informational advantage over other corporate constituencies, the more they are able to tilt managerial behavior in their favor.  Meanwhile, so long as the only path to corporate disclosure runs through the federal securities laws, advocates for various causes must couch their demands for information in the language of investor protection and financial return, no matter how far-fetched the connection.

A requirement that large corporations provide regular, standardized reports of operations to the general public would free the SEC to focus on the needs of investors alone, help align shareholder and stakeholder interests, and ensure a level informational playing field between “public” and “private” companies, thus encouraging more companies to conduct public offerings in the first place.

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