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Archive for the ‘Corporate Governance Theory’ Category

Why do boards exist? The board as a team and its superiority.

The post follows an article by Stephen Bainbridge, William D. Warren Distinguished Professor of Law at the UCLA School of Law in Los Angeles, (1).

A) The board statutory role.

Boards are given by Corporate Law the power to manage companies, while shareholders are only entitled to vote a few things and react in a limited number of situations. Decisions at the board (or any other group) should be done through “consensus”, efficient when members of an organization have very similar information and interests, or “authority”, efficient when this is not the case and somebody gathers information and adopts the correct decisions, (see (2)).

Boards nevertheless are not there to manage day-to-day operations as Corporate Law grants the role of those under whose authority companies are run (by managers nominated by boards), in a waterfall of authority and power delegation. Companies have nevertheless become more a hierarchy of teams than of individuals.

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Although hierarchies are accepted as more efficient in complex organizations, both New Institutional Economics (3) and Behavioral Economics (4) accept their members to be only rationally bounded individuals. Branching hierarchies (waterfall of small groups) are an efficient solution to this reality, (both in production and transfer of information and in limiting agency costs –though with the problems of incomplete contracts, collective action problems, etc-). Contracting is an efficient ex-ante mechanism and governance an ex-post one, leading to reduce shirking and punish it, (see for example the M-form corporation).

At the top though there is a team, the board, not an individual. As there are problems arising for that, (individual input measurement, task often being even non separable, the creation of intra-team specific human capital, social loafing due to coordination, motivation difficulties, etc), the questions arises as to why a collective body at the top has been chosen. Read more…

Voice: the perspective of Minority Shareholders

In firms with concentrated structure, (be it because of the economic stake or as a result of multiple-share capital structures, or as a result of the retail shareholders´apathy), the fact that controlling shareholders can extract private benefits from other shareholders, who still remain passive is appealing, and constitutes the theme for Dov Solomon´s “The voice: the minority shareholder´s perspective”, published in May 2017, (1).

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Rational apathy (2) has been identified as a main factor for the passive attitude, and measures addressing it try to (i) increase the benefits arising from participating and voting: rising the influence in the voting outcome pushing institutional investors to vote; (ii) decrease the costs of voting, introducing online voting for instance. If voting reality improved, all other activism tools would be enhanced also, thus its relevance. Read more…

Economic consequences of Shareholder Value Maximization (SVM)

Insead has recently published a short article (1) in which they try to draft the economic consequences of the SVM principle first made explicit by Milton Friedman. (2)

I will here only made some brief comments on several statements that I consider not rigorously introduced. Read more…

The Duty of Loyalty

February 19, 2017 Leave a comment

The Duty of Loyalty is established in the Spanish Corporate Law (1) in articles 227 until 232. According to it directors need to act with good faith and in the best interest of the corporation; a breach would entail restitution of the damage suffered by the corporation plus the return of the profit the director could have made.

The legislator wanted to further explain the extent of the obligations:

a) Directors must use their powers with the aim they were granted to them.
b) They must keep confidentiality.
c) They must refrain from deliberation and vote when they face a conflict of interest. They also need to adopt measures not to incur in situations where their interests (or those of related parties) face those of the corporation.
d) They need to act free from instructions and criteria established by third people.

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Referring to the conflict of interest, the legislator further explains that it can appear when a director does a transaction with the corporation, when he uses the name of the corporation or its assets in its own interest, when he takes a business opportunity from the corporation, when he/she is paid by a third-party or acts in business as a competitor of the company.

The prohibitions to act may be relaxed if the shareholders general meeting (or in some cases the rest of directors if they are independent with regard to the affected director)) so decides. In general the approval can only be granted if no damage is produced to the company or if it is somehow compensated.

In connection with the Duty of Loyalty, some questions arise in all legal frameworks: Read more…

The Business Judgement Rule

January 29, 2017 4 comments

The last Spanish Corporate Governance reform introduced the Business Judgement Rule (BJR) concept, stemming basically from the US courts in Delaware.

We will make an effort to give a broad and modern vision on the BJR in this post, given its prevalence in modern Corporate law or practice. In this effort we will primarily follow D. Gordon Smith`s article on “The Modern Business Judgement Rule”, (1).

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An initial BJR formulation by courts is recognized in 1927 Delaware court´s decision in the Bodell vs. General Gas & Electric Corporation case. A first approach would outline the BJR protects directors from liabilities stemming from “honest mistakes”either as to law or fact, somehow recognizing the human fallability, but also the fact that it reduces legal costs as directors find it difficult to please every shareholder, as S. Samuel Arsht stated in 1979 (2). Read more…

What to do with the “Comply or Explain” principle? (II)

In November 2015 I published a comment on an article by Hadjikyprianou, George C. (1) who considered the principle needed some practical reform, because both the quality of the explanations and its oversight by shareholders and supervisory bodies was defective. In order not to steal the shareholders ‘role and to reduce private monitoring costs he suggested that a public institution could create a rating system for the CG practice by public firms.

In 2014 the same concern had also led the EU to publish a recommendation on how to use the “comply or explain” principle, so apparently institutions started offering guidelines for better explanations instead of creating the rating system, (2).

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The EU suggested that firms explain what CG guideline they did not abide by, how, why, the decision-making process they followed to decide not to comply (temporarily or not), and what action they were taking so as to follow best CG practices for their “size”.

In July 2016, and partly with the aim to give the EU guideline some additional public exposure, the Spanish SEC equivalent, CNVM, has published a Guide for best practices when applying the “comply or explain” principle, (3). Read more…

Engagement: an eclectic approach

In a paper published in the spring of 2016, (1) Mattew J. Mallow and Jasmin Sethi dip into two opposing views in Corporate Governance, the one advocating to give shareholders as much power as possible to influence directors and management´s decisions, (favoring unclassified boards, frequent voting, ability to change the company`s charter), and the one pushing for keeping the board insulated from them, (opposite recommendations and overall deference to elected directors). (1)

 Bebchhuk (who states that shareholders activism increases firm value) and Strine, (who asserts it only favors short-termism) both rely in empirical studies which are not conclusive.

 Mallow and Sethi introduce “Engagement” in the discussion. Whatever the definition, it refers to some cooperation between board and shareholders or institutional investors´ managrs, and at least an enhanced dynamism in their relationship. Managers are supposed to owe fiduciary duties to final investors in order to maintain the log-term value of the investments. We will herein follow their analysis in several topics: Read more…