This isn’t an arcane financial question.
On Wednesday, a procedural motion will be argued in a Wilmington, Delaware courthouse. The judge will be asked to decide whether a shareholder can continue with a lawsuit against Meta Platforms, the owner of Facebook, Instagram, Messenger, and WhatsApp. At issue is whether Meta and other corporations can account for the impact their activities have on the economy. The answer has profound implications as to whether our free market system is equal to the task of protecting investors and allocating society’s resources.
The consequences flow from four simple factors.
First, investors are diversified. Modern finance demonstrates that investors should seek high returns by investing in risky securities, such as the stock of public companies, but minimize that risk by diversifying their portfolios. In fact, fiduciaries who manage pensions, endowments, and other funds are generally legally required to diversify their portfolios. Index funds and other diversified products dominate the retail fund market.
Second, this diversification means that the performance of any one individual company is less important to most investors than the overall return of the market. Quite simply, investors will do well if the market does well over the long run, and individual company or portfolio variation will have only marginal impact.
Third, that market performance is dependent almost entirely on the performance of the economy (because owning a diversified portfolio is like owning a slice of the economy). Last, some decisions that boost a company’s profits can come at the expense of the broad economy because companies can externalize costs.
Putting these factors together, when a company’s business has the potential to create significant externalities — indirect effects such as pollution — the average shareholder has an interest in making sure that the company accounts for the full economic impact of its decisions. The case asks the court to ensure that Meta is considering the impact its externalities have on the diversified portfolios of its shareholders.
To be clear, this case is not about stakeholder capitalism, the mushy idea that companies should be managed for the unprioritized benefit of multiple constituencies. In Delaware — corporate home to most large American firms — the law is clear that executives must act “for the benefit of shareholders.” This case will define the interests of the modern shareholder.
This case arose because a whistleblower revealed that Meta uses algorithms that increase traffic on its sites — and thus advertising revenue, even though the algorithms create multiple harms, including mental health issues, threats to the rule of law, and false vaccine information. Documents revealed that Meta platforms enable drug cartels, ethnic violence, and human trafficking.
While these items are themselves awful, they also impede the economy. The lawsuit alleges that by tweaking products to maximize revenue, Meta was financially harming most of its shareholders: for diversified investors, the harm that Meta was doing to the economy outweighed any rise in stock price at the company itself. The complaint details the burden that poor mental health, pandemics, and threats to the rule of law place on an economy.
Meta is arguing that its executives cannot consider such economic and portfolio effects, and that they must make business choices as if the shareholders owned nothing but Meta stock. The company argues that it must design algorithms to maximize the company’s profits, even if it knows that those choices harm the economy and the portfolios of most investors.
Meta’s narrow interpretation of fiduciary duties is bad for the average Meta investor: over 75 percent of the shares in Meta are owned by institutions, whose clients and beneficiaries are likely diversified. But it would also have a dangerous implication for capitalism. We rely upon a free market system that uses the pursuit of profits to allocate resources efficiently: by seeking the highest return, capital investment steers labor and materials to their best use.
But if Delaware law were to require that corporate executives only measure success and profit at the company level, and that they ignore the impact their decisions have on diversified portfolios (which reflect the true cost of corporate activity by including externalities), it would severely hamper the utility of capital markets as a resource allocation mechanism. Such a ruling would require companies to use assets in a radically inefficient manner if doing so maximized returns at the company level — what the lawsuit alleges is happening at Meta. That doesn’t just hurt diversified investors, it hurts the entire economy.
Properly functioning markets are critical to the economy, but they do not organize themselves. We should all be watching this case to make sure our markets are set up for success — for investors and everyone else.
Mr. Alexander is the CEO of The Shareholder Commons, which is assisting the shareholder in the lawsuit.
