3.1.2.6 Reflecting on the shareholder—manager conflict

As the preceding discussion suggests, the shareholder-manager conflict is more acute in the U.S. than elsewhere. In two principal corporate law jurisdictions— France and the UK—shareholders seem clearly to have the upper hand in determining corporate policies. In France, concentrated ownership gives controlling shareholders the power to discipline managers without the need for elaborate proxy fights or corporate takeovers. Likewise, although ownership is more fragmented in the UK, cooperation among institutional investots assures that shareholder interests dominate in most public corporations.

Japan and Germany are more complex. Although ownership is concentrated in Japan, the implications of this are unclear because so much ownership takes the form of cross holdings and corporate coalitions. These forms of concentrated ownership imply managerial dominance over shareholders rather than vice versa. In Germany ownership is also concentrated, but the presence of labor directors deters shareholders from fully exerting their control rights.

By con trast, the shareholder-manager conflict remains active in the U.S., which may explain why many unique features of U.S. law seem to cut against effective shareholder governance. These features include costly proxy and securities law rules that burden shareholder collective action (although less so than in the past),

90 See infra 7.4 and 7.5. 91 See infra 7.2.3 and, e.g., Kahan and Rock, supra note 35.

comparatively cramped limitations on the proper subjects of shareholder action at general shareholders meetings, and (as we discuss in Chapter 7) broad managerial discretion to defend against hostile takeovers.92 There are, of course, two possible interpretations of these managerialist features of U.S. law. Some argue that they are necessary to equip managers to protect dispersed shareholders against opportunistic or coercive takeovers, while others claim that they serve managerial interests over those of shareholders by crippling the market for corporate control.

3.2 PROTECTING MINORITY SHAREHOLDERS

Although the corporate governance system is principally designed to effectuate the interests of the shareholder class, it can—and to some extent must—also address the other agency problems of the corporate form: the conflict between minority and majority shareholders and that between shareholders and non-shareholder constituencies. Moreover, to the extent that law adapts the instruments of corporate governance to mitigate either of these agency problems, it inevitably modifies the governance system in ways that reduce the power of the shareholder majority for the benefit of minority shareholder and non-shareholder constituencies.

3.2.1 The appointment rights strategy

Consider how appointment rights can be used to protect minority shareholders. In general there are two possibilities. One technique is to reserve seats on the board of directors for minority shareholders. A second technique is to limit the voting rights of large (and potentially controlling) shareholders.

Turning first to the board, it is clear why large-block minority shareholders might wish to have reserved seats. Board seats are valuable even if a minority shareholder acting alone cannot determine corporate policy. They provide access to information, a forum for articulating minority interests, an opportunity to pressure controlling shareholders, and perhaps a real chance to shape policy by forming coalitions with independent directors on the company's board.93 Moreover, there is a simple technique for assuring minority representation on the board: namely, a proportional or cumulative voting rule. Such a rule permits any shareholder with holdings exceeding a critical threshold to select one or more directors. The power of these minority directors can be further increased by assigning them certain committee roles or selective veto powers on the board.

91 See mfra 7X3.

93 A recent study that appears to confitrn the utility of minority board representation finds that minority investors arc more likely to have board representation in closed corporations that are managed by controlling shareholders than in those that are not. See Morten Bennedsen, Why do firms have boards? (Working Paper 2002, available at ssrn.com).

Thus, the newly adopted company law of the Russian Republic provides (or mandatory cumulative voting precisely in order to ensure board representation for large-block minority shareholders.9''

Despite the potential value of proportional voting as a device for protecting minority interests, however, none of the major jurisdictions mandate cumulative voting. Japan comes closest, with a default rule permitting any shareholder to demand cumulative voting—but almost all Japanese companies opt out of this rule in their charters.95 In the U.S., mandatory cumulative voting—which was once common96—survives today in only a couple of states.97 In most jurisdictions, straight voting is the default rule, and some jurisdictions, such as Getmany, ban proportional voting entirely.98

Where proportional voting seeks to ensure minority representation on the board, the second minority protection technique—limits on the aggregation of control rights or 'vote capping'—seeks to reduce representation for large shareholders. This device can take two forms. Strong vote capping reduces the voting rights of large shareholders below their proportionate economic ownership, and thus implicitly inflates the voting power of smaller shareholders: for example, a stipulation that no shareholder, regardless of the size of her holdings, may exercise more than 5% of the votes at the annual shareholders meeting. Most major jurisdictions apart from Japan and Germany permit voting caps of this sort, precisely because they promise to protect minority investors by diluting the power of large shareholders. Historically, voting caps were common among U.S. corporations in the first half of the nineteenth century,99 among German companies until recently,100 and among Dutch, French, and Swiss corporations today,

M Art. 66 Russian Joint-Stock Companies Law provides for mandatory cumulative voting if the number of shareholders exceeds 1,000. If the company has less than 1,000 the charter may provide for cumulative voting. In addition, the Russian statute requires disinterested directors to unanimously approve a variety of conflicted transactions, including those that implicate the interests of controlling shareholders. Art. 66 Russian Joint-Stock Companies Law (cumulative voting); Art. 81-S4 (interested transactions). Consequendy, 'disinterested* minority directors can block all transactions between the company and its controlling shareholders or managers.

« Art. 241, 256-3 Commercial Code.

96 Jeffrey N. Gordon, Institutions as Relational Investors: A New Look at Cumulative Voting, 94

COLUMBIA LAW REVIEW 124 (1994).

97 Including California, where it ts required for unlisted companies. Sec 5708(a) California

Corporation Code (mandatory cumulative voo'ng); 5301.5(a) (authorizing opt-out from cumulative

voting for listed companies).

98 See $101 Aktiengesetz (electing board members); Hftffet, supra note 42, N*8 $101 Aktiengesetz

(no proportional voting for shares that are freely transferable).

99 See Colleen A. Dunlavy, Corporate Governance m the Late 19th-century Europe and USA,

in Hopt et at., supra note 30, 5. (In the first half of the nineteenth century, voting caps and graduated

voting scales were common in the special charters granted by the state legislatures, and were later

imposed by general legislation on corporations in certain industries, such as banking, insurance, and

railroads.)

100 Voting caps were abolished for German open companies in 1998. See Art. 1 N°20 KonTraG; $134 Aktiengesetz (still permiting voting caps in non-listed corporations as well as non-voting 'preference' shares).

where they are said to play an important role in stabilizing controlling coalitions of shareholders and deterring hostile takeovers.101

By contrast, weak vote caps limit the extent to which controlling shareholders can exercise voting rights in excess of their economic stake in the firm. A familiar example is a one-share one-vote rule. A weak voting cap protects minority shareholders by assuring that a 'majority' shareholder cannot dominate a company without acquiring a commensurate claim on its cash flow rights. To date, Japan and Germany are the only major corporate jurisdictions to adopt a mandatory one-share, one-vote rule,102 although the merits of such a rule have been widely discussed in the EU. At present, French law allows corporations to award double voting rights (a mechanism that serves to deter takeovers and enhances the power of the state as shareholder) to long-term shareholders who have held their shares two years or more.103 The U.S. and UK do not regulate multiple voting rights at all, although exchange listing rules Iimii the ability of firms to recapitalize in order to dilute the voting rights of public shareholders.

What, then, are we to conclude about the use of the appointment strategy to protect minority shareholders? The main lesson is that most jurisdictions permit its use, but it is seldom employed as a mandatory protection. Mandatory cumulative voting is unpopular in all core jurisdictions because, we suspect, controlling shareholders fear both strategic behavior (hold-ups) by minority shareholders and higher decision-making costs arising from the risk of conflict and possible deadlock on the board.

Voting caps remain popular in many jurisdictions, but their popularity does not reflect a desire to protect minority shareholders. These caps have other functions as well, including deterring would-be acquirers and stabilizing relations among controlling shareholders (to the possible detriment of minority shareholders).10,1 We suspect that it is these functions rather than solicitude for minority shareholders that motivate most strong voting caps in Northern Europe and France. By contrast, the one-share, one-vote rule (now mandatory in Germany and Japan) does reflect the concerns of minority shareholders—and this is why, we suspect, that it remains the voting rule of choice for public companies in all major jurisdictions.

101 See Book 2, Art. 118 (4-5) Dutch Civil Code (authorizing charter provisions limiting number of

votes shareholders can exercise); Art. L. 225-125 Code de commerce (same for French corporations);

van Empel, supra note 11, 142 (showing the complementary role of other voting restrictions in Dutch

corporations); Peter Bockli, SCHWEIZER AjmENHECHTN"1411 (2nd ed. 1996} (use of voting caps by

Swiss corporations).

102 Art. 241 Japanese Commercial Code; 512 Aktiengesetz. German law was amended to bar

shatcs with multiple voting rights only recendy, in the 1998 KonTraG. Japanese law allows for non-

voting shares.

103 Art. L. 225-123 Code de commerce.

104 Sec also infra 7.2.2 (voting caps in takeover contexts).

3.2.2 The decision rights strategy

Minority shareholder interests also receive modest attention in the regulation of fundamental corporate transactions that require a shareholder vote. No jurisdiction, to our knowledge, requires the approval of minority shareholders for any corporate decision (although, as we detail in Chapter 5, majority-of-minority approval is strongly advisable for certain fundamental transactions in the U.S.).10J Minority interests are accorded a weaker form of decision rights, however, insofar as every major jurisdiction requires an effective supermajority vote to approve fundamental corporate decisions. As we discuss in Chapter 6, the range of significant decisions subject to shareholder voting varies, as does the precise voting threshold required for approval.106 However, in every jurisdiction this threshold exceeds 50% of the voting shares.107

Arguably, then, all major corporate law jurisdictions use the decision rights strategy to protect minority shareholders, but only at the margin—to give large minority shareholders (25% +) a blocking right and prevent the 'bare majority' from trumping the will of the 'near majority.' Presumably the costs of such protection are small, since a minority that owns 25% or more of a company is unlikely to harm it. But the benefits are limited as well, since supermajority requirements are unlikely to aid dispersed public shareholders except in unusual circumstances in which turnout is low and small numbers of minority shareholders can carry the day. In most circumstances, supermajority voting, like voting caps or proportional voting, is likely to matter chiefly in closely held companies and public companies with concentrated ownership.

3.2.3 The trusteeship strategy

As with the appointment and decision-rights strategics, the extent to which core corporate law jurisdictions employ the trusteeship strategy to protect minority

103 See infra 5.2.2. ,os See infra 6.2,2.

107 For example, German;- requires a 75% vote of shares represented at the meeting to approve fundamental transactions fot closed corporations. Sec 553 GmbH-Gesetz (charter amendment); 560 (dissolution); 550 Umwandlungsgesetz (merger). And Germany imposes the same requirement for open corporations. See $179 Aktiengesetz (charter amendment); $$162, 222 (increase or decrease authorized capital); $262 (dissolution); 565 Umwandlungsgesetz {merger); 5176 (sale of substantially all assets); and 5240 (change of legal form). Similarly, company law in the UK requires a vote of 75% of represented shares to pass 'extraordinary resolutions'; 5378(2) Companies Act. See Davies, supra note 14, 343-4. France requires a two-thirds majority of represented shares for charter amendments in open corporations (Art. L. 225-96 Code de commerce); for increasing capital by issuing new shares (Art. L, 225-129, with an exception for bonus shares). A 75% vote of shares represented at the meeting is required for converting an SA into an SARL (Art. L. 225-245 and 223-30). The last requirement is generally mandatory for closed corporations. See Art. L. 223-30 Code de commerce (charter amendement, increasing capital). Note, too, that the French securities authority encourages a shareholder vote on all significant corporate transactions. See Pierre-Henri Conac, LA REGULATION DES MARCHES BOURSIERS PAR LA COB ET LA SEC NM86-9 (2002). The Japanese

shareholders is limited. Directors can usefully represent the interests of the shareholder class to the extent that they are independent from the corporation's managers. But for these same directors to serve as trustees for minority shareholders, they must be independent not from managers but from the firm's controlling shareholders. The cost of such independence is clear. Directors who can successfully oppose the shareholder majority to aid the shareholder minority can also oppose the interests of the shareholder class to pursue their own interests.

There are several techniques by which directors can be given a measure of independence from controlling shareholders. One is to weaken the rights of . shareholders as a whole over the appointment of board members. In the extreme, shareholders can be stripped of the power to appoint directors on the model of the Dutch structure regime. In this case, directors come to resemble the trustees who manage charitable trusts and nonprofit corporations, and the company is only beneficially owned by its shareholders; A second and (much) weaker technique for cultivating the independence of a company's directors is to disrupt their financial ties to the company's controlling shareholder, as when parent companies are barred from appointing their employees to the boards of their partially held subsidiaries.108

Finally, a third—and even more modest—application of the trusteeship strategy is simply to require board approval for important company decisions. For example, the authority to initiate proposals to merge or dissolve the company can be vested exclusively in the board of directors, as it is under U.S. law. Alternatively, shareholders may be barred from directly making any decisions about corporate policy without the invitation of the board, as they are under German law.103 These measures constrain the shareholder majority from pursuing its policies through directors who, although appointed by the majority, nevertheless face a different set of responsibilities and potential liabilities by virtue of their roles and financial stakes. Even if they are appointed by a controlling shareholder, these directors are likely to be less interested and more solicitous of the interests of minority shareholders than the shareholder who selected them.

None of these legal techniques for protecting minority shareholders are aggressively developed by our major jurisdictions, however. In France, the UK, and Japan, controlling shareholders can easily dismiss directors and, if necessary,

Commercial Code requires an approving vote of two-thirds of voting shares with a quorum of half of all voting shares (the quorum may be reduced to one-third by charter) for the approval of mergers and other basic transactions. Art- 245 (sale of asset); Art, 343 (charter amendment); Art. 405 (dissolution); Art, 408 (merger). Finally, even Delaware implicitly mandates supermajority approval for mergers, asset sales, dissolutions, and charter amendments by requiring the approval of a majority of outstanding shares for these decisions. See J251 Delaware General Corporation Law (merger); $271 (sale of assets); $175 (dissolution); J242 (charter amendment).