Ofer Eldar

The long-standing debate about the purpose and role of business firms has recently regained momentum. Business firms face growing pressure to pursue social goals and benefit corporation statutes proliferate across many U.S. states. This trend is largely based on the idea that firms increase long-term shareholder value when they contribute (or appear to contribute) to society. Contrary to this trend, this Article argues that the pressing issue is whether policies to create social impact actually generate value for third-party beneficiaries—rather than for shareholders. Because it is difficult to measure social impact with precision, the design of legal forms for firms that pursue social missions should incorporate organizational structures that generate both the incentives and competence to pursue such missions effectively. Specifically, firms that have a commitment to transacting with different types of disadvantaged groups demonstrate these attributes and should thus serve as the basis for designing legal forms.

While firms with such a commitment may be created using a variety of control and contractual mechanisms, the related transaction costs tend to be very high. This Article develops a social enterprise legal form that draws on the legal regime for community development financial institutions (CDFIs) and European legal forms for work-integration social enterprises (WISEs). This form would certify to investors, consumers, and governments that designated firms have a commitment as social enterprises. By obviating the need for costly social impact measurement, this form would facilitate the provision of subsidy-donations to social enterprises from multiple groups, particularly investors (through below-market investment) and consumers (via premiums over market prices). Thus, this social enterprise form would be to altruistic investors and consumers what the nonprofit form is to donors.

Moreover, the proposal could facilitate the flow of investments by foundations in social enterprises (known as program-related investments, “PRIs”) because it would help foundations verify the social impact of their investees. In addition, by giving subsidy-providers greater assurance that social enterprises pursue social missions effectively, the proposed legal form could facilitate public markets for social enterprises.

Introduction

In recent years, there have been efforts to encourage firms to pursue social goals. In a striking statement to public corporations, Larry Fink, Blackrock’s CEO, wrote: “Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”¹ 1.Letter from Larry Fink, Chairman & Chief Exec. Officer, Blackrock, to CEOs (2018), https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter [https://­perma.cc/7QRQ-9DG6]. For a similar statement by Martin Lipton, the renowned legal advisor for public corporations, see Martin Lipton et al., The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors To Achieve Sustainable Long-Term Investment and Growth, Harv. L. Sch. F. on Corp. Governance (Jan. 11, 2017), https://corpgov.law.harvard.edu/2017/01/11/corporate-governance-the-new-para­digm/ [https://perma.cc/B5AJ-EWNW].Show More The imperative that firms pursue social goals, however, is very vague. What range of permissible non-pecuniary goals should companies be encouraged to pursue?² 2.See generally Oliver Hart & Luigi Zingales, Companies Should Maximize Shareholder Welfare Not Market Value, 2 J.L. Fin. & Acct. 247 (2017) (arguing that company and asset managers should pursue policies consistent with the non-pecuniary preferences of their investors).Show More This question reflects a much re-hashed debate regarding the role and purpose of corporations. Many studies view this topic as a matter of corporate governance. That is, the key question is whether policies that seek to create social impact—often referred to as “CSR” (for corporate social responsibility)—maximize shareholder value in the long term. If the answer is yes, then it is a win-win situation for all because such policies are assumed to benefit society.

This Article takes a different approach by arguing that the pressing question should be: Does the pursuit of social missions by for-profit organizations actually benefit the intended beneficiaries? While the literature is not conclusive,³ 3.Compare Ronald W. Masulis & Syed Walid Reza, Agency Problems of Corporate Philanthropy, 28 Rev. Fin. Stud. 592, 619–21 (2015) (claiming that corporate donations advance CEO interests and reduce firm value), with Allen Ferrell, Hao Liang & Luc Renneboog, Socially Responsible Firms, 122 J. Fin. Econ. 585, 585–91, 596–605 (2016) (arguing that well-governed firms are more engaged in CSR, and there is a positive association between CSR and shareholder value).Show More it is easy to see how a reputation for being socially responsible can help companies sell more products, attract investments, or even get more lenient treatment from regulators. However, just having a good reputation does not mean that CSR policies achieve their putative purpose of helping stakeholders and society at large. Without a mechanism for ensuring that CSR actually benefits the stakeholders, companies can easily use it as a means of “greenwashing.”⁴ 4.“Greenwashing occurs when a corporation increases its sales or boosts its brand image through environmental rhetoric or advertising, but in reality does not make good on these environmental claims.” Miriam A. Cherry, The Law and Economics of Corporate Social Responsibility and Greenwashing, 14 U.C. Davis Bus. L.J. 281, 282 (2013).Show More Greenwashing may be particularly conducive to shareholder value because it promotes a strong reputation and higher sales without actually doing anything substantial for society.⁵ 5.This arguably explains why well-governed firms that are more accountable to their shareholders tend to engage in value-enhancing CSR. See generallyFerrell, Liang & Renneboog, supra note 3. For a similar argument in the context of regulation, see Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 Notre Dame L. Rev. 1, 3–4 (2016) (arguing that regulation designed to align managers’ and investors’ interests does not necessarily help address negative externalities).Show More But—while false signals of doing good may increase shareholder value—those who support companies for their good deeds would presumably be disappointed were the truth to come to light.

The problem is that it is extremely difficult to verify companies’ social impact. Existing measures of social impact tend to be vague, include metrics that are difficult to quantify, and even mix shareholder protection metrics with environmental or societal ones.⁶ 6.This is most obviously manifested in the ESG metrics because they include both (i) governance metrics, which are supposed to increase accountability to shareholders and (ii) social and environmental metrics, which are supposed to measure firms’ contributions to social and environmental objectives.Show More But if measurement is rarely available, how do we know that firms are pursuing social goals effectively?

The legal approach to addressing these questions has been to introduce legal hybrid forms—in particular, the benefit corporation.⁷ 7.See infra Part II.Show More These forms are supposed to communicate to investors, consumers, workers, and society at large that firms’ activities benefit society. To date, as many as thirty-six states, including Delaware, have adopted one or more such legal forms.⁸ 8.B Lab, State by State Status of Legislation, Benefit Corp., http://benefitcorp.net/policy­makers/state-by-state-status? [https://perma.cc/X524-35UE] (last visited Mar. 18, 2020).Show More However, existing legal forms fail to clarify the actual impact of companies’ social goals.⁹ 9.See, e.g., John E. Tyler III, Evan Absher, Kathleen Garman & Anthony Luppino, Purposes, Priorities and Accountability Under Social Business Structures: Resolving Ambiguities and Enhancing Adoption, 19 Advances Entrepreneurship Firm Emergence & Growth 39, 39 (2017) (arguing that “social business models do not meaningfully prioritize or impose accountability to ‘social good’ over other purposes”).Show More Just like CSR, these forms could portray a misleading picture of companies’ social contributions. Many of the companies that adopt these legal forms have little or no discernible social impact.¹⁰ 10.See Ofer Eldar, The Role of Social Enterprise and Hybrid Organizations, 2017 Colum. Bus. L. Rev. 92, 99 (discussing Laureate University, a for-profit network of universities incorporated as a benefit corporation but that uses aggressive promotional tactics and has low graduation and loan repayment rates); see also Michael B. Dorff, James Hicks & Steven Davidoff Solomon, The Future or Fancy? An Empirical Study of Public Benefit Corporations 46 (Eur. Corp. Governance Inst., Working Paper No. 495, 2020), https://papers.ssrn.com­/sol3/papers.cfm?abstract_id=3433772 [https://perma.cc/D9R8-VZWC]. Dorff et al. list standard firms, such as Ripple Foods, as having incorporated as benefit corporations, even though these firms do not have any clear social impact other than producing goods (such as dairy-free milk) that appeal to certain consumers.Show More And companies that appear to be highly successful in pursuing social missions already had such impact before they adopted the legal forms.¹¹ 11.Two such examples include the Greyston Bakery and Patagonia. See Eldar, supra note 10, at 189 n.270.Show More

Why have these forms seemingly failed to generate greater social impact? In this Article, I claim that they suffer from the same underlying problem as CSR policies. These forms are simply not structured in a way that makes companies more likely to pursue social goals effectively. Therefore, the legal forms cannot serve as useful signals to investors or consumers that the firms benefit society in the ways they purport to.

An effective legal form must meet two conditions. First, the form must give firms incentives to pursue social missions effectively. At the very least, the goal of maximizing shareholders’ profits should not interfere with the firm’s social mission. Ideally, the firm should have a financial stake in the accomplishment of the social mission. Second, the firm should have the competence to pursue such missions. Competence is particularly important because social goals, such as unemployment or access to capital, tend to be complex. Accomplishing complex social goals requires the firm to tailor its social programs to the specific attributes and needs of the beneficiaries.

The issues of incentives and competence are very similar to standard issues in corporate governance. Broadly stated, the main goal of corporate governance policy is to ensure that managers have both (i) the incentives to maximize shareholder value and (ii) the competence to make decisions on behalf of the corporation.¹² 12.See Zohar Goshen & Richard Squire, Principal Costs: A New Theory for Corporate Law and Governance, 117 Colum. L. Rev. 767, 784 (2017) (identifying conflict costs and competence costs as the two main sources of costs that corporate governance is designed to address).Show More What complicates things when it comes to social responsibility is that a firm that purports to pursue CSR not only makes profits on behalf of the investors, but it also serves as a conduit for a subsidy or a donation. As I explain elsewhere, these subsidies or donations need not be direct transfers from the government or donors. In fact, they are usually latent in the sense that they reflect premium prices paid by consumers or below-market returns from investors.¹³ 13.Eldar, supra note 10, at 104–05.Show More

For policy makers, the main design issue is how to assure those who provide subsidy-donations that they will be used effectively. Thus, the principal goal of this Article is to develop a legal form with key structural elements that give managers the incentives and competence to accomplish this. This form can signal to stakeholders that firms professing to promote social impact actually do what they claim.

The policy I propose is modeled on the structural elements found in social enterprises that transact with their beneficiaries (e.g., as consumers or workers), which I have addressed in previous work.¹⁴ 14.See id.; see also Ofer Eldar, The Organization of Social Enterprises: Transacting Versus Giving 10–15 (July 27, 2018) (unpublished paper), https://papers.ssrn.com/sol3/papers.­cfm?abstract_id=3217663 [https://perma.cc/S36D-3LWP].Show More The transactional relationship with its beneficiaries gives the firm a stake in helping them develop, and also enables the firm to observe beneficiaries’ abilities and needs. Thus, such firms have both the incentives and competence to serve certain social goals. The proposal builds on the regulatory regime for community development financial institutions (CDFIs), which certifies financial institutions as firms that serve low-income populations,¹⁵ 15.The CDFI regime is currently limited to low-income borrowers, but it could be extended to a wider class of beneficiaries, and extended beyond the U.S.Show More and combines this regime with certain elements found in benefit corporations.¹⁶ 16.Specifically, as in benefit corporations, a qualified majority voting is required to change the mission of the firm. See infra text accompanying note 111.Show More

In essence, the proposal is to introduce a new social enterprise (SE) legal form. Firms organized under the SE legal form would be required to obtain a government certification as a “Social Enterprise” if they commit, in their charters, to transacting with one or more carefully defined classes of beneficiaries. These beneficiaries may include, among others, workers, borrowers, and consumers. Beneficiaries will be divided into different classes in accordance with certain criteria of need (e.g., level of income). To maintain the certification, firms must commit to having a minimum percentage of their business associated with beneficiary transactions. Whereas current benefit corporation laws permit companies to choose a third-party standard that measures their social purpose,¹⁷ 17.The MBCL provides criteria for third-party standards, but companies have discretion to select how their performance will be measured. See infra Part II.Show More my proposed reform would require companies to adhere to one federal standard defined by a single federal certifier.

The main goal of this proposed policy is to facilitate the flow of subsidized capital and income to social enterprises. This legal form is necessary to attract subsidies from dispersed subsidy-providers, such as investors and consumers. Currently, investors and consumers mainly rely on costly contractual and ownership mechanisms to ensure that relevant firms transact with their beneficiaries. Under the proposed system, investors and consumers would have notice that the firm transacts with beneficiaries before they purchase shares or products. In this respect, the proposed law would be to altruistic investors and consumers essentially what the nonprofit form is to donors.¹⁸ 18.The nonprofit form assures donors that the managers of donative organizations have limited incentives to expropriate the subsidy-donations; hence, they are more likely to distribute donations to the intended beneficiaries. Henry B. Hansmann, The Role of Nonprofit Enterprise, 89 Yale L.J. 835, 838–39 (1980). Similarly, the proposed legal form would assure investors and consumers that the firm has incentives to use subsidies effectively.Show More Thus, the proposal is likely to unlock much-needed capital to scale social enterprises and increase social impact.

The ability of the SE legal form to source subsidies from a wider range of subsidy-providers could serve two additional complementary objectives. First, it could help facilitate the process for allocating subsidized investments (known as program-related investments or “PRIs”) from foundations. While most policy initiatives seek to attract institutional shareholder investment to channel capital for social goals, the best candidates for investing in social impact are foundations. The reason is that they have vast amounts of capital that they are supposed to employ to further philanthropic goals.¹⁹ 19.See, e.g., Matt Onek, Philanthropic Pioneers: Foundations and the Rise of Impact Investing, Stan. Soc. Innovation Rev. (Jan. 17, 2017) https://ssir.org/articles/entry/­philanthropic_pioneers_foundations_and_the_rise_of_impact_investing# [https://perma.cc/­MJ7A-52Q8].Show More Paradoxically, foundations often resist making PRIs in for-profit social enterprises because such investments could expose them to tax penalties if they cannot verify the social mission of their investees. Currently, such verification is cumbersome and subject to legal uncertainty. Thus, making certified firms eligible for PRIs would facilitate the process for allocating such investments.

Second, more ambitiously, the proposal has the potential to meet a long-awaited goal of social entrepreneurs: facilitating their access to capital markets. The inability of social enterprises to tap into capital markets substantially burdens their ability to grow and increase their social impact. Attempts to establish social exchanges for firms that combine profit and missions have largely been futile, primarily due to the difficulties of measuring social impact. A new legal form could help by providing adequate assurance to the investors who are expected to subsidize such impact.

One objection to this proposal might be that a legal hybrid form based solely on firms’ transactional relationships with their beneficiaries is overly reductive or too narrow. Should a legal hybrid form not capture the universe of social missions, such as the protection of the environment, diversity, and human rights? These objectives are indeed laudable, but it does not follow that legal forms can adequately address them. In the absence of credible certification mechanisms and clear metrics of social impact, legal forms for organizations with broad social purposes are not likely to signal that these firms pursue social missions effectively. Furthermore, the class of organizations that transact with disadvantaged persons is large and highly consequential.²⁰ 20.For example, they range from microfinance institutions to firms that provide eyeglasses in developing countries.Show More Concentrating on these firms could transform legal hybrid forms from a marginal phenomenon to a remarkable vehicle for promoting development.

This Article proceeds as follows: Part I describes how legal hybrid forms are supposed to serve as a commitment device to potential subsidy providers and explains why a new form is necessary to facilitate the formation of social enterprises. Part II critically evaluates the principal existing legal forms for companies with a social purpose and explains why they fail to serve as adequate commitment devices. Part III discusses the key elements of the CDFI regime and why other certification mechanisms do not work as well. Part IV proposes a design for a new legal form for social enterprises and discusses its principal elements in detail. Part V discusses the design of possible government subsidies for the proposed legal hybrid form.

1. * Duke University School of Law; Duke Innovation and Entrepreneurship Initiative. I thank Richard Brooks, Jamie Boyle, John Coyle, Elisabeth De Fontenay, Brian Galle, Henry Hansmann, Yair Listokin, Richard Schmalbeck, Steven Schwarcz, Michael Simkovic, Emily Strauss, Rory Van Loo, Andrew Verstein, and participants in seminars at Duke University School of Law and Boston University School of Law for helpful comments and suggestions. I am also grateful to Heather Cron, Zach Lankford, Renuka Medury, Kelsey Moore, Catherine Prater, and Hadar Tanne for excellent research assistance. Email: eldar@law.duke.edu. ↑
2. Letter from Larry Fink, Chairman & Chief Exec. Officer, Blackrock, to CEOs (2018), https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter [https://­perma.cc/7QRQ-9DG6]. For a similar statement by Martin Lipton, the renowned legal advisor for public corporations, see Martin Lipton et al., The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors To Achieve Sustainable Long-Term Investment and Growth, Harv. L. Sch. F. on Corp. Governance (Jan. 11, 2017), https://corpgov.law.harvard.edu/2017/01/11/corporate-governance-the-new-para­digm/ [https://perma.cc/B5AJ-EWNW]. ↑
3. See generally Oliver Hart & Luigi Zingales, Companies Should Maximize Shareholder Welfare Not Market Value, 2 J.L. Fin. & Acct. 247 (2017) (arguing that company and asset managers should pursue policies consistent with the non-pecuniary preferences of their investors). ↑
4. Compare Ronald W. Masulis & Syed Walid Reza, Agency Problems of Corporate Philanthropy, 28 Rev. Fin. Stud. 592, 619–21 (2015) (claiming that corporate donations advance CEO interests and reduce firm value), with Allen Ferrell, Hao Liang & Luc Renneboog, Socially Responsible Firms, 122 J. Fin. Econ. 585, 585–91, 596–605 (2016) (arguing that well-governed firms are more engaged in CSR, and there is a positive association between CSR and shareholder value). ↑
5. “Greenwashing occurs when a corporation increases its sales or boosts its brand image through environmental rhetoric or advertising, but in reality does not make good on these environmental claims.” Miriam A. Cherry, The Law and Economics of Corporate Social Responsibility and Greenwashing, 14 U.C. Davis Bus. L.J. 281, 282 (2013). ↑
6. This arguably explains why well-governed firms that are more accountable to their shareholders tend to engage in value-enhancing CSR. See generally Ferrell, Liang & Renneboog, supra note 3. For a similar argument in the context of regulation, see Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 Notre Dame L. Rev. 1, 3–4 (2016) (arguing that regulation designed to align managers’ and investors’ interests does not necessarily help address negative externalities). ↑
7. This is most obviously manifested in the ESG metrics because they include both (i) governance metrics, which are supposed to increase accountability to shareholders and (ii) social and environmental metrics, which are supposed to measure firms’ contributions to social and environmental objectives. ↑
8. See infra Part II. ↑
9. B Lab, State by State Status of Legislation, Benefit Corp., http://benefitcorp.net/policy­makers/state-by-state-status? [https://perma.cc/X524-35UE] (last visited Mar. 18, 2020). ↑
10. See, e.g., John E. Tyler III, Evan Absher, Kathleen Garman & Anthony Luppino, Purposes, Priorities and Accountability Under Social Business Structures: Resolving Ambiguities and Enhancing Adoption, 19 Advances Entrepreneurship Firm Emergence & Growth 39, 39 (2017) (arguing that “social business models do not meaningfully prioritize or impose accountability to ‘social good’ over other purposes”). ↑
11. See Ofer Eldar, The Role of Social Enterprise and Hybrid Organizations, 2017 Colum. Bus. L. Rev. 92, 99 (discussing Laureate University, a for-profit network of universities incorporated as a benefit corporation but that uses aggressive promotional tactics and has low graduation and loan repayment rates); see also Michael B. Dorff, James Hicks & Steven Davidoff Solomon, The Future or Fancy? An Empirical Study of Public Benefit Corporations 46 (Eur. Corp. Governance Inst., Working Paper No. 495, 2020), https://papers.ssrn.com­/sol3/papers.cfm?abstract_id=3433772 [https://perma.cc/D9R8-VZWC]. Dorff et al. list standard firms, such as Ripple Foods, as having incorporated as benefit corporations, even though these firms do not have any clear social impact other than producing goods (such as dairy-free milk) that appeal to certain consumers. ↑
12. Two such examples include the Greyston Bakery and Patagonia. See Eldar, supra note 10, at 189 n.270. ↑
13. See Zohar Goshen & Richard Squire, Principal Costs: A New Theory for Corporate Law and Governance, 117 Colum. L. Rev. 767, 784 (2017) (identifying conflict costs and competence costs as the two main sources of costs that corporate governance is designed to address). ↑
14. Eldar, supra note 10, at 104–05. ↑
15. See id.; see also Ofer Eldar, The Organization of Social Enterprises: Transacting Versus Giving 10–15 (July 27, 2018) (unpublished paper), https://papers.ssrn.com/sol3/papers.­cfm?abstract_id=3217663 [https://perma.cc/S36D-3LWP]. ↑
16. The CDFI regime is currently limited to low-income borrowers, but it could be extended to a wider class of beneficiaries, and extended beyond the U.S. ↑
17. Specifically, as in benefit corporations, a qualified majority voting is required to change the mission of the firm. See infra text accompanying note 111. ↑
18. The MBCL provides criteria for third-party standards, but companies have discretion to select how their performance will be measured. See infra Part II. ↑
19. The nonprofit form assures donors that the managers of donative organizations have limited incentives to expropriate the subsidy-donations; hence, they are more likely to distribute donations to the intended beneficiaries. Henry B. Hansmann, The Role of Nonprofit Enterprise, 89 Yale L.J. 835, 838–39 (1980). Similarly, the proposed legal form would assure investors and consumers that the firm has incentives to use subsidies effectively. ↑
20. See, e.g., Matt Onek, Philanthropic Pioneers: Foundations and the Rise of Impact Investing, Stan. Soc. Innovation Rev. (Jan. 17, 2017) https://ssir.org/articles/entry/­philanthropic_pioneers_foundations_and_the_rise_of_impact_investing# [https://perma.cc/­MJ7A-52Q8]. ↑
21. For example, they range from microfinance institutions to firms that provide eyeglasses in developing countries. ↑