Home > Director Elections, Estructura del Consejo, Minority Shareholder Rights > Controlled Companies and Independent Directors

Controlled Companies and Independent Directors

Lucien Bebchuk and Assaf Hamdani have recently published an article, (1) in which they present an alternative to current director elections so that true independence is assured, in particular at controlled companies, where beyond the fact that Nomination Committees are responsible for the selection, controller shareholders usually de facto fully control the procedures so that independence does no actually happen, (as it may be thought to be the case at widely held companies).

Enhanced Independence (as they call it) may emerge if directors are held accountable by public investors; Bebchuk and Hamdani think that not only controller shareholders are to be dispossessed of their complete influence in the nomination process, but that some influence must be granted to public investors, at least regarding some of the independent directors. Their influence can be executed in appointment, reelection and termination decisions.

Bebchuk and Hamdani state that even with director nomination restricted to Nomination Committees populated only with independent directors, controller shareholders have a big say in the process. Independent directors cannot be elected or reelected without their decisive voting rights as shareholders, and also find it difficult to remain when controlling shareholders leave the company. Apart from the social gratitude stemming from having been elected, directors very often suffer the direct or indirect, explicit or not pressure from controller shareholders regarding decisions that affect them and value, particularly related-party transactions.

In certain transactions –freezeout transactions-, (Delaware) courts and (at least formally) corporate governance practices have reacted not relying only on special committees made of independent directors but also on minority shareholders´majority decisions, (excluding the concerned controlling shareholder). But outside this particular case, controller shareholders retain their power and influence, (in compensation, derivative litigation matters, for instance).

For Bebchuk and Hamdani, incentives to favor the controller should be cut and strong incentives to protect public investors introduced instead. They still think the controlling shareholder needs to keep rights to elect some or many directors and run the company according to his stake, but they propose that enhanced independent directors play a decisive role when certain transactions are analysed. Italy, Israel, the UK, (in this case with a very interesting dual election voting system, by majority of all and majority of minority shareholders) and AMEX in the USA have already introduced some of their proposals.

What do Bebchuk and Hamdani propose? Building blocks of Enhanced-Independence

  1. Initial Appointment, Reelection, and Termination.
  2. Degree of influence by public investors: (i) No say; (ii) Veto rights; (iii) Exclusive decision power even against the controller´s will. Public investors and controlling shareholders can (should) have different influence levels in different areas, so that an acceptable balance is reached.

An example of regulatory options is introduced below (taken from (1).

Are Veto Rights enough to promote the desired effects?

Public investors should at least have veto rights on initial appointment, reelection, and termination, the authors argue. In this case, public investors can`t elect a director rejected by controlling shareholders. This is a balanced mechanism that is particularly powerful when reelection of directors having favored the controller´s private interests is decided. It acts as a pervasive incentive tool for enhanced-independent directors.

This leaves open the question of who has the power to suggest or propose the candidates. The authors suggest that public investors should, against the well-known collective action problems faced by them, (rational apathy, lack of common interests and decision forums, etc.).

Bebchuk and Hamdani though, go beyond veto rights in their recommendation and propose that exclusive rights are allocated to public investors regarding reelection and termination. They know a minority-election system faces collective action problems and the lack of incentives by public investors to bear the cost to be informed, apart from the information asymmetries favoring controllers. Furthermore, such a system for at least some of the directors, would reinforce their independence and help create a market for enhanced-independent directors only to the extent that public investors execute their rights to nominate and/or elect certain directors.

These problems are downgraded when it comes to reelection and termination. While keeping veto rights for both controller and public investors in initial appointments, they suggest to give decision rights to the latter in the other two dimensions. Accountability to public investors is improved, and still decision rights for the controlling shareholder remain.

The authors finally analyze how judicial review systems and legislation or regulatory regimes may provide the proposed result, which we leave readers to go through.

What should be their number and role if the change is to provide results?

The authors propose the following:

  1. Number. The suggest at least two enhanced-independent directors, and still a minority of the board.
  2. Role. They should be able to veto related-party transactions and other tunneling deals. But in order to respect the controller´s stake and rights, they should not be given extraordinary rights over matters that do not affect the cash flows going to controllers or the full base of shareholders.
  3. Length of term. Term limits and minimum length can be useful of counterproductive depending on the decisions taken above. When there are veto rights to reelection and termination, term limits may protect the controller. In the case that rights to elect are granted to public investors, term limits are actually unnecessary.
  4. Independence from minority blockholders. The authors simply raise the concern.

What could be the objections to their proposal.

Bebchuk and Hamdani briefly refer to some of them:

  1. The fact that the controller´s ability to run the company could be reduced.
  2. The loss of cohesiveness in the board.
  3. The public investor passivity.
  4. The possibility that some public investors may act opportunistically.



(1) Bebchuk, Lucian A. and Hamdani, Assaf, Independent Directors and Controlling Shareholders (April 2017). Available at SSRN: https://ssrn.com/abstract=2741738


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