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Corporations Outline
Reduction of Agency costs Unsystemic risks (unique to individuals) Systemic risk: moral hazard Remedies when corporation is improperly used Derivative actions Benefits could reduce systemic (market) risk by reducing agency costs -- but this would assume that shareholders are fully diversified
Piercing Managers seem to be able to exploit shareholder disunity to entrench -- and maybe judicial is the only rational means to distribute corporation assets Parties who piercing has effect on Employees It wouldn’t be so bad, except if liability were joint and several Some would rather have pro-rated share Alternative viewpoint: Agency theory: benefits of agency exceed the costs Direct costs Costs of controlling managerial assets Shareholders may vote to do things that are irrational because of the control of the corporation If the firm was a true contract there would be true-opting out of things that enabling things allow Fiduciaries get a fixed amount, and they don’t get any more
Intra-firm incentives: may not be effective in controlling agency costs -- legal doctrine seems to be closest to contract model, and furthest form the fiduciary model which would grant bonus’s
Shareholders: Optimizes investment decisions The relationships between shareholders and management seems to be vaguely strutted by the laws, and these laws have changed politically Evolution of corporations Chaos: hard to predict exactly where they go Path dependence: corporations may adapt to threats that stop existing: could be reason for strong managers and week owners, but there other alternatives Modern evolutionary theory: no assurances that a destroyed group will reappear
Difficult to tell which is always efficient There are few inequalities between markets for corporate control
Things might be better if firms had more choice of organization
Managers: can act efficiently because of liquidity Close corporations aren’t as efficient Mangers seem to be able to exploit shareholder disunity to entrench -- and maybe judicial is the only rational means to distribute corporation assets
Voluntary creditors can bargain to protect themselves Courts pierce most often in contract cases Reasons for piercing – Federal courts will only have jurisdiction under tort if there is a piercing issue -- burden of proof is on Plaintiff Some say that There can be statutory insurance or bond requirements Alternative Maybe the best time is when creditors are mislead
Outside director is defined as not part of, or have strong ties to the management Reasons Can reduce agency costs, but differences as to how long their scope should be -- ALI recommends mostly outsiders
problems Outside directors may still be reluctant to displace an incumbent CEO Outsiders aren’t good monitors, because of limited information Directors have other demands Lack experience in that business (s) Few financial incentives Not much time devoted Most of the stuff doesn’t require the board of directors anyway Business people are not lawyers who will peruse a right answer like lawyers Boards make take an overly non-legal holistic view There may be few decisions made Board doesn’t necessarily control agenda Board may want to maintain a management Board may want to main control and information systems Board may be unable to ignore trouble
Possible, in hindsight to always second-guess a board Board won’t be devoted to researching Attendance might not be all telling People may unjustly place reliance on directors with certain expertise Delegation to certain members of the board might not be the best solution Decision making may be political in nature -- and may defer to management, anyway May hesitate to rock board
Most boards have a majority of outsiders "significant relationship with senior executives has never worked for the corporation or subs not a relative proves no services not employed by a firm providing services to the company receives no compensation other than directors fees
still may be structural bias -- could be a "do unto others rule" there may be too many shared perspectives still might work Structural bias even of outside directors is ever-present -- Rejected in Delaware absent showing of specific facts Committees will be biased because it is asking corporate brethren to kill each other Corporate dealings and investment is no structural bias Contributions to a University may be enough (rare) for bias in Delaware Mass: because of the danger of structure bias judicial oversight is necessary Independent must have no interest at all Just because someone is elected by interested people doesn’t make them interest If there is an Independent majority, Plaintiff’s have burden of proof of showing that the majority of the board isn’t independent, else other way around
perhaps board should include employees and other constituencies having ethnic diversity might limit talent pool still open as to whether special interests should be on board perhaps professional directors (maybe institutional investors) a market for it might be more efficient -- but expertise is finite, and much of it may be inside
Professionalism: independence, integrity, competence Might be a need to limit number of years
Check this – go back to ch. 15
Board committees – usually to deal with technical work Audit Nominating Compensation For derivative suits NACD: suggests oversight "governance" committee
Choice of law to piece -- states can’t place their corporate creatures above congress NY: law of incorporation would govern Not uniform CERCLA has lead to shareholder liability
Who the court looks at when deciding whether to piece Bankruptcy Fraudulent conveyances: but there are federal bankruptcy laws that will do the same as piecing Equitable subordination: also known as the "Deep Rock Doctrine," equitable subordination addresses this situation: A controlling shareholder (or other insider) makes a loan to the corporation, which also has outside creditors. The corporation becomes insolvent and is faced with bankruptcy or receivership. Should the controlling shareholder’s claim have equal priority to those of the other creditors? The principle of equitable subordination says that, if it would be manifestly unfair and inequitable to permit the controlling shareholder equal priority, the court will subordinate his loan to the other creditors (and even preferred shareholders’) claims. Loans to close people – ultra vires Old: need approval from stockholders New: what is reasonably expected to benefit
corporate control: totality of the circumstances theoretical criteria for mere conduit status unity of interest separate personalities of corporation no longer exist usually governed in the sate in which the transferor sits
specific things that are indicative of being a conduit directors, departments, tax returns, finance, caused the incorporation, capital, salaries, exclusive business, use of property formalities) Not paying attention to formalities Abuse of corporate entity Common office space Degree of discretion shown by the alleged dominated corporation Payment or guarantee of corporations debts by entity Intermingling of debts MO variant: control (complete), fraud, proximate caused by the fraud of the injury Initial Undercapitalization: Initial capitalization can be telling of a sham -- evidence need to show the traditional inadequacy, but There aren’t that many undercapitalization ceases
Tests for subsidiaries: Equitable ownership: Courts have used the "mere instrumentality’" test about subsidiaries -- and representations If the corporation is a fragment of a larger corporation there is no piercing to hold individual shareholders liable Arbitration: When things are pieced, people can be held to contractual duties
things that along are not enough just sharing cash management system isn’t enough requiring approval might not be enough to pierce literature might not do it Self insurance may be possible (or by subsidiary) based on market convention
Closely held corporations (i.e., with one or a few shareholders): Courts will honor the corporate veil as long as there’s no fraud or wrongdoing, the business is conducted on a corporate (not personal) basis, and the corporation had adequate initial capitalization. Parent-subsidiary (or affiliated) corporations: Courts won’t hold the parent liable for the subsidiary’s obligations if there’s no fraud or wrongdoing, there’s no intermingling of respective business transactions, accounts, and records, the subsidiary was adequately financed in light of normal obligations foreseeable in businesses of its size and character, and the parent and subsidiary are held out to the public as separate corporations.
Market for corporate control means that things should not be pierced pro Stock market tender offers: efficient market may cause the firm to become more efficient Firm’s assets are worth more in the hands of the new mangers There are legal restrictions on this market for corporate control Tender offers create wealth Could be from production and distribution economies of the corporations Technology transfers Cost reducing Assets shifted to higher valued losses Gains from improved management Operating synergies Desire to increases the equity share price, in fact motivates the acquisition Wealth maximizing Efficiency Wealth transfer or expropriation Market inefficiency Non-wealth maximizing
Tax benefits may be canceled out
Takeovers make society worse off because it makes corporations willing to terminate implicit long term contracts In general, efficient market aligns management interests with that of shareholders No direct evidence that anti-takeover measured caused the decline
Market prices will reflect information about value of firms Markets may serve to constrain managerial discretion
Identity and wealth of investors is irrelevant good things about the fact that markets could get around everything: Shareholders really are separate (Bearle)
Can be efficient diversification of investments `
Problems with free market for corporate control Corporate legal duties may be necessary to deal with things that the market doesn’t have time to respond to Control usually lies in the hands of those who select the proxy committee, as the stockholders have very little sway There is no pressure to disclose exactly how much discretion a manager has
Ownership is widely distributed: Separation between people and the equity they control: now passive ownership is the norm Wall-street rule: investors are rationally ignorant: "rational ignorance" presents managers with power Shareholders might be rationally apathetic, be ignorant, or take a "free ride in corporate decision making" - - proxy statements are not viewed as real votes There is opportunity cost in complex statements Prisoner’s dilemma: he may realize that the temptation to give in is great, but he stands to lose more – e. g. there may be more to gain by collective action, but too high a risk
Institutional investors Note: in Japan there is far more inter-corporate equity holding Institutional investors might create a bit more – economies of scale that speak to activism. Exponential incentive for institutional investors to be informed, diversification may also create economies of scale in monitoring, Large investors may be constrained by SEC rules (e. g. short-swing forfeiture) , Risk of being deemed to be a control person,
There is a fiduciary duty on pension plans to act on behalf of beneficiaries, but this might not be enough to get pension active Investment advisors have to produce profits Some argue that institutions owe a duty to smaller shareholders to oversee Institutions may wish more liquidity that oversight -- and there is not enough incentive to monitor If the exit is blocked than one may be better sought to be diligent Passive institutions may be more competitive -- more conflict of interest with money managers, and they won’t
Mutual funds raise their own issues of corporate governance -- conflict of interest, conflicts of scale, and regulatory concerns Controlling shareholders may divert funds at expense of others This is still an issue of agents watching agents Reputation of money mangers might be the only check
In America there is not the degree of institutional control of corporations, but there is some institutional voice Legal rules today put institutional investors toward the passive end
Note about institutional investment: Public pension funds might become more susceptible to shareholder interests -- but TIAA has shown some results, except when limiting blank check proposals
Restrictions on self dealing are somewhat less slack than under contract
Reducing agency cost by looking at the corporation as a series of contracts: Contractual theory of the corporation: the directors and the officers are really involved in contractual relationships -- agency cost isn’t reduced to zero but state-imposed discipline might not be worth it Alternative: State imposed rules could be mere background rules Revisionist theory of contracts looked not at unfair wealth transfers but there was misallocate gains
There might be actually bargaining over the terms of their relationship Some corporate rules cannot be bargained around and the contracts may be hard Rules can be hard to determine in the first place Some of the contracts may not be real contracts: contracts could be contracts of adhesion -- but they aren’t really forced into it -- the extra cost of the package might not be worth the benefit of dickering
The contractualists would not say that the inter-corporate arrangements are presumed to be efficient These aren’t real contracts because they are enforced by the market, not legal mechanisms
external risks corporate form risk reduction
risks
Directors dissent has to be in writing (minutes or registered letter) and the dissent has be liable to avoid any liability, and presumption of concurring with action Absent directors not liable Good faith reliance can be a defence
Agency Some statutes requires certain officers – RMBCA doesn’t like Types of authority Express: must be bylaw or resolution -- but the secretary of the corporation is allowed to sign for it Board meetings Directors have one vote and can’t vote by proxy unless bylaws provide for it Must be a majority to pass, and must have a quorum
Intent of the law is to get the directors to act as a collective Abnormal situations Telephone is okay, but must be able to here each other Informal, but unanimous written consent is okay In some states, it is okay when they are not present, but written With conference call: hence, a director can veto just by withholding consent
Proxies: Board members can’t give proxies Emergency: corporation may proceed based on contact only with the directs that contact was made Shareholders present If it is made with all shareholders present it will probably be binding Even if informal meeting g of shareholders could be ok
Tradition: when the legislature specifies the means by which directors act, and they do contrary to that by tradition, it may be struck down Long time Vacancies may be a place where customary practices are upheld
Notice -- must be given or invalid Directors must get notice of regularly scheduled board meetings Directors can waive Showing up at a meeting to protest is not a waiver
Sub-committees of board Executive committee will have full authority except for dividends, and merger Audit committee (required by NYSE and NASD) Finance Can have temporary committees
Directors can rely on reports of committees Can’t have committee declare a dividend Can’t have committee declare fundamental change
Shareholders giving authority Elect board members Annually Staggered -- or a classified board Multiple types of stock as classified in the articles of incorporation
Vacancies on the board Directors can fill If the size of the board increased Majority: only the shareholders
Minority: everyone
Usually need the approval of all present, or present by proxy (directors can’t vote by proxy) at common law, one shareholder could block – this was based on a contractacian view appraisal and opt-out rights: if there is a fundamental change, and the shareholder dissents, the stockholder can invoke the appraisal rights some says that it is like a veto rights
shareholders can’t assert dissenters rights
Actual Inherent: (not really agency) but enough of a relationship to make one liable under respondeat superior doctrine Apparent: the third person acted reasonably in thinking that someone who purported to be an agent was such an agent -- officers usually have apparent authority – if it is in the usual course of business Will depend not just on the nature, but on who is doing it Exceptions: extraordinary nature rule If consideration or reliance is given, courts are willing to find authority
Things to look for Statutory provision Articles of incorporation Bylaws Resolution of board of directors Evidence that the corporation to act in similar matters and had recognized, approved and ratified A failure to repudiate
Ratifying: after the fact -- the courts seem to say that if a board did thing, and the shareholder relected this is ratification, and the best remedy is the shareholders dismissing Implied: inferred from the circumstances An gent is vest with the implied authority to do all those things necessary or incidental to the agency assignment Third party must reasonably rely
Limited authority: corporation is liable if there is no actual authority given or apparent authority is manifested to the third party
Few rules with respect to which officers can bind the corporation By statute authorization is required for large, or fundamental transaction Bylaws can be amended to change what the responsibility is
Procedures Actual voting – shareholder vote is sacred, and the business judgment rule won’t cover attempts to manipulates Disparate voting right plans but not under state law -- the SEC wants to prevent the deprivation of voting rights once a stock has been purchased re-capitalization plan are not a type of proxy -- this is not an issue of disclosure or proxy. The SROs not have voting rights rules
Someone who wants to gain control of the board of directors will usually be grated the right even if not directly a proxy proxies Defining proxies Not just specific forms, it can be a solicitation for a proxy, communication about whether or not to give a proxy, or the furnishing of a proxy to other people Newspaper ads information the public in general might not be A specific newspaper ad, is a proxy -- could be first amendment issue
An influenced brokerage firm report would be
Tension between speed of informing, and slowness of proxy process – may give the benefit to news releases
Exceptions from proxy rules Exempted: If a solicitations oral or is by a person who owns less than $5 million, no notice is required except if Not available to the registrant, a person on behalf of the registrant, a person solicitation in opposition to a merger or extraordinary transaction, large shareholders trying to control, a person who would receive a benefit other than a pro rata share Exempted: announcement of how people intend to vote
Required proxy content Details for what it included in scheduling of proxy material Requirement that management explain changes in company Must be an opportunity to vote for or against a given matter or withhold vote for directors Preliminary proxy materials are public
Shareholders meeting Record date: the date at which one is considered to be a stock hold for the purpose of being invited -- board, not the shareholders set Notice: corporation must given written notice to all shareholders -- and only matters within the purpose of the notice may be considered Shareholders can waive Timing requirement may be a big deal Quorum must be a majority of shares entitled to vote
Can be proxies or by consent
Once a year, in the spring, after financial documents there is an annual meeting of shareholders Calling: Can be called by the board of directors, or owners of 10% of the stock DE: one doesn’t need to own stock President doesn’t have discretion to deny the meeting -- there are no improper subject for any class (even in staggered voting, if the purpose is to dismiss)
Board will nominate people a that meeting, but proxies are given instructions on who to vote for. Later approved by SEC -- now can usually be filed in definitive form Directors can be removed without cause In general, power to remove directors can’t be restricted At common law was with cause Courts can remove directors for serious cause
Proxy Corporations have to attempt to communicate with beneficial owners, and brokers will vote the proxy in an uncontested matter unless told otherwise Costs of proxy Cost is born by company except if no issue of policy is involved
Defenses to negative proxy material: directors who shareholders are solicited against have a right to a defense statement In Delaware law there is no statute which specifically goes into the removal by stockholder action
there is no requirement to make predictions of whether you will make a proxy contest criteria for including shareholder proposals within the shareholders concern and benefits (audit) specific right provided by state law (e. g. change bylaws) "no logical basis for not including" (e. g. not reporting on the meeting to shareholders) there has been shareholder social activism
reasons for excluding preventing abuse of shareholder proposals proper subject for action by security holders can omit proposals that are about ordinary business operations -- especially if they are just a report on ordinary business operations if the matters are mundane and don’t involve substantial policy or business, one can omit them cracker barrel (overruled) held that employment was an ordinary matter
changing public and shareholder concerns have changed the way that the SEC Will consider policy not significantly related to company’s actions economic significance : things that don’t exceed 5% of sale, assets or earnings, but they still may be significant just becomes things are under the threshold, they can still be considered -- the "otherwise" language can force inclusion
political causes used to be excludable nothing wrong with asking for assurances
even non-binding recommendations, if significant are a proxy matter -- a binding resolution on something the shareholders can’t do is ommitable -- if it isn’t’ ordinary business it can’t be excluded a resolution condemning a political action (Dam) might be excludable
adjudication of proxy issues propriety of proposal under state law -- SEC will adjudicate state (DE law) federal law, (e. g. compliance with EEO) some states won’t allow bylaw generating committees
in some states just because bylaws are written by the board, it doesn’t mean that they are the only way the things can get written deference will be given to no-action letters by courts there was an SEC ruling saying it wouldn’t consider employment an issue
courts hold that employment is nt excludable -- especially if it just a report
adjudication of questions as to whether things can be excluded are done by the commission in no action letters (corporate finance may disagree with enforcement) – corporate finance doesn’t have to state a reason staff can find a middle ground – and can note that the defect can be cured no action letters aren’t binding
SEC could seek injunctive relief to compel
Counting votes Sometimes proxies can be revoked Sometimes unofficial voting rules between parities
Disclosure People in the same family who go over the threshold for disclosure are consider to be one person
shareholder proposals proxy soliciting process is the surrogate for the meeting a solicitation that doesn’t include information is misleading
remedies: Court can use equity to deal with improper board of directors manipulation
Voting methods Straight line voting: Each share is entitled to one vote for each director to be elected, but the shareholder is limited in the number of votes she may cast for a given director to the number of shares she owns Cumulative voting: each share has the number of votes proportionate the number of directors to be elected. Number of shares require to elect is defined as 1 +(( number of shares represented at meeting * number of directors to elected)/(1+number of directors to be elected)) If the board is divided, than the board decisions could be left to managers
Staggering: will lower the total number of votes in a given year for each shareholder Class voting: shares elect defined block of directors Could be a problem if the person who fulfills the vacancy is the sole holder of the stock
Non-corporate arrangements Voting trusts Shareholders convey legal title to a trust, and get beneficial ownership. The ‘trust certificates" are transferable Arrangements that create constructive trusts are also considered to be trusts
Irrevocable proxies (give someone else the power to vote) – ordinary proxies can be revoked at any time Prohibition of voting trust Definition of voting trust Voting right s of the stock are separate from the attributes of ownership Voting rights are intended to be irrevocable for a definite period of time Principal purpose of the grant of voting rights is to acquire voting control
Will look at the substance, not the language of the agreement – if the contracts is so for divorced, it won’t be considered to be a rust Might need a residual interest to remain No voting trust created if failure to comply with non-illusory voting trust provisions A voting trust is not a voting trust if it is illusory, or if more is required than an arbitrator’s decision Giving a nominal class of shares, with voting agreements to a third party is not a voting trust -- can’t be a delegation
Can make grant subject to conditions Granter must have an interest in an irrevocable proxy Minority: interest must be in the stock itself Sometimes have been upheld where the irrevocable proxy has been given as an inducement for the holder to furnish money to the corporation Courts have held that inducement to buy stock, creating a future interest, might be creating a proxy States have said that mutual promises might be all that is necessary, because it is what could make the corporation secure In closed corporations, some states have eliminated the need for an interest to maintain a proxy
Pooling agreements Remedy: Specific performance might be the only remedy Restrictions Powers delegated to non-directors by a voting agreement between two shareholders are be too braud Pooling agreements are okay Directors will act in every way as if they own it, but the directors do not own the corporation’s property
It is possible to have a contractual arrangement to vote, provided there is no oppression against other stockholders Stockholders can do as they wish with corporate assets provided they don’t screw the creditors Stockholders can’t make agreements to keep one another in office (they can’t limit the ability of each other to select agents) It is okay to have an agreement that the directors will keep each other in office Shareholder agreements can agree to infringe "slightly" on the statutory authority
Cannot completely delegate the power to clark
Invalidity and illegality – conditions on shareholder agreements are separate In a close corporation, it may be possible to grant heirs stock that will exist after their deaths (the lack of a public market for the stocks seems to make things more free) There is a notice requirement of unorthodox management structure (e. g. directors do not have that much control)
Voting requirements Unanimous requirements Common law: unanimity requirements are outlawed Under Statute are okay -- or provision that it is required to transact any business
Quorum (can serve the same purpose): must be a majority, or else otherwise specified in the voting rules If a director stays away from the meeting, he loses his right to complain In a closed corporation, a bylaw that allows all shares to vote by be acceptable
Veto rights Easy way to say that an extraordinary number of shareholders must approve a certain transaction
Some states require mandatory cumulative voting, some have opt-out provisions shareholders votes influencing shareholder votes on board decisions (e. g. primary purpose) not allowed extended time to consider is okay recapitalization won’t impede stock holder votes
a vote which would remove from judicial scrutiny unilateral board action might not be allowed
close corporation Contracts for employment in close corporations --- general rule is that even though shareholders can’t remove directors, they can remove them provided they are willing to write check for breach of the contract Generally not enforceable as they may bind future generations of directors Editors of newspaper may be given an exception (granted specific performance) Most courts would award only contracts damages
Solution may be to agree to employ the employee, though not as an officer Delaware: Although not ever discharge an employee who owns stock in a closed corporation will result in a breach of the fiduciary duty, the termination of relationship has to be viewed under the Donhue principles (e. g. business purpose) -- for efficiency purposes Other courts follow a different path
It a closely held, but not statutory corporation, in Delaware, people would be treated as having a fiduciary duty (applying Illinois law) (e. g. one can sidestep the issue by focusing on an implicitly employment contract) Fiduciary duty not to waste corporate assets on people close to them Minority can block only if waste or the like Cannot show bad faith in scheduling a meeting
Stock purchase plans in closed corporation (some places where the relationship is determined, by contracts, others where it is determined by fiduciary duty) – in Delaware it is by contracts
Closely held, but not statutorily close corporation: A lack of parity in treatment between employee and non-employee shareholders might be okay, if it advances corporate objectives (including stock purchase plans) In a closely held, but not a statutory close corporation
Avoiding oppression of minority interests: in a close corporation, shareholders have fiduciary relationships to each other. But there may be legitimate business reasons that override. Stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that the partners one to one another Definitions Oppression is defined as NY: frustrating the reasonable interests of the minority -- can give an equitable remedy which include a buy-out Courts can dissolve if there is deadlock, failure to elect directors, waste, or illegality Supreme court can create a trustee
Must be balance with the business judgment rule Shareholders bind together to vitiate the voting power of certain parties Courts have held that in small corporations the stockholders have to treat each other as partners Minority: patricians adopt the corporate form, they also agree to be bound by the tradition norms of corporate form
Freezing out (salary and dividends) of certain stock -- some have looked at it as a tort When normally business judgments rule duties (e. g. excessive salaries) are tied to a freeze-out, it won’t stand Would have to have the conduct that was tied to a freeze-out that froze the minority out form all beneficial interest
There is a fiduciary duty to inform people who have resigned from the board but are now in a minority position Deadlock Some state laws have taken the provision that in the face of deadlock, a court can dissolve a corporation – if it is causing irreparable injury, and there is oppression of the shareholders The court may examine a failure to do something, but it must be in the face of all parties fulfilling their duty of good faith
Reasonable expectations theory NJ: often the expectations of what the business will do is what will be considered to be oppression. Oppression may be a failure to achieve a resolution of any of the shareholders Expectations can include retirement allocation (and things that are inherited from death) If Plaintiff’s are not active participants, the only thing that they can rationally expect is the payment of the dividends
Shareholders have to have a large measure of discretion nevertheless
Remedies Buyout may be necessary
Remedies Dissolution Entry of an order that the company will be dissolved, but at a future date if things aren’t resolved Appointment of a receiver, until differences are resolved Appointment of a fiscal agent to tell the court about the minority’s stockholders plight Ordering accounting by majority in control about the funds that have been misappropriated Injunction against the oppressive acts Ordering of affirmative relief (e. g. distribution of capital) Ordering one side to purchase the other’s stock Letting the minority purchase more stock Award of oppression tort damages Looking at the fiscal condition of the parities and deciding who should buy the other out
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