1. What you know about Fiduciary Duty is probably wrong

A lot of people on the internet like to blame fiduciary duty for corporations going out of control.

The fact that corporations are obsessed about their quarterly profits is because companies have a fiduciary duty to their shareholders!

Companies are REQUIRED to maximize their profits at all costs!

Dodge vs Ford ruined capitalism by forcing companies to only make profits for their shareholders!

If companies don’t make as much money as possible, then they are breaking their fiduciary duty and can be sued!

Private companies are way better than public companies because they aren’t constrained by fiduciary duties or the need to maximize profits!

All of these statements are factually incorrect.

So let’s start myth busting then.

2. So what is fiduciary duty then?

To understand fiduciary duty, you need to understand how the modern corporation is structured and run.

2a. Principal Agent Theory

One of the revolutionary ideas in modern capitalism is the idea called Separation of Ownership and Control.

This is the idea that the people who own the company don’t have to be the same people who run the company. This is why you can buy shares on the stock market but you aren’t obligated to actually work for the company.

This immediately creates several problems however:

• The owners of the company (the shareholders) aren’t involved in the day-to-day running of the company. They therefore need to hire people (the management) to run the company on their behalf;
• The management who run the company have access to more information and resources than the owners of the company, so can hide information (asymmetric information) or take hidden actions (moral hazard);
• The owners of the company need to know that the people they hired are doing a good job running the company and aren’t, say, committing fraud or stealing the money

This is known as the Principal Agent Problem.

Company management (the Agent) has been hired to take actions on behalf of someone else (the Principal).

Ideally, you want the Agent and Principal to agree to a framework that:

• Gives the Agent the freedom to take actions without being constantly micromanaged in order to make the company successful; but
• Also gives the Principal assurance that the Agent isn’t scamming them or ruining the company the Principal owns

So, we humans created this framework. It’s called Corporate Governance.

2b. Corporate Governance and Fiduciary Duty

Corporate governance is the fancy way of saying “What are the rules for how companies should operate to make sure company management makes the right decisions?”

Corporate governance can be implemented both under formal legal regulations (e.g. Sarbanes–Oxley Act of 2002, UK FRC Corporate Governance Code, etc.) or through informal voluntary schemes (e.g. Toronto Stock Exchange Guidelines).

Fiduciary duties is one way to formally and legally express the duties that an Agent has to their Principal.

2c. What exactly does Fiduciary Duty require?

For the purpose of this section, I will use the US system of Delaware corporate law to keep things simple. However, the general principles outlined here broadly apply to most legal jurisdictions.

Fiduciary duties apply to a very specific type of employee at a company. These are essentially people who have significant management responsibilities or control over the company’s operations.

So for example¹Some exceptions apply such as shareholders who aren’t part management but own a large % of the shares of the company. Let’s avoid getting into technical and esoteric law here. It’s not important.:

• Directors of the company such as CEO / CFO / Non-executive members of the board of directors: Covered by fiduciary duty
• The IT manager responsible for the US East data centre: Not covered by fiduciary duty

Fiduciary duty says that these Directors have 2 key responsibilities²Disclaimer: Some other governance systems may name additional responsibilities such as Duty of Good Faith, Duty of Disclosure, etc. However Delaware law considers these as obligations that stem from the 2 core Duties of Care and Loyalty so I will not cover them here.:

2ci. The Duty of Care

This rule basically says: “With great power comes great responsibility.”

The idea is that as a Director, you have a lot of power over the company. So you also have the responsibility to take your job seriously the same way that any prudent and ordinary person would manage their personal matters.

So for example:

• Did you make sure to learn everything possible about a situation before making your decision?
• Are you working to advance the company’s overall goals?
• Are you participating in relevant meetings?
• etc.

2cii. The Duty of Loyalty

The duty of loyalty is pretty straightforward: Your job is to look after the shareholders of the company and not your own personal interests.

This directly addresses the key issue of the Principal Agent Problem.

So for example:

• You aren’t allowed to conduct insider trading due to the special access to information you have as a Director of the company;
• You aren’t allowed to have conflicts of interest such as recommending the company acquire your friend’s company for 10x of its proper value for no reason;
• etc.

2d. That’s it?

That’s it.

That’s literally all fiduciary duties mean.

So if you are a Director of a company and you:

• Turn up to Board meetings;
• Ask sensible questions;
• Stay informed about the situation and think before you make a decision;
• Keep confidential information confidential;
• Don’t create conflicts of interest;

Then you’re basically fulfilling your fiduciary duties.

Don’t just take it from me. Here’s a bulletin written by Skadden, Arps, Slate, Meagher & Flom LLP³Skadden is one of the top 5 law firms in the world and specializes in corporate law, so they’re a very big deal. saying the same thing.

Disclaimer: This is not legal advice. If you are a Director of a company, please actually get proper Board training from your lawyers. I am deliberately ignoring all the rules about record keeping, disclosure, board governance frameworks, etc. because these are incredibly boring and not relevant to this discussion.

3. Wait, so fiduciary duty doesn’t mean companies are legally required to maximize profits?

No.

It is telling that whenever people make this claim, they cannot point to the actual law in question.

Because… you know. This magical law doesn’t actually exist. Huh.

For a more specific and formal explanation: the Duty of Care rule does not actually require the Directors to take any specific actions⁴Taking specific actions such as attending board meetings and participating in discussions does help prove you were fulfilling your duties though..

This means that Directors are not required to maximize profits or minimize taxes.

For example⁵Emphasis in bold for all quotes is mine:

While it is certainly true that a central objective of for-profit corporations is to make money, modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not do so.

Burwell v. Hobby Lobby Stores (2014)

Delaware law is clear that there is no separate duty to minimize taxes, and a failure to do so is not automatically a waste of corporate assets.

Seinfeld v. Slager (2012)

4. But what about Dodge v Ford Motor Co?

If you understand how Fiduciary Duty works, then you can start to see why Dodge v Ford is not actually some demonic legal case that turns corporations into monsters.

4a. What was the case about?

If I may use the words of Professor Henderson from the University of Chicago Law School who does a better job than me explaining the case:

The case, Dodge v. Ford Motor Company, was about minority shareholders’ ability to challenge the authority of the board of directors to make business decisions that were alleged to be serving interests other than maximizing the value of plaintiffs’ shares. 

[…]

The Michigan courts struggled. Ford was emphatic in both his pretrial comments and his testimony that the decision to build the factory was about doing “as much good as we can, everywhere, for everybody concerned . . . [a]nd incidentally to make money.” Faced with Ford’s candor about using someone else’s money to achieve his personal goals, the court ordered the payment of a large dividend (about $19 million), and enjoined construction of the factory

Henderson (2007)

Can you see what went wrong here? What did the Duty of Loyalty say Directors needed to do again?

The duty of loyalty is pretty straightforward: Your job is to look after the shareholders of the company and not your own personal interests.

So what did Ford do wrong? He basically said out loud that he wanted to use the company to achieve his own personal goals and didn’t care about the shareholders.

This is a pretty straightforward violation of fiduciary duty. So this legal case is very uninteresting.

4b. Hang on, but Ford said he wanted to do good for other people. Isn’t this also banned?

No.

Courts are extremely hesitant to second guess the decisions a business makes. After all, “judges are not business experts”.

This isn’t me trying to sound fancy. The legal opinion written by the Michigan court in Dodge v. Ford Motor Company literally says:

We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. […] The judges are not business experts.

Dodge v. Ford Motor Co. (1918)

So long as the decisions of a company can be justified as ultimately serving the interests of the shareholders, the legal system is extremely deferential to Directors.

This is known as the Business Judgement Rule.

That being said, however, as I understand binding Delaware precedent, I [the judge] may not substitute my business judgment for that of the Airgas board.

[…]

This course of action has been clearly recognized under Delaware law: “directors, when acting deliberately, in an informed way, and in the good faith pursuit of corporate interests, may follow a course designed to achieve long-term value even at the cost of immediate value maximization.”

Air Products v. Airgas (2011)

Notice some familiar words creeping back in such as “acting deliberately, in an informed way, and in the good faith“?

If the Director can prove that they upheld the Duty of Care and Duty of Loyalty, courts will generally agree with any decision a Director makes.

So if the Directors of a company sit down and decide “It is good for our shareholders in the long run if we do things that benefit other people and this is not a personal conflict of interest for me” then this is perfectly legal and okay⁶But how do you know if the Directors even plan on still being here in the long-run? Can’t they just say “but the long-run” as an excuse and no one questions it? Ah, well you my friend have just found the reason why the Business Judgement Rule is so powerful..

This is why companies are allowed to do things like make donations to charitable causes for example⁷The Hobby Lobby case I linked earlier also explicitly noted this fact: “For-profit corporations, with ownership approval, support a wide variety of charitable causes, and it is not at all uncommon for such corporations to further humanitarian and other altruistic objectives.”.

Donating to charity doesn’t make a company any money and is just good for society. But if the Directors say: “Well we should do this for the sake of our shareholders because it creates a lot of intangible value that is hard to measure but is still good for the shareholders” then sure. The law says there’s no problem⁸Once again the standard disclaimer that this is not legal advice, please consult your actual lawyer about proper disclosure and record keeping rules, etc..

5. Private Companies have fiduciary duties too

I also want to make clear here: Fiduciary duties apply whenever you have any company incorporated in a location that has corporate governance requirements.

So it’s not just publicly listed companies that fall under scope here.

For example, charities also have their own fiduciary duty rules. Afterall, you wouldn’t want the Directors of the charity just stealing the money and running away… right?

6. So if fiduciary duty isn’t to blame, then why do public companies obsess about quarter earnings?

The problem with the public company obsession over quarterly earnings is really due to several other deeper issues including, but not limited to:

• What are the principal agent problems that corporate governance can’t solve?
• How do you measure if a company manager is actually doing a good job even if they fulfil their fiduciary duties?
• What does the stock market even think a good company manager looks like?
• What does “good company performance” even look like?

Explaining all of this requires explaining the history of companies / corporate governance and the events that got us to this mess.

This really requires its own essay in order to explain properly. I’ll write about that another time.

• 1
  Some exceptions apply such as shareholders who aren’t part management but own a large % of the shares of the company. Let’s avoid getting into technical and esoteric law here. It’s not important.
• 2
  Disclaimer: Some other governance systems may name additional responsibilities such as Duty of Good Faith, Duty of Disclosure, etc. However Delaware law considers these as obligations that stem from the 2 core Duties of Care and Loyalty so I will not cover them here.
• 3
  Skadden is one of the top 5 law firms in the world and specializes in corporate law, so they’re a very big deal.
• 4
  Taking specific actions such as attending board meetings and participating in discussions does help prove you were fulfilling your duties though.
• 5
  Emphasis in bold for all quotes is mine
• 6
  But how do you know if the Directors even plan on still being here in the long-run? Can’t they just say “but the long-run” as an excuse and no one questions it? Ah, well you my friend have just found the reason why the Business Judgement Rule is so powerful.
• 7
  The Hobby Lobby case I linked earlier also explicitly noted this fact: “For-profit corporations, with ownership approval, support a wide variety of charitable causes, and it is not at all uncommon for such corporations to further humanitarian and other altruistic objectives.”
• 8
  Once again the standard disclaimer that this is not legal advice, please consult your actual lawyer about proper disclosure and record keeping rules, etc.