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Shareholder Litigation and Corporate Governance

Arad Reisberg

in Derivative Actions and Corporate Governance

This chapter is concerned with an indefinite but fundamental: what purpose lies at the heart of the company's cause of action which justifies the use of derivative actions? Section 1.2 firstly ... More

This chapter is concerned with an indefinite but fundamental: what purpose lies at the heart of the company's cause of action which justifies the use of derivative actions? Section 1.2 firstly identifies the limitations of the traditional view of the derivative action. Subsequently it explicates the relation between the derivative action and two concepts, namely ‘control’ and ‘agency costs’. Section 1.3 outlines some major techniques of accountability, which share the goal of reducing agency costs. Section 1.4 focuses on one such major alternative as it examines whether it is true that the market for corporate control may constitute an effective functional substitute for litigation. As will be seen, from a governance perspective (as opposed to a narrowly legal one), the interaction of the derivative action with the market for corporate control raises some interesting issues.Less

Explaining Western Securities Markets

Mark J. Roe

in Corporate Governance and Firm Organization: Microfoundations and Structural Forms

This chapter questions the power of law in solving CG problems and maintains that there are societal and political forces that are likely to shape governance structures irrespective of any ... More

This chapter questions the power of law in solving CG problems and maintains that there are societal and political forces that are likely to shape governance structures irrespective of any regulation. In particular, the most common configuration of those forces around the world tends to reinforce concentrated ownership no matter what laws are adopted to protect minority shareholders. The chapter presents a new regression analysis of a wide database on political indicators and ownership concentration in sixteen major countries, which supports the conjecture that political variables, in particular the degree of employment protection and trade union strength, are strong inverse correlates of ownership separation and the diffusion of public companies.Less

The Quality of Corporate Law and its Limits

Mark J. Joe

in Political Determinants of Corporate Governance: Political Context, Corporate Impact

This chapter demonstrates why the data indicates that the quality-of-corporate-law argument, although it explains transition economies nicely, is over-stated for several of the world's richest ... More

This chapter demonstrates why the data indicates that the quality-of-corporate-law argument, although it explains transition economies nicely, is over-stated for several of the world's richest nations. In too many of them, even with good shareholder protection, stock can be sold, but ownership does not separate from control. Based on the data, several nations have good corporate law, but not much diffusion and separation. These nations also have a high potential for managerial agency costs: relatively weaker product market competition and relatively stronger political pressures on managers to disfavour shareholders.Less

Agency Costs and the Nexus of Contracts

M. W. Lau

in The Economic Structure of Trusts: Towards a Property-based Approach

This chapter examines Robert Sitkoff's agency costs theory of trust law, which is derived from Michael Jensen and William Meckling's theory of the firm. Sitkoff's account of trusts consists of two ... More

This chapter examines Robert Sitkoff's agency costs theory of trust law, which is derived from Michael Jensen and William Meckling's theory of the firm. Sitkoff's account of trusts consists of two parts. The first part describes the trust as a nexus of contractarian relationships and the second part demonstrates how various trust laws reduce agency costs. This chapter argues that the trust is not a nexus of relationships; in fact, it is closer to a tripartite contract than to the web of relationships that Sitkoff describes. It then argues that most of the trust problems that Sitkoff identifies as being resolved by trust law are actually not agency cost problems, but mere conflicts of interests. Furthermore, it observes that there are many other non-legal factors influencing and incentivizing the various parties. These include social norms, reputation, and trustee remuneration. Finally, it argues that the misapplication of agency economics gives credence to apologists of the ‘trust deal’.Less

Its Limits: Theory

Mark J. Joe

in Political Determinants of Corporate Governance: Political Context, Corporate Impact

This chapter explores the limits of the theory of corporate law. It holds that the quality-of-corporate-law theory needs to be refined or replaced. Ownership cannot readily separate from control if ... More

This chapter explores the limits of the theory of corporate law. It holds that the quality-of-corporate-law theory needs to be refined or replaced. Ownership cannot readily separate from control if managerial agency costs are very high for shareholders, and law does not directly affect all managerial agency costs. Elaborate legal doctrine prohibits judicial inquiry into managers' basic business decisions. Other primarily non-legal institutions control the size of managerial agency costs, and these carry in effectiveness from firm-to-firm and nation-to-nation. Thus, corporate law can only be one-half of the central story in the understanding of why ownership does or does not separate.Less

Rents

Mark J. Joe

in Political Determinants of Corporate Governance: Political Context, Corporate Impact

Weaker product markets and the concomitant monopoly rents can affect corporate governance. They do so by loosening a constraint on managers, thereby increasing managerial agency costs to ... More

Weaker product markets and the concomitant monopoly rents can affect corporate governance. They do so by loosening a constraint on managers, thereby increasing managerial agency costs to shareholders, costs than shareholders would then seek to reduce. Monopoly profits can also affect corporate governance structures indirectly by setting up a fertile field for conflict inside the firm as the corporate players seek to grab those profits for themselves.Less

Social Democracies and Agency Costs: Raising the Stakes

Mark J. Joe

in Political Determinants of Corporate Governance: Political Context, Corporate Impact

This chapter discusses social democracies and agency costs. Social democracies raised agency costs for shareholders in the public firm and the shareholders' natural reaction would have been to use an ... More

This chapter discusses social democracies and agency costs. Social democracies raised agency costs for shareholders in the public firm and the shareholders' natural reaction would have been to use an alternative organizational form that kept those costs down. The discussion looks first the effects of social democracy through codetermination, by looking at the dilemma that a family-owned firm faces when considering whether to take their firm public. Then, it looks at the effects of social democracy on agency costs and ownership structure without codetermination. The formal social-democratic institution of codetermination is not needed for social democracy to affect the public firm's internal workings, but the formal institution clearly illustrates the political effects.Less

Capital Structure and Financing Decisions

H. Kent Baker, J. Clay Singleton, and E. Theodore Veit

in Survey Research in Corporate Finance: Bridging the Gap between Theory and Practice

This chapter reviews the findings of academic surveys of corporate executives indicating how firms make capital structure and financing decisions. The chapter compares the survey findings to the ... More

This chapter reviews the findings of academic surveys of corporate executives indicating how firms make capital structure and financing decisions. The chapter compares the survey findings to the theoretically correct methods and applications described and recommended in the academic literature. The chapter describes five theoretical capital structure models: static tradeoff, pecking order, signaling, agency cost, and neutral mutation. It then reviews the survey literature that tests the connections between these normative theories and corporate practice. Some survey studies find evidence that one or more theories tend to explain capital structure decisions. Other surveys find evidence that financial planning rules-of-thumb (e.g. financial flexibility, long-term survivability, and impact on security prices) are the primary guides for firms making capital structure decisions. While most studies discussed here focus on large U.S. firms, many focus on non-U.S. firms, and small U.S. firms.Less

The Wrongful Trading Provisions

RIZWAAN JAMEEL MOKAL

in Corporate Insolvency Law: Theory and Application

This chapter considers the impact of insolvency on the obligations of the debtor's managers by examining the wrongful trading provisions in section 214 of the Insolvency Act 1986. It employs the ... More

This chapter considers the impact of insolvency on the obligations of the debtor's managers by examining the wrongful trading provisions in section 214 of the Insolvency Act 1986. It employs the tools of agency theory and the ACM to analyze the need for these provisions, their structure, role, and effect. It asks whether a scheme of fair co-operation about insolvency issues would include a section 214-type duty, and if so, why. The analysis reveals that the duty would not be equally relevant for all types of companies, and that the influence of the market for managerial labour ensures most section 214 actions are likely to be brought against directors of closely-held companies, and against shadow directors. The analysis utilizes the insight that section 214 plays a role similar to that of security itself. An important aim of the chapter is to challenge the Law and Economics proposition that to re-distribute the rights of parties in a corporate liquidation creates socially wasteful incentives. After arguing that section 214 is redistributive in the relevant manner, the incentives created by those provisions for the managers of both healthy and distressed companies are examined. It is suggested that these incentives are generally socially efficient. In the result, the provisions would be acceptable to all those affected by them, regarded as equals.Less

Rents and Politics

Mark J. Joe

in Political Determinants of Corporate Governance: Political Context, Corporate Impact

If a nation has many firms capturing monopoly rents, two major corporate governance consequences are expected. First, potential managerial agency costs to shareholders will be higher than elsewhere, ... More

If a nation has many firms capturing monopoly rents, two major corporate governance consequences are expected. First, potential managerial agency costs to shareholders will be higher than elsewhere, making owners try to tighten up to avoid those potentially heavier costs. Second, with more rents for the players to split, the corporate governance splits could have political correlates, as the players would seek to use politics to grab or block rent acquisition.Less

Epilogue: Challenges to the UK System of Ownership and Control

Brian R. Cheffins

in Corporate Ownership and Control: British Business Transformed

After 1990, activism by traditionally dominant institutional shareholders increased and ‘offensive’ shareholder activism (primarily by hedge funds) and ‘public-to-private’ buyouts carried out by ... More

After 1990, activism by traditionally dominant institutional shareholders increased and ‘offensive’ shareholder activism (primarily by hedge funds) and ‘public-to-private’ buyouts carried out by private equity firms became part of UK corporate governance. While activism implies a ‘hands on’ approach to the running of public companies and private equity buyouts involve the removal of companies from the stock market, these trends do not pose a threat to outsider/arm's-length corporate governance. Instead, the institutional investors that have traditionally dominated share ownership (pension funds and insurance companies) have been exiting the UK stock market, the scepticism of neutral investors imposes significant limits on the viability of offensive activism, and private equity deal flow is modest in relation to the population of publicly traded companies. Moreover, since shareholder activism and private equity buyouts help to keep agency costs in check, they may even fortify current arrangements going forward.Less

Financial Advice: Does It Make a Difference?

Michael Finke

in The Market for Retirement Financial Advice

The financial advice profession provides a potentially valuable service to consumers within an increasingly complex financial marketplace. Financial advice professionals can substitute for costly ... More

The financial advice profession provides a potentially valuable service to consumers within an increasingly complex financial marketplace. Financial advice professionals can substitute for costly investment in financial knowledge by households. This chapter provides evidence that financial advisers can improve financial outcomes when the interests of the advisor and household are aligned. Yet professional advice can harm consumers if conflicts of interest create high agency costs. Understanding how differences in compensation methods and regulatory frameworks affect incentives is essential to improving the breadth and quality of professional advice.Less

Setting the Scene

Brian R. Cheffins

in Corporate Ownership and Control: British Business Transformed

This chapter puts the historical analysis offered by the book into contemporary context. The reader will find out the UK differs from most other industrialized countries in that ownership (in the ... More

This chapter puts the historical analysis offered by the book into contemporary context. The reader will find out the UK differs from most other industrialized countries in that ownership (in the sense of ownership of shares) is separated from control (having the authority to manage) and that concerns about the adequacy of managerial accountability have dominated debates concerning corporate governance in the UK. While the relevant empirical data offers at best a partial picture of how ownership and control evolved over time, there is sufficient evidence to organize the chronology into distinct periods, around which Chapters 5 to 11 are organized. The chapter acknowledges that the book's treatment of relevant issues is not definitive but argues that the book offers readers various insights concerning the timing of the divorce between ownership and control, the multi-causal nature of the split, the law's role and the durability of current arrangements.Less

The Determinants of Ownership and Control: Current Theories

Brian R. Cheffins

in Corporate Ownership and Control: British Business Transformed

This chapter outlines the leading theories that have been advanced in the comparative corporate governance literature to account for why patterns of ownership and control differ across borders and ... More

This chapter outlines the leading theories that have been advanced in the comparative corporate governance literature to account for why patterns of ownership and control differ across borders and shows that they have limited explanatory power in the British context. Due to managerial ‘agency costs’ the economic pre-dominance of the widely held company is not pre-ordained. The ‘law matters’ thesis implies that ‘tough’ company law can prompt a divorce between ownership and control but UK company law was not highly protective of shareholders as ownership separated from control. ‘Trust’ is an insufficiently precise analytical concept to offer much assistance in explaining the configuration of share ownership in the UK. Theories concerning the regulation of financial institutions, politics and ‘legal origins’ (the legal family to which a country belongs) similarly lack substantial explanatory power and analyzing what happened in terms of path dependence generally obscures more than it reveals.Less

Bracketed Flexibility: Standards of Performance Level the Playing Field

CLAIRE MOORE DICKERSON

in The Governance of Close Corporations and Partnerships: US and European Perspectives

This chapter explores the role of fiduciary duties in limiting opportunism in closely held businesses. In a closely held firm, high standards of performance are believed to be necessary to constrain ... More

This chapter explores the role of fiduciary duties in limiting opportunism in closely held businesses. In a closely held firm, high standards of performance are believed to be necessary to constrain opportunism. Yet it is widely recognized that there has been considerable pressure in the US to de-emphasize standards of performance, such a fiduciary duty or heightened good faith, for unincorporated business forms. There is evidence of similar pressure in Europe. The main reason given for opposing standards of performance is that they impede the parties'ability to bargain freely. However, the standards are designed to level the playing field and thus enhance the possibility of meaningful bargaining. The standards accomplish this goal by being flexible and rising in relation to the transactor's power and conflict.Less

The Puzzle of Entity-Level D&O Coverage

in Ensuring Corporate Misconduct: How Liability Insurance Undermines Shareholder Litigation

This chapter investigates why firms purchase Directors' and Officers' liability (D&O) insurance for corporate identity even though the entity-level coverage appears to be a negative net present-value ... More

This chapter investigates why firms purchase Directors' and Officers' liability (D&O) insurance for corporate identity even though the entity-level coverage appears to be a negative net present-value transaction. It analyzes the agency cost explanation for the purchase of entity-level coverage, arguing that this coverage transfers a great deal of the corporation's liability risk to a third-party insurer and diminishes the deterrent effect of shareholder litigation. The chapter also contends that entity-level coverage produces greater moral hazard that traditional corporate property and casualty insurance.Less

Constantine and Rome’s Acceptance of Christianity

Robert B. Ekelund Jr. and Robert D. Tollison

in Economic Origins of Roman Christianity

This chapter offers an economic theory illustrated with historical discussion underlying the adoption of Christianity by the late Roman Empire. It suggests that efficiency considerations (which ... More

This chapter offers an economic theory illustrated with historical discussion underlying the adoption of Christianity by the late Roman Empire. It suggests that efficiency considerations (which include rent seeking and cost savings) led the Roman state to at first adopt and then cartelize the religion under the emperor Constantine and other state leaders in the fourth century ce. The provision of a unified Christian religion may be described in economic terms as an arrangement that reduced agency costs—the costs of maintaining order and a stable, functioning society—for the state and provided rents to the Christian church.Less

Law and Economics and Capital Mobility across Advanced Capitalist Economies

Michel Goyer

in Contingent Capital: Short-term Investors and the Evolution of Corporate Governance in France and Germany

What institutional arrangements best account for the willingness of short-term investors to acquire important equity stakes in listed companies? The law and economics perspective on cross-national ... More

What institutional arrangements best account for the willingness of short-term investors to acquire important equity stakes in listed companies? The law and economics perspective on cross-national variations in capital mobility is grounded in principal-agent theory — the principals being dispersed shareholders that invest in companies but do not run them; and the agents being either managers or large controlling shareholders. The analytical starting point is that noncontrolling shareholders need assurance that they will get a return on their investment before departing from their financial assets. This chapter presents the institutional arrangements of legal protection for minority shareholders in French and German corporate law. The expectations are that companies with diffused ownership should be primarily targeted. The legal systems of these two economies are better at protecting the interests of noncontrolling shareholders from the value-destroying actions of managers, as compared to wealth-diverting moves by the controlling shareholder.Less