BALANCING THE UN-BALANCED
“The Majority is always wrong and the minority is rarely right”
Corporate law is the yardstick for the business sector which chaperons and molds the behavior of a Company. Corporate Law establishes the structure of the corporate form as well as formulates rules for the smooth flow of operations in the company.The other vital function of corporate law is to control the conflict of interests amongst the corporate constituencies such as the shareholders, directors, creditors etc. These conflicts are referred to as the ‘Agency Problems where the wellbeing of one party, depends on the actions of another party. Title 8, Chapter 1 of the Delaware General Corporation Law (the Delaware Code) is the statute governing corporate law in the U.S. state of Delaware.The Delaware General Corporation Law has been a vital authority in the United States corporate law since the early 20th century. In the USA, every state has their own corporate governance law, however, since Delaware has a more developed and flexible approach to corporate law that provides greater guidance and transaction liability issues, most larger corporation choose Delaware General Corporation Law.
The typical corporate governance framework views shareholders as the principal, and the objective of the management of a corporation is to maximize the interests of the shareholders. Even though shareholders delegate the board of directors to guide and monitor the management, they are given privileges and opportunities to participate directly in monitoring and operating their firms.
Categorically, we can outlook four (4) main agency problems in a company on which the Law has paid utmost attention, as follows:
- Shareholders v. Managers
- Controlling Shareholders v. Minority Shareholders
- Shareholders v. Non-Shareholder Constituencies
- Shareholders v. Bondholders.
Tug of War between Majority-Minority
A key agency problem that exists in any corporation is the struggle between the minority shareholders (the principal) and the majority shareholders (the agents). This is a high occurrence issue in jurisdictions where the concentrated shareholding dominates. It is an evident fact that the majority shareholders have more control over the governance of the company and therefore it holds an advantageous position for the minority shareholders.Protecting minority shareholders dates back to 1970s in the USA. The states rely on its underlying concept of democracy in every aspect, starting from the government to the corporate governance in companies. They believe that it is vital to protect the rights of all individuals. Therefore, it is important that majorities keep minorities in their mind when they make decisions that affect everyone in corporations. The nature of shareholders and their share structure in the USA in public holding companies differ from other jurisdictions. Investment institutions own most of the shares in public US companies. Therefore, each of the state laws, USA stock exchange regulations, and the federal law tend to protect public shareholders by regulating mandatory disclosure and establishing a relationship between minority shareholders and directors. All these issues get worse when the majority shareholding is concentrated among a limited number of shareholders. The senior management and even the Board of Directors of such companies are directly appointed or associates of major shareholders, so ultimately the decisions taken by the company are more favorable towards the major shareholder. This situation is deteriorated in large US public corporations which is mostly owned by a shareholder or group of shareholders who take all the possible benefits from the company.
The main resources in the USA for minority protection includes Statutes, Common law, Company by-laws and the USA federal law securities. Each of the 50 states has its own corporate law. Most large incorporation chooses Delaware, where a minority shareholder in a company incorporated in Delaware state protects its minorities from the Delaware General Corporation law, company’s bylaws, and common law. However, these developed in addition protection fail to fully provide the required balance between majority and minority shareholders. The corporate law has been developed in a manner to give additional protection to the minority shareholders to protect them as they do not have the contractual protection other parties like the employees or the third-party constituencies enjoy. The corporate law can either empower the minority or can limit the advantages enjoyed by the majority shareholders. The USA allowing public companies to cap vote, mandatory disclosure and shareholder-friendly accounting methodologies are some instances where the corporate law has protected the interest of the minority shareholders by constraining the activities of the major shareholders.
Generally, there are three (3) common issues that arise between these two parties which are as follows:
- Profit expropriation
- Tunneling of assets
- Improper dilution
In addressing agency problems, the law repeatedly turns to a basic set of strategies. There are two types of legal strategies used to address these agency problems, namely the Regulatory Strategies and the Governance Strategies. Under Regulatory Strategies, the law aims at constraining the behavior of the parties.
Governance Strategies aims at facilitating the principal in controlling the Agent’s behavior. To achieve these aims, the Corporate Law uses three toolsCompliance, Enforcement, and Disclosure that are designed for Corporate Law as a solution for this agency problem. The governing strategy has suggested several approaches to resolve these issues between the majority and minority shareholders. Appointing Non-Executive Directors for the main committee roles is one such way to protect the interest of the minority in a sense that it is strongly believed that the Non-Executive Directors shall act in an impartial manner for the best interest of the Company. Strong representation of independence shall constrain the controlling power of the majority shareholders as well as of the managers who bear allegiance to the controlling shareholders. The effectiveness of the practical appliance of these solutions bears a heavy question as we consider how independent are, these so-called “Non-Executive Directors” in a company. The selection of these independent directors is done by the Board of Directors of the Company who inadvertently bears fidelity towards the controlling shareholder. There are some instances where the controlling shareholders screen the proposed “Non-Executive Independent Directors” prior to their appointment. Therefore, even this method does have some positive effect to limit the activities of the controlling shareholders it cannot be distinguished as an immaculate method to protect the minority shareholders.
There are other methods like derivative actions, mandatory disclosures, pre-emptive rights that are used to protect the minority. These methods do have a strong effect on a company to say that most of these methods are pertinent to the shareholders but also to the capital and labor markets in the broader picture.
The minority shareholders can be empowered by awarding them excellent voting powers such as overweighing the votes carried by minority shareholders, reserving board seats, giving key committee roles, tag-along rights, vote capping, assigning veto powers etc. Countries like UK, USA, France, and Germany have the aforementioned methods in practice to safeguard the minority shareholders in such jurisdictions. Nevertheless, in general, these minority shareholders lack expertise and have fewer facts to decide on every matter of the corporation. Few wrong decisions can damage large corporations long aim of maximizing profit. However, despite this lack of intelligence in minority shareholders, US law and courts keep supporting and encouraging them with shaping and changing the law according to their requirement.One good example for that is the Delaware court of chancery supporting minorities in many circumstances.
The watermark case of Halpin v Riverstone National [i] is one such example, in which, the company proceeded for a merger without the vote count of the minorities and they decided to file a class action against the majority shareholders decision. Delaware court ruled in favor of minorities by setting an example. Therefore, the corporate law plays the role of finding the balance between different shareholders.
Having some level of controlling power at the Board level or containing the power to screen and supervise the actions taken by the major shareholders which concern the profit expropriation, asset tunneling and improper dilution of shares, can assist the minor shareholders to protect their wellbeing at the company level, as a group. The protection from the above-mentioned regulation can help the minorities on the aforementioned then the bylaws of the companies as it is always written and it favors the majorities or the founder of the large companies in the USA.
The right to bring a class action lawsuit against the company is another right given under Delaware General Corporation Law and New York to minority shareholders. They can bring the action in violation of their rights. For example, violations of disclosure obligations. Similarly, Delaware, New York, and many other states law give the rights to inspect corporate books and related books for a proper purpose. The mechanism will allow the group of minority shareholders in a corporation to investigate corporate mismanagements. Minority shareholders encourage the development of new laws protecting themselves and the other stakeholders of the company. They believe, it is important for the corporate law to provide protection to minorities. Nevertheless, they are minorities, they are a large number of shareholders when they are taken into the account in overall.
However, the dictators of the US public companies believe that it is not inevitably necessary to empower minorities in public companies. They argue promoting minority can harm in the long run of the corporations. According to one study, some of the largest public companies in the USA such as Walmart, Ford, and Berkshire have concentrated shareholder structure with empowered majority shareholders domination and success in long run. Finance scholars study the balance maintained between shareholders in large public companies such as Google, Fiat, Lego, and Facebook and how a small group of shareholders helped the corporation in long run. The framework of dual class structure and concentrated shareholding protects the major investors and entrepreneurs who risk most at the beginning of the corporations. They believe minority shareholders must rely on exit option rather than on their “voice”. They are always given the option of leaving the company whenever they wanted to leave. In contrast, Majority shareholders are well known for the abuse of their power ‘private benefits of control’at the expense of the minority shareholders. It includes entering into conflicts-of-interest transactions, misusing corporate resources for personal ends, expropriating corporate opportunities, and building a conglomerate empire.
Conflicts and consequences
The conflict between shareholders can lead to the expropriation of funds and assets that will affect the corporate overall. For example, managers of corporations will steal and shirk from the corporation as well as promote the proposals that will support the majority shareholders to diverge the interest of the minority. Similarly, most of the time the majority shareholders interests are not aligned with the interest of other shareholders. Which can lead the majorities to promote self-dealing transactions, damaging the entire corporate interest?
As Kraakman argues in his book called the Anatomy of Corporate Law, that to a greater extent, the regulations come to save the minority shareholders at the beginning or end. Which is a successful strategy for majority-minority shareholder agency problem as it can bring more minority shareholders to the public firms and benefit in overall?Current USA approach of balancing the majority-minority shareholders in public company considered to be successful. Active involvement of minority shareholders in large public firms improves the quality of the protection of investors which will improve the public trust in the stock market and develop the economy in total. Minority shareholders must feel secure and safe from all the powerful entities in the corporation. Delaware is the best-known state in theUS for identifying agency problems in advance and providing a solution for that. Delaware finds help from all the legal parties who can help to improve the regulations. The bar association guides and shape Delaware regulation in every step and therefore, the corporate matters advised by the best corporate lawyers in advance.
Companies can accomplish their corporate objectives and goals of advancing company growth and profitability by executing balance between shareholders right. It can increase the ability to raise funds through stock offerings, offer a feasible stock option program to court executives, and prevent hostile takeovers by other company can be done by mutual understanding between shareholders. The leaving of shareholders (majority or minority) can damage the reputation of a corporation and will not attract more shareholders to the company. Therefore, the companies require the help of regulatory framework to bring the regulations to govern the problem and also to develop strategies time and time according to the needs of the large corporations.
[i] C.A. No. 9796-VCG
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