Download this Paper Open PDF in Browser

Stockholders, Stakeholders, and Bagholders (or How Investor Diversification Affects Fiduciary Duty)

50 Pages Posted: 17 Feb 1999  

Richard A. Booth

Villanova University Charles Widger School of Law

Abstract

The traditional wisdom is that management should serve the interests of the corporation and the stockholders who own it by maximizing stockholder wealth. But a significant number of legal scholars argue that management duty should be more broadly construed to include other constituencies (stakeholders), such as employees, creditors, customers, suppliers, and the community at large. The broader view of management duty means that management has more discretion and that stockholders will seldom have recourse if management fails to maximize profits. Nevertheless, many states have adopted so-called other constituency statutes permitting management to consider such other interests.

The difference between the two views of management duty depends on how one defines a reasonable stockholder. If management duty is measured by the interests of a diversified stockholder, management's duty is to maximize profits even at the risk of bankrupting the firm. If management duty is measured by the interests of an undiversified stockholder, the duty is to maximize profits and to minimize risk. Because rational investors diversify, most commentators have assumed that fiduciary duty should be construed as if owed to a diversified stockholder. The thesis here, however, is that (i) it is impractical to measure fiduciary duty by reference to diversified stockholders because management itself is often a significant undiversified investor in the business, and (ii) diversified stockholders will, in any event, prefer management to behave as if it owes its duty to undiversified stockholders. Thus, in practice, management duty should be seen as owed to the corporation but not necessarily to the stockholders.

JEL Classification: E52, E58

Suggested Citation

Booth, Richard A., Stockholders, Stakeholders, and Bagholders (or How Investor Diversification Affects Fiduciary Duty). Business Lawyer Vol. 53, No. 1, 1997. Available at SSRN: https://ssrn.com/abstract=149731

Richard A. Booth (Contact Author)

Villanova University Charles Widger School of Law ( email )

299 North Spring Mill Road
Villanova, PA 19085
United States
6105197068 (Phone)
610595672 (Fax)

HOME PAGE: http://www1.villanova.edu/villanova/law/staffadmin/Faculty%20Directory/biodetail.html?mail=booth@law

Paper statistics

Downloads
176
Rank
144,223
Abstract Views
3,080