COMPARATIVE COMPANY LAW AND CORPORATE GOVERNANCE

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

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

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. 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. 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. 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. 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. 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. Historical theories on company law • Fiction theory • Organic theory • Aggregate theory

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. 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. 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. Aggregatetheory • 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)

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

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

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

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

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

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

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

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

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

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. 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. Historical developments • Four basic models • manager-oriented • labour-oriented • state-oriented • shareholder-oriented

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