The mainstream theory of corporate governance in the United States holds that the primary responsibility of the board of directors and management is to maximize the wealth of shareholders. This is the theory of shareholder primacy. If directors and officers stray from their duty, shareholders can constrain or remove them. An alternative theory is that directors and management should consider all stakeholders, including employees, customers, and communities. This theory offers limited guidance when decisions affect stakeholders differently, so it gives much more discretion to directors and officers than the shareholder primacy theory. As a result, the stakeholder theory enables insiders to pursue their own interests and find excuses for underperformance.

In the United States, the corporate law that applies to a firm is determined by the state in which it is incorporated. Delaware is the most popular state of incorporation for public firms, and its laws declare that boards of directors owe responsibility primarily to shareholders. Nevada is the second-most popular state for incorporation. Although Nevada law does not follow the theory of shareholder primacy, before 2017, its courts often followed Delaware court decisions, so shareholder primacy affected judicial decisions for Nevada-incorporated firms. In 2017, the Nevada legislature ended this practice by unanimously passing Senate Bill No. 203, which clarified that shareholder primacy does not apply in Nevada and that directors and officers are protected from shareholder litigation.

Our research examines the law’s effects on Nevada-incorporated firms and their shareholders, comparing their outcomes with other firms two years before and after its adoption. We limited our investigation to the two years after the adoption of the law to avoid the impact of the COVID-19 pandemic. Moreover, by comparing the same firms before and after the adoption of the law, our findings are not affected by changes in the composition of firms incorporated in Nevada or elsewhere.

The law had striking adverse effects on the quality of corporate governance: Firms adopted policies that made it more difficult for shareholders to influence management, more relatives of executives joined corporate boards, the proportion of independent directors fell, and director attendance dropped. While the law freed insiders to pursue stakeholder-friendly policies, firms’ environmental and social performance decreased significantly, suggesting that insiders did not pursue these policies. Furthermore, accounting issues increased: Firms’ auditors became more likely to have concerns, and firms were more likely to receive a letter from the Securities and Exchange Commission about problems with their reporting.

The law clearly hurt shareholders, but since insiders made no effort to offset the impact, they must have benefited from it. Indeed, CEOs experienced abnormal pay raises after the passage of the law. Furthermore, the sensitivity of their compensation to the performance of the firm decreased. Insiders also became less subject to monitoring. Institutional shareholders, such as mutual funds and pension funds, are often viewed as having a responsibility to monitor the governance of the firms in which they invest. When shareholder primacy weakens, institutional investors who hold a small portion of a firm’s stock may find it more difficult to influence corporate decisions. Accordingly, our findings reveal that these institutional investors reduced their ownership of Nevada-incorporated firms after the law passed.

Federal law enables shareholders to sue publicly traded corporations to prevent actions detrimental to shareholders. We would expect this approach to be used more if a firm’s corporate governance weakens. However, Nevada’s law weakened shareholders’ ability to use this approach, so the frequency of these lawsuits dropped after the adoption of the law.

Additionally, the law reduced the value of Nevada-incorporated firms. These firms experienced a significant negative abnormal return on the day the law became effective, and their stock performed poorly in the two years after the adoption of the law. A common measure of firms’ valuation (Tobin’s q) decreased for Nevada-incorporated firms compared with firms incorporated in other states. The reduction in the value of large firms was nearly twice that of small firms, consistent with research suggesting that shareholders of large firms more strongly oppose greater discretion for insiders. Firms’ cost of debt also increased after the adoption of the law. Thus, market mechanisms penalized firms for weakening shareholder primacy and investor rights.

Finally, our research examines the effects of the law on firms’ investments. Firms substantially increased acquisitions, especially diversifying acquisitions, and substantially decreased asset sales. Firms also diversified by increasing their number of product lines or service offerings. Moreover, firms significantly reduced capital expenditures, but research and development expenses increased by a similar amount. This finding might suggest that a decrease in shareholder primacy promotes innovation, but it is hard to reconcile such a conclusion with the decrease in firm values.

Firms’ investments also became less efficient. Though firms made more acquisitions, the market reacted more adversely to acquisition announcements, suggesting that these acquisitions were poor choices. Additionally, firms’ capital expenditures became less sensitive to their value, consistent with a decreased focus on maximizing shareholder wealth. Lastly, firms’ research and development expenses generated less revenue than they did before the adoption of the law.

In sum, our findings provide robust evidence that weakening shareholder primacy imposes real costs on firms. The results contribute to ongoing debates in corporate governance and legal scholarship over the proper objectives of corporations, highlighting that shareholder primacy is central to accountability, efficiency, and value creation. Reforms that diminish directors’ and officers’ fiduciary obligations to shareholders must therefore be carefully evaluated for potential unintended consequences. Although many scholars and practitioners advocate a stakeholder-oriented model of governance to help boards resist short-term pressures, our findings indicate that weakening shareholder primacy does not necessarily lead directors and officers to place greater weight on stakeholders or the firm’s long-term interests.

Note
This research brief is based on Benjamin Bennett et al., “What Are the Costs of Weakening Shareholder Primacy? Evidence from a US Quasi-Natural Experiment,” European Corporate Governance Institute Finance Working Paper no. 1064/2025, June 2025.