When our investment affiliate, Marc J. Lane & Company, and other investment advisers and money managers consider a stock for their clients' portfolios, they look at "return on equity," "price-earnings ratio," "revenue, earnings and dividend growth rates," "debt burden" and many other financial characteristics.
More and more, they may be looking at "state of incorporation," too. And they may not like what they see.
It has long been a basic tenet of corporate law that directors owe a fiduciary duty to stockholders. A board's primary responsibility has always been to promote their best interests and generate profits for them.
But some controversial new laws threaten to rank stockholders' interests second to those of other "constituencies" to whom directors may also feel obligated.
One glaring example is a Pennsylvania statute which allows a board to consider the impact of any corporate decision on everyone it might affect - including shareholders, but also employees, suppliers, customers, creditors and the communities in which the corporation does business. What's more, the law lets the board decide which particular group's interests are most important. And, to the surprise of many investors, a decision's impact on stockholders need not be paramount.
In a provocative recent decision, U.S. District Judge Donald Vanartsdalen supported Conrail's directors in their acceptance of CSX's bid to acquire the company even though higher offers were successively placed on the table by Norfolk Southern. The board's rationale: CSX might be a better employer for Conrail's employees and, amazingly some might say, for its CEO.
Judge Vanartsdalen stood by the board. Applying Pennsylvania's "constituency" statute, he concluded that, when directors make corporate decisions, they may place the interests of employees - and presumably other interested parties - ahead of those of stockholders. Already, would-be suitors are declining to make tender offers for Pennsylvania-incorporated companies. The unavoidable conclusion: the stock of such companies is worth less than it might be were they incorporated in another state.
The investing public should be wary. Since boards of Pennsylvania companies have broad latitude to make decisions which are at odds with their stockholders' best interests, prudent investors may well elect to seek opportunities elsewhere.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.