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COMPARATIVE COMPANY LAW AND

CORPORATE GOVERNANCE
Lectures on Company Law
Prof. Jukka Mhnen
October 2012

Lectures on company law


Jukka Mhnen: Comparative Company Law and Corporate
Governance
Wed 10.10.2012 1620 P722
Thu 11.10.2012 1619 P673
Fri 12.10.2012 1619 P673
Seppo Villa: Corporate Finance
Tue 16.10.2012 1013 P674
Wed 17.10.2012 1013 P722
Thu 18.10.2012 1014 (12.15 14:00 exam) AUD XII (Main
building)
Re-exam day: public exam day 20.11.2012 Place: PI Time:
09:00

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

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

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

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

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, 439468 (2001)

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, 294314 (2010)

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, 201262 (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

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, 305360 (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
Shareholders 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
Recdual 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

51

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

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

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

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

Shareholder oriented model


In the United States, from the 1960s
Other parts of the world, from the 1980s and
1990s

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

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

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

Principal agency theory


Main features
Agency
Asymmetric information
Incomplete contracting
Moral hazard (opportunism)
Legal tools
Fiduciary duties
Transparency

60

Principal agent theory in a company


A firm is nexus of contractual input and output
relations between the firms 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

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

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
Directorss duties to and only to shareholders
Fiduciary duties: duty of care and duty of
loyalty
Company interest = Shareholder interest

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

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

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

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

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

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

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

Protection of other stakeholders


Distribution rules
Lifting the corporate veil
Labour law
Environmental law
Insolvency law

71

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

72

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

73

Critique towards shareholder primacy


Director primacy
Stakeholder primacy

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

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 riskadjusted returns enjoyed by the team members
Directors fiduciary duties towards all risk-bearing
stakeholders: business judgment rule
Problems?

76

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

77

Corporate social responsibility

Sustainable development
Economic responsibilities
Environmental responsibilities
Social responsibilities
Test of theories
Shareholder primacy
Director primacy

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

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

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

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

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

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

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

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

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

Goals of the FCA


Adaptation in changes in intl 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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Corporate governance in Finnish law: Comparison


Partnerships
Limited partnerships
Limited liability companies
Cooperatives

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

Limited liability companies


Separation of powers
General meeting
Management
Board of directors
Managing directors (optional)
Supervisory board (optional)

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

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

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

Limited liability companies


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

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)