Volume 12, Issue 2

Questions about corporations and social good have become central in busi- ness law and legal scholarship. Both academics and practitioners are focused on environmental, social, and governance (ESG) issues, and on the the very purpose of corporations. Meanwhile, some commentators and practitioners have begun to hint that these large questions about social good might be linked to litigation risk. We show, for the first time in the literature, that measures of social good and litigation risk are in fact linked, and we explore the important implications of this new finding.

Specifically, we examine how ESG scores purport to capture the degree to which corporations are, or are not, good corporate citizens based on an analysis of the relationship between ESG scores and securities litigation. We develop theories about how ESG might be related to litigation risk, and then we test those theories. We show that firms with poor ESG scores are substantially more likely to be sued and to settle cases. We also show that being sued harms a firm’s ESG reputation, but that settling a case stops the decline. We discuss the mecha- nisms that might account for these relationships, along with their implications for law and policy. We explore interpretations that are based on the behavior of firms, plaintiffs’ lawyers, and regulators, and we discuss how these interpreta- tions relate to recent changes in both federal and state law.

From Facemash to Facebook to Meta, Mark Zuckerberg’s path and com- pany have been fraught with conflicts, controversy, and even illegality.1 Did he steal the idea from the Winklevoss brothers? Has he invaded people’s privacy? Does he care about privacy? Does he mean what he says?2 Does he respect the law? Does he respect his shareholders? Does he respect his stakeholders? The answer to all of the above appears to be, no.

Zuckerberg has never played by the rules. Instead, from the beginning, he appears to have operated as if he were above the rules, not subject to regulation, and outside the zone where other people’s concerns about privacy or false information were infringements on his rights instead of the reverse. His response, time and again, is to apologize, pay a fine if required, and then repeat the process. Yet, the harm created by Facebook is real and exten- sive—from human rights violations to election outcomes to teenage girls contemplating suicide—Facebook’s reach is massive and its choices seeming unchecked. Zuckerberg apparently ignores the law, his fiduciary duties, the harm his choices create, and the role of social license. He operates Facebook as if it were his own private company, emphasizing growth, scale, and prof- its over the law, stakeholders, and safety. He appears to operate without candor and appears to run roughshod over the norms and internal controls designed to ensure both that the company’s corporate governance mecha- nisms are functioning and that it achieves sustained, profitable, and compli- ant growth.

Over the past few decades, we have seen an explosion of so-called “human capital firms”—that is, firms that generate value due to the knowledge, skills, competencies, and attributes of their workforce. Yet, despite the value generated by employees, U.S. accounting principles provide virtually no information on firm labor. Barely fifteen percent of firms disclose information as basic as labor costs.

In today’s economy, human capital is likely the biggest asset missing from firms’ balance sheets. Human capital is omitted because employees are not as- sets for accounting purposes; after all, employees can leave the firm. Yet, the lack of disclosure on labor costs under accounting principles causes a signifi- cant gap in financial reporting for firms that are reliant on their employees. The lack of disclosure also leads to difficulty when valuing the growing number of loss firms; in 2020, for the first time, the number of public companies reporting a net loss exceeded the number of firms reporting a profit. These loss firms are valued based on future profitability, necessitating more information on labor and other operating costs.

In the absence of movement by accounting standard-setters, a series of human capital disclosures have sprung up in voluntarily- disclosed sus- tainability reports and under Regulation S-K. These disclosures have largely focused on metrics, however, and are not a substitute for disclosures under ac- counting standards. Moreover, as noted by prior literature, these disclosures lack consistency, comparability, and reliability. As an illustration, we collected all human capital disclosures for four European issuers and found that they collectively disclosed seventy different metrics; only one metric was disclosed by all four issuers.

This Article argues that human capital should be integrated with account- ing standards. First, we propose that labor costs be treated pari passu with research and development costs, meaning that labor costs be expensed for ac- counting purposes but disclosed. We propose a standardized grid to be disclosed in the notes to the financial statements. Second, we advocate that managers be required to discuss what portion of their labor costs should be considered an investment in future firm profitability. Finally, we argue that the income state- ment should be disaggregated to show what portion of major expenses are at- tributable to labor costs. These changes would not violate the accounting principle of conservatism but would allow investors to capitalize human capital in their own valuations, initiating the modernization of accounting principles.

Mandated board gender balancing is a social-policy instrument, which in principle is unrelated to concerns about firms’ economic performance. Nonetheless, imposing such a policy may have unintended consequences (positive or negative) for firm value, which is important for all of the firm’s constituencies—not only shareholders. In this paper, we highlight and extend our recent research on the economic effects of Norway’s pioneering gender-quota law, which forced board gender balancing of all domestic public limited corporations by early 2008. This research subsumes and econometrically corrects controversial conclusions of extant studies. Most important, our research shows that quota-induced changes in market valuations and operating performance were both ec- onomically and statistically negligible. Furthermore, we show that corporate conversions to a legal form that prevents the firm from raising public equity capital—but does not require gender balancing—were unrelated to the company’s pre-quota female director shortfall. We also present new evidence that boards managed to preserve directors’ large-firm CEO experience without in- creasing director busyness. We conclude that the supply of qualified female director candidates was sufficiently large to avoid board concentration and negative economic effects of the quota restriction.

BOARD COMMITTEE CHARTERS AND ESG ACCOUNTABILITY

Lisa M. Fairfax

In the last few years, we have witnessed a sharp increase in corporate attention on environmental, sustainability, and governance (“ESG”). This increase has been propelled and buttressed by pressure from an ever-widening array of large and influential shareholders, as well as non-shareholder stakeholders, prompting many to assert that ESG has gone “mainstream.” The steep rise in corporate focus on ESG has inevitably prompted discourse around accountability as we seek to ensure that corporations deliver on their ESG goals and commitments. A wide range of accountability measures has been discussed, proposed, and even implemented, from increased ESG disclosure to tying ESG goals to CEO compensation.