M. A. P. Insights
Cesar L. Villanueva
(Second of two parts)
THE very essence of what constitutes “good corporate governance” for stock for-profit corporations depends largely on properly delineating the constituencies to whom their Board and Management owe the fiduciary duties of responsibility, accountability and transparency.
Under contemporary Philippine Corporate Law settings, there are mainly three competing corporate governance (CG) doctrines, briefly described as follows:
• The Stockholders Theory: The primary duty of the Board and Management is to maximize the profits of the corporation for the benefit of its stockholders; hence, the fiduciary duties of the Board and Management are owed only to the corporation and its stockholders.
• The Stakeholders Theory: The primary duty of the Board and Management is owed not only to the stockholders, but also to members of the public whose economic welfare is affected by the corporate enterprise.
• Doctrine of Corporate Social Responsibility (CSR): Since the corporation is a creature of the State, then the Board and Management are burdened by social obligations relating to public welfare which the State is bound to promote.
Under Philippine Corporate Law, the Doctrine of Maximization of Shareholders’ Value has for the longest time been the only prevailing doctrine to define what constitutes “good CG.” The well-established principle under the Corporation Code (CC) is that directors and corporate officers owe fiduciaries duties of diligence and loyalty only to the corporation and it stockholders, and to no others, based on the following grounds:
• the fact that whenever the duties are covered by statutory provisions, they are defined in relation to the corporation and its stockholders;
• the CC provides for a separate set of provisions for non-stock non-profit corporations to serve eleemosynary objectives (i.e., CSR), then certainly the institution of stock for-profit corporations should be devoted towards a single objective of maximizing the profits of the corporation for the benefit of its stockholders who by both statutory and common-law doctrine have the right to the profits of the company;
• When it comes to other stakeholders, their rights are governed under separate laws and disciplines, such as Labor Code for employees, Contract Law for creditors and suppliers, Consumer Protection Laws for clients and consumers, and Environmental Laws for the public interests.
The primacy of the Doctrine of Maximization of Shareholders’ Value over the Stakeholders Theory and CSR has been supported by the writings of market gurus like Milton Friedman who in his seminal paper published in the New York Times Sunday (13 September 1970) posited that
In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. . . . in a free society . . . “there is one and only one social responsibility of business―to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
Our Supreme Court (SC) in Prime White Cement Corp. v. Intermediate Appellate Court, affirmed in no uncertain terms that the primary obligation of the Board is “to seek the maximum amount of profits for the corporation,” thus: “As corporate managers, directors are committed to seek the maximum amount of profits for the corporation. This trust relationship is not a matter of statutory or technical law. It springs from the fact that directors have the control and guidance of corporate affairs and property and hence of the property interests of the stockholders.”
The fact that Board of Directors (BOD) is vested under Section 23 of the CC with legal title to the corporate assets and its enterprise to be employed for the benefit of stockholders provides the legal bedrock for the prevalence of the Doctrine of Maximization of Shareholders’ Value in CG; it is also the legal basis used to support the proposition that inherently BODs owe no fiduciary duties to stakeholders other than stockholders.
To illustrate, in its decision in Nielson & Co. v. Lepanto Consolidated Mining Co., the SC held as unlawful a provision in a Management Contract that entitled the management company to stock dividends as compensation payment on the ground that “only stockholders are entitled to dividends. They are the only ones who have a right to a proportional share in that part of the surplus which is declared as dividends…If a stockholder is deprived of his stock dividends — and this happens if the shares of stock forming part of the stock dividends are issued to a non-stockholder — then the proportion of the stockholder’s interest changes radically. Stock dividends are civil fruits of the original investment, and to the owners of the shares belong the civil fruits.”
Since it is only the stockholders of a corporation who have “equity standing” to the corporate assets and it business, they are the only sole “beneficiaries” to whom the BOD and Management would clearly owe fiduciary duties. Other stakeholders would have rights arising against the corporation on bases other than the trusts relationship. Thus, customers, supplier and creditors do not have any equity claims against the company, and would locate their rights against the corporation on the basis of the contracts they entered into with the corporation, through its BOD. Therefore, the relationship of the BOD with such stakeholders is purely economic in character, based on contracts entered into “at arms length,” and is no way fiduciary in character or based on trust.
In the same manner, employees—who actually spend more time within the company than its stockholders—have no proprietary claims on the business of the corporation, and they expect and may legally demand to be compensated for their services in accordance with their employment contract, whether the company is making profits or is operating at a loss.
The prevalence of the Doctrine of Maximization of Shareholders’ Value can also be supported based on the truism that it provides for a strong enforcement and accountability mechanism under a good CG framework: The maximization of profits goal is a clear measure that everybody can agree with as a measure of the Board and Management’s performance of their primary fiduciary obligation.
The Stakeholders Theory has a built-in drawback in the sense that “it fails to provide adequate guidance to decision making by management. In insisting that the corporation or management has many responsibilities toward its various stakeholders, it does not furnish a neat or suitably precise formula with which the weighing and balancing of competing considerations are to be made.” Prof. Niceto S. Poblador observes that the theory “has no concept of what economists call ‘equilibrium,’ the imaginary point towards which a system tends to gravitate. But more seriously for the practicing manager, it provides no rational basis for action,” and summarized the “crux” of what is lacking in the Stakeholders Theory:
In more precise terms, our main concerns are two-fold: (1) How do we specify the firm’s ultimate objective or goal? (2) How can we pursue this goal in such a way as to satisfy the needs of all groups that have a stake in the enterprise? If we can come up with a precise statement of the firm’s ultimate goal (that is, specify clearly what economists call its “objective function”), then we have a basis for defining rationality. If we can come up with a set of criteria for meeting the needs of all corporate stakeholders, then we have defined in operation terms what is and what is not ethical behavior.
The essence of the first criticism against the Stakeholders Theory is summarized by Prof. Emmanuel Q. Fernando as follows: “And although the first stakeholder theories acknowledge the existence of other stakeholders and the moral duties the corporation had toward them, they did not sufficiently explain the nature of these duties, how they are to be weighed and measured against each other in case of conflict and whether there was an ethical difference between them.”
Although our Constitution provides for the principle that the use of private property “bears a social function” (Section 6, Article XII, 1987 Constitution), nevertheless, jurisprudential application of the CSR doctrine has been quite limited.
To start with, Section 36 is the lone instance in the CC that alludes to the CSR doctrine to circumscribe the power of the corporation, acting through its BOD “to make reasonable donations, including those for the public welfare or for hospital, charitable, cultural, scientific, civic, or similar purposes,” which dovetails it with the provisions under the National Internal Revenue Code (NIRC) on tax deductible charitable contributions. Even in academic discussions, the determination of what constitutes “reasonable donation” is often linked to improving the goodwill of the company for it to operate more profitably in its dealings with customers and the communities where it operates.
A good illustration of the State’s intervention into corporate affairs to promote social good can be found in the decision of the SC in Chamber of Real Estate and Builders Association v. Romulo, where the main issue that had to be resolved was the lawfulness of the minimum corporate income tax (MCIT) imposed upon all corporations which did not report taxable income after the initial three succeeding taxable years of operations, thus: “The MCIT on domestic corporations…came about as a result of the perceived inadequacy of the self-assessment system in capturing the true income of corporations. It was devised as a relatively simple and effective revenue-raising instrument compared to the normal income tax which is more difficult to control and enforce. It is a means to ensure that everyone will make some minimum contribution to the support of public sector.”
In its decision in Professional Services, Inc. v. Court of Appeals, the SC began to recognize that corporations which operate enterprises vested with public interest, such as that of operating a hospital, assume certain legal relationship with members of the public whom they invite to use its facilities, and thereby become responsible for the negligent acts of even contractors, such as doctors, who treat them in their facilities. Our SC held that apart from the professional relationship between a doctor and his patient, and the relationship between the hospital and the doctor who uses the hospital’s facilities, there is a separate and independent legal relationship that is created between the hospital and the patient, for which the hospital would owe a certain degree of responsibility of prudence.
In an earlier resolution in Professional Services, Inc., the SC had invoked for the first time the “Doctrine of Corporate Responsibility,” when it held that “The challenged Decision [making the hospital liable for the malpractice of a physician] also anchors its ruling on the doctrine of corporate responsibility. The duty of providing quality medical service is no longer the sole prerogative and responsibility of the physician. This is because the modern hospital now tends to organize a highly-professional medical staff whose competence and performance need also to be monitored by the hospital commensurate with its inherent responsibility to provide quality medical care. Such responsibility includes the proper supervision of the members of its medical staff. Accordingly, the hospital has the duty to make a reasonable effort to monitor and oversee the treatment prescribed and the administered by the physicians practicing in its premises.”
(The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the M.A.P.)
CESAR L. VILLANUEVA is a member of the Management Association of the Philippines (M.A.P.) , the former Chair of the Governance Commission for GOCCs and the Founding Partner of the Villanueva Gabionza & Dy Law Offices.
