Shareholder Activism and the Law

The Future of US Corporate Governance

Ekrem Solak

• Publisher: Taylor & Francis
• Year: 2020
• eBook ISBN: 9781000069747
• Edition: 1
• Topic: Droit
• Subtopic: Finances d'entreprise

This book provides a complete framework for contemporary shareholder activism and its implications for US corporate governance, which is based on director primacy theory.

Under director primacy theory, shareholders do not wish to be involved in the management of the company; in the rare event that they wish to be involved, it is considered a transfer of power from the board of directors to shareholders, which in turn reduces the efficiency of centralised decision-making in public companies. However, this book demonstrates that shareholders do not use their power to transfer corporate control from the board to themselves, and that some form of shareholder activism is even collaborative, which is a new paradigm for US corporate governance. This book shows that while monitoring remains a key contribution of shareholders, they also bring new informational inputs to corporate decision-making that could not be obtained under the traditional board model. Accordingly, contemporary shareholder activism enhances the board's decision-making and monitoring capacity, without undermining the economic value of the board's authority. Therefore, this book argues that the complete approach of contemporary shareholder activism should be accommodated into US corporate governance. In doing so, this book considers not only legal and regulatory developments in the wake of the 2007–2008 financial crisis, but also the governance developments through by-law amendments. Furthermore, the author makes several recommendations to soften the current director primacy model: establishing a level playing field for private ordering, adopting the proxy access default regime, the majority voting rule, the universal proxy rules, and enhancing the disclosure requirements of shareholders.

The book will be of interest to academics and students of corporate governance, both in the US and internationally.

1 Introduction

1.1 Background to this research

The primary aim of this research is to examine the question of whether director primacy theory should be softened to accommodate greater shareholder activism in US corporate governance. In doing so, this study builds a theoretical framework for the evolving role of shareholders in the US to analyse how the role of shareholders has been incorporated into practice in the US and to examine whether it should be further accommodated into US corporate governance. Under US corporate governance, directors are vested with authority to manage the company. The board of directors is generally protected from shareholder interference; therefore, US corporate governance is described as one that adopts the director primacy theory as the best means to ensure shareholder wealth. However, there have been significant market and policy developments that incentivise and encourage shareholders to participate in the management of companies. This causes tension between directors and shareholders in the US. This research, therefore, investigates whether shareholders should be further accommodated into US corporate governance by considering the potential benefits and side effects of shareholder activism.

In its simplest definition, corporate governance is a ‘system by which companies are directed and controlled’.¹ It contains a combination of legal rules and principles which have been developed over time and are based on the distinctive features of each nation’s legal and financial tradition.² If one needed to categorise corporate governance systems, it could be done under two major types: the ‘outsider’ (Anglo-American) and the ‘insider’ (continental European) models.³ The primary differences between these dichotomous corporate governance models are the share ownership structure of public companies and their predominant objectives of public companies.⁴ With regard to the share ownership of companies, in outsider corporate governance models, shares of large companies are usually held by widely dispersed shareholders and this contrasts with companies in continental Europe and the insider model where large companies tend to have a controlling shareholder.⁵ The ownership of shares is, therefore, separated from the control in outsider corporate governance models. As regards the objectives of public corporations, in outsider corporate governance models the maximisation of shareholders’ wealth prevails as the fundamental objective of public corporations, while in insider corporate governance models, corporations tend to embrace the interests of different stakeholders such as employees, creditors, and suppliers.⁶

1 Cadbury Committee, Report of the Committee on the Financial Aspects of Corporate Governance (Gee 1992) para 2.5.

2 Thomas Clarke, International Corporate Governance: A Comparative Approach (Routledge 2007) 170.

3 See, Christine Mallin, Corporate Governance (4th edition, Oxford University Press 2013) Chapter 10; Ruth Aguilera and Gregory Jackson, ‘The Cross-National Diversity of Corporate Governance: Dimensions and Determinants’ (2003) 28 Academy of Management Review 447.

4 Aguilera and Jackson (n 3); John Armour, Simon Deakin and Suzanne Konzelmann, ‘Shareholder Primacy and the Trajectory of UK Corporate Governance’ (2003) 41(3) British Journal of Industrial Relations 531, 533; Ruth Aguilera, ‘Corporate Governance and Director Accountability: an Institutional Comparative Perspective’ (2005) 16 British Journal of Management 39.

5 Cynthia Williamson and John Conley, ‘An Emerging Third Way? The Erosion of the Anglo-American Shareholder Value Construct’ (2005) 38 Cornell International Law Journal 493, 498; Aguilera and Jackson (n 3), 448–450; Ruth Aguilera et al, ‘Putting the S Back in Corporate Social Responsibility: A Multi-level Theory of Social Change in Organisations’ (2007) 32(3) The Academy of Management Review 836, 845.

6 See Andrew Keay, ‘Tackling the Issue of the Corporate Objective: An Analysis of the United Kingdom’s “Enlightened Shareholder Value Approach”’ (2007) 29 Sydney Law Review 577; Aguilera et al (n 5) 836–863.

The similar ownership pattern and objectives of public companies gave rise to the implicit assumption that there is a unified and stable Anglo-American corporate governance model. This assumption is rightfully challenged in the literature on the grounds of its failure to take into account the allocation of powers between shareholders and directors.⁷ In this respect, a further distinction is made between director primacy and shareholder primacy, depending on whether directors or shareholders should have ultimate control over corporate affairs.⁸ US corporate governance is better described by the notion of director primacy, while the UK follows the shareholder primacy model.⁹

The core tenet of US corporate governance is its trust in directors and the limited role for shareholders. ‘Shareholders exercise virtually no control over either day-to-day operations or long-term policy’.¹⁰ The board of directors is vested with managerial power to make the vast majority of corporate decisions. As Bainbridge argues, ‘corporation law virtually carves the separation of ownership and control into stone’.¹¹ Likewise, Delaware’s traditional approach to companies has been described by the leading judges of the Delaware Court as follows:

7 Stephen Bainbridge, ‘Director v. Shareholder Primacy in the Convergence Debate’ (2002) 16 The Transnational Lawyer 45.

8 Stephen Bainbridge, The New Corporate Governance: In Theory and Practice (Oxford University Press 2008); Stephen Bainbridge, ‘Director Primacy: The Means and Ends of Corporate Governance’ (2003) 97 Northwestern University Law Review 547, 549.

9 Christopher Bruner, Corporate Governance in the Common-Law World: The Political Foundations of Shareholder Power (Cambridge University Press 2013); John Armour and Joseph McCahery, ‘Introduction’ in John Armour and Joseph McCahery (eds) After Enron: Improving Corporate Law and Modernising Securities Regulation in Europe and the US (Hart Publishing 2006) 13; Lynn Stout, The Shareholder Value Myth (Berrett-Koehler Publishers 2012) 56; Sofie Cools, ‘The Real Difference in Corporate Law between the United States and Continental Europe: Distribution of Powers’ (2005) 30 Delaware Journal of Corporate Law 697.

10 Bainbridge (n 7) 46.

11 Bainbridge, The New Corporate Governance (n 8) 4.

The notion that stockholders should have the power to disrupt the functioning of the republic whenever they see fit is viewed as fundamentally inconsistent with the Delaware model of the corporation … [T]he election of directors is the one area in which stockholders may act affirmatively … [T]he normative appeal of this analogy to republican democracy is limited, however, by the realities of the corporate election process. One fundamental reality is that the annual election process is tilted heavily towards management and does not operate in a way that encourages genuine choice or debate.¹²

Shareholder participatory rights are considered so weak that ‘they scarcely qualify as part of corporate governance’.¹³

Legal constraints that prevent shareholders from exercising control and influence over the board and management are supplemented by economic factors. Shareholder activism is generally assumed to be prohibitively expensive for shareholders because any benefit flowing from activism will be equally shared amongst shareholders, while the cost is borne by the activist shareholder. In other words, shareholders are generally assumed to be ‘rationally pathetic’ or ‘rationally passive’ because of collective action and free-rider problems.¹⁴ The limited shareholder influence over corporate decision-making is often thought to be the way it ought to be,¹⁵ given the economic efficiency of a centralised decision-making body that has power to act by fiat.¹⁶

As with all powers, directors and managers could exercise power inefficiently or to advance their own private interests. The separation of ownership and control gives rise to significant agency and accountability problems in public companies.¹⁷ Under agency cost theory, directors and managers are the agents of shareholders (principals) and manage companies on behalf of shareholders. As a result, ensuring the accountability of directors¹⁸ and addressing the agency problems became the primary concerns of company law.¹⁹

12 William Allen, Jack Jacobs and Leo Strine, ‘The Great Takeover Debate: A Meditation on Bridging the Conceptual Divide’ (2002) 69 The University of Chicago Law Review 1067, 1094.

13 Bainbridge ‘The Means and Ends of Corporate Governance’ (n 8) 569.

14 Adolf Berle and Gardiner Means, The Modern Corporation and Private Property (Transaction Publishers 2009); Frank Easterbrook and Daniel Fischel The Economic Structure of Corporate Law (Harvard University Press 1991) 65–68.

15 Jennifer Hill, ‘Visions and Revisions of the Shareholder’ (2000) 48(1) The American Journal of Comparative Law 39, 57.

16 Bainbridge, The New Corporate Governance (n 8) 38–53.

17 Michael Jensen and William Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economics 305.

18 Iris Chiu, The Foundations and Anatomy of Shareholder Activism (Hart Publishing 2010) 22.

19 Klaus Hopt, ‘Comparative Company Law’ in Mathias Reimann and Reinhard Zimmermann (eds) The Oxford Handbook of Comparative Law (Oxford University Press 2006) 1180–1186; Gordon Smith, ‘Corporate Governance and Managerial Incompetence: Lessons from Kmart’ (1996) 74 North Carolina Law Review 1059, 1054; John Armour, Henry Hansmann, and Reiner Kraakman, ‘Agency Problems and Legal Strategies’ in Reiner Kraakman et al (eds) The Anatomy of Corporate Law: A Comparative and Functional Approach (3rd edn, Oxford University Press 2017) 29.

In ensuring accountability in companies, director primacy relies heavily on the market for corporate control. Under the market for corporate control, it is usually assumed that dissatisfied shareholders exercise the monitoring function by selling shares, thereby leading to a decrease in the share price of the company and making hostile takeovers possible.²⁰ It is argued that the market for corporate control encourages managers to act ‘as if they have the shareholders’ interests at heart’.²¹ Exit, i.e. the ‘Wall Street Walk’, is regarded as a more effective way to express dissatisfaction with the management and to address accountability concerns within the corporation. The market for corporate control ha...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Table of Contents
• Acknowledgements
• Foreword
• Preface
• 1. Introduction
• 2. Corporate governance: framework and control mechanisms
• 3. Theoretical aspects of shareholder activism
• 4. The landscape of institutional shareholders
• 5. Shareholder activism in US corporate governance
• 6. Accommodating shareholder activism in the US system of corporate governance
• 7. Conclusion
• Bibliography
• Table of cases
• Table of legislation, governance codes, and principles
• Index