Benefit Corps - A Third Look
A healthy degree of skepticism is necessary when it comes to any investment opportunity.I have examined benefit corporations at a high level in two prior posts:
- Benefit Corporations: The Ultimate Challenge to the Friedman Doctrine
- Can Benefit Corporations Successfully Serve Two Masters?
After digging deeper, I have arrived at some interesting (well I think so, anyway) conclusions. But first, some history.April 14, 2010: Maryland state legislature passes the first benefit corporation act. This "Model Act", as referred to today, permitted companies to incorporate as a business entity with the objective of creating a general public benefit, and of considering not only shareholders, but community, society, and the environment. Companies which incorporate as B-Corps are required to report on their environmental and social performance - and thus, a company’s fiduciary duty is expanded to engender positive social and environmental impact.July 17, 2013: Delaware becomes the nineteenth state to enact benefit corporation legislation, permanently launching this new corporate structure into legitimacy. Delaware stands as an important role-model, as the state is home to over 50% of all publicly traded companies, including 64% of the Fortune 500. Upon signing this hallmark legislation, Delaware Governor Jack Markell heralded the public benefit corporation as an “attractive investment opportunity for the growing number of investors who increasingly want to make money and make a difference.” (Jack Markell, Huffington Post, July 2013)Benefit corporations are a hybrid structure attempting to serve both shareholders and society. But society already benefits from non-profit organizations, which raise capital through philanthropy. Philanthropists expect no material return from their investment. In contrast, shareholders of corporate for-profit structures invest based on an expectation of future financial return. Essentially, as long as a company calls itself a benefit corporation, it can raise capital from investors and subsequently use those funds to further its social mission(s).If you are reading this as a savvy (or less than savvy) investor, you are likely skeptical right now. You're right. A benefit corporation is susceptible to falling short of maximizing shareholder value. The major impediment to shareholders of a B-Corp is that the governing documents are overly broad, such that shareholders are, in effect, granting management a blank check - and consequently relinquishing their control and vote.Benefit corporations pose two chief concerns: the principal agency issue caused by separation of control and ownership, and the obstruction of acquisitions. Both phenomena will quite plausibly cause a B-Corp to trade at a discount to intrinsic value.Principal-Agent Issue: broadly defined as management's pursuit of selfish interests at the expense of shareholders. Companies with two share classes are prone to principal-agency issues because not all voices are heard equally. Similar to non-voting shares in dual-share class companies, the perception that B-Corp management is not forced to maximize shareholder value will likely lead to a discounted share price.Obstruction of Acquisitions: substantial research indicates that a major component of excess return is due to acquisitions, particularly for small-cap companies. Moreover, numerous studies have confirmed that takeover obstructions are a significant detractor from investment return. Most benefit corporations are small companies which ordinarily would be subject to takeovers. Interestingly, B Corps require a 2/3 vote of shares for change of control or status (significantly higher than the customary 50.1% required). Takeover becomes unlikely. The small company acquisition premium is lost. What remains? The higher volatility and risk of a smaller company.But the real question is why a company must call itself a “benefit corporation” in order to pursue social mission? The creation of benefit corporations suggests a trade-off between social good and shareholder value maximization. Apple, Starbucks, and Google are three prominent examples of companies, not named “benefit corporations”, yet have successfully pursued both sustainability and profitability. At the extreme, there is no reason for the existence of benefit corporations other than to abscond with a shareholder’s right to vote. Moreover, shareholders have historically been able to mitigate the principal-agency issue by joining together with a common interest of furthering shareholder wealth, should management fail to act in their best interest. The rationale can be made that the shareholder base of a benefit corporation will be so diverse that cohesive shareholder action in any one direction may be deemed impossible.The loss of shareholder voice is an instant destructor of shareholder value.