Учебный год 22-23 / Critical Company Law
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134 Critical company law
large shareholders would not allow their stock to be dispersed if this would be the outcome. The only conditions where large shareholders would divest themselves of stock is when they can be sure that such an action would not harm their investments. According to Roe, the conditions for this are political. What does the government believe to be the right orientation for company managers? What does the judiciary believe to be the right focus of a director’s attention? In other words, share ownership is more dispersed in England (as well as America) because the political conditions were and are so conducive to shareholders’ interest. And the judiciary, through doctrines such as ultra vires and through its slant on a director’s fiduciary duties, displays a much greater commitment to shareholders’ interests than to other people connected to the company such as employees, consumers and even creditors.
Paddy Ireland
In ‘The myth of shareholder ownership’ Ireland maintains that the root cause or justification for distinguishing a shareholder who makes a money contribution from a creditor who does the same is that the shareholder is said to have risked his capital whereas the creditor has not.85 A shareholder has invested his capital in the corporation whereas the creditor has merely lent his money for a limited period of time. The importance of risk in distinguishing the two has long historic origins, which Ireland traces back to the moral abhorrence and legal prohibitions against money lending, or usury. Usury was distinguishable from other forms of money investment because the usurer parted with ownership of his property for a period of time and did not risk that property during the period it was lent. Ireland notes that the moral aversion to usury is clearly articulated in the classics where Aristotle railed against the unnatural arts of the usurer. According to Aristotle, money facilitated human happiness because it helped cohere society by creating a symbolic value which made exchange a simpler process than bartering commodities. Usury subverted the fairness of exchange because it gave something that was a symbol of value, a value in itself. So for example, while one coin might represent the value of a chicken, if a usurer lent that coin for one year, it might be worth the value of two chickens. While a chicken might reproduce itself in a year, it was unnatural that a symbol of value, money, might do the same. Money was barren, the chicken was not, therefore the activities of the usurer subverted the nature of money and in so doing subverted the harmony of society.
Ireland argues that usury was condemned in Ancient Greece and, filtering through Christian doctrines, condemned in Britain for many centuries. For the most part usury was defined as charging more than 5 per cent interest on
85 Ireland, P, ‘The myth of shareholder ownership’ (2001) MLR.
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loans and the penalties were harsh. Although during the Elizabethan period this was increased to 10 per cent, which indicated the basic problem of usury laws for British capitalism. However, anti-usury laws were firmly entrenched in British society both through the Christian church and its accompanying anti-Semitism – they were part of the moral fabric of British society. On the other hand capitalism required capital and that meant extensive borrowing, but the limits on interest set by the usury laws made lending unattractive. According to Ireland, the judiciary responded to this conundrum in an interesting and innovative way. Throughout the eighteenth and part of the nineteenth centuries, British capitalism was rapidly developing. The usury laws retained a general application but certain financial institutions were explicitly exempted from its provisions.86 Individuals, however, were not exempted and could not on the face of it invest in business for a good rate of return. The partnership was the dominant vehicle for business during this period and investment was crucial for business development. Thus, following the decision in Grace v Smith 87 the judiciary adopted a practice of construing investors in partnerships as partners, even though they were not declared as such and played no part in the business. By construing them thus investors could enjoy high rates of return without incurring the penalties of the usury laws. Investing capital was su cient to qualify as ‘business in common with a view of profit’, the later statutory definition of a partnership, which retained enjoying the profit as prima facie evidence of partnership.88 Partners, who merely invested in the partnership, were morally exempted from the usury law because unlike the usurer they were risking their capital. Partners owned and controlled the business, they were all equally entitled to the firm’s profits, and personally responsible for the firm’s debts.
Inevitably, the judiciary’s approach to lending in a partnership resulted in cases when an investor/partner faced such a huge personal liability for the firm’s debts that he sought to be reconstrued as a creditor, one to whom debts were owed.89 This situation and the Hobson’s choice it presented were witnessed in a 1787 letter where a partner in the Cornish Metal Company was advised thus: ‘I told him the point of law was clear and that he was a partner in a trading company and liable to pay all deficiencies, and that if he was not a partner he was liable under the statute of usury to forfeit three times his capital.’90
86 Building societies, for example, were specifically exempted under the Benefit Building Societies Act 1836.
87(1775).
88Partnership Act 1890. Section 2(3)(d) provides that a loan paid in line with profit and accompanies with a loan agreement will not give rise to the assumption of partnership, but this was passed after the Usury law was repealed.
89Re Megavand (1887).
90DuBois, AB, The English Business Company after the Bubble Act, 1938, New York: The Commonwealth Fund, p 257.
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Ireland maintains that when early companies evolved from the roots of partnership law, the same values which construed an investor in a partnership as a partner, likewise served to construe an investor in a company as an owner. In early companies formed under the Companies Act 1844, this was more understandable as the few hundred companies formed under this Act did not provide for members’ limited liability and members retained some proprietary connection to the company assets. In other words they were not dissimilar to partnerships. However, as company law responded to the changing nature of the company and its shareholders, it developed as a distinct area of law with distinct principles. This, perhaps, should have been a time when the notion of shareholder as owner/partner was abandoned, but it was not. It was this failure to fully shake o the values of partnership law (which had allowed pure investors to be considered as partners to avoid the usury laws), which Ireland asserts is the reason why shareholders today retain their status as owners. Thus, notwithstanding the polar di erences between a general partner and a modern shareholder, the latter continue to be regarded as the raison d’être of corporate governance procedures. Ireland’s interesting theory provides a fascinating account of the role of law, but it doesn’t entirely explain why the fiction of shareholder ownership has not been revised to reflect the economic reality of most shareholders. Why has it been so resilient? Or indeed, does it matter that it results from a historical misconception if the result of maintaining the fiction of shareholder ownership is in contractarian terms, economically e cient. The following piece provides some answers to this by drawing out the importance of ideology in retaining the shareholder as owner.
Daniel Greenwood
Greenwood opens his 2006 article on American corporate law by asserting that shareholders are not owners and are not deserving of the fruits of corporate ownership, namely corporate profits: ‘Everybody knows that shareholders receive dividends because they are entitled to the residual returns of a public corporation. Everyone is wrong.’91 He argues that no theory that justi- fies shareholders’ claims stands up to scrutiny at either the level of law or of economics. Instead, Greenwood argues that shareholder primacy is largely the result of CEOs’ successful pursuit of their self-interest, which is much better served through association with shareholders than by association with employees. An ideology which supports shareholder primacy, he maintains, is one that supports managerial goals. Thus he is diametrically opposed to both the agency costs analysis and Berle and Means’ thesis. Furthermore, the victory of top managers and wealthy shareholders has been the elevation of shareholder interests at the level of scholarship, law and government policy.
91 Greenwood, DJ, ‘The dividend problem’, ExpressO Preprint Series, 2006, Paper 1185, p 1.
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He argues that across the spectrum of corporate governance theories and corporate law scholarship there is a startling accordance with the notion that shareholders are entitled to the corporation’s profit which at di erent levels of coherence is justified as the entitlement of ownership. Those who say explicitly that shareholders are the owners justify shareholders’ entitlement to profits as a logical attribute of ownership while the nexus of contract theorists who theoretically consider the notion of ownership as irrelevant argue that the entitlement to profit arises from the bargain made by shareholders. For the latter, shareholders cannot really be owners because the corporation only exists as a fiction. However, they conversely maintain that the corporation (despite being a fiction) should be run in shareholders’ interests – a conclusion which, Greenwood maintains, cannot be justified by the notion of market bargains.
Greenwood argues that whether one considers economic analysis or whether one considers black letter doctrine, there is no justification for shareholders’ claims to ‘the residual returns of a public corporation’.92 Under the former analysis, he argues, shareholders who are ‘purely fungible providers of a purely fungible commodity’ have no intrinsic claim to profit in a capitalist system.93 In a market, each player is rewarded according to the market value of his contribution. A purely financial contribution in a capital-saturated market should not provide such high returns as those enjoyed by shareholders. ‘Accordingly, market-based analyses of the firm should conclude that shareholder returns result from a market distortion.’94
Furthermore, he argues, black letter legal doctrine makes clear that shareholders are not ‘owners’ or ‘principals’ and have no legal claim on corporate assets, even as ‘trust beneficiaries’.95 And, although the ownership and control debate is predicated on the corporation as property which is owned by shareholders, ‘the legal reality is that shareholders have political voting rights in an organisation, not rights of ownership’.96 He concludes that the claims of shareholders as owners result from ideology promulgated by CEOs to justify shifting profit away ‘from employees to the CEO/shareholder alliance’. An alliance, he argues, which is much more pertinent to the self-interest of both groups than the purported alliance between managers and employees previously noted in corporate governance debates: ‘those conflicts are dwarfed by the common interests of the two groups’.97
Greenwood argues that the origins of the problem lie in the historical reconceptualisation of the corporation which has erroneously allowed private
92Ibid,
93Ibid, p 2.
94Ibid.
95Ibid.
96Ibid.
97Ibid.
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interests to determine social production. Early corporations were understood to deserve privileges and protection from the state because they were engaging in public works which the state would otherwise have undertaken. However, later, when corporations were engaged in private industry they were reconceptualised as private individuals, citizens that were understood to need protection from state interference. So, in 1886 the Supreme Court said that corporations could enjoy the same rights as natural people in respect of the right to due process under the equal protection clause of the Fourteenth Amendment.98 Private owners, not the state, would prevail upon the governance of corporations.
The corporation was reconceptualised as something which promoted private interests and those private interests were articulated in law to be those of shareholders. And, in the famous pronouncement on whose interest the corporation should be run the court stated that ‘a business corporation is organised and carried on primarily for the profit of the shareholders. The powers of the directors are to be employed to that end. The discretion of directors . . .
does not extend to a change in the end itself.’99
Greenwood maintains that the CEO and shareholder alliance is evidenced by the managerial decisions actually made, which, he argues, are far more pro-shareholder than the law requires. Greenwood asserts that notwithstanding the pronouncements in Dodge, both corporate law generally and the doctrine of separate corporate personality specifically give the directors huge discretion in the performance of their duties. Dividend law, for example, does not give shareholders a right to the company’s profits. In law, all surplus is owned by the corporation unless it declares a dividend.100
Furthermore, he argues the business judgment rule even after Smith v Gorkom 101 prevails and the courts only really interfere in clear incidences of self-dealing or insider dealing. Indeed, he argues, the courts have been traditionally lax in respect of directors’ activities so that even in the highly unionised post-war period the courts didn’t interfere if the corporation was run in the interests of ‘unionised employees and middle-level management’.102 Directors are largely left to their own devices and even when deciding their own level of remuneration, ‘no American court has yet set any limit to the amount a public corporation’s fully informed board may publicly pay its CEO. Even if the board had no evidence that services were valuable or priced correctly.’103
98Ibid, Santa Clara v Southern Pacific RR, 118 US 394.
99Ibid, Utah Dodge v Ford Motor Co (1919) 170 NW 669 Mich.
100In most American states the RMBCA 6.40(7) – where declared dividends are treated as an unsecured debt in line with other unsecured debt – applies. In England ss 263 and 264 of the 1985 Act applied.
101Discussed in Chapter 1.
102Ibid, p 8.
103Ibid, p 9, citing Brehm v Eisner (2000) 746 A2d 244 (Del).
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Shareholder primacy is particularly emphasised by law and economics scholars. But as Greenwood points out, it is particularly di cult to justify shareholder returns in the nexus of contract theories. A shareholder’s claim must be based on the negotiated agreement (albeit not as an ordinary contract) but shareholders possess neither a contractual claim on profits nor a claim based on market value. Shareholders, he concludes, are merely a ‘factor of production’ who have a product (capital) which firms buy with stock (or rent with debentures). In a negotiated agreement they would get the market price for this product but not a claim to corporate profits. Thus ‘it is virtually inconceivable that shareholders would be able to win a share of the rents in a competitive market. Shareholder returns, therefore, must be the result of a non-competitive process that cannot be legitimated by market claims.’104 Thus by taking on the contractarian claims that the corporate players receive that which they have bargained for, he demonstrates that such a bargain is so grossly favourable to shareholders that no market could sustain it and their claims could only be the result of other machinations.
ECONOMIC OWNERSHIP AND THE REFUTATION OF THE SEPARATION THESIS
There is a growing amount of scholarship which indicates that there has been no separation of control from ownership, and at least for major shareholders, control of the corporation has remained firmly held. Economic ownership within this perspective refers to the kind of ownership possessed by the wealthiest investors who continue to exercise control over the corporation and may be distinguished from other shareholders who are the separate, passive recipients of dividends of Berle and Means’ thesis.
An article by Michel De Vroey in 1976 showed that the dispersed ownership patterns in England and America did not result in a loss of shareholder control over the corporation. Indeed, conversely, his study concluded that share dispersal among the many has tended to enhance rather than undermine their power resulting in the increasing tendency for economic power in the corporation to be held by an increasingly smaller elite.105 According to De Vroey, the joint stock company generated a number of phenomena. These include the distinction and functional separation of ownership from the managing role, the dispersal of share ownership among the public and, lastly (the part that Berle and Means minimise), the concentration of power in the hands of large shareholders.
Utilising C Bettleheim’s models of ownership, De Vroey demonstrates that
104Ibid, p 9.
105De Vroey, M, ‘The separation of ownership and control in large corporations’ (1975) Review of Radical Political Economics Vol 7, No 2, p 1.
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within a corporation there are three forms of ownership: possession, economic ownership and legal ownership.106 The first concept refers to the ability to put the company to work and therefore describes the ‘ownership’ of the manager. The second concept describes ownership that possesses the power to assign or dispose of the assets in question and the third concept describes the ownership rights of the title-holder of a share. The latter two concepts are connected because they both involve the right to vote, a right that is part of legal ownership and an entitlement to dividend. They di er, however, because in order to have e ective voting power it is necessary for the shareholder to have a su cient number of shares to pass the desired resolutions. Therefore, an economic owner will possess legal ownership but a legal owner may not be an economic owner.
The economic owner will hold the amount of stock required to control the outcome of major resolutions, including those that may dispose of directors. Thus although the manager has ‘possession’ of the corporation, managing the day-to-day running of the business, he does so with an eye on the interests of the economic owners. In De Vroey’s view, the emergence of the nonowning manager merely represents a stage of capitalist development when the rich no longer justify their claim to profits by dint of their entrepreneurial or managerial input into production. Their claim is justified by ownership of shares alone while the managerial tasks are undertaken by skilled employees. The ‘why have a dog and bark yourself ?’ approach.
Furthermore, and indeed crucially, as legal ownership spreads a large minority of shareholders require a smaller percentage of the total stock in order to exercise economic ownership because other stockholders are too dispersed to organise e ectively.107 So rather than share dispersal inhibiting the control of large investors it enhances control as they may now invest in and control many more companies. First because managers/employees perform the routine tasks of managing the business and second because the large investor may retain economic control with a smaller stake in any given business, liberating capital to be invested elsewhere. In De Vroey’s words, ‘the corporate system allows an increase of the power sphere of big capitalists who now control larger economic units with a reduced proportion of legal ownership’.108 Or, in the somewhat archaic language of R Hilferding cited by De Vroey:
With the extension of the shares system, capitalist ownership is increasingly transformed into a restricted ownership, giving nominal rights to the capitalist without allowing possibility to exert any real influence of
106Bettleheim, C, Economic Calculation and Forms of Property, 1976, Routledge & Kegan Paul.
107Op. cit., De Vroey.
108Ibid, p 3.
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the production process. The ownership of a great number of capitalists is constantly being restricted and their unlimited disposition of the productive process is suppressed. But, on the other hand, the circle of masters of production becomes more restricted. Capitalists form a society in the governing of which most of them have no voice. The e ective disposition of the means of production is in the hands of the people who have only partially contributed to it.109
In this way De Vroey radically departs from the managerialist school of thought originating with Berle and Means by essentially denying their final stage of evolution, managerial control. Indeed, De Vroey’s analysis (and Hilferding’s, although he predated the managerialists) is posited on the continuation of minority control in large corporations. Hilferding’s assertion that production is controlled by ‘people who have only partially contributed to it’ describes the ownership of Rockefeller and the Van Swering brothers noted by Berle and Means. Accordingly, his perspective provides a mechanism for re-interpreting statistics which, on the face of it, chime with the separation thesis. In a set of statistics derived from managerialists Smith and Franklin, and cited by De Vroey, there appears at first blush to be clear evidence of share dispersal and a corresponding diminishing of the wealthiest investors’ ownership in and thus control over corporations. Here we can see that while in 1953, the wealthiest 0.5 per cent of society held 77 per cent of all stock, by 1969 this had dropped to 44 per cent of all stock. Likewise, in 1953 the wealthiest 1 per cent owned 86.3 per cent of all stock but by 1969 this had dropped to 50.8 per cent.110 These decreases were steady in the intervening years. However, when one considers these statistics in the context of a massive increase in the number of shares and shareholders the statistics paint a di erent picture. In De Vroey’s words, ‘If the overall dispersion increases, which seems to be the case (the New York Stock Exchange figures show an increase of nearly 500 per cent in the number of shareholders between 1952 and 1970) the limit of economic ownership in terms of percentage of total stock has consequently lowered.’111 Furthermore he notes that it is in the interests of large investors to keep ‘participation in ownership close to this limit so as to function using other people’s funds and to be able to take part more freely in new ventures’.112
This perspective may aid a new interpretation of comparative statistics on share dispersal. For example, a study which analysed the 20 largest
109Hilferding, R, Le Capital Financier, 1970, Paris: Editions de Minuit, p 33, quoted by De Vroey, p 3.
110Op. cit., De Vroey, p 5.
111Ibid.
112Ibid.
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companies in each country concluded that English and American companies have a high incidence of dispersed ownership while in contrast continental Europe has more closely held firms.113 Here, the authors set the point at which a firm could be described as di usely owned as when there is no one owner who owns more than 20 per cent of the stock. Accordingly all such companies in England could be described as di usely owned as were 80 per cent of companies in America. In contrast, in Belgium and Austria the figure was 5 per cent, in Italy 20 per cent, in Norway and Sweden 25 per cent, in the Netherlands 30 per cent, in Germany 50 per cent and in France 60 per cent.114
However, this high level of dispersal in English and American companies does not necessarily denote a low level of shareholder control. As De Vroey maintains, shareholder control may be exercised through economic ownership, made possible by the high level of dispersal of all shares not held by an economic owner. In this way, under 20 per cent of the shares may be more than enough to exercise economic control where shares are widely dispersed. This chimes with Roe’s argument that in Europe large, often family, shareholdings maintain a majority stake in the business because this is the only mechanism by which they may maintain control. It would be curious to imagine that the wealthy in England and America are not likewise concerned to maintain control, preferring instead to leave their wealth to chance. More likely is that large investors in Anglo-American corporations have proportionally smaller stakes in the business than their European counterparts because share dispersal allows them to maintain control through a smaller stake. This allows them to diversify and to extend their influence in a way that is not available to European investors. This possibly is borne out by other work on control patterns in Anglo-American corporations. For example, DL McConaughty states that while there has been a tendency for share dispersal in over 20 per cent of America’s largest corporations, the founding family, not simply an outside economic owner, ‘retains significant influence’.115 Furthermore, research from Anderson, Mansi and Reeb showed that 20 per cent of large American publicly traded firms have families with shareholdings of 20 per cent or more.116 In 1998, 34 per cent of Standard and Poor’s 500 Corporations had founder family equity of
113Op. cit., La Porta.
114Ibid, figures. These figures may be misleading in their underestimation of closely held businesses in Europe. For example, these figures suggest a large percentage of widely held companies in France whereas that figure would drop to 30 per cent were the cut-o point to be set at 10 per cent. Furthermore, Italy has many small family-owned firms and few public companies and these statistics only look at public companies.
115McConaughty, DL, et al, ‘Founding family controlled firms: e ciency and value’ (1998) 7 Rev of Financial Economics 1, p 8.
116‘Founding family ownership and the agency cost of debts’ (2003) J Fin Econ, p 269.
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18 per cent.117 Even in the absence of a family holding shareholders seem to operate as a group when their interests are threatened. In 1993, the shareholders of IBM, Westinghouse and Kodak emerged from their supposed passivity to dismiss their poorly performing directors. And in England, ‘performance pay became the rallying call for British investors’.118
There is also a significant body of literature which charts the rise of institutional shareholders and which indicates that dispersed share ownership has become reunited under the umbrella of such institutions which can e ectively represent shareholders’ interests. In America by 1994, institutions owned 40 per cent of all shares, although as The Economist noted, as they came late to the market they were obliged to buy shares in small and medium-sized companies and adopted a ‘hands o ’ strategy.119 In contrast institutional shareholding in Britain has a much longer tradition so that some institutions have a very significant shareholding in the business of around 5 per cent.120 Additionally, as a group, institutional shareholders make up the vast majority of shareholders in Britain. Statistics cited by Ronald Gilson show that in 2004, 81 per cent of shares were held by institutional investors while only 8 per cent were owned by families.121 Other statistics are lower, showing a steady rise from 29 per cent in 1963 to a high in 1998 of 70 per cent, dropping to 48 per cent by 2004.122 Notwithstanding this di erence, institutional shareholders, as a whole, retain a significant proportion of company shares.
However, the rise of the institutional shareholder is only really significant as a vehicle to promote shareholders’ interests if they act in unity, and the evidence on this is mixed. Lee Roach argues that despite the factors which would make institutional investors well suited for interventionist activities (including the fact most are based in the city, they operate in a lenient legal environment, and it is relatively cheap to communicate through their various trade associations), institutional investors have taken a relatively passive approach to shareholding. This he attributes to a number of factors, or barriers to acting as a coalition. First the costs of acting as a coalition are high, although communication is cheap, including legal expenses and the cost of information. The ‘free rider’ problem, where other shareholders benefit from the activity and expenditure of the involved shareholder, is cited as a reason for institutional investors’ passivity. Furthermore, when undertaking action against the company’s management, institutional investors need to know the position of their portfolio companies. Loach argues that the monitoring of
117Ibid.
118The Economist, Survey, ‘Watching the boss’, 29 January 1994.
119Ibid, p 6.
120Ibid.
121Op. cit., Gilson.
122Roach, L, ‘CEOs, chairmen and fat cats: the institutions are watching you’ (2006) Company Lawyer 27, p 299.