Week of 15 February 2021
The new European law should push directors to longer-term thinking; explicitly amending director duties could be overkill
Should the European Commission’s mandatory human rights due diligence law fold in requirements that would push corporate boards to move away from short-termism? Not according to John Ruggie, who argues that adding this additional thread would not strengthen the law for three reasons: 1) investors—not directors—are the real source of short-termism; 2) amending directors’ duties is controversial and could tank the entire endeavour; and 3) a properly constructed mandatory due diligence requirement itself would significantly change directors’ duties in the desired direction. In short, legally requiring human rights due diligence would already push directors to look to the long-term, without explicitly amending existing duties of corporate directors.
In a new paper, John Ruggie, Former UN Secretary-General’s Special Representative for Business & Human Rights, welcomes the forthcoming European Commission Initiative on Mandatory Human Rights Due Diligence in line with the expectations set out in the UN Guiding Principles. However, he cautions against the current proposal to push companies to look towards the long-term by amending the existing duties of corporate directors within the law.
The paper raises three core points:
- “Directors are not the main driver of short-termism”
- Investors put substantial pressure on corporate boards: “Directors themselves are responding to investor pressure, especially from hedge funds, other so-called activist investors and private equity firms, whose primary interest is in obtaining short-term returns and then moving on. Investors elect directors. Only investors can bring derivative suits against the company and its directors for not acting in what they consider to be the best interest of the company. … There are numerous ways to penalize investor short-termism and encourage longer-term investments, including robust forms of variable taxation, unrelated to directors’ duties. But, in the language of social science, directors are intervening variables in short-termism, not independent factors.”
- What’s more, directors are no longer limited by the law from looking to the long-term: “Even under Delaware law, perhaps the jurisdiction more business friendly than most others (which is why more than half of major U.S. corporations are registered there), directors are largely protected by the so-called business judgment rule, whereby courts typically defer to the judgment of corporate executives acting provided that they are exercising their duty of care.”
- “Opposition to addressing directors’ duties is substantial and may jeopardize the entire initiative”
- Companies are more socialised to their human rights responsibilities than ever: “[L]eading companies have had nearly a decade of exposure of working with the human rights due diligence provisions of the UNGPs, and many have appointed chief sustainability officers. Thus, when the [European Commission] indicated that it would issue an obligatory Directive on human rights and environmental due diligence it was welcomed by numerous companies and business associations as a way of bringing laggards along.”
- But broader acceptance of amending directors’ duties still has a way to go: “[O]pening up directors’ duties is unlikely to be well received by the community of corporate counsel, which at the end of the day exercises considerably more power with companies and over securities law than chief sustainability officers, and when challenged frontally might well turn against the entire [European Commission] initiative.”
- “Doing so may be largely unnecessary, because a properly constructed mandatory due diligence requirement itself will significantly change directors’ duties in the desired direction”
- Human rights due diligence (HRDD) is by design an ongoing process: “HRDD is not a transactional process, as for a new acquisition, partnership or investment, but an ongoing process. […] This both broadens and lengthens the horizon of company decision making.”
- Which stakeholders a company needs to engage with as part of HRDD is dynamic: “It is a distinct feature of HRDD that it does not attempt to identify general classes of stakeholders ex ante. Instead, it places the focus on and requires engagement specifically with those people (or their legitimate representatives) whose basic dignity and equality are at risk of harm from the ways in which a company does business. In other words, the relevant stakeholders are identified situationally, not in ex ante categorical terms.”
- HRDD causes a company to internalise costs it would have previously put on its stakeholders: “While HRDD can be included within broader enterprise risk management systems, it must go beyond simply identifying and managing material risks to the company itself, to include risks it poses to these affected stakeholders. This requires companies to internalize more of the costs of doing business that they previously imposed on stakeholders.”
To read more, see John G. Ruggie, Former UN Secretary-General’s Special Representative for Business & Human Rights, Harvard Kennedy School, European Commission Initiative on Mandatory Human Rights Due Diligence and Directors’ Duties (February 2021)