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COMPARATIVE COMPANY LAW AND CORPORATE GOVERNANCE Lectures on Company Law Prof. Jukka Mähönen October 2012.

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Presentation on theme: "COMPARATIVE COMPANY LAW AND CORPORATE GOVERNANCE Lectures on Company Law Prof. Jukka Mähönen October 2012."— Presentation transcript:

1 COMPARATIVE COMPANY LAW AND CORPORATE GOVERNANCE Lectures on Company Law Prof. Jukka Mähönen October 2012

2 2 Lectures on company law Jukka Mähönen: Comparative Company Law and Corporate Governance Wed 10.10.2012 16–20 P722 Thu 11.10.2012 16–19 P673 Fri 12.10.2012 16–19 P673 Seppo Villa: Corporate Finance Tue 16.10.2012 10–13 P674 Wed 17.10.2012 10–13 P722 Thu 18.10.2012 10–14 (12.15 – 14:00 exam) AUD XII (Main building) Re-exam day: public exam day 20.11.2012 Place: PI Time: 09:00

3 3 Comparative company law and corporate governance Aims Theoretical basis of modern company law and corporate governance: contract and agency theory, governance models History of company law and corporate governance and company law families General structure of EU company law

4 4 Comparative company law and corporate governance Main features of corporate form (legal personality, limited liability, residual rights, separation of control and ownership, free transfer of shares) Literature Reinier Kraakman et al.: The anatomy of corporate law : a comparative and functional approach, 2nd ed., Oxford University Press: New York 2009

5 5 Corporate Finance Aims The structure of corporate finance The distinction between equity and loans Mezzanine finance: subordinated loans, preferred shares The annual accounts

6 6 Corporate finance The doctrine of capital maintenance Distribution of funds Creditor protection: solvency and balance sheet tests Literature Kraakman et al (2009) Seppo Villa: Creditor Protection and the Application of the Solvency and Balance Sheet Tests under the Company Laws of Finland and New Zealand

7 7 Theoretical basis Mainstream corporate law paradigm Kraakman et al. (2009) End of history of corporate law Henry Hansmann & Reinier Kraakman: The end of history for corporate law. Georgetown Law Journal, 439–468 (2001)

8 8 Theoretical basis Critique against mainstream paradigm Adolf Berle & Gardiner Means: The Modern Corporation and Private Property (1932) Luh Luh Lan & Loizos Heracleous: Rethinking agency theory: The view from law. Academy of Management Review, 294–314 (2010)

9 9 Mainstream paradigm Emphasis on contracting and self-regulation Basis on microeconomics: theory of the firm Nexus of contracts theory Principal agent theory Shareholder primacy

10 10 Critique Managerialism Expert management the corporate strategic centre in a bureaucratic hierarchy Stakeholder primacy Duty of managers and directors to take into consideration the interests of non-shareholder constituencies having stakes in the company as important as those of shareholders Director primacy The board of directors a central, independent decision-maker mediating competing stakeholder interests and allocating the firm surplus among them

11 11 Important to remember Long history of corporate law Roman law: familia, peculium, societas, societas publicanorum Medieval law: societas, compagnia, commenda, guilds Early modern time: great companies Dutch East Indian Company (VOC) English East Indian Company (EIC) Modern regulation ca 1850-

12 12 Historical theories on company law Fiction theory Organic theory Aggregate theory

13 13 Fiction theory Company a state-created legal fiction only, without substantial reality or own free will Public good Basis: state concession German variant: Friedrich von Savigny, Karl Puchta U.S. variant: Darthmouth College v. Woodward (1819); David Millon: Frontiers of legal thought I: Theories of the corporation. Duke Law Journal, 201–262 (1990) Influence: Stakeholder primacy

14 14 Organic theory Company a real entity having a separate existence from its shareholders Company a naturally occurring being German variant: Georg Beseler, Otto von Gierke U.S. variant: Ernst Freund: The legal nature of corporations (1897) Influence Managerialism: Berle & Means (1932)

15 15 Aggregate theory Company formed by voluntary private contracting Basis: contract theory German variant: Rudolf von Ihering (interest theory) U.S. variant: Victor Morawetz: Private corporations (1886), Charles Beach: The Law of Private Corporations (1891)

16 Aggregate theory Influence Shareholder primacy: Michael J. Jensen & William H. Meckling: Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 305–360 (1976); Hansmann & Kraakman (2001) Director primacy: Margaret Blair & Lynn Stout: A team production theory of corporate law. Virginia Law Review, 247– 328 (1999) 16

17 17 Company law regulation contract law corporate agreement, by-laws, articles of association etc. specific company legislation legal personality limitations of stakeholder responsibilities joint and self-regulation corporate governance codes public supervision general: eg Companies House, Finnish Board of Patents and Registration securities markets: eg. SEC, FSA

18 18 Comparative approach Three legal families Anglo-American Continental European (French-Germanic) Scandinavian Harmonization of EU company law

19 19 Comparative approach Different views on the scope of company law Relation to other branches of law contract law securities law labour law environmental law tax law administrative law basic and human rights four freedoms in the EC Treaty Different kinds of corporate forms

20 20 Comparative approach Typical corporate forms partnerships limited partnerships company limited by shares private (ltd, GmbH, SARL, SAS, ApS) public (plc, AG, SA, AS) cooperatives non-profit organizations civil law “foundations” cf. trust and its European counterparts charitable companies “associations”

21 21 European harmonization Changes in British company law Convergence to Continental company law ”Americanization” of EU company law during the last decade

22 22 French-German system Civil law Emphasis on the legislator and jurisprudence Inefficient role of courts as rule makers Debt finance Emphasis on creditor protection Weak shareholder rights against directors  Strong dividend rights (substitution hypothesis: weak shareholder protection is compensated by dividends)

23 23 French-German system Example: German Aktiengesellschaft (AG) Two-tier system Vorstand (”board”) Aufsichtsrat (”supervisory board”) Strong creditor protection Hausbank system Growing importance of securities markets Kodex

24 24 Scandinavian system French-German basis Legal realism Courts as law-makers Stronger role of equity financing than in French-German system but weaker than in Anglo-American world Modern legislation Norway 1997 Sweden 2005 Finland 2006 Denmark 2009

25 25 Scandinavian system Points to be remember Multiple voting rights Cf. Germany Equal treatment of shareholders Cf. Anglo-American law

26 26 Anglo-American system Statutory law like in Continental and Scandinavian countries Common law: courts as law-makers Codification of case law in statutory law Equity financing Strong role for securities markets Strong investor protection Strong shareholder rights against directors

27 27 Anglo-American system UK: 2006 Companies Act SME approach Enlightened value maximization US State legislation Fiduciary duties and business judgment rule Corporate law competition: Delaware

28 28 ”Americanization” of European law Recent trends in EU company law National law: the new 2006 Finnish Companies Act ”Revlon duties”: directors’ duties in takeovers Business judgment rule in duty of care

29 29 EU company law 4 Regulations European Economic Interest Groupings (EEIG, 1985) European Companies (SE, 2001) IAS/IFRS Standards (IAS Regulation, 2002) European Cooperative Societies (SCE 2003)

30 30 EU company law 13 Directives “Old” directives Disclosure (1st Dir., 1968) Capital (2nd Dir., 1977) Merger (3rd Dir., 1977) Annual Accounts (4th Dir., 1978) Division (6th Dir., 1982) Consolidated Accounts (7th Dir., 1983) Auditors (8th Dir., 1984) Branches (11th Dir., 1989) Single-Member Companies (12th. Dir., 1989)

31 31 EU company law “New” directives  US impact Takeovers (13th Dir., 2003) Transparency (2004) Cross-border mergers (10th Dir. 2005) Auditing (new 8th Dir, 2007) Shareholders’ rights (2007)

32 32 European corporate forms European economic interest grouping (EEIG) primarily a cross-border partnership or ‘joint venture’ depending on the applicable law – eg. Finnish law: rules of a partnership European public company (SE) cross-border public company limited by shares Finnish law: rules of a plc European cooperative society (SCE) cross-border cooperative society Eg Finnish law: rules of a cooperative society European private company (SPE)

33 33 General features of limited liability law a limited liability company a very young phenomenon classical company laws 1855-1900 Britain 1855 France 1867 Germany 1871-91 Sweden and Finland 1895 U.S. States (New York, New Jersey, Delaware) end of the 19th Century a recognizable company form in all industrialized countries by 1900

34 34 Main features full legal personality limited liability recidual rights separation of control and ownership free transfer of shares

35 35 Legal personality Enables separation of corporate assets and corporate creditors from shareholders’ assets and liabilities (asset partitioning) Protection of corporate assets from shareholders’ creditors (entity shielding) See Henry Hansmann & Reinier Kraakman & Richard Squire: Law and the Rise of the Firm, Harvard Law Review), 1333-1403 (2006)

36 36 Legal personality Three elements Protection of creditors from shareholders Protection of company from shareholders’ creditors Protection of corporate creditors from shareholders’ creditors Weak forms Partnership Strong forms Limited liability company

37 37 Legal personality State intervention necessary to achieve protection of corporate assets from shareholders’ creditors Transaction costs! Negotiations between every shareholders and every creditor Moral hazard! Free transfer of shares Asymmetric information

38 38 Pros Reduction of potential creditor information costs reduction of creditor monitoring costs reduction of management agency costs reduction of administrative costs of bankruptcy Reduction of amount of inefficient bankruptcies Protection of going concern value

39 39 Pros Enables capital accumulation and investment diversification Increases transfer of shares Cf partnership Shareholder’s creditor Right to corporate assets Right to share

40 40 Cons Debtor opportunism and moral hazard Risk premium Shareholders’ creditors! Enforcement costs A sophisticated bankruptcy system Weak legal personality

41 41 Cons Illiquid investments Dispersed ownership Free transfer of shares! Exploitation by controlling persons Opportunistic behaviour of controlling shareholders and directors Problem of private benefits

42 42 Private benefits Pecuniary private benefits v non-pecuniary private benefits See Ronald J. Gilson: Controlling Shareholders and Corporate Governance: Complicating the Comparative Taxonomy, Harvard Law Review, 1641-1679 (2006) Pecuniary benefits: ”stealing” (eg tunnelling) Non-pecuniary benefits: do not reduce corporate value Political influence Societal status

43 43 Legal tools Fiduciary duties: directors and controlling shareholders Equal treatment Derivative suits Market for corporate control

44 44 Limited liability Owner shielding Shareholders protected from corporate creditors Not very important Cf. partnership Not necessary for free transfer of shares Directors’ competence: agency

45 45 Limited liability Not problematic for creditors Contractual protection – eg control covenants Risk premium Weak creditors and non-contractual creditors Free-riding

46 46 Other Recídual rights Against opportunistic partial liquidation before total liquidation Separation ownership and control Agency problem Free transfer of shares Legal personality

47 47 Main features – exceptions recidual rights belong to the shareholders v. charitable companies full legal personality v lifting the corporate veil moral hazard free transfer – exceptions for private companies

48 48 Main features – exceptions Separation of control and ownership: lots of variations shareholders meeting v board of directors board of directors v general manager board of directors v supervisory board one tier – two tier – one and a half tier – two and a half tier systems

49 49 Historical developments Four basic models manager-oriented labour-oriented state-oriented shareholder-oriented

50 50 Manager-oriented model United States ca 1930-1970 power vested with independent professional management best possibilities to govern the company for the benefit of the society cf. corporate social responsibility if no control – danger of opportunistic behavior principal agency problem

51 51 Labour-oriented model the most important stakeholder: the employees (=trade unions) Germany after WWII Mitwirkungsrecht in AG supervisory boards (Aufsichtsrat)

52 52 Labour-oriented model EU proposal for the 5th directive 1983 British resistance see however directives attached to the SE and SCE Regulations and cross-border directives on employee participation

53 53 State-oriented model direct government intervention on firms’ governance control vested with the state bureaucracy instead of owners or management France and Japan after WWII

54 54 State-oriented model Tools direct state ownership regulation of foreign investments licence systems and other restrictions for competition criminal and adminstrative law sanctions (cf. private law sanctions)

55 55 Shareholder oriented model In the United States, from the 1960s Other parts of the world, from the 1980s and 1990s

56 56 Why dominant? US dominance in the global markets weakening of German and Japanese economics critique against state ownership financial reporting by quarters instead of fiscal years critique against public regulation from the 1980s

57 57 Shareholder primacy Main idea shareholder primacy: the shareholders have a special role among the corporate stakeholders emphasis on contracting and self-regulation theoretical basis: principal agent theory

58 58 Theoretical basis Theory of the firm (Akerlof, Fama, Jensen, Meckling) Agency theory Principal-agent theory: problem of asymmetric information Incomplete contracting theory: problem of transaction costs Origins in large profit-making firms How to govern the relationships between management and shareholders?

59 59 Principal agency theory Main features Agency Asymmetric information Incomplete contracting Moral hazard (”opportunism”) Legal tools Fiduciary duties Transparency

60 60 Principal agent theory in a company A firm is nexus of contractual input and output relations between the firm’s stakeholders From this point of view, a firm does not have ”owners” in the traditional sense Shareholders input only one among other contractual parties, eg creditors

61 61 Special role of shareholders Shareholders carry the residual risk on the firm The most vulnerable stakeholder group for management opportunism The most vulnerable of all: the minority shareholders Management opportunism Controlling shareholder opportunism How to prevent opportunism?

62 62 Principal agent relationship The board of directors: agents of shareholders monitoring the management The board must be seen as the agent for all shareholders and shareholders only Directors’s duties to and only to shareholders Fiduciary duties: duty of care and duty of loyalty Company interest = Shareholder interest

63 63 Division of control rights In a company with no controlling shareholders: the directors ”own” the company by controlling it without hearing the investors “director primacy” New interest conflict between the directors and the shareholders: the directors have the control but not a residual risk  no incentives to maximize the residual Other two interest conflict relationships Controlling sharreholders v the minority shareholders Shareholders v creditors

64 64 Corporate governance How to solve the interest conflicts between shareholders v directors and controlling shareholders v minority shareholders How the shareholders ensure that the directors serve shareholders’ without opportunism? How the minority can trust the controlling shareholders?

65 65 Corporate governance Problems to be solved Information asymmetry: Efficient monitoring? Transparency Tools Legal rules Self-regulation Shareholders’ decisions Information duties

66 66 Main question: How to monitor? The essential role of intermediaries Auditors Analysts Rating agencies Duty to verify agent information on behalf of principals Moral hazard Enron Financial crisis

67 67 Importance of information Transparency rules Balances information asymmetry between principals and agents Enables efficient markets for corporate governance

68 68 Creditor protection Primarily an insolvency law not company law problem Continental and Nordic company law: main focus in company law – efficient? Change of focus in company law reforms: Creditor protection  shareholder protection

69 69 Capital maintenance rules Distribution rules Balance sheet tests Solvency tests Minimum capital rules Maintenance of going concern value Prevents partial liquidations nad so moral hazard

70 70 Protection of other stakeholders Distribution rules Lifting the corporate veil Labour law Environmental law Insolvency law

71 71 Example: Finland 1978 Companies Act: State-oriented model State-controlled firms Licencing systems Restrictions to foreign ownership Employee representation: labour law

72 72 Example: Finland 2006 Companies Act: Shareholder primacy Investor protection Freedom of contract Creditor protection Ex post protection of shareholders

73 73 Critique towards shareholder primacy Director primacy Stakeholder primacy

74 74 Director primacy The company is a a nexus of firm-specific investments complex productive activity involving many parties where the resulting output is generally neither separable nor individually attributable to original contributors = “team production” Purpose of the company maximize total corporate returns satisfy group-specific stakeholder returns so that commitment to team production is sustained

75 75 Director primacy The board mediates the competing interests of different team members The company itself the principal Duty of the board to maximize the sum of all risk- adjusted returns enjoyed by the team members Directors’ fiduciary duties towards all risk-bearing stakeholders: business judgment rule Problems?

76 76 Stakeholder primacy The board and the management balance the needs of all corporate constituents = stakeholder community “Communitarianism” Stakeholders’ representation rights Problems?

77 77 Corporate social responsibility Sustainable development Economic responsibilities Environmental responsibilities Social responsibilities Test of theories Shareholder primacy Director primacy

78 78 Corporate social responsibility Shareholder primacy ”Enlightened” value maximization: Long-term interest of the shareholders Specific corporate law duties towards stakeholders, communities, environment? Director primacy The board mediating the conflicting interests of team members Communitarianism Public interest Example: Human right risks

79 79 Human right risks Examples Legal risk from human right violations Risks from tarnishing brands and reputation Operational risk from weakening competitiveness Can shareholder primacy solve these problems?

80 80 Example of European company law: Finland General aspects of Finnish corporate law National commercial corporate forms Partnership Limited partnership Co-operative society Private company Public company European corporate forms European economic interest grouping (EEIG) European company (SE) European co-operative society (SCE) Not very popular in Finland, you may say …

81 81 Background General aspects No limited liability parnership (”Kommanditaktiengesellschaft”) – problem for private equity/venture capital Basically same rules for both private and public companies No ”GmbH”/”SARL”/”SAS” corporation forms All companies governed by the Finnish Companies Act of 2006 (FCA) Tax rules create incentives to use private company for all kinds of business Problems for medical, law and accounting firms

82 82 Background History of Finnish corporate law Partnerships and limited partnerships based on medieval Continental practices Partnership law codified in the Commercial Code of 1734 Limited partnership law codified in the Limited Partnerships Decree of 1864 Now both codified in the Partnerships Act of 1988 (FPA) Co-operative law based on Swedish models Especially Co-operatives Act of 1954 New Co-operatives Act of 2001 influenced by Companies Act of 1978

83 83 Background History First Companies Decree of 1864 based on French Code de commerce of 1807 Concession principle Companies Act of 1895 based on Swedish, German and French law Registration principle Companies Act of 1978 heavily based on Swedish Companies Act of 1975 Based on Swedish Companies Act of 1944 Implementation of EC Company Directives in 1997 Different solutions in Sweden and Finland: end of copying Swedish law Why?

84 84 Finnish Company Law Theory Based traditionally on German and Swedish doctrine Fiction theory Organic theory Change in the paradigm in mid-1990s Law and economics approach Theory of the firm Principal agency theory Shareholder value maximization  ”Americanization” of Finnish corporate law academia

85 85 Change in the markets Great depression in the early 1990s Bank crisis Diminishing influence of banks in Finnish listed companies Finnish securities markets opened European Economic Area Barriers to hinder foreign investments broken down Reform of Finnish Securities Markets Act From Hausbank system to Berle & Means companies Dispersed international ownership in many major listed companies

86 86 Change in the Legal Structure Member of the EEA in 1994 Member of the EU in 1995 Implementation of EC company law Need for total evaluation of Finnish company law Result: Companies Act of 2006

87 87 Goals of the FCA Adaptation in changes in int’l cross-border financial markets Changes in the economic environment of Finnish firms: towards competitive markets How to reach these goals? Totally new and competitive Companies Act: Race to the top

88 88 Goals of the FCA More possibilities for Finnish firms both domestically and internationally Effective protection to minority shareholders and creditors Suitable for SMEs Decrease of minimum share capital from 8,000 euros to 2,500 euros Answers to challenges created by changes in legal environment Especially the IFRS

89 89 How to reach the goals? Less and lighter formalities Principle-based approach More emphasis on freedom of contract On the other hand: idea of the Companies Act as a standard form contract Comprehensive collection of non-mandatory default rules Theoretical background: firm as nexus of contracts (Jensen & Meckling)

90 90 How to reach the goals? Change in the ideology of minority and creditor protection From ex ante approach to ex post approach From invalidity to damages Modernization of legal language

91 91 Changes in practice However, not a revolution but more fine-tuning Revising bad written law Division rules Codifying best practices Fast and easy incorporation New possibilities, e.g., for M&As Triangular mergers Change of corporate form Company  partnership Company  limited partnership Company  co-operative

92 92 Principle-based approach Difficult principal agency problems solved used by principles Discretion of shareholders (FCA 1:9): freedom of contract Purpose of the company (FCA 1:5): shareholder value Equal treatment of shareholders (FCA 1:7) Fiduciary duties (FCA 1:5) Interpretation: Towards U.S. law

93 93 Discretion of shareholders Right to deviate the default rules by using articles of association Not the mandatory creditor protection rules Unanimous shareholders can deviate non-mandatory law and articles of association act in writing instead of holding general meetings

94 94 Shareholder value Idea of ”enlightened” shareholder value maximization Michael Jensen Cf. The UK Companies Act of 2006 Exception when the company is on sale: Revlon duties Problem: How to implement corporate social responsibility?

95 95 Fiduciary duties Duty of care Duty of loyalty Business judgment rule Clearest sign of direct U.S. influence in the FCA

96 96 Minority protection Equal treatment of all shareholders Right for derivative suit for all shareholder when the principle is grossly violated In other cases: 10 % minority No right for indirect loss (no incentive for opportunism)

97 97 Minority protection On the other hand: possibility to restrict the right of the company to damages from directors, the CEO, shareholders and auditors by a provision in the articles of association (FCA 22:9) Strict limitations for the provision Adaptation of the provision requires shareholders’ unanimity Does not cover violations of mandatory rules of the FCA (creditor protection rules) Does not cover losses caused deliberately or through gross negligence

98 98 Changes in finance and distributions Default rule: shares without par value (FCA 3:5) Par value can be introduced by articles of association: freedom of contract Solvency test in distributions (FCA 13:2) Balance sheet test (FCA 13:5) required by the Capital Directive

99 99 Corporate governance One tier system as a general rule Negative attitudes towards supervisory boards Too negative? Alternative for board committees American way in nominating board member candidates for the general meeting Nomination committee of the board However, important exceptions use the Swedish model Nominated by the controlling shareholders E.g., the State-controlled listed companies

100 100 Is the new law a success? Who knows – but yearly incorporations have been increased by 60 % after the new law was introduced 83 % of the new companies without par value

101 101 Challenges Still need for more flexibility for SMES Problems from one law fits for all ideology still exists How to interpret the duty of loyalty? the business judgment rule? the solvency test? Special problems in takeovers What kinds of poison pills are applicable? Interpretation of fiduciary duties of the directors of the target company Helsinki Takeover Code

102 102 Challenges No clear doctrine on piercing the corporate veil fiduciary duties of the controlling shareholders No case law yet

103 103 Challenges But the most important one No clear picture of the future of EU company law Reform of capital maintenance rules? One share one vote principle? New European corporation forms? Total right for transfer of seat? Cartesio pending in the ECJ Race to the top or race to the bottom?

104 104 Corporate governance in Finnish law: Comparison Partnerships Limited partnerships Limited liability companies Cooperatives

105 105 Partnerships and limited partnerships no statutory organization models in FPA the partners have a right to agree on the organization each partner with unlimited liability, in that capacity, has a right and a duty to act partners with unlimited liability have a veto-right actions affecting the basis of collaboration unanimity (limited partners included)

106 106 Limited liability companies Separation of powers General meeting Management Board of directors Managing directors (optional) Supervisory board (optional)

107 107 Limited liability companies Board of directors Mandatory All corporate matters other than those vested in the hands of the shareholders at a general meeting Fiduciary duties Business judgment rule

108 108 Limited liability companies General meeting Only matters specifically mentioned in the CA Transfer of powers of the directors Articles of Association Unanimous shareholders in casu

109 109 Limited liability companies Optional organs Supervisory board if so stipulated in the Articles Managing director Two- or three-tier management affects the division of powers between the organs responsible for the management

110 110 Limited liability companies Finnish corporate governance code 2008 Listed companies Board committees Audit committee Nomination committee Remuneration committee

111 111 Cooperatives Approximately similar to a company Meeting of the Members The by-laws may transfer the powers to a body called the Representatives Default rule: one member-one vote Board of directors Managing director (optional) Supervisory board (optional)

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