5.3 Explaining differences in the regulation of related party transactions

All jurisdictions must protect shareholders against opportunism at the hands of corporate managers and controlling shareholder, but the extent to which corporate law attempts to provide such protection is less far reaching than one might expect. In part, this is because shareholders can protect themselves, either through articles of incorporation and shareholder agreements or by selling their equity stake. In large part, however, reticence about regulating related-party transactions reflects an awareness of the potential costs of regulation. No one doubts, for example, that some forms of related party transactions are necessary {management compensation contracts) and other forms are efficient, especially in the context of closely held firms. Thus, overly stringent regulation would undercut the value of the corporate form by discouraging valuable transactions. In addition, some methods of protecting minority shareholders, such as granting them veto rights over the conflicted transactions of controlling shareholders, give rise to a risk of strategic behavior by minority shareholders— including opportunistic hold-ups of innocent transactions.166

In broad outline, all of our major jurisdictions regulate related party transactions in similar ways. All jurisdictions rely heavily on approval—by disinterested directors, shareholders, or both—as the primary check on the conflicted transactions of corporate officers and directors. All jurisdictions rely on the standards strategy as the primary check on the conflicted transactions of controlling shareholders. And finally, at least in the case of public companies, all

1S* Minority opportunism {also called abus de mtnoritS—abusive practices by minority shareholders) is of particular concern in Europe: sec Klaus J. Hopt, Shareholder Rights and Remedies: A View from Germany and the Continent, 2 COMPANY FINANCIAL AND INSOLVENCY LAW REVIEW 261, 267-26? (1997); more generally, see Easterbrook and Fischel, supra note 139, 238.

jurisdictions follow the lead of U.S. securities law in providing for the mandatory disclosure of related parry transactions and prohibiting insider trading by corporate managers and controlling shareholders.

The differences among our jurisdictions reflect in part differences in the modal ownership structures of companies and, in part, different perspectives on the board of directors. Consider ownership structure first. Capital markets are less developed, and shareholdings more concentrated, in continental Europe and Japan than in the U.S. and UK.167 Investor protection concerns thus play a more important role in Anglo-Saxon jurisdictions, whereas minority shareholder protection is an essential issue in continental Europe and Japan. Conversely, transparency is essential to protect dispersed U.S. and UK shareholders against opportunistic managers, but it is less useful in continental European firms where controlling shareholders have better access to company information. Similarly, continental European and Japanese mandatory board and/or shareholder approval requirements facilitate the monitoring role of controlling shareholders, whereas U.S. litigation mechanisms are more adequate in a dispersed investors environment.

However, the nature of the capital markets cannot explain legal differences among our jurisdictions entirely. Another important element of divergence is the extent to which jurisdictions have faith in boards of directors.

At bottom, most company laws rely on the board of directors to police the fairness of most related party transactions. Hence, divergence among jurisdictions largely reflects differences of opinion about how to deal with the board's potential failure to monitor suspicious transactions or to ensure for their fairness. Jurisdictions differ first in their expectations about the abiLity of boards of directors to evaluate the fairness of transactions with managers. German law, which almost invariably defers to the board's judgment, is the most trusting jurisdiction. Japan and the U.S. show greater mistrust insofar as they provide for at least the possibility of substantive judicial review of disinterested board decisions. Finally, France and the UK are least confident of the board's ability to evaluate conflicted managerial transactions, since they mandate a shareholder vote on conflicted managerial transactions that are not so ordinary as to be trivial (in France) or insignificant (in the UK). In addition, France and the UK are also the two jurisdictions that make the broadest use of public suits and criminal sanctions to deter illicit self-dealing, while Germany by contrast makes even a shareholder suit against a director who acted dishonestly almost impossible.

Finally, different jurisdictions implicitly stake out individual positions on how far boards can be trusted to prevent controlling shareholder opportunism. It seems that no jurisdiction relies entirely on the board to screen interested

167 See Mark J. Roe, POLITICAL DETERMINANTS OF CORPORATE GOVERNANCE (2002); Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert W. Vishny, Law and Finance, 106 JOURNAL OF POLITICAL ECONOMY 1113 (1998); supra note 107.

transactions by controlling shareholders. Perhaps the U.S.—and maybe the UK—come closest, insofar as they assign considerable legal importance to the considered approval of a disinterested board. But the U.S. retains the entire fairness standard to allow courts to review such transactions, and UK minority shareholders are protected by the oppression doctrine in extreme situations. France, for its part, constrains controlling shareholder opportunism by allowing minority shareholders to ask for the designation of an expert de gestion to investigate controlling shareholder transactions. Reversing the approach it adopts for the regulation of managerial transactions, Germany no longer relies on board discretion to protect the interests of subsidiary companies in corporate groups, but instead turns to a mandatory indemnification rule to compensate these subsidiaries and their rmnority shareholders for the costs imposed by their corporate parents.

These comparisons show that there is no clear divide between common and civil law jurisdictions. At best, jurisdictions can be arrayed according to how much they rely on public enforcement when boards of directors fail to reliably screen interested transactions. France and the UK both assign public prosecutors a significant deterrence role, both in investigating conflicted transactions and in strengthening the bargaining position of litigants who challenge these transactions. By contrast, Japan and, especially, the U.S., prefer to encourage private litigation through doctrines that support derivative suits and shareholder class actions. Lastly, Germany takes yet another tack. It devotes numerous statutory provisions to the regulation of related party transactions, especially in the context of corporate groups. However, Germany also gives individual shareholders almost no tools to enforce these provisions. It is as if German law was intended to reinforce social norms and was designed to be enforced not by lawsuits but by reputational penalties.168

168 See Melvin A. Eisenberg, Corporate Law and Social Norms, 99 COLUMBIA LAW REVIEW 1253 (1999). See, more generally, Symposium, Norms and Corporate Law, 149 UNIVERSITY OF PENNSYLVANIA LAW REVIEW 1607 (2001).

Significant Corporate Actions

EDWARD ROCK, HIDEKI KANDA and REINIER KRAAKMAN

In this Chapter we consider the familiar triangle of corporate agency problems in the context of significant corporate actions, such as mergers, major sales of corporate assets, or alterations of capital.

Corporate law everywhere reserves a handful of decisions for special regulation. No jurisdiction, for example, authorizes the board of directors to unilaterally effect a merger that alters the company's legal identity, or to unilaterally amend the company's charter in a material way. The board's power over such basic decisions is always circumscribed, usually by shareholder decision rights and sometimes by other forms of legal regulation as well. Although the efficiencies of the corporate form require centralizing management power, shareholders need not (and generally do not) delegate all authority to act for the corporation to the board of directors.1 Even a board-centered jurisdiction such as Delaware must grapple with the problem of optimal delegation—that is, of just how much discretion to delegate to the board. Indeed, in Chapter 5, we have already reviewed the limits on board authority to approve transactions involving high-powered conflicts of interest between the company and its directors or controlling shareholders.2 In this Chapter, we address how corporate law limits board authority to make other important transactions and decisions.