The AGM in Europe

Theory and Practice of Shareholder Behaviour

Anne Lafarre

• Publisher: Emerald Publishing Limited
• Year: 2017
• Print ISBN: 9781787435346
• eBook ISBN: 9781787435674
• Topic: Commerce
• Subtopic: Droit des affaires

Business, Economics and Legal scholars have all argued about the theoretical importance of annual general meetings in assessing business shareholder relations and wider issues of corporate governance, but often without knowing how the AGM functions in practice. Anne Lafarre combines wide ranging empirical legal and economic research to analyse and understand the real role of the AGM in the European businesses and corporate governance frameworks today. Focusing on seven European member states (Austria, Belgium, France, Germany, Ireland, the Netherlands and the UK) the author persuasively explores how the impact of legal rulings and business pressures effects shareholder representation in European AGMs and their propensity to affect change through these forums. Drawing wide ranging data sets to challenge existing economic and legal theory, the author presents practical conclusions and future policy implications.

PART I
INTRODUCTION

CHAPTER 1

THE LAW & ECONOMICS OF THE AGM

ABSTRACT

From a theoretical agency perspective, the Annual General Meeting of Shareholders (‘AGM’) is an important corporate law solution for mitigating agency problems between shareholders and managers in large public corporations. At the AGM, shareholders are informed, they are offered a venue to discuss and ask questions, and they are involved in decision-making. Despite these theoretical important functions, the AGM is largely criticized in practice. Criticism contains, for example, rational apathy and free-rider behaviour that lead to low shareholder turnout, a lack of (meaningful) dialogue and side-stepping behaviour. Yet, fundamental empirical research on the AGM in practice is lacking, which makes this book highly relevant. This chapter provides the outline of the research that is conducted in this book.

Keywords: Annual General Meeting of Shareholders; corporate governance; agency problem; shareholder voting; shareholder activism

1. INTRODUCTION

There is a large and ongoing debate on whether the Annual General Meeting (hereinafter: AGM¹) of shareholders is the appropriate corporate body to have decision-making powers in corporate governance (e.g., see Bainbridge, 2002, 2012, and Bebchuk, 2005, for opposite points of view). One of the key questions is whether decision-making by the AGM is optimal, or just a matter of legal formality instead. AGMs are often portrayed in the media as joyful day trips for seniors and retirees, who are offered delicious refreshments and drinks and some interesting goodies. For instance, Bremmer (2016) quotes a private shareholder attending the 2016 AGM of Unilever NV: ‘[f]or me, the main reason to attend AGMs is the nice atmosphere and the snacks. For example, the [Dutch] construction company Koninklijke BAM: they perform badly, but they have nice food and drinks, and organised a trip to the sealock in IJmuiden. The best snacks are catered at Acomo in Rotterdam, and you can even get champagne there. I also enjoy the catering at the meetings of Ahold and ING. Walking is more difficult for me lately, but for as long as I am able to do so, I will visit these meetings’ (translated by the author). The above state of affairs in (Dutch) AGMs, or ‘circuses’ per Bremmer (2016), does not correspond to their role as prescribed in corporate law.

Besides the apparent reputation for offering entertainment, the AGM faces other obstacles. Small shareholders in particular consider the costs of participating in the AGM too high and are reluctant to vote according to economic theory. Thus, turnout rates, especially of small shareholders, are generally considered to be quite low. Is advocating for enhanced shareholder participation still expedient? The European Commission (EC) seems to think so, following its proposal to amend the Shareholder Rights Directive (Directive 2007/36/EC²). With this proposal, which was published in an amended version in the Official Journal of the European Union on 20 May 2017 after the legislative procedure,³ the EC is aiming at increasing shareholder participation in AGMs. The proposal also increases the decision-making rights of shareholders at the European level, as it includes, inter alia, a shareholder say on pay-and-large-related party transactions.

1.1. Outline of This Chapter

In short, the goal of this book is to investigate the apparent discrepancies between the legal theoretical role and the practical role of the AGM of listed companies, and whether and how its functioning may be enhanced. For this, we largely focus on shareholder turnout. In this introduction chapter, we provide an elaborated introduction to the discussion of the role of AGMs and shareholder decision-making from a law and economics perspective, starting with the agency theory in the next section. We discuss the AGM’s theoretical role in Section 3 and its apparent practical (economic) problems in Section 4. In Section 5, we (briefly) discuss why shareholders have control rights. Finally, in Section 6 we provide the research outline for this book including the research methods.

2. THE AGENCY THEORY AND CORPORATE GOVERNANCE

Virtually every study to date in the field of corporate governance refers to the agency theory. This book is no exception in this respect. Agency theory lies at the heart of corporate governance, but relationships between principals and agents exist in many other situations as well: agency theory is directed at any relationship in which one party – the principal – delegates work to another one – the agent. As Sappington (1991) points out, the central question in these kinds of relationships is how the principal can motivate the agent to perform as the principal would prefer, while keeping in mind that monitoring is generally costly. Agency theory focuses on the optimal structure of a contract to govern such a relationship and has frequently been used in many fields.

There is also an agency relationship between owners and managers in large public corporations. Shareholder decision-making regarding corporate strategy would be largely inefficient due to coordination failures, and hence these powers are usually delegated to a board of directors (also described as the fourth fundamental characteristic of corporations by Hansmann & Kraakman, 2009). Nonetheless, economists have paid no attention to the internal organization and decision-making of companies for quite a long time. Only in the 1930s did economists consider looking inside the corporate ‘black box’. Before this time, how and why firms operated in the market in the first place and how decisions were made was not considered to be important. This thinking changed when economist Ronald Coase developed his theory on transaction costs in his seminal article “The Nature of the Firm” in 1937. Per Coase (1937), ‘economists in building up a theory have often omitted to examine the foundations on what it was erected’ (p. 386). It was about time to consider the meaning of the term ‘firm’, as price theory offered ‘a very incomplete picture of our economic system’ (Coase, 1937, p. 387). Accordingly, Coase made a distinction between transactions via markets and organizations and argued that transactions take place within an organization if the transaction costs of the market are too high (i.e., when the price is far from a sufficient statistic; also see Demsetz & Lehn, 1985; Shleifer & Vishny, 1986; Williamson, 1981). At the margin, the costs of organizing within the firm will be equal either to the costs of organizing in another firm or to the costs involved in leaving the transaction to be ‘organized’ by the price mechanism.

This theory of transaction costs was the first theory that dealt with the existence of firms or other organizations and their internal structure. Firms had become more than just a ‘black box’ in academic literature. In their seminal article, Jensen and Meckling (1976) further developed the theory of the firm. According to these authors, a theory that explained how the conflicting objectives of individual actors within a firm were brought into equilibrium did not yet exist. Prior to Jensen and Meckling’s research in 1976, a consensus already existed regarding the fact that because of the separation of ownership and control as described by Berle and Means (1932), in public companies the interests of shareholders did not completely overlap with those of directors and managers, and that managers did not always serve shareholder interests. For example, Adam Smith already referred to this matter in his famous book The Wealth of Nations. Jensen and Meckling (1976) brought the agency theory in the corporate field to the next level and explained in their research that the principals (i.e., shareholders) and the agent(s) (i.e., the director or board of directors, or in economic literature often referred to as managers) generally will incur positive monitoring and bonding costs. Next, there will be some remaining divergence between the agent’s decisions and those decisions which would maximize the welfare of the principal. Jensen and Meckling call this cost to the principal the ‘residual loss’ (p. 308).

Firms were not alone in being considered black boxes for a long time as ownership structures were not entirely discussed too, especially in civil law countries. Although the world seem to have assumed for a very long time that the model of dispersed ownership of American companies as described by Berle and Means (1932) was the prevalent corporate model, nowadays scholars seem to agree that this is not a common model in every country. The fact that ownership patterns in continental Europe and Asian countries are more concentrated than in Anglo-Saxon countries (e.g., Van der Elst, 2008; also see Franks & Mayer, 1995; La Porta, Lopez-de-Silanes, & Shleiffer, 1999; La Porta, Lopez-de-Silanes, Shleiffer, & Vishny, 1997, 1998) is considered a stylized fact. The differences in ownership structures have important implications for corporate governance; one can identify problems of conflicting goals and opportunistic behaviour not only between managers and shareholders but also in the relationships between small shareholders and controlling blockholders (also see Becht & Roëll, 1999). The presence of blockholders can add agency costs due to an increased risk of private benefit extraction. Blockholders may have incentives to use their majority stake to maximize their private benefits instead of the total value for all shareholders. For example, these shareholders may have incentives to forego profitable investment opportunities if for these investments additional external funds are required because this would mean a dilution of their controlling stake. Another example of opportunistic behaviour that is often mentioned by scholars is the situation where a large shareholder negotiates a cheap loan with the company, for example, with an interest rate below the market rate (also referred to as ‘tunnelling behaviour’). It is important to note that the smaller the de facto controlling stake of the blockholder is, the larger the benefits of opportunistic behaviour at the company’s expense. Thus, minority shareholders need to monitor not only the behaviour of the board of directors but also of the blockholders to be able to counter or prevent this possible opportunistic behaviour.

Nevertheless, the conclusion that concentrated ownership equals inefficient opportunistic behaviour is certainly not correct in every case. When the risk of opportunistic behaviour is lower, the presence of blockholders may decrease small shareholders’ agency costs since these small shareholders may be able to free-ride on the monitoring efforts of the large shareholders in terms of management action. In this case, the public good problem of shareholder monitoring is (partly) internalized by the blockholder (e.g., Grossman & Hart, 1980; cf. infra, chapter 12).

3. THE AGM’S THEORETICAL ROLE

Corporate law aims at mitigating agency problems in the corporate setting, thereby raising the willingness of investors to invest. First, in many countries, the supervisory board or the non-executive directors monitor the management board or executive directors on behalf of the shareholders. Second, the external auditor plays a large role in the corporate checks and balances and also the external market for corporate control is often considered (Manne, 1965). Third, a large part of direct (collective) shareholder monitoring takes place during the (A)GM. Though often only shareholder voting is taken into consideration, the role of the AGM in corporate law can be divided into three functions. First, AGMs have an information function as the board provides its shareholders with (financial) information about the company. Second, these shareholder meetings serve as a platform for shareholders to ask questions and to engage in discussions with the board about corporate matters (forum function). Third, the AGM serves the legal decision-making of shareholders regarding decisions that are outside the board’s discretion (decision-making function). The decision-making function of AGMs is often considered to be the core function of the AGM (Strand, 2012). In effect, the other functions serve the decision-making function: shareholders need to be able to make an informed voting decision, and hence need access to information. Although (regularly) disclosed information is usually very detailed – annual reports usually contain hundreds of pages – companies simply cannot provide all information about every corporate engagement to interested shareholders: there is an incomplete information problem, i.e., complete disclosure is usually far too expensive and, most of all, just not feasible. In addition, shareholders may ask for clarifications of the disclosed information. Hence, these three theoretical functions of AGMs are closely linked.

The theoretical importance of the AGM in corporate governance is widely recognized by scholars. For instance, in many corporate law books, the AGM is considered one of the most important corporate bodies and corporate diagrams often show shareholders at the top of corporate structures. According to Per De Jong, Mertens, and Roosenboom (2005), the AGM is an integral part of the corporate governance model and plays a crucial role in the realization of the powers of shareholders. And, Easterbrook and Fischel (1991) even state that ‘if limited liability is the most distinctive feature of corporate law, voting is second’ (p. 63).

4. THE AGM IN PRACTICE

Despite its large theoretical importance, the functioning of the AGM is largely criticized. Whereas some scholars even argue that the board is not a mere agent of shareholders, but serves as the nexus for corporate contracts (Bainbridge, 2002, 2012) and that shareholder voting only undermines the role of the board as a central decision-making body (Bainbridge, 2012), others question the position of the AGM as a means to shareholder primacy. In the next sections, we provide a brief overview of the different (economic) problems that are mentioned in the literature regarding AGMs, including rational apathy and free-rider problems, lack of dialogue and side-stepping behaviour.

4.1. Rational Apathy and Free-Rider Problems

Low attendance rates, especially of small shareholders, usually referred to as ‘shareholder absenteeism’, are often mentioned as a point of criticism. Economic theory provides several explanations for low shareholder attendance. Shareholders can express their discontentment with the corporate state of affairs by selling their shares and investing elsewhere (often referred to as the ‘Wall Street Walk’, e.g., see Admati & Pfleiderer, 2009). This ‘exit strategy’ is feasible for small shareholders since a small amount of shares is unlikely to have an effect on the price of the stock in a liquid market (e.g., Chakravarty & Hodgkinson, 2001). Whereas widely dispersed ownership contributes to the liquidity of the market, it also causes problems since no individual small shareholder has incentives to engage in direct monitoring (Becht & Roëll, 1999; Chakravarty & Hodgkinson, 2001). The outcome of the vote will be the same regardless of whether a small individual shareholder participates or not. In other words, the marginal effect of a small shareholder’s vote on the outcome will be insignificant. Rational shareholders weigh the marginal costs of voting against the marginal benefits and invest the amount of effort for which these benefits exceed the costs. When the benefits of voting are small (approximately zero), and voting comes at a cost, no individual shareholder would be willing to incur this cost of voting; in this case, their optimal monitoring investment will be zero (Easterbrook & Fischel, 1991). Cahn and Donald (2010) refer to this behaviour as ‘rational apathy’ (pp. 474–475), stating that shareholders may have to ‘sit down after work some evening and read a 150-page proxy statement’ (p. 474). These information costs and other costs (e.g., see Zetzsche, 2008) are assumed to contribute to low attendance rates of (small) shareholders.

A second related economic problem is the free-rider problem. In (partly) widely dispersed (‘oceanic’) ownership structures (Leech, 2002), shareholder monitoring can be considered a public good. Public goods are (i) non-rival, which means that one player consuming the good does not prevent another player from doing so as well, or does not lower the benefits of consumption for this other player, and; (ii) non-excludable, which means it is impossible or extremely expensive to prevent another player from using the good. In other words, a public good enhances the welfare of all (Samuelson, 1954). Due to the non-excludable and non-rival characteristics of shareholder monitoring, i.e., a shareholder cannot prevent other shareholders from be...

Table of contents

• Cover
• Title Page
• Part I Introduction
• Part II The Agm’s Legal Outline
• Part III Descriptive Analyses of The Agm
• Part IV Statistical Interference on The Agm’s Practical Relevance
• Part V Theoretical Analysis of Small Shareholder Behaviour
• Part VI Introduction
• References
• Case Law
• Policy Documents
• Index