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The Case for Including Benefit Corporations In Next Generation Innovation Conversations

Tuesday, February 11, 2014

By Christine C. Franklin  

Christine C. Franklin, the founding attorney of Franklin Advocacy, P.C. in Chicago, provides general counsel services relating to owning and operating businesses, based on her in-house and commercial litigation experience, much of it in the financial services sectors. She co-chairs the Banking and Financial Services Committee within the American Bar Association's Administrative Law and Regulatory Practice Section and she formerly was a deputy attorney general for the state of California. She can be reached atcfranklin@franklinadvocacy.com.

President Obama's January 15 speech launching the public-private energy innovation initiative headquartered at North Carolina State to develop next generation power electronics drew little reaction apart from the usual political criticism. But it deserves recognition as a step toward building the economy of the future and an opportunity to extend the innovation to consider next generation business models as well. This article will discuss the advantages of a particular model, benefit corporations, to that conversation.

Specifically, this article discusses: 1) the innovation initiative's role; 2) brief insights into two past innovation efforts; 3) strategic advantages and opportunities offered by benefit corporations; and 4) benefit corporations as a bottom-up solution in the financial recovery.

I. The Next Generation Power Electronics Innovation Institute

The NC State Initiative is a step forward in developing the economy of the future, a task which has for the most part been relegated to a back seat in the financial recovery. NC State is leading this manufacturing innovation for next generation power electronics to be known as the “Next Generation Power Electronics Innovation Institute”.1 The federal government, seven universities and laboratories, and 18 leading manufacturers, materials producers, and critical users are forming a consortium to bridge the gap between applied research and development of wideband gap (“WBG”) semiconductors. Headquartered at NC State and using its educational and research / testing facilities, the Institute has $140 million to deploy, with half from the Department of Energy and half from the consortium and the State of North Carolina.

The WBG semi-conductors the Initiative intends to develop enable electronic components to be smaller, faster and more efficient than existing semiconductors made from silicon. This technology potentially could increase the efficiency of everything using a semiconductor across a wide range of applications, from household appliances and industrial motors to electric vehicles, power grids, and satellites.

II. The Past as Prologue

Of course, this is not the first time the United States has undertaken large scale innovation projects that moved the country forward economically. Projects such as the Tennessee Valley Authority or the space program come to mind. My own career happened to involve a decade at a California law firm—Thelen, Marrin, Johnson & Bridges—which was involved in many large construction projects in the West through clients. One—the Hoover Dam—was a large concrete anti-gravity dam built during the Depression to provide water for irrigation and hydroelectric power and was unprecedented at the time. The federal government provided the plans, and six businesses, including Bechtel and Kaiser, had to form a joint venture in order to satisfy the bid requirements due to the difficulties of the Depression. Workers had to be brought to Lake Mead to build the dam, and, eventually, the federal government also oversaw construction of a planned urban community at Boulder City to improve living conditions for the workers and their families. Boulder City was touted at the time as an example for clean living, although it likely would not be immune from criticism today for its lack of schools and hospitals. Not perfect, but an example of doing what it took to make the project work.

We also have seen individual entrepreneurs work to implement their innovation plans with varying success. Henry Ford's early efforts at corporate responsibility ran up against shareholder rights in Dodge v. Ford Motor Co.2 The Dodge brothers, Ford shareholders and exclusive suppliers to it but interested in heading out on their own, clashed with Henry Ford over use of the Ford Company's assets.3 The brothers wanted a special dividend paid in accord with a Michigan statute capping maximum corporate cash assets above authorized capital stock at $50 million. They were seeking a distribution of 75 percent of the Ford Motor Company's cash surplus (what amounted to about $39 million) and planned to use their share of the dividends to fund their own auto company.4

Holding a 58 percent ownership stake, Henry Ford mounted the equivalent of a modern PR campaign, talking to press in Detroit and nationwide. Although his company had grown from an assembly to a manufacturing plant, it had been unable to keep up with demand, so Henry Ford declared it company policy going forward not to pay special dividends and put all future earnings money back into the company except the five percent statutorily authorized dividend. His plans to expand operations and increase profits were multifaceted and included lowering vehicle prices, increasing production, and building a new plant for increased production.

Ford wanted, if possible, to avoid discharging large numbers of employees were business to become depressed. He said publicly:

  • My ambition is to employ still more men, to spread the benefits of the industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business.5

He is reported to have said at trial: “I do not believe that we should make such an awful profit on our cars.  A reasonable profit is right, but not too much.”6

The Dodge brothers were successful in the lower court with respect to the dividend issue and injunctive relief restraining aspects of Ford’s plans.7 Ultimately, the Michigan Supreme Court agreed with the lower court that the special dividend was required, but reversed on injunctive relief issues, accepting Ford’s exercise of discretion in the business decisions for the operation and expansion of the company for which the undistributed capital was available.8

The Court acknowledged: “A business, one of the largest in the world, and one of the most profitable, has been built up.  It employs many men, at good pay.”9 It also noted:

  • The difference between an incidental humanitarian expenditure of corporate funds for the benefit of the employés [sic], like the building of a hospital for their use and the employment of agencies for the betterment of their condition, and a general purpose and plan to benefit mankind at the expense of others, is obvious.10

Still, Dodge v. Ford became historical precedent for the dominance of shareholder rights in traditional corporations.

III. Expanding The Innovation Conversation Through Benefit Corporations

The situation is changing today.  Statutes in 19 states and the District of Columbia authorize benefit corporations – responsible, sustainable for-profits with defined public purposes.  This structure is available to for-profit businesses with a public benefit, such as those in the environmental and health care sectors.11

Benefit corporations offer innovators and established businesses a flexible model which can foster the kind of wide-ranging, creative thinking about stakeholder interests and allocation of resources that motivated Ford.  This is not to suggest that any particular allocation is “right” or more worthy than others.  It is simply to suggest that entity form can have value as intellectual property does and innovators may increase their overall success by considering how entity form may facilitate mission, success, and profitability.  Also, doing this early in the process rather than later may increase the probability of success, particularly if it is possible to include investors.  For these reasons, consortium projects like the NC State Initiative which bring players to the table can play a pivotal role in facilitating and expanding the conversation.

There are many noteworthy aspects of benefit corporations which can contribute to the bottom line.  This article focuses on those particularly relevant to the Ford case: broadening stakeholder interests beyond shareholders; correlated allocation of resources and, if desired, flattening of multiples; profitability; and human talent.

A. Broadening And Elevating Stakeholder Interests

From a legal perspective, the most significant characteristic of statutes authorizing benefit corporations is the mandate to directors to consider the interests of stakeholders in addition to those of shareholders.  A benefit corporation elevates, not just its chosen public purposes, but also the interests of various stakeholders and the environment to the same level as shareholder pecuniary interests.  This shifts directors’ focus from solely maximizing shareholder value to a longer-term strategy considering this expanded range of interests and pursuing high social and organizational standards.

How this plays out as a practical matter can be seen in benefit corporation statutes.  For purposes of this article, the statutes of Delaware, the home of American corporate law, and Illinois, the author’s home state, are used.  Delaware mandates directors balance shareholders’ pecuniary interests, the best interests of those materially affected by the benefit corporation’s conduct, and public benefits identified in the certificate of incorporation.12Directors of Illinois benefit corporations are mandated, in evaluating the corporation’s best interests, to consider the effects of proposed action on shareholders, employees, customers, the community, the environment, short- and long-term interests, as well as the benefit corporation’s ability to achieve its general and any specific benefit purposes.  Directors can prioritize as they see fit unless the articles of incorporation require otherwise.13

In addition to the mandate, directors of benefit corporations are legally protected when considering this broader range of stakeholder interests. This protection has been a primary rationale for efforts to enact authorizing statutes.  Illinois’ statute affirms that directors do not have a duty to beneficiaries of general or specific public benefit purposes and are not personally liable for monetary damages for not pursuing general or specific public benefit purposes.14 Only injunctive relief is available against the entity for failures relating to the benefit corporation statute, and standing for “benefit enforcement proceedings” is limited to the entity itself, or, derivatively, to shareholders, directors, investors of certain levels, or others expressly specified in articles or bylaws.15 This effectively eliminates third-party actions by those who might otherwise consider themselves beneficiaries of the public benefit purpose(s).

Delaware’s statute also relieves directors of any duty based on a person’s alleged interest in the public benefit corporation’s purposes.  A Delaware director’s fiduciary duties to shareholders and the entity with respect to that state’s balancing requirement are satisfied if the decision was informed and disinterested, and “ … not such that no person of ordinary, sound judgment would approve.” Delaware limits derivative suits challenging directors’ exercise of its balancing requirement to stockholders holding positions at certain levels.16

As can be seen, benefit corporation statutes do not eliminate shareholder interests, but other interests are afforded consideration, to Henry Ford’s point.

B. Resource Allocation

The ability to consider this broader range of stakeholder interests means that a benefit corporation can tailor its finances and use resources to serve stakeholder interests and achieve mission goals, as Henry Ford wanted to do.  For example, it may decide to forego expensive infrastructure and high administrative salaries and instead lower and equalize multiples for expenditures among stakeholder constituencies such as employees and suppliers,17 strengthening businesses and improving the overall economic situation.  Raising the boats of all concerned in this way may result in a short-term reduction of profits, but an increase in profitability longer-term.

Consider the resources that could be freed up and put to work, regardless of the type of corporation, if compensation multiples were lowered even a bit.  The ratio of CEO to average pay was 231 to 1 in 2011 according to the non-profit, non-partisan Economic Policy Institute—faster than the stock market or productivity in the economy.18 Whole Foods has relatively low multiples and presents an interesting contrast, even though not a benefit corporation. Recent total cash compensation for any of its teams reportedly was capped in the vicinity of 19 times the pay of all team members, whereas the average for publicly traded companies may be much higher multiples. The top seven executives at Whole Foods receive the same salary, bonus, and stock options (except co-founder and co-CEO John Mackey’s $1 salary).19

Compensation is an interesting point to flag and watch in the coming year as the Securities and Exchange Commission (“SEC”) considers its proposed rule requiring public companies to disclose the ratio of the CEO pay to the median compensation of employees for whom pay has been virtually stagnant for some time. 20 There currently are no publicly traded benefit corporations but that may change in the near future.  Regardless, this proposed SEC rule may be impactful for social enterprises and other businesses operating with lower multiples.

C. Profitability

Henry Ford’s plans underscore the multiple pathways to profitability.  Many practices adopted by benefit corporations make good economic sense and are adopted by traditional businesses.  Wal-Mart, for example, has learned from the sustainability efforts of Patagonia, California’s first statutory benefit corporation, despite the difference in the size of their operations.21

There is a belief that “doing business by doing good” actually effects savings, drives brand recognition, and attracts capital investment. In fact, Patagonia’s practices have led to the perception that its products are worth a higher price and to customers’ willingness to pay for quality.22

This is underscored by John Mackey and Raj Sisodia who espouse what they call “conscious capitalism.”  This is a value-driven concept, more conscious of higher purpose than corporate social responsibility or sustainability, and mindful of its impact on the world and relations with stakeholders and constituencies. They believe that doing the right things for the right reasons for a wide variety of stakeholders creates synergies and superior economic performance for the long-term. The key to maximizing long-term value and profits for shareholders, in their view, is creating value for all stakeholders.23 Such an internal value-driven synergy is equally descriptive of the dynamic within a benefit corporation and bodes well for success.

D. Enhanced Workplace Environment And Retention Of Employees

Henry Ford appreciated workers as consumers as well as producers.  Employees are among the stakeholders benefit corporation directors consider in making their decisions.  Benefit corporations typically strive for work environments fostering diversity, flexibility, professional development, and employment benefits.  This can be significant in attracting and retaining employees, particularly those supportive of mission.

IV. A Better Way

President Obama mentioned in his speech launching the Energy Power Initiative that he was acting on his own where he could, even as he urged Congress to pass legislation authorizing a total of 45 such initiatives.  One of the attractions of benefit corporations is that they are a bottom-up solution in the financial recovery, which may be a reason authorizing statues for the most part have received bipartisan support.  Individuals, as well as innovators can create them, with or without the involvement of government, and draw on their structure and flexibility to transform their visions into profitable, mission-driven enterprises.

Still, innovation initiatives like the NC State Institute have a uniquely significant role to play by virtue of their ability to convene and facilitate conversations about the economy of the future.  A particularly important aspect of this effort in social entrepreneurship is the ability to include potential investors at an early stage and better gauge how interests can be accommodated.  If one accepts the notion that creating value for a wide range of stakeholders gives rise to a dynamic that maximizes long-term value and profits, consortiums and conversations of this kind should be encouraged and extended to consider the most appropriate business model.  After all, if we are having a conversation about innovation, aren’t we asking if there is a better way to do things? In the right circumstances, that may be a benefit corporation.

 1 The information relating to the Initiative primarily was obtained from: White House, Press Release: President Obama Announces New Public Private Manufacturing Innovation Institute (Jan. 15, 2014) (available athttp://www.whitehouse.gov/the-press-office/2014/01/15/president-obama-announces-new-public-private-manufacturing-innovation-in). It was supplemented by information available through the NC State website athttp://www.ncsu.edu/power/.

2 The Michigan Supreme Court’s opinion can be found at Dodge v. Ford Motor Co., 204 Mich. 459, 170 N.W. 668, 671, 673 677-79, 683 (Mich. 1919) (“Dodge v. Ford”).

Id. at 670-71, 673J. Bakan, The Corporation: The Pathological Pursuit of Profit and Power, 36 (2004) (“The Corporation”).

Dodge v. Ford, supra, 170 N.W. at 671-73, 676.

Id. at 671 and 683.

The Corporation, supra, at 36, including n. 11.

Dodge v. Ford, supra, 170 N.W. at 677-79.

Id. at 683-85.  The Court observed at page 683: “The purpose of any organization under the law is earnings— profit.  Undistributed profits belong to the corporation, and, so far as any limitation can be found in this act, may be lawfully employed as capital.”

Id. at 683.

10 Id. at 684.  The spelling is as in the original.

11 Illinois Benefit Corporation Act, 805 ILCS 40 / § 1.10, Definition, “Specific public benefit”; 40 / § 3.01(b) (including preserving the environment and improving human health); Del. Code, tit. 8, ch. 1, subch. XV, Public Benefit Corporations, § 362(a)-(b) (available at http://delcode.delaware.gov/index.shtml) (“Del. Code”) (including environmental, technological, scientific, and medical). A benefit corporation is not limited to serving under-served populations as may be the common interpretation of “social enterprises,” although an entity may serve such communities and, if it does, would have dual benefit purposes.

12 Del. Code, § 365(a).  Illinois’ statute is similar in general to a model used as the basis for many states’ statutes; Delaware’s statute, more recent, includes some variations.

13 805 ILCS 40 / § 4.01(a)-(b).

14 805 ILCS 40 / § 4.01(c)-(d).

15 805 ILCS 40 / § 4.20.

16 Del. Code, §§ 365(a)-(b) and 367.

17 See, e.g., J. Mackey and R. Sisodia, Conscious Capitalism, 18, 93-95, 117-20 (2013) (“Conscious Capitalism”).  Lowering funding multiples for various aspects of a business frees up funds to treat participants in the business chain more equitably.

18 Lawrence Mishel, Economic SnapshotCEO pay 231 times greater than the average worker, Economic Policy Institute (May 3, 2012) (available at http://www.epi.org/publication/ceo-pay-231-times-greater-average-worker/).

19 Conscious Capitalism, supra, at 93-95.

20 SEC, Press Release: SEC Proposes Rules for Pay Ratio Disclosure (Sept. 18, 2013) (available athttp://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539817895#.Ut1WfHXna1s).

21 The Responsible Company: What We’ve Learned from Patagonia’s First 40 Years, at 8 (2012); S. Stevenson,Patagonia’s Founder Is America’s Most Unlikely Business Guru, Wall St. J., Apr. 26, 2012 (“Patagonia’s Founder”) (available at https://search.yahoo.com/search;_ylt=AhV1EVmi.B9q08Fj6Y4ZGWqbvZx4?p=%27wall+street+journal+%22+and+%22de+chouinard%22&toggle=1&cop=mss&ei=UTF-8&fr=yfp-t-901).

22 Patagonia’s Founder,supra, at 4.

23 Conscious Capitalism, supra, at 32-38, 108.

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