The most famous case in American corporate law, decided in the Supreme Court of Michigan in 1919. It posed a short but complicated question: what is a corporation supposed to do, and who gets to decide its fate? Is it really all about maximizing shareholder value?
Facts of the case
Henry Ford started the Ford Motor Company in 1903. By 1916, the company was worth $130 million and was paying regular dividends of over $1 million per year. And it was growing exponentially. Between 1911 and 1915, it paid out a total of $41 million in "special dividends" to its shareholders, on top of the regular dividends. In today's money, that's roughly $800 million; not a bad return over four years.
Ford himself owned over half of the company's stock. This meant that he controlled the company more or less single-handedly. And, as many history students will know, Ford wasn't a particularly profit-driven businessman; he was expansionist. He would rather sell more cars than sell more expensive cars, even if more expensive cars would be more profitable. He believed that profits weren't everything—that they were incidental to core goals of employing people and making cars.
To this end, in 1916, Ford decided that the company would not pay another special dividend. Instead, it would reinvest its profits. Ford wanted to double the size of the factory in Highland Park, purchase iron ore mines in northern Michigan, and build a new smelting plant in River Rouge. He planned to cut the prices of Ford cars to increase sales and keep the expanded assembly lines busy.
John F. Dodge and Horace E. Dodge together owned around a quarter of the company, making them the next-biggest shareholders. They were enraged by Ford's plans. For one thing, their investment totaled over $50 million, and if they didn't get their special dividends, their return would go down to nothing. There was also a vested interest at work. At the time, Ford was only assembling cars: the parts came from a number of outside vendors, one of which was Dodge—the brothers' own company. Dodge was also starting to build cars at the time. It all added up to a huge threat to the brothers' livelihood.
So the Dodges told Ford they wanted special dividends of no less than half of the capital surplus. Ford responded that the matter would be considered at the next board meeting. Since Ford controlled the board, this was a polite way of telling the Dodge brothers to get stuffed. They then did what any good American would do: they sued Ford Motor Company, Henry Ford, and the company's other four directors (Edsel Ford, Horace H. Rackham, F. L. Klingensmith, and James Couzens), seeking to enjoin the new construction projects and impose a special dividend of no less than 75% of the corporation's surplus.
Among their allegations were the following:
(27) In the face of the increased labor and material cost and the uncertain conditions that will prevail in the business world at the termination of the present world war, the policy of said Henry Ford, in continuing the expansion of the business of said corporation, is reckless in the extreme and seriously jeopardizes the interest of your orators as stockholders of said corporation.
(28) That there are many other corporations engaged in the business of manufacturing cars in competition with the only car manufactured by the Ford Motor Company, to-wit, the class recognized in the trade as 'low priced cars'; that the annual production of such other companies of such class of cars runs into the hundreds of thousands of cars per annum. That if the said Henry Ford is permitted to continue the policy that he has inaugurated and announced he is determined to carry out, of increasing production, reducing the price of cars, and increasing the capital investments in the conduct of such business by withholding the dividends from stockholders to which they are entitled, the necessary result will be the destruction of competition on the sale of the class of cars manufactured by such corporation and the creation of a complete monopoly in the manufacture and sale of such cars in violation of the State, Federal and common law.
(31) That the operations of said corporation should by the injunction of this honorable court, be limited at least to the conduct of the company's business within the limits of its present capital investment, not including its cash accumulations, and your orators' interests as such stockholders should not be put in jeopardy by the reckless ventures proposed to be entered upon in connection with the carrying out of the policy of expansion of the said Henry Ford as above herein outlined.
Ford's response in his individual capacity said, in part:
(That it) has been the practice of the Ford Motor Company for the past eight or ten years to cut the price of the car annually and to increase the output. That such policy has been productive of great prosperity to the company and to its stockholders. That what was done in that regard on the first of August, 1916, was strictly in pursuance of the regular policy of the company. That this policy of cutting the price was not carried out on the first of August, 1915, because in the counsels of the company, among its active managers it was, after full discussion, decided that the proposed expansion and buildings were necessary to the continued success of the company and that it would be wiser and better not to cut the price during the fiscal year ending July 31, 1916, in order that a considerable additional fund might be accumulated for the very purpose of building the extensions and making the improvements that are now being complained of by the plaintiffs. This policy so adopted for the fiscal year ending July 31, 1916, was thoroughly understood by all the directors and active members of the management and as this defendant is informed and believes by all of the stockholders, including the plaintiffs. Original price of the touring car which is now sold at three hundred and sixty dollars was upwards of nine hundred dollars, being substantially the same car although it has been greatly improved in many respects since the time when it was sold at nine hundred dollars and upwards. The cuts in the price have been made substantially every year except for the fiscal year ending July 31, 1916. This defendant has every reason to believe that the action of the board of directors in reducing the price for the current year was very wise and this defendant denies that it was adopted for any reason except the permanent good of the company.
...This defendant shows that the expenditures of the Ford Motor Company from day to day are very great and its requirements of cash are enormous. He shows that if, by any chance, there should be a sudden falling off of business or collapse of business that it would require great sums of money to carry on the business of the company, and his idea is to be well fortified against emergencies. This defendant is opposed to any policy which would necessitate the discharge of large numbers of employees in case there should be a sudden depression of business if there be any way to avoid it, and this defendant believes that the latter methods and policies ultimately redound to the best financial interests of the company and its stockholders. This defendant is not in favor of paying out in dividends the surplus of the company to the danger point or any point where it could be regarded as risky in the least degree. This defendant further shows that he is not in favor of keeping up the price of the car to the highest possible point that the public will apparently stand for the time being, but he is in favor of the policy of reducing the price of the car from time to time as the safety and welfare of the company and stockholders will dictate, since he believes such to be a better, permanent policy for the company. Such always has been the policy adopted in the past and he believes that such has been one of the causes of the unexampled success of the company.
At the next board meeting, the construction of the River Rouge plant was approved, as well as plans for new offices and showroom space in Manhattan. However, in December of 1916, a three-judge panel granted a preliminary injunction against Ford to halt its investment projects, stating that the projects constituted an "abuse of discretion" by the directors.
The trial, in the Wayne County Court, lasted from May to December of 1917. Henry Ford testified that he intended to continue his low-profit strategy "indefinitely" into the future. He told the Dodges' lawyers that he considered Ford's profits to be "awful profits," and that moneymaking was incidental to his real business. When questioned about his strategy of keeping prices low and wages high, he replied: "If you give all that, the money will fall into your hands. You can't get out of it."
Ford lost. The county court ordered the company to pay half of its surplus in a special dividend. It enjoined Ford from building the River Rouge plant—indeed, from entering the ironmaking business at all. And it placed a ceiling on the company's capital assets, keeping the company from expanding at all. (This was something of a technical issue. At the time, Michigan corporations could not have a capital value of over $25 million. Ford Motor had about $60 million paid in by shareholders, but the combined par value of its stock was only $2 million. The Dodges argued, successfully, that the company had exceeded the bounds of the statute by accepting such huge investments, even though it was the brothers themselves who provided part of that investment.)
Understandably, Ford didn't want to take this sitting down, so he took the case to the Supreme Court of Michigan. Their opinion, sans dissent, said:
A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes.
There is committed to the discretion of directors, a discretion to be exercised in good faith, the infinite details of business, including the wages which shall be paid to employees, the number of hours they shall work, the conditions under which labor shall be carried on, and the prices for which products shall be offered to the public. It is said by appellants that the motives of the board members are not material and will not be inquired into by the court so long as their acts are within their lawful powers. As we have pointed out, and the proposition does not require argument to sustain it, it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others, and no one will contend that if the avowed purpose of the defendant directors was to sacrifice the interests of shareholders it would not be the duty of the courts to interfere.
Pretty selfish, huh? But the court went on to say:
We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. In view of the fact that the selling price of products may be increased at any time, the ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture. The experience of the Ford Motor Company is evidence of capable management of its affairs. It may be noticed, incidentally, that it took from the public the money required for the execution of its plan and that the very considerable salaries paid to Mr. Ford and to certain executive officers and employees were not diminished. We are not satisfied that the alleged motives of the directors, in so far as they are reflected in the conduct of the business, menace the interests of shareholders. It is enough to say, perhaps, that the court of equity is at all times open to complaining shareholders having a just grievance.
And so the court unanimously overturned the injunction, allowing Ford to proceed with its expansion plans.
The dividends, however, were a trickier matter. Five of the eight justices decided that it was "arbitrary" for Ford to hold back extra dividends when the company was expected to have $30 million in leftover profits after accounting for its expansion plans.
Defendants say, and it is true, that a considerable cash balance must be at all times carried by such a concern. But, as has been stated, there was a large daily, weekly, monthly, receipt of cash. The output was practically continuous and was continuously, and within a few days, turned into cash. Moreover, the contemplated expenditures were not to be immediately made. The large sum appropriated for the smelter plant was payable over a considerable period of time. So that, without going further, it would appear that, accepting and approving the plan of the directors, it was their duty to distribute on or near the first of August, 1916, a very large sum of money to stockholders.
The court therefore upheld the county court's decision to award a $19 million special dividend. The other three justices disagreed without comment.
Although Dodge was chiefly a case about dividends, it is now remembered as the definition of the corporation's role in society. There has always been a difficult balance in the law between the rights of shareholders and the rights of managers and directors. When a corporation is "for profit," profit doesn't need to be its first concern. At the same time, the corporation cannot completely disregard the rights of its shareholders in favor of some other policy.
In big corporations today, the balance isn't hard to resolve. If shareholders don't like what a company is doing, they call up their broker and sell their stock. By the end of the day, they've recovered their money and they can invest it elsewhere. But when a person has a share that's too large to easily sell, or owns part of a company that isn't publicly traded, the balance becomes more difficult. And we have common law rules, like the business judgment rule, to indicate whose interests should prevail when the two sides disagree.
Ford Motor Company, for its part, did pretty damn well in the years afterwards.
- Dodge v. Ford Motor Co., 170 N.W. 668 (1919)
- Bauman et al., Corporations: Law and Policy (5th ed., West 2003)