Corporate Gifts Should Be Disclosed

Enron’s charitable donations raise disturbing questions about corporate governance and the purposes of corporate philanthropy. Enron was well known in the Houston area for contributing to local charities, some of whose officials had close ties to the energy company. To take one example, Enron donated approximately $600,000 to the University of Texas M.D. Anderson Cancer Center, whose president and president emeritus are Enron board members. That gift could not have made their task of asking difficult questions of Enron’s managers any easier — if indeed they fulfilled that task at all.

Such situations point to a dilemma. Corporate donations to nonprofit groups at times serve mainly the interests of the corporation, and they may undermine the very reason that corporate reformers have long advocated the appointment of outsiders to corporate boards of directors. Yet, communities would be poorer without corporate philanthropy.

Observers such as Arthur Levitt, former chairman of the Securities and Exchange Commission, have proposed banning charitable contributions to outside directors’ favorite nonprofit organizations.

But we have a more modest proposal, one that is in keeping with the prevailing view of corporate philanthropy as a social good. We would require disclosure of significant donations by public corporations to nonprofit groups in cases where directors or executive officers of the corporations serve as directors or officers of the charities.

The SEC requires that all transactions in excess of $60,000 between a public company and an entity in which one of its officers or directors has a “material interest” must be disclosed, but the commission does not require disclosure of gifts to charities.

We propose that serving as an officer or director of a nonprofit group should be deemed a “material interest” requiring disclosure of charitable contributions.

And disclosure does work. The day that Tyco International, another American energy-related corporation under public scrutiny, reported that it had earlier contributed $10-million to an outside director’s favored nonprofit group, its stock price fell precipitously.

Shareholder proposals requiring the disclosure of all charitable contributions have been presented at annual meetings, but such overly broad proposals have failed to garner a majority of shareholder votes. A similar idea was floated in Congress, but without success. Our proposal preserves corporate philanthropy while focusing on disclosure of contributions that may be in the nature of compensation or that risk affecting a director’s independence.

Under the rubric of “corporate social responsibility,” the law and the public have generally applauded charitable contributions by publicly held companies. But that view is an almost complete reversal of the stance taken by courts a century ago, when they invalidated such contributions on the ground that the corporation’s sole aim should be to maximize shareholder wealth.

Judicial decisions evolved for good reasons. Courts recognized that corporations benefited directly and indirectly from their philanthropy. For example, by donating money to improve conditions in the localities where they operated, corporations also improved their ability to attract talent. Corporations also basked in the favorable publicity of charitable giving, in some cases partially offsetting the negative images generated by the products the companies produced. Philip Morris, a tobacco company that for years has given money to charity, is a prominent example.

Most important, courts recognized that the days had passed when society could expect huge sums from a relatively few philanthropists, such as the Rockefellers, Carnegies, and Mellons. It was necessary, the courts felt, to allow corporations to donate a portion of their wealth for the public good. Promoting corporate social responsibility in effect amounted to reducing the risk that substantially all social decisions in society would be made by the government. American society has always sought to avoid a monopoly of decision making by any one group. The mix of public funding and private philanthropy to fulfill social needs reflects this diversification.

Critics such as the economist Milton Friedman have decried the liberalization of the legal doctrine on corporate philanthropy, saying it allows people never elected by popular vote to influence basic social decisions. But that is not what worries us, especially in cases like Enron.

Our principal concern focuses more on the threat to sound corporate governance when the lines between “inside” and “outside” corporate directors are blurred. In a trend that began several decades ago, more and more companies are structuring their boards of directors with a majority of outside directors, believing that outsiders can best monitor corporate insiders in management and on their boards. The most dangerous risk of all is that corporate donations may be part of an unwritten quid pro quo between outside directors and their corporation-employed counterparts.

As the Enron case suggests, the expectation of serious monitoring can be undermined when the outside director’s favorite institution receives substantial financial support from the corporation on whose board the director sits.

Corporate donations to nonprofit groups may also tend to be made disproportionately to institutions with which the corporate donor’s officers and inside directors have a direct or indirect relationship. Some justification for such relationships may exist, of course. A corporate official may keep in close touch with a nonprofit institution and thus be able to monitor the group’s use of the company’s gifts. Even so, such donations are a kind of interested transaction. Corporate officers or directors are benefiting their pet nonprofit groups with money that indirectly belongs to shareholders. That is a form of “compensation” to the officers or directors that never appears — but should — on an annual report or shareholder proxy statement.

Michael J. Bohnen practices business law at Nutter, McClennen & Fish, in Boston. David M. Phillips teaches corporate law at Northeastern University School of Law, in Boston.