5.1.2.3 Costs and benefits of board approval

Requiring—or encouraging—disinterested director approval of conflicted transactions has two virtues: compliance is (relatively) cheap for public companies, and it is unlikely to discourage efficient transactions (i.e., it leads to few 'false positives'). Indeed, board approval may actually encourage value-increasing transactions by insulating them from outside attack. The principal costs of a board approval requirement, however, are just the inverse of its virtues. Independent directors may not be the disinterested trustees that the law contemplates. For the most part, they are selected with the consent of top executive officers, principal shareholders, or both. If they are unlikely to intervene to derail efficient transactions, they may also be unlikely to object to inefficient ones. Thus, the incidence of 'false negatives'—inefficient transactions deemed to be efficient—is likely to be high. Insofar as board approval protects illicit deals against outside legal attack, it might even be value decreasing on balance. We do not believe that disinterested board approval is ineffective or counterproductive. Nevertheless, the fragility of the trusteeship strategy must always be kept in mind. For example, rampant self-dealing approved by a disinterested board of directors appears to have been an important contributor to the Enron debacle.48

5.1.3 Shareholder voting: The decision rights strategy

A principal alternative to disinterested board approval of conflicted transactions is shareholder approval. Shareholders, after all, are the parties who lose from

45 In particular, the stringent French approval procedure mainly aims at minimizing court review of

the validity of the transaction; see also Ferran, supra note 32, 163 regarding the due respect for

directors' business judgment shown by UK courts when applying the proper purpose' doctrine.

46 To be indemnified, directors of U.S. corporations must show that they were disinterested in the

transaction, acted in good faith, and reasonably believed the transaction to be in the corporation's

interest. See $8.51 RMBCA (indemnification); Robert W. Hamilton, THE LAWS OF CORPORATIONS

533 (5th ed. 2000) (insurance coverage). In Japan, directors are liable to the company under a strict

liability rule (Art. 266{l)(iv) Commercial Code).

47 For France, see Cozian et al., supra note 25, N°729, 1357; for Germany, see Abeltshauser,

supra note 4, 435-44; for the UK, see Brian R. Cheffins, COMPANY LAW, THEORY, STRUCTURE

AND OPERATION 316-317 (1997). For a mote general discussion of managerial liability, see infra

5.1.5.

48 See William C. Powers, Raymond S. Trough and Herbert S. Winokur, Report of Investigation by

the Special Investigative Committee of the Board of Directors of Enron Corp (February 1, 2001).

managerial opportunism. Outside directors are disinterested, while shareholders are affirmatively interested in preserving corporate value. It might therefore appear that the shareholders meeting should screen conflicted transactions. But, of course, this reasoning runs counter to the logic of the corporate form, which fosters delegation of decision making to the board in order to avoid the costs and the collective action problems associated with direct governance by shareholders. Unless shareholders have large holdings or are few in number, they are unlikely to have the interest or the expertise to screen interested managerial transactions. Moreover, attempting to educate dispersed shareholders about these transactions is sure to impose large costs on companies from the outset. Thus, we return to the familiar question, when do the efficiencies of short circuiting the corporate governance structure justify the costs?

France appears to be the most optimistic jurisdiction about the value of shareholder approval of conflicted managerial transactions, just as it is about the value of board approval. French law requires shareholder approval (as well as disinterested board approval) for all self-dealing transactions that are not taken in the ordinary course of business and reflect market conditions.''9 In addition, SA shareholders are entitled to a special report by the company's external auditor prior to their vote.50

By contrast, other jurisdictions are less insistent on shareholder approval. The UK, for example, has traditionally submitted conflicted transactions with directors to shareholder consent,51 but the rule is nowadays mandatory only for various significant transactions and, for listed companies, director remuneration.52 Consequently, as previously noted, UK companies generally substitute board approval for shareholder consent by charter provision when conflicted transactions are not significant. In Germany, Japan, and the U.S., traditional self-dealing transactions are not subject to any mandatory shareholder approval requirement. These jurisdictions require shareholder approval only for some forms of managerial compensation.53

49 Art. L. 223-19 (SARL) and Art. L. 225-40 (SA) Code de commerce. Shareholders with 5% of

legal capital may demand a court-supervised investigation (expertise de gestton) of failures to request

shareholder approval. See Art. L. 225-231 Code de commerce (applicable to SA and SARL).

50 Art. L. 225-40 Code de commerce.

51 See Aberdeen Ry v. Blaikte (1854) 1 MACQUEEN'S SCOTCH HOUSE OF LORDS 461 (generally

requiring shareholder approval).

52 See $$320-322 Companies Act (property transactions that exceed TJK£100,000, or 10% of the

company's net assets, subject to a minimum of UK£2,000), $319 (directors' contracts of employment

that last for more than 5 years), $312 (payments to directors for loss of office). Shareholders of all

listed companies must now approve a detailed director remuneration report (see Company Directors'

Performance and Compensation Act of 2002), while shareholders of companies listed on the London

Stock Exchange must also approve transactions above 5% of net assets (Listing Rules 11) and long-

term incentive schemes, including share option schemes (Listing Rules 13.13-13.17).

53 For Germany, see $113 Aktiengesetz (overall compensation of members of the management

board); for Japan, see Art. 269 and Art. 280-21 Commercial Code (overall compensation of directors

and stock option plans); for the U.S., see NYSE rules (stock option plans for top managers—but not on

plans that compensate a large number of employees).

Significantly, the timing of shareholder consent is not an important consideration among major jurisdictions. Shareholder approval appears to have the same legal effect, whether it precedes or follows a conflicted transaction. Indeed, shareholder ratification shifts the burden of proof in U.S. courts not only after self-dealing occurs, but also after it is discovered and challenged in court. Even France, a jurisdiction that particularly values shareholder consent, allows it to validate conflicted transactions ex post that required ex ante board authorization by law but were never actually submitted to the board.54 The UK goes further still by permitting post-transaction ratification by shareholders to protect directors against all liability claims.55

Unlike timing, however, materially inadequate disclosure or fraud invalidates shareholder consent in every jurisdiction, while the participation of conflicted shareholder/managers invalidates shareholder approval in some jurisdictions. At one extreme, French law categorically forbids conflicted managers from voting shares to approve their own transactions—and nullifies the outcome if they are found to have voted.56 At the other extreme, Japan permits conflicted managers to vote their shares almost like any other shareholders.57 Germany, most U.S. states, and the UK adopt a variety of intermediate positions that permit them to recognize the transactional or litigation effects of shareholder approval, unless it appears that shares voted by conflicted managers might have decided the outcome of the vote.38

5.1.4 Prohibiting conflicted transactions: The rules strategy

Sweeping prohibitions of conflicted managerial transactions were once cornmon in company law,59 but today they extend to only a handful of conflicted transactions.60 The only form of managerial self-dealing that is currently prohibited outright is a credit transaction between a company and one of its directors. Until recently, only France and the UK had maintained the rule.61 Company loans

54 See Art. L. 225-42 Code de commerce. Germany adopts a similar approach: see Abeltshauser, supra note 4, 359. 53 See Davies, supra note 1,437-9. 56 Art. L. 225-40 Code de commerce.

37 See, however, Art. 247(1 )(iii) Commercial Code (courts may nullify the outcome if interested voting results in a 'significantly unfair' resolution).

ss For Germany, see Marcus Lutter and Peter Hommelhoff, GMBH-GESETZ KOMMEMTAR, N°26 $47 (15th ed. 2000) (vote is forbidden and abuses make resolution voidable—applicable mainly to smaller, closely held corporations); Uwe Huffner, AKTIENGESETZ N°61 $243 (5th ed. 2002) (vote must be determinant—applicable mainly for larger, publicly held corporations); for the UK, see Davies, supra note 1, 439-40 (discussing shareholder ratification of breaches of duties by directors); for the U.S. see Clark, supra note 4,179.

19 See Grossfeld, supra note 42, 4-142 and supra 5.1.

60 Of course, conflicted transactions are regulated more extensively in certain specialized lines of business, such as banking, investment, and insurance.

€t For France, see Art. L. 223-21 and Art. L. 225-43 Code de commerce (loans, credit lines, guarantees to directors and general managers); for the UK, see $330 Companies Act (loans, guarantees, security). For Germany not following such an approach, see Karsten Schmidt, GESELLSCHAFTS-RECHT 895, 1147-8 (4th ed. 2002).

having allowed managers to leverage their ownership of company shares and led them to fraudulent practices once the stock market started to crash, the U.S. has dealt with the issue by prohibiting public companies to make personal loans to executives.62 While such reaction is understandable in the wake of post-Enron scandals, it remains unclear why loans to managers should be more suspect than other conflicted contracts (for example, consulting contracts).63 At best, the logic must be that these loans are especially unlikely to generate efficiencies to offset their risks: for example, informed directors might arguably be the least-cost lenders to their companies, but it is less plausible to suppose that companies are the best informed—and therefore least-cost lenders—to their directors. Still, circumstances are bound to arise in which the right to a company loan is a valued element of compensation for senior executives and directors alike.

Apart from bans on loans, prohibitions on managerial conflicts tend to focus on transactions between managers and third parties that are thought to jeopardize the financial value that the law assigns, implicitly or otherwise, to the company or its shareholders. One example is Germany's non-compete rule for top executives in closely held companies.64 (Curiously, the supervisory boards of German public companies may allow top managers to compete.65) Of course, barring executives from competing with their companies often makes sense; executives who serve two competing firms will inevitably favor one over the other in allocating time and sensitive information. Nevertheless, here too it is possible to imagine circumstances in which companies might prefer to allow their managers to compete. For example, smaller companies may need to permit competition to attract competent executives, and larger firms may benefit from the know-how gathered by their executives as directors of competitors in the same industry. For this reason, most jurisdictions deal with competition issues through standards rather than prohibitions.

Insider trading is a second—and much more important—class of conflicted managerial transactions that jurisdictions typically subject to per se restrictions. In brief, there are two sorts of rules against managerial insider trading: prophylactic restrictions on short-term trading and direct bans on trades informed by material inside information. The most important prophylactic rules are restrictions on short-term (less than six months) 'round trip' purchase-and-sale or sale-and-purchase transactions by 'statutory insiders' of U.S, and Japanese public companies, including directors and officers.66 These rules effectively prohibit short-term trading by allocating the resulting profits (or losses avoided) to the corporate treasury, on the theory that these gains are likely to reflect

62 $402 Sarbanes-Oxley Act.

" But see Enriques, supra note 3, 306-7 (commentators often argue that directorial loans are especially likely to divert value).

64 See Lutter and Hommelhoff, supra note 58, N°20 Anhang 56 GmbH-Gesetz. ** See 588 Aktiengesetz.

s* For the U.S., see 516(b) 1934 Securities Exchange Act; for Japan, sec Art. 164 Securities and Exchange Act.

corporate value gleaned through inside information. Major exchanges such as the London Stock Exchange adopt similar restrictions in their listing requirements for the same reason.67

Still more significant, all major jurisdictions now impose some kind of direct ban on insider trading on the basis of non-public information about the value of issuer securities. European countries and Japan primarily bar the officers and directors of listed companies from trading in their companies' securities prior to the disclosure of material non-public information.68 The U.S., by contrast, bars insider trading on undisclosed information in 'any security,' which includes not only the securities of public companies but also those of closely held companies.63 Similarly, although all jurisdictions mandate stiff civil (e.g., disgorgement of profits and treble damages) and criminal (e.g., prison sentences) sanctions for insider trading,70 only the U.S. mounts an enforcement effort large enough to apply these sanctions regularly while enforcement remains notoriously spotty in Europe and Japan.71

As an empirical matter, it is unclear how effective prohibitions against insider trading really are. Even in the face of tough U.S. enforcement, law seems to have had a limited effect on the overall volume and profitability of insider trading.72 Studies of insider trading outside the U.S. reach contradictory results. For example, one study, based on data from 38 jurisdictions, finds that the cost of equity decreases significantly after the first prosecution for insider trading

67 See the minimum requirements set by the UK Listing Authority's Model Code: a director must

not deal in securities of the listed company on considerations of a short term nature ($2).

68 For the EU, see Art. 2 Market Abuse Directive [2003] OJ L 96/16, whereas various EU Member

states have extended the scope of the insider trading ban to securities that, while not listed, are

publicly traded: see 512(1) Wertpapierhandelsgesctz (Germany); for Japan, see Art. 166 Securities and

Exchange Act.

69 S10(b) 1934 Securities Exchange Act and Rule 10b~5.

70 For the U.S., see the 1984 Insider Trading Sanction Act (allowing the SEC to sue for treble

damages) and the 1988 Insider Trading and Securities Fraud Enforcement Act (submitting insiders to

fines of up to $1 million and jail sentences of up to 10 years); Loss and Seligman, supra note 8,

982-988 (discussing speciai sanctions such as disgorgement, civil penalties, and bounty provisions);

for France, see Hubert de Vauplane and Jean-Pierre Bornet, DROIT DES MARCHES FINANCIERS

N°1041 (3rd ed. 2001); for Germany, see Heinz-Dieter Assmann and Peter Cramer, in Heinz-Dieter

Assmann and Uwe H. Schneider, WERTPAPIERHANDELSGESETZ KOMMENTAR N"98-100 $14 (1999);

for the UK, see Davies, supra note 1, 774-5.

71 Various factors weaken enforcement levels in Europe and Japan. See Gerard Hertig,

Convergence of Substantive Law and Convergence of Enforcement: A Comparison, in Jeffrey

N. Gordon and Mark J. Roe (eds.), CONVERGENCE AND PERSISTENCE TN CORPORATE GOVERNANCE

328 (2004). One of the most important is that a statutory preference for criminal over

civil sanctions burdens EU and Japanese prosecutors with a higher burden of proof. This is especially

true for the UK. Between 1995 and 1999, there were 3 convictions only—which compares to 162

civil case successes for the U.S. SEC (Anita Raghavan et al., Europe's Police Are Out of Luck on

Insider Cases, WALL STREET JOURNAL (U.S. ed.) 17 August 2000, CI); the record has slightly

improved in 2000-02, with 12 convictions for 19 prosecutions (Davies, supra note I, 775 and

footnote 26).

72 See H. Nejat Seyhun, The Effectiveness of Insider-Trading Sanctions 35 JOURNAL OF LAW AND

ECONOMICS 149 (1992); Thomas H. Eyssell and J. P. Reburn, The Effects of the Insider Trading

Sanctions Act of 1984: The Case of Seasoned Equity Offerings 16 JOURNAL OF FINANCIAL RESEARCH

161 (1993).

violation/3 apparently because even minimal enforcement increases the attractiveness of the equity market to outside investors. However, a second multi-jurisdictional study concludes that legal prohibitions generally fail to control insider trading, and only serve to make takeovers more expensive.7"1

Another question is why mandatory prohibitions are the strategy of choice for combating insider trading. The reason, we speculate, is that the benefits of managerial insider trading are much less visible, and therefore less plausible, than those resulting from most self-dealing transactions, or even some form of manager-firm competition. Mutually advantageous transactions between directors and small corporations are easy to imagine: for example, the director with superior information may be the only party willing to transact with her firm. To date, most lawmakers remain unpersuaded that insider trading, especially in the public market, might sometimes have similar benefits. It should be noted, however, that some academics have argued that companies ought to be permitted to allow insider trading by managers, precisely on the grounds that it too might be mutually beneficial for both managers and firms—for example, by serving as a form of incentive compensation or by channeling non-public information into share prices.75

5.1.5 The duty of loyalty: The standards strategy

If rules are rarely used to regulate most conflicted transactions today, standards are pervasive. All jurisdictions impose standards—which we group under the umbrella phrase 'duty of loyalty'—to control management conflicts and limit the risk of managerial diversion of assets or information.76 As discussed earlier, remedies for these standards include personal liability for resulting damages to the corporation, as well as the nullification of conflicted transactions.77

Duty-of-loyalty doctrines have a variety of labels across jurisdictions, such as the duty of entire fairness, the prohibition against 'wrongful profiting from position,' or the ban on 'abus de biens sociaux'. But whatever their labels, these doctrines have a similar thrust: they forbid directors, officers, and auditors from entering unfair or illicit self-dealing transactions or otherwise misappropriating

73 Utpal Bhartacharya and Hazem Daouk, The World Price of Insider Trading, 57 JOURNAL OF

FINANCE 75 (2002) (data based upon the 87 jurisdictions that have insider trading laws).

74 ArturoBris, Do Insider Trading Laws Work? (Working Paper 2000, availableatssm.com). For a

similar conclusion, based upon an analysis of 10 European securities markets, see Javier Estrada and

J. Ignacio Pena, Empirical Evidence on the Impact of European Insider Tradmg Regulations, 20

STUDIES IN ECONOMICS AND FINANCE 12 (2002).

75 See, e.g., Dennis W. Carlton and Daniel R. Fischel, The Regulation of Insider Tradmg, 35

STANFORD LAW REVIEW 857 (1983); Ian Ayers and Joe Bankraan, Substitutes for Insider Tradmg,

54 STANFORD LAW REVIEW 235 (2001). But see Reinier Kraakman, The Legal Theory of Insider

Trading Regulation in the United States, in Klaus J. Hopt and Eddy Wymeersch (eds.), EUROPEAN

INSIDER DEALING 39 (1991).

7S See, e.g., Baums, supra note 12. On the broader scope of fiduciary duties regarding managerial opportunism in the vicinity of insolvency, sec supra 4.2.3.1. 77 See supra 5.1.2.2.

company assets.78 As we described in Section 5.1.2, all jurisdictions assign responsibility for enforcing the duty of loyalty to disinterested directors, through the widely required—or encouraged—screening of conflicted transactions.79 Thus, the standards strategy frequently operates in conjunction with the trusteeship strategy. Jurisdictions differ, however, in the extent to which the standards strategy functions independently of other strategies. The duty of loyalty plays the largest independent role in the U.S., where courts generally assess the 'fairness' of conflicted transactions that independent directors have not approved, and sometimes review the fairness of conflicted transactions even when they have been approved by disinterested directors. By contrast, European courts are very reluctant to second guess independent board approval of conflicted transactions, at least in the absence of gross negligence on the part of the approving directors.80

The seemingly greater role for judicial enforcement of a free-standing duty of loyalty in U.S. jurisdictions, however, may be less significant that it at first appears to be for several reasons. First, U.S. courts frequently avoid close review of conflicted transactions by deferring to the views of disinterested directors. Since Europe and Japan often require board approval of conflicted transactions, at least for companies with outside directors, there is simply less room for judicial review of transactions that have not received prior board approval in those jurisdictions. Second, however, litigation outside the U.S. for breach of the duty of loyalty is on the upswing nonetheless. Although such lawsuits are uncommon in Japan, prosecutions for abus de biens sociaux are relatively frequent in France—and often highly publicized.81 Third, conflicted managers risk stiff sanctions outside the U.S. for breach of the duty of loyalty. For example, without supermajority shareholder approval, interested directors are strictly liable for value diversion in Japan,82 while self-dealing managers face criminal sanctions in France.83 Finally, at least some European jurisdictions impose tough reporting duties on auditors, such as the duty of auditors

76 For significant similarities between the German and the U.S. approaches, see Abeltshauser, supra note 4, 441-2.

79 Officers are also subject to liability for managerial transactions approved at their level, but this is

of limited practical importance from a litigation perspective; for the UK, see, e.g., Ferran, supra note

32, 154.

80 See s«pra 5.1.2.2 and note 45. See also Marcus Lutter, Limited Liability Companies and Private

Companies, in XLT INTERNATIONAL ENCYCLOPEDIA OF COMPARATIVE LAW 2-267,2-273 (1997).

81 For France, see Cozian et al., supra note 25, N"752~3 (underlying that prosecutors are most

likely to focus on bribery cases) and NT71-4 (shareholders play an increasing role in abus de biens

sociaux prosecutions).

81 Art. 266(6) Commercial Code (requiring a 2/3 majority, except for loans and other actions requiring a unanimous vote); see also Supreme Court Decision, 20 October 2000 (Minshu 54-8-2619) (breach of fiduciary duty despite approval by a 2/3 shareholder majority).

83 See Art, L. 241-3 and Art. L. 242-6 Code de commerce, applicable to SARL, respectively SA (jail up to 5 years, fine up to €375,000). On the popularity of abus de biens sociaux resulting from courts being overly restrictive in civil procedures, see Cozian eta!., supra note 25, N°370. Note that $317(7) Companies Act subjects UK directors who fail to disclose their interest in a transaction to fines up to UK£5,000, but that enforcement is close to inexistent.

of French SA to report all material information about managerial self-dealing to the shareholders (under pain of civil liabihty).84

All jurisdictions also deploy the duty of loyalty to prevent misappropriation of corporate information or opportunities. Under the corporate opportunity doctrine in the U.S, courts first determine whether a business opportunity is 'corporate,' and, if it is, then inquire into whether a director has violated his duty of loyalty by taking advantage of the opportunity.85 The general approach is not unlike the one adopted for self-dealing: the director is presumed to have acted fairly if he properly disclosed the business prospect to disinterested directors and took it with their approval. The UK and Japan currently follow a similar approach: directors may appropriate business opportunities within the company's line of business as long as they receive the informed consent of the disinterested directors.86 Indeed, virtually the same doctrine has also gained acceptance in Germany (under the rubric of the Geschdftscbancen doctrine87) and even in France (as an abus des bienslpouvoirs sociaux).ss

Contrary to widespread impressions, then, the duty of loyalty is fundamentally similar in common and civil law jurisdictions. Courts are more interventionist when transactions are tainted by self-interest than when they are not.89 Conversely, courts rarely impose liability when a disinterested body, such as the entire board or one of its committees, has approved a conflicted managerial transaction.90

This said, however, U.S. jurisdictions have a more developed duty of loyalty than other jurisdictions.91 One reason is that U.S. courts are more willing to review managerial transactions, as we discussed above. A second reason is that U.S. law encourages shareholder lawsuits. Not only are the procedural thresholds for shareholder suits relatively low in the U.S., but a combination of discovery mechanisms and generous attorney's fees is also available to support a specialized plaintiff's bar.92 However, these factors alone may not fully explain the richness of U.S. case law. The most popular U.S. litigation device, the shareholder

84 Art. L. 225-40 and 225-241 Code de commerce.

85 See Hamilton, supra note 46, 479-83; Clark, supra note 4, 225-30.

86 For the UK, see Ferran, supra note 32, 187-192; Davies, supra note 1, 416-22; for japan, see

Art. 264 Commercial Code.

87 See Abeltshauser, supra note 4, 373 and Uwe Huffer, AJOTENGESETZ, N"4 $116 (5th ed. 2002).

88 See Art. L. 225-251 and Art. L, 242-6 Code de commerce; see Cozian r.t a!., supra note 25,

N°756 (causing the loss of a profit opportunity is potentially abusive).

89 See, for Anglo-Saxon jurisdictions: Cheffins, supra note 47, 316-317; for continental European

jurisdictions: Grossfeld, supra note 42, 4-142-160; for Japan, Supreme Court, 20 October 2000

(Minshu 54-8-2619).

90 See supra 5.1.2.2.

91 See also Klaus J. Hopt, Common Principles of Corporate Governance m Europe, in Basil S.

Markesinis (ed.), THE COMING TOGETHER OF THE COMMON LAW AND THE CIVIL LAW 105, 109

(2000).

92 On U.S. derivative litigation being driven by attorney's fees, see John C. Coffee, The Unfaithful

Champion: The Plaintiff as Monitor in Shareholder Ltttgation, 48 LAW AND CONTEMPORARY PROB-

LEMS 5 (1985); Roberta Romano, The Shareholder Suit: Litigation Without Foundation? 7 JOURNAL

OF LAW, ECONOMICS AND ORGANIZATION 55 (1991). See also infra 8.4.2 (discussing the role of

shareholder class actions).

derivative suit, is also available in Europe and Japan.93 For example, France uncharacteristically makes an exception to its strict 'nut ne plaide par procureur' rule and allows shareholders to sue collectively in order to minimize the individual cost of derivative actions.94 (On the other hand, procedural obstacles remain substantial outside the U.S.95) In addition, it appears that substantial litigation activity is possible without U.S.-style incentives for the plaintiff's bar. For example, a modest procedural reform sparked an explosion in Japanese derivative litigation in 1993,96 while most European jurisdictions have strong public enforcement agencies to supplement private enforcement of the duty of loyalty.97 We thus believe that other factors contribute to the extensive development of the duty of loyalty in U.S. jurisdictions. First, institutional investors are likely to form voting coalitions in the UK, whereas ownership in publicly held companies is (still) more concentrated in Japan and, especially, continental Europe.98 Thus, European and Japanese shareholders have non-judicial ways to constrain managerial opporttrnism, whereas litigation is the primary monitoring device in the U.S.99 This explanation is consistent with the increase in shareholder litigation as European ownership structures become more dispersed.100 It is also consistent with historically low levels of liability for professionals such as auditors in Germany and France,101 who can expect to enjoy the protection of controlling shareholders.

53 For France, see Art. L. 223-22 and Art. L. 225-252 Code de commerce; for the UK, Davies,

supra note 1, 453-63; for Japan, Art. 267 Commercial Code; Mark D. West, The Pricing of

Shareholder Derivative Actions in Japan and the United States, 88 NORTHWESTERN UNIVERSITY

LAW REVIEW 1436 (1994).

54 Shareholders in companies that have adopted the SA form can sue as a class, provided that they

represent 5% (decreasing to 1% for larger companies) of the share capital: Art. L. 225-120 Code de

commerce; Cozian et al., supra note 25, N°746, 773.

9s For the UK, see Poss v. Harbottle (1843) 2 HARE'S REPORTS, CHANCERY 461 (laying down the foundation of elaborate and restrictive standing requirements); for Germany, see $147 Aktiengesetz (for derivative suits being easier to bring against managers of GmbHs, see Friedrich Kiibler, GESELLSCHAFTSRECHT S6 II 3b (5th ed. 1998)).

96 See Mark D. West, Why Shareholders Sue: The Evidence from Japan, 30 JOURNAL OF LEGAL STUDIES 351 (2001).

91 France has well-established criminal procedures for abus de biens sociaux (see supra note 81 and accompanying text), while the UK Secretary of State has extensive value diversion investigation and petition powers under 5432 (appointment of inspectors) and $447 (investigation of company documents) Companies Act.

98 See Rafel Crespi-Cladera and Luc Renneboog, Corporate Monitoring by Shareholder Coali-

tions in the UK (Working paper 2003, available at ssm.com); La Porta etal., mfra note 107.

99 Note, however; that the evidence regarding large European shareholders' monitoring of man-

agement seems mixed. See, e.g., Julian R. Franks and Colin Mayer, Ownership and Control of

German Corporations, 14 REVIEW OF FINANCIAL STUDIES 943 (2001); Saugata Banerjec, Benott

Leleux and Theo Vermaelen, Large Shareholding and Corporate Control: An Analysis of Stake

Purchases by French Holding Companies, 3 EUROPEAN FINANCIAL MANAGEMENT 23 (1997).

100 See Deborah Steinbohrn, Getting Legal, Lawsuits are the Latest Trend for European Share-

holders, THE WALL STREET JOURNAL EUROPE, 11 June 2001,15.

101 For Germany, see S323 Handelsgesetzbuch (HGB) (limiting negligent auditor's liability to

€1,000,000, respectively €4,000,000 for listed companies); for France, Art. L. 225-242 Code de

commetce (statute of limitation; 3 years from the discovery of the damaging act; but see Cozian etal.,

supra note 25, N°971, 974).

Second, Japanese and, especially, European corporate laws are more creditor-oriented than U.S. corporate laws.102 As a result, managers in European and Japanese companies are more likely to be sued or investigated for fiduciary duty violations in the vicinity of insolvency. Managers of U.S. corporations, on the other hand, are sued for fiduciary duty violations throughout the life of the firm, which obviously allows for richer case law.103

Third, the effectiveness of the duty of loyalty is not only a function of legal enforcement mechanisms, but also of the extent of its internalization as a social norm.104 Differences in business ethics may affect litigation levels in various ways.105 For example, compensation levels for top managers being generally lower in continental Europe than in the U.S., French and German judges may prove more lenient when it comes to related party transactions—which in turn reduces the attractiveness of shareholder suits.