Tuesday, May 13, 2014
Is the UK really more shareholder-centric than the US?
Many thanks to Matt for organizing this book club, and to all the participants for their thoughtful and challenging critiques of the theory developed in the book (those already posted, as well as those forthcoming). I’m deeply grateful for the opportunity to engage in this comparative discussion of US, UK, Canadian, and Australian corporate governance here at Prawfs, and will respond in a series of posts organized by theme/subject. In this first post I’ll address a question that cuts to the core of the descriptive account presented in my book: Is the UK really more shareholder-centric than the US?
The book advances two core claims. The first part of the book advances the claim that the US, the UK, Canada, and Australia – four countries typically lumped together in the comparative literature as representing a single “Anglo-American,” Anglo-Saxon,” or “Common-Law” corporate governance system – in fact differ enormously in their relative degrees of shareholder-centrism. For example, UK, Canadian, and Australian shareholders possess far greater ability to call special meetings, remove directors without cause, initiate charter amendments, and control the outcome of hostile takeovers than their US counterparts do. The second part of the book advances the claim that external regulatory structures affecting the interests and welfare of other stakeholders – notably, the form and degree of social welfare protections available to employees – have decisively impacted the degree of shareholder-centrism exhibited by their respective corporate governance systems. Specifically, stronger stakeholder-oriented social welfare structures have permitted the UK, Canadian, and Australian corporate governance systems to focus more intently on shareholders without precipitating political backlash, while the opposite has occurred in the US, where weaker social welfare structures have inhibited the corporate governance system from doing the same. The final part of the book explores the boundaries of the theory’s explanatory domain, and considers various factors that might lead the countries examined to become more or less shareholder-centric in the future.
Various aspects of this theory will be addressed in posts to come, but I’ll start with a critical question raised by Brett McDonnell in his post earlier today: Is the UK really more shareholder-centric than the US? This claim, after all, constitutes the descriptive core of the book, and Brett rightly pushes me here, asking specifically whether greater capacity for US shareholders to sue, and/or greater US reliance on stock-based compensation, might close the gap.
Brett is quite right that UK market and legal structures alike have long favored “shareholder collective action via voting” (or at least the threat thereof). As I describe in the book, UK institutions gained prominence decades earlier than their US counterparts did; have traditionally inhabited a single geographic marketplace (London’s “Square Mile”); and enjoy substantial legal powers vis-à-vis boards – notably, a strong removal power and virtually unfettered ability to determine the outcome of hostile takeover bids. On the efficacy of the foregoing, we agree entirely.
But what about shareholder suits and stock-based compensation as potential US substitutes? As a threshold matter, if either were intended to substitute for strong shareholder governance powers, then we might reasonably expect to find correlatively shareholder-centric statements of corporate purpose in US corporate law – yet we find no such thing. To the contrary, whereas § 172 of the Companies Act (2006) states that a UK director must direct her efforts toward “the success of the company for the benefit of its members” (i.e. its shareholders), in Delaware the closest we get to a statement of corporate purpose is an ambiguous formulation of the duty of loyalty, said to be owed “to the corporation and its stockholders,” simultaneously. Only in the narrowest of final-period-type circumstances has the Delaware Supreme Court mandated single-minded focus on shareholders.
As Brett notes, I acknowledge the indeterminacy of the empirical literature on potential deterrence effects of ex post shareholder suits, yet question the plausibility that they could provide protection to shareholders equivalent to strong ex ante governance powers. The little comparative empirical work conducted in the area to date concludes that public company directors are indeed more likely to face corporate lawsuits in the US than the UK, yet further concludes that, even in the US, the chances of facing out-of-pocket payments are quite remote. (See John Armour, Bernard Black, Brian R. Cheffins & Richard Nolan, Private Enforcement of Corporate Law: An Empirical Comparison of the UK and US, 6 J. Empirical Legal Stud. 687 (2009).) These conclusions are consistent with anecdotal accounts of the conduct of investors with real money on the line, who have to assess the comparative merits of such varying systems for themselves. For example, when News Corp. proposed reincorporating from Australia to Delaware in 2004, the move was opposed by Australian, UK, and US institutions alike. Their protests suggested that they did not consider expanded opportunities to engage in ex post Delaware litigation as providing protection equivalent to the strong ex ante governance powers that would be sacrificed.
The 1993 amendment to the US Internal Revenue Code that fueled the explosion in stock-based compensation surely was not intended to strengthen shareholders – the aim, rather, was to reduce compensation (ha). There is no gainsaying, however, that the growth of performance-based pay over the last couple decades has strongly tended to align managers’ incentives with those of shareholders. I acknowledge these developments, and suggest later in the book that this likely contributed to the climate of excessive risk-taking that culminated in the recent financial crisis – a dynamic rendering post-crisis reforms aimed at further empowering shareholders difficult to explain.
In the final substantive chapter examining prospects for stability and change over time, I argue that – while premised on a fundamental misread of what caused the crisis – it’s important to recognize that pro-shareholder moves in its aftermath in fact provide fresh evidence of the centrality of employees in the politics of corporate governance. In much the same way that hostile takeovers in the 1980s prompted an employee-manager coalition to counter premium-seeking shareholders, the crisis in the 2000s prompted an employee-shareholder coalition to counter perceived managerial recklessness (particularly in financial firms, though certain reform efforts reached further). The outcome differed, to be sure, yet each was substantially rooted in – and fueled by – widespread social and economic concerns for the welfare of middle-class working families in an unstable social welfare environment. In each case, a threat to middle-class financial and social welfare stability arose; the problem was conceptualized in corporate governance terms; blame was assigned to one of the power constituencies, the shareholders or the board, as the case may be; an employee coalition emerged with the other; and governance power shifted toward the board or the shareholders, as the case may be.
The upshot is that, while there has absolutely been a shift toward substantially greater shareholder-centrism in US corporate governance over recent decades, the underlying social welfare concerns and associated politics remain fundamentally similar. In a later post I’ll consider the stability of such corporate governance policy shifts in light of shifting social welfare policies – both in the US and the UK.
Posted by Christopher Bruner on May 13, 2014 at 03:15 PM | Permalink
. . . And what of the fact that most shareholder litigation is derivative as opposed to direct? This raises interesting questions, too, doesn't it?
Since two folks have mentioned it today in posts (including Chris's post here) and since I have long discussions with my casebook co-authors about this, I thought I would briefly mention a matter in this context that gets little play--to whom directors owe their fiduciary duties. While there are cases, especially in the takeover context, that reference a director's duty to the corporation and its stockholders, I think Vice Chancellor Laster gets it right in his 2013 opinion in In re Trados Incorporated Shareholder Litigation, Consol. C.A. No. 1512-VCL (Aug. 16, 2013), when he says (after referring to a few of these cases): "[t]his formulation captures the foundational relationship in which directors owe duties to the corporation for the ultimate benefit of the entity's residual claimants." Thus--my view--the duties are owed to the corporation.
While this distinction may not make a difference in certain circumstances, it is very helpful in others, including in situations where the rationale for or efficacy of derivative--as opposed to direct--shareholder litigation is at issue, as I think it is here. What do you think about that, Chris, vis-a-vis your observations?
Posted by: Joan Heminway | May 13, 2014 3:45:25 PM
Thanks for this, Joan. Personally I think Lyman Johnson got it right in his 1990 Texas Law Review article, The Delaware Judiciary and the Meaning of Corporate Life and Corporate Law, where he argued that this formulation effectively "bracketed" the tension between more and less shareholder-centric visions of the corporate entity. Chancellor Allen basically said the same in his 1989 TW Services opinion, where he wrote that "this particular phrase masks the most fundamental issue" - i.e. reconciling "corporate entity interests" with "current share value interests." That the shareholders are favored with capability to advance corporate claims derivatively, yet are not identified with the underlying interests motivating such claims, provides yet another reflection of our long-standing US ambivalence regarding shareholders.
Posted by: Christopher Bruner | May 13, 2014 9:32:13 PM