Implementing the New Purpose of the Corporation : The Duty of Directors to Tie Executive Pay to Employees’ Interests

The traditional view of executive pay as a financial incentive to enhance firm performance that is often equated with shareholder value maximization has been put into question in the last few years. The rise of the new purpose of the corporation and stakeholder capitalism has put that traditional view under further scrutiny. This work elaborates on a proposed duty of directors to tie executive compensation to improvements in employees’ working conditions as a mechanism to more effectively implement the new purpose of the corporation. Compensation drives directors’ and officers’ conduct and can thus be a strong incentive for adopting pay policies that may be linked to gradual improvements in wages, health and safety in the workplace, productivity, innovation, job security, equality and diversity particularly when shareholder value, firm profitability and executive pay increase. However, shareholders and self-serving directors and officers are unlikely to welcome, if not oppose, such a practice and a legal duty can ensure that directors tie pay to employees’ interests by creating additional incentives, protections and liabilities. While this proposed duty may increase labor cost and reduce shareholder value in the short-term, the evidence suggests that it will improve firm profitability, maximize shareholder value and help build a more stable and sustainable economy and society in the medium and long term. This argument questions Harvard professor Lucian A. Bebchuk’s claim that executive compensation cannot be redesigned to serve the interests of stakeholders such as employees. It also challenges the new corporate rhetoric of the new purpose of the corporation that has not delivered any significant changes notably by the world’s biggest institutional investors such as BlackRock. An effective and wide implementation of a duty to tie executive pay to employees’ interests will need an appropriate metric of employees’ interests; an adequate method of directors’ balancing of multiple stakeholders’ interests; regulatory mechanisms to curb the likely opposition from self-serving directors and officers, influential shareholders and common owners to both employee-friendly practices and favorable legal reforms; the deemphasizing of stock-based executive compensation in order to align pay with employees’ interests; and some mechanisms for employees’ participation in corporate decisions. While this research agenda is beyond the scope of this paper, this work makes a contribution by articulating the merits, desirability and feasibility of a proposed duty to tie executive pay to employees’ interests