COMPARATIVE COMPANY LAW AND CORPORATE GOVERNANCELectures on Company LawProf. Jukka MhnenOctober 2012

OIKEUSTIETEELLINEN TIEDEKUNTA

*Lectures on company lawJukka Mhnen: Comparative Company Law and Corporate GovernanceWed 10.10.2012 1620P722Thu 11.10.20121619P673Fri 12.10.20121619 P673Seppo Villa: Corporate FinanceTue 16.10.20121013 P674Wed 17.10.20121013 P722Thu 18.10.20121014(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 governanceAimsTheoretical basis of modern company law and corporate governance: contract and agency theory, governance modelsHistory of company law and corporate governance and company law familiesGeneral structure of EU company law

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

*Corporate FinanceAimsThe structure of corporate financeThe distinction between equity and loansMezzanine finance: subordinated loans, preferred sharesThe annual accounts

*Corporate financeThe doctrine of capital maintenanceDistribution of fundsCreditor protection: solvency and balance sheet testsLiteratureKraakman 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 basisMainstream corporate law paradigmKraakman et al. (2009)End of history of corporate lawHenry Hansmann & Reinier Kraakman: The end of history for corporate law. Georgetown Law Journal, 439468 (2001)

*Theoretical basisCritique against mainstream paradigmAdolf 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 paradigmEmphasis on contracting and self-regulationBasis on microeconomics: theory of the firmNexus of contracts theoryPrincipal agent theoryShareholder primacy

*CritiqueManagerialismExpert management the corporate strategic centre in a bureaucratic hierarchyStakeholder primacyDuty of managers and directors to take into consideration the interests of non-shareholder constituencies having stakes in the company as important as those of shareholdersDirector primacyThe board of directors a central, independent decision-maker mediating competing stakeholder interests and allocating the firm surplus among them

*Important to rememberLong history of corporate lawRoman law: familia, peculium, societas, societas publicanorumMedieval law: societas, compagnia, commenda, guildsEarly modern time: great companiesDutch East Indian Company (VOC)English East Indian Company (EIC)Modern regulationca 1850-

*Historical theories on company lawFiction theoryOrganic theoryAggregate theory

*Fiction theoryCompany a state-created legal fiction only, without substantial reality or own free willPublic goodBasis: state concessionGerman variant: Friedrich von Savigny, Karl PuchtaU.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

*Organic theoryCompany a real entity having a separate existence from its shareholdersCompany a naturally occurring beingGerman variant: Georg Beseler, Otto von GierkeU.S. variant: Ernst Freund: The legal nature of corporations (1897)InfluenceManagerialism: Berle & Means (1932)

*Aggregate theoryCompany formed by voluntary private contractingBasis: contract theoryGerman variant: Rudolf von Ihering (interest theory)U.S. variant: Victor Morawetz: Private corporations (1886), Charles Beach: The Law of Private Corporations (1891)

Aggregate theoryInfluenceShareholder 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, 247328 (1999)*

*Company law regulationcontract lawcorporate agreement, by-laws, articles of association etc.specific company legislationlegal personalitylimitations of stakeholder responsibilitiesjoint and self-regulationcorporate governance codespublic supervisiongeneral: eg Companies House, Finnish Board of Patents and Registrationsecurities markets: eg. SEC, FSA

*Comparative approachThree legal familiesAnglo-AmericanContinental European (French-Germanic)ScandinavianHarmonization of EU company law

*Comparative approachDifferent views on the scope of company lawRelation to other branches of lawcontract lawsecurities lawlabour lawenvironmental lawtax lawadministrative lawbasic and human rightsfour freedoms in the EC TreatyDifferent kinds of corporate forms

*Comparative approachTypical corporate formspartnershipslimited partnershipscompany limited by sharesprivate (ltd, GmbH, SARL, SAS, ApS)public (plc, AG, SA, AS)cooperatives non-profit organizationscivil law foundationscf. trust and its European counterpartscharitable companiesassociations

*European harmonizationChanges in British company lawConvergence to Continental company lawAmericanization of EU company law during the last decade

*French-German systemCivil lawEmphasis on the legislator and jurisprudenceInefficient role of courts as rule makersDebt financeEmphasis on creditor protectionWeak shareholder rights against directors Strong dividend rights (substitution hypothesis: weak shareholder protection is compensated by dividends)

*French-German systemExample: German Aktiengesellschaft (AG)Two-tier systemVorstand (board)Aufsichtsrat (supervisory board)Strong creditor protectionHausbank systemGrowing importance of securities marketsKodex

*Scandinavian systemFrench-German basisLegal realismCourts as law-makersStronger role of equity financing than in French-German system but weaker than in Anglo-American worldModern legislationNorway 1997Sweden 2005Finland 2006Denmark 2009

*Scandinavian systemPoints to be rememberMultiple voting rightsCf. GermanyEqual treatment of shareholdersCf. Anglo-American law

*Anglo-American systemStatutory law like in Continental and Scandinavian countriesCommon law: courts as law-makersCodification of case law in statutory lawEquity financingStrong role for securities marketsStrong investor protectionStrong shareholder rights against directors

*Anglo-American systemUK: 2006 Companies ActSME approachEnlightened value maximizationUSState legislationFiduciary duties and business judgment ruleCorporate law competition: Delaware

*Americanization of European lawRecent trends in EU company lawNational law: the new 2006 Finnish Companies ActRevlon duties: directors duties in takeoversBusiness judgment rule in duty of care

*EU company law4 RegulationsEuropean Economic Interest Groupings (EEIG, 1985)European Companies (SE, 2001)IAS/IFRS Standards (IAS Regulation, 2002)European Cooperative Societies (SCE 2003)

*EU company law13 DirectivesOld directivesDisclosure (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)

*EU company lawNew directives US impactTakeovers (13th Dir., 2003)Transparency (2004)Cross-border mergers (10th Dir. 2005)Auditing (new 8th Dir, 2007)Shareholders rights (2007)

*European corporate formsEuropean economic interest grouping (EEIG)primarily a cross-borderpartnership or joint venturedepending on the applicable law eg. Finnish law: rules of a partnershipEuropean public company (SE)cross-border public company limited by sharesFinnish law: rules of a plcEuropean cooperative society (SCE)cross-border cooperative societyEg Finnish law: rules of a cooperative societyEuropean private company (SPE)

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

*Main featuresfull legal personalitylimited liabilityrecidual rightsseparation of control and ownershipfree transfer of shares

*Legal personalityEnables 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)

*Legal personalityThree elementsProtection of creditors from shareholdersProtection of company from shareholders creditorsProtection of corporate creditors from shareholders creditorsWeak formsPartnershipStrong forms Limited liability company

*Legal personalityState intervention necessary to achieve protection of corporate assets from shareholders creditorsTransaction costs!Negotiations between every shareholders and every creditorMoral hazard!Free transfer of sharesAsymmetric information

*ProsReduction of potential creditor information costsreduction of creditor monitoring costsreduction of management agency costsreduction of administrative costs of bankruptcyReduction of amount of inefficient bankruptciesProtection of going concern value

*ProsEnables capital accumulation and investment diversificationIncreases transfer of sharesCf partnershipShareholders creditorRight to corporate assetsRight to share

*ConsDebtor opportunism and moral hazardRisk premiumShareholders creditors!Enforcement costsA sophisticated bankruptcy systemWeak legal personality

*ConsIlliquid investmentsDispersed ownershipFree transfer of shares!Exploitation by controlling personsOpportunistic behaviour of controlling shareholders and directorsProblem of private benefits

*Private benefitsPecuniary private benefits v non-pecuniary private benefitsSee 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 valuePolitical influenceSocietal status

*Legal toolsFiduciary duties: directors and controlling shareholdersEqual treatmentDerivative suitsMarket for corporate control

*Limited liabilityOwner shieldingShareholders protected from corporate creditorsNot very importantCf. partnershipNot necessary for free transfer of sharesDirectors competence: agency

*Limited liabilityNot problematic for creditorsContractual protection eg control covenantsRisk premiumWeak creditors and non-contractual creditorsFree-riding

*OtherRecdual rightsAgainst opportunistic partial liquidation before total liquidationSeparation ownership and controlAgency problemFree transfer of sharesLegal personality

*Main features exceptions recidual rights belong to the shareholders v. charitable companiesfull legal personality v lifting the corporate veilmoral hazardfree transfer exceptions for private companies

*Main features exceptionsSeparation of control and ownership: lots of variationsshareholders meeting v board of directorsboard of directors v general managerboard of directors v supervisory boardone tier two tier one and a half tier two and a half tier systems

*Historical developmentsFour basic modelsmanager-orientedlabour-orientedstate-orientedshareholder-oriented

*Manager-oriented modelUnited States ca 1930-1970power vested with independent professional managementbest possibilities to govern the company for the benefit of the societycf. corporate social responsibilityif no control danger of opportunistic behaviorprincipal agency problem

*Labour-oriented modelthe most important stakeholder: the employees (=trade unions) Germany after WWIIMitwirkungsrechtin AG supervisory boards (Aufsichtsrat)

*Labour-oriented modelEUproposal for the 5th directive 1983British resistancesee however directives attached to the SE and SCE Regulations and cross-border directives on employee participation

*State-oriented modeldirect government intervention on firms governancecontrol vested with the state bureaucracy instead of owners or managementFrance and Japan after WWII

*State-oriented modelToolsdirect state ownershipregulation of foreign investmentslicence systems and other restrictions for competitioncriminal and adminstrative law sanctions (cf. private law sanctions)

*Shareholder oriented modelIn the United States, from the 1960sOther parts of the world, from the 1980s and 1990s

*Why dominant?US dominance in the global marketsweakening of German and Japanese economicscritique against state ownershipfinancial reporting by quarters instead of fiscal yearscritique against public regulation from the 1980s

*Shareholder primacyMain idea shareholder primacy: the shareholders have a special role among the corporate stakeholdersemphasis on contracting and self-regulationtheoretical basis: principal agent theory

*Theoretical basisTheory of the firm (Akerlof, Fama, Jensen, Meckling)Agency theoryPrincipal-agent theory: problem of asymmetric informationIncomplete contracting theory: problem of transaction costsOrigins in large profit-making firmsHow to govern the relationships between management and shareholders?

*Principal agency theoryMain featuresAgencyAsymmetric informationIncomplete contractingMoral hazard (opportunism)Legal toolsFiduciary dutiesTransparency

*Principal agent theory in a companyA firm is nexus of contractual input and output relations between the firms stakeholdersFrom this point of view, a firm does not have owners in the traditional senseShareholders input only one among other contractual parties, eg creditors

*Special role of shareholdersShareholders carry the residual risk on the firmThe most vulnerable stakeholder group for management opportunismThe most vulnerable of all: the minority shareholdersManagement opportunismControlling shareholder opportunismHow to prevent opportunism?

*Principal agent relationshipThe board of directors: agents of shareholders monitoring the managementThe board must be seen as the agent for all shareholders and shareholders onlyDirectorss duties to and only to shareholdersFiduciary duties: duty of care and duty of loyaltyCompany interest = Shareholder interest

*Division of control rightsIn a company with no controlling shareholders: the directors own the company by controlling it without hearing the investorsdirector primacyNew interest conflict between the directors and the shareholders: the directors have the control but not a residual risk no incentives to maximize the residualOther two interest conflict relationshipsControlling sharreholders v the minority shareholdersShareholders v creditors

*Corporate governanceHow to solve the interest conflicts between shareholders v directors and controlling shareholders v minority shareholdersHow the shareholders ensure that the directors serve shareholders without opportunism?How the minority can trust the controlling shareholders?

*Corporate governanceProblems to be solvedInformation asymmetry: Efficient monitoring?TransparencyToolsLegal rulesSelf-regulationShareholders decisionsInformation duties

*Main question: How to monitor?The essential role of intermediariesAuditorsAnalystsRating agenciesDuty to verify agent information on behalf of principalsMoral hazardEnronFinancial crisis

*Importance of informationTransparency rulesBalances information asymmetry between principals and agentsEnables efficient markets for corporate governance

*Creditor protectionPrimarily an insolvency law not company law problemContinental and Nordic company law: main focus in company law efficient? Change of focus in company law reforms:Creditor protection shareholder protection

*Capital maintenance rulesDistribution rulesBalance sheet testsSolvency testsMinimum capital rulesMaintenance of going concern valuePrevents partial liquidations nad so moral hazard

*Protection of other stakeholdersDistribution rulesLifting the corporate veilLabour lawEnvironmental lawInsolvency law

*Example: Finland1978 Companies Act: State-oriented modelState-controlled firmsLicencing systemsRestrictions to foreign ownershipEmployee representation: labour law

*Example: Finland2006 Companies Act: Shareholder primacyInvestor protectionFreedom of contractCreditor protectionEx post protection of shareholders

*Critique towards shareholder primacyDirector primacyStakeholder primacy

*Director primacyThe company is a a nexus of firm-specific investmentscomplex productive activity involving many parties where the resulting output is generally neither separable nor individually attributable to original contributors = team productionPurpose of the companymaximize total corporate returnssatisfy group-specific stakeholder returns so that commitment to team production is sustained

*Director primacyThe board mediates the competing interests of different team membersThe company itself the principalDuty of the board to maximize the sum of all risk-adjusted returns enjoyed by the team membersDirectors fiduciary duties towards all risk-bearing stakeholders: business judgment ruleProblems?

*Stakeholder primacyThe board and the management balance the needs of all corporate constituents = stakeholder communityCommunitarianismStakeholders representation rightsProblems?

*Corporate social responsibilitySustainable developmentEconomic responsibilitiesEnvironmental responsibilitiesSocial responsibilitiesTest of theoriesShareholder primacyDirector primacy

*Corporate social responsibilityShareholder primacyEnlightened value maximization: Long-term interest of the shareholdersSpecific corporate law duties towards stakeholders, communities, environment?Director primacyThe board mediating the conflicting interests of team membersCommunitarianismPublic interestExample: Human right risks

*Human right risksExamplesLegal risk from human right violationsRisks from tarnishing brands and reputationOperational risk from weakening competitivenessCan shareholder primacy solve these problems?

*Example of European company law: FinlandGeneral aspects of Finnish corporate lawNational commercial corporate formsPartnershipLimited partnershipCo-operative societyPrivate companyPublic companyEuropean corporate formsEuropean economic interest grouping (EEIG)European company (SE)European co-operative society (SCE)Not very popular in Finland, you may say

*BackgroundGeneral aspectsNo limited liability parnership (Kommanditaktiengesellschaft) problem for private equity/venture capitalBasically same rules for both private and public companiesNo GmbH/SARL/SAS corporation formsAll companies governed by the Finnish Companies Act of 2006 (FCA)Tax rules create incentives to use private company for all kinds of businessProblems for medical, law and accounting firms

*BackgroundHistory of Finnish corporate lawPartnerships and limited partnerships based on medieval Continental practicesPartnership law codified in the Commercial Code of 1734Limited partnership law codified in the Limited Partnerships Decree of 1864Now both codified in the Partnerships Act of 1988 (FPA)Co-operative law based on Swedish modelsEspecially Co-operatives Act of 1954New Co-operatives Act of 2001 influenced by Companies Act of 1978

*BackgroundHistoryFirst Companies Decree of 1864 based on French Code de commerce of 1807Concession principleCompanies Act of 1895 based on Swedish, German and French lawRegistration principleCompanies Act of 1978 heavily based on Swedish Companies Act of 1975Based on Swedish Companies Act of 1944Implementation of EC Company Directives in 1997Different solutions in Sweden and Finland: end of copying Swedish lawWhy?

*Finnish Company Law TheoryBased traditionally on German and Swedish doctrineFiction theoryOrganic theoryChange in the paradigm in mid-1990sLaw and economics approachTheory of the firmPrincipal agency theoryShareholder value maximizationAmericanization of Finnish corporate law academia

*Change in the marketsGreat depression in the early 1990sBank crisisDiminishing influence of banks in Finnish listed companiesFinnish securities markets openedEuropean Economic AreaBarriers to hinder foreign investments broken downReform of Finnish Securities Markets ActFrom Hausbank system to Berle & Means companiesDispersed international ownership in many major listed companies

*Change in the Legal StructureMember of the EEA in 1994Member of the EU in 1995Implementation of EC company lawNeed for total evaluation of Finnish company lawResult: Companies Act of 2006

*Goals of the FCAAdaptation in changes in intl cross-border financial marketsChanges in the economic environment of Finnish firms: towards competitive marketsHow to reach these goals? Totally new and competitive Companies Act: Race to the top

*Goals of the FCAMore possibilities for Finnish firms both domestically and internationallyEffective protection to minority shareholders and creditorsSuitable for SMEsDecrease of minimum share capital from 8,000 euros to 2,500 eurosAnswers to challenges created by changes in legal environmentEspecially the IFRS

*How to reach the goals?Less and lighter formalitiesPrinciple-based approachMore emphasis on freedom of contractOn the other hand: idea of the Companies Act as a standard form contractComprehensive collection of non-mandatory default rulesTheoretical background: firm as nexus of contracts (Jensen & Meckling)

*How to reach the goals?Change in the ideology of minority and creditor protectionFrom ex ante approach to ex post approachFrom invalidity to damagesModernization of legal language

*Changes in practiceHowever, not a revolution but more fine-tuningRevising bad written lawDivision rulesCodifying best practicesFast and easy incorporationNew possibilities, e.g., for M&AsTriangular mergersChange of corporate formCompany partnershipCompany limited partnershipCompany co-operative

*Principle-based approachDifficult principal agency problems solved used by principlesDiscretion of shareholders (FCA 1:9): freedom of contractPurpose of the company (FCA 1:5): shareholder valueEqual treatment of shareholders (FCA 1:7)Fiduciary duties (FCA 1:5)Interpretation: Towards U.S. law

*Discretion of shareholdersRight to deviate the default rules by using articles of associationNot the mandatory creditor protection rulesUnanimous shareholders candeviate non-mandatory law and articles of associationact in writing instead of holding general meetings

*Shareholder valueIdea of enlightened shareholder value maximizationMichael JensenCf. The UK Companies Act of 2006Exception when the company is on sale: Revlon dutiesProblem: How to implement corporate social responsibility?

*Fiduciary dutiesDuty of careDuty of loyaltyBusiness judgment ruleClearest sign of direct U.S. influence in the FCA

*Minority protectionEqual treatment of all shareholdersRight for derivative suit for all shareholder when the principle is grossly violatedIn other cases: 10 % minorityNo right for indirect loss (no incentive for opportunism)

*Minority protectionOn 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 provisionAdaptation of the provision requires shareholders unanimityDoes not cover violations of mandatory rules of the FCA (creditor protection rules)Does not cover losses caused deliberately or through gross negligence

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

*Corporate governanceOne tier system as a general ruleNegative attitudes towards supervisory boardsToo negative? Alternative for board committeesAmerican way in nominating board member candidates for the general meetingNomination committee of the boardHowever, important exceptions use the Swedish modelNominated by the controlling shareholdersE.g., the State-controlled listed companies

*Is the new law a success?Who knows but yearly incorporations have been increased by 60 % after the new law was introduced83 % of the new companies without par value

*ChallengesStill need for more flexibility for SMESProblems from one law fits for all ideology still existsHow to interpret the duty of loyalty?the business judgment rule?the solvency test?Special problems in takeoversWhat kinds of poison pills are applicable?Interpretation of fiduciary duties of the directors of the target companyHelsinki Takeover Code

*ChallengesNo clear doctrine onpiercing the corporate veilfiduciary duties of the controlling shareholdersNo case law yet

*ChallengesBut the most important oneNo clear picture of the future of EU company lawReform of capital maintenance rules?One share one vote principle?New European corporation forms?Total right for transfer of seat?Cartesio pending in the ECJRace to the top or race to the bottom?

*Corporate governance in Finnish law: ComparisonPartnershipsLimited partnershipsLimited liability companiesCooperatives

*Partnerships and limited partnershipsno statutory organization models in FPAthe partners have a right to agree on the organizationeach partner with unlimited liability, in that capacity, has a right and a duty to actpartners with unlimited liability have a veto-rightactions affecting the basis of collaborationunanimity (limited partners included)

*Limited liability companiesSeparation of powersGeneral meetingManagementBoard of directorsManaging directors (optional)Supervisory board (optional)

*Limited liability companiesBoard of directorsMandatoryAll corporate matters other than those vested in the hands of the shareholders at a general meetingFiduciary dutiesBusiness judgment rule

*Limited liability companiesGeneral meetingOnly matters specifically mentioned in the CATransfer of powers of the directorsArticles of AssociationUnanimous shareholders in casu

*Limited liability companiesOptional organsSupervisory boardif so stipulated in the ArticlesManaging directorTwo- or three-tier management affects the division of powers between the organs responsible for the management

*Limited liability companiesFinnish corporate governance code 2008Listed companiesBoard committeesAudit committeeNomination committeeRemuneration committee

*CooperativesApproximately similar to a companyMeeting of the MembersThe by-laws may transfer the powers to a body called the RepresentativesDefault rule: one member-one voteBoard of directorsManaging director (optional)Supervisory board (optional)