US academic urges kiwis down the pro-director path
Professor Stephen Bainbridge of the UCLA School of Law was this year’s visiting Cameron Fellow at the University of Auckland’s Faculty of Law. He is highly regarded as an international authority and speaker in the area of corporate law, with over 75 published articles to his name.
The aim of his public lecture, held in Auckland on Tuesday 27 May 2014, was to offer some comparative insights into the law governing corporate entities in the US and in New Zealand. Law News was invited to attend.
Control of the company – different theories
Professor Bainbridge commenced his talk by considering two key questions that arise in relation to any system of corporate governance – what are the ends which the entity seeks to pursue, and who is in charge?
In terms of the question of who is in charge, he suggested three ways in which control can operate. However, he says that neither of the first two approaches – “shareholder primacy” (where the ultimate objective is shareholder profit and shareholders decide how the company is run); and the “communitarian approach” (where the objective is not just the creation of wealth but also advancing the interests of all stakeholders) – are “normatively very appealing”, nor descriptive of the reality of US corporate law, where the third approach prevails, namely “director primacy”.
Professor Bainbridge’s preferred theory of “director primacy”, like the “shareholder primacy” approach, rejects the concept of a company existing for its wider stakeholders. Where they differ however is on the issue of control.
There has been some divergence of opinion on this in the US – some leading cases have enshrined the principle of shareholder interests, with directors being the agents of the shareholders (Katz v. Oak Indus., Inc. (Del. Ch. 1989) and Blasius Indus., Inc. v. Atlas Corp. (Del. Ch. 1988)), however, the prevailing approach, with which Professor Bainbridge agrees, is more director-centric.
“Director primacy” argues that the powers of a company’s board are original and undelegated, with most decisions being made by the directors and shareholder power largely being limited to the election of those directors.
US corporate law is generally agreed to be board-centric, particularly in the state of Delaware, whose laws govern a dominant proportion of US corporate entities.
The Kamin case’s treatment of the “business judgement” rule is an extreme example of this deference to the board of directors. Despite everyone in court realising the board of directors had made the wrong decision, and even the board itself probably knowing this, the court still rejected the shareholders’ argument of breach of fiduciary duty. As Professor Bainbridge put it, “The boardroom, not the courtroom, is where corporate policy is set”.
New Zealand approach
What about New Zealand corporate law? Where does it fall on the spectrum of shareholder versus director primacy?
Based on his time in New Zealand and his perusal of our laws on the face of the statute books, Professor Bainbridge considers this may be an area where New Zealand and US corporate law “fall out”. Professor Bainbridge cautioned that his comments on New Zealand must be taken as being made “on the books” (i.e. based on what he has read in statute and case law), rather than real life of corporate practices here, which he has not experienced, but where the day-today reality may be different. In the US at least, he notes that while in the past the daily reality may have been that top management/the CEO effectively ran the company, practices have now moved closer back to the law “on the books”.
Comparative examples – US versus New Zealand
On balance (and probably obviously to New Zealand readers), Professor Bainbridge considers that New Zealand law is more shareholder-centric than US law.
The objective of US corporate law is certainly still shareholder maximisation, with no real attempts to balance a variety of stakeholder interests. While this aim may not be enforceable as such, case law enshrines the centrality of shareholder profit (Dodge v. Ford Motor Co. (Mich. 1919)) and confirms that directors cannot unilaterally decide to pursue other interests (say, those of employees).
In New Zealand we have section 131 of the Companies Act 1993, which, not particularly helpfully, simply says that directors have to act in the best interests of the company. “What is ‘the company’?” asked Professor Bainbridge. But whatever it means, he considers it does not mean that New Zealand corporate law is stakeholder-oriented – it is (more or less) shareholder-oriented. So, thus far, the law in both jurisdictions is similar.
But what of the crucial issue of control – who is in charge? As noted above, the US clearly leans towards “director primacy”. In New Zealand, Professor Bainbridge’s view of the “law on the books” is that New Zealand is closer to the “shareholder primacy” end of the spectrum (although he acknowledged that the listing rules for companies listed on the NZX may be more director-focused).
In New Zealand, shareholders can select a CEO; in the US, this is a board prerogative. In New Zealand, shareholders can remove business decision-making power from directorial control; in the US, limits can only be imposed by unanimous shareholder agreement (which is probably harder to achieve in companies the size of which they have there).
In New Zealand, section 129 of the Companies Act requires shareholder approval for “major transactions”, although as Professor Bainbridge ironically commented, “I’m told a lot of effort goes into avoiding having a transaction characterised as a ‘major’ one”.
New Zealand law is also more shareholder friendly in terms of how we call a special meeting. In the US, how this works is state dependent, however in dominant Delaware it is possible to “outright eliminate” the shareholders’ right to call a special meeting.
Under section 109 of our Companies Act, shareholders can pass a binding resolution regarding the management of the company. In the US, there is no state right, and only a limited federal right, to do so. There, shareholder resolutions can be excluded from proxy statements if they relate to a matter of ordinary business.
One of the biggest differences between US and New Zealand law, in Professor Bainbridge’s opinion, occurs in the area of takeovers. New Zealand’s Takeovers Code Rule 38(1) is a good illustration of shareholder friendliness – the directors of a company cannot frustrate a takeover offer, and shareholders have the opportunity to consider the offer on its merits. As he puts it, “Half of my lectures would go up in smoke if that were the case in the US!”
In the US, directors are more regarded as the “Robin Hood”-type bastion against evil in takeover situations – defending the company from the threat of the takeover bidder who is cast in the role of “Sheriff of Nottingham”. Directors are accordingly empowered to prevent takeover offers from going forward (Unitrin, Inc. v. American General Corp. (Del. 1995)). .
“Authority” versus “accountability”
Professor Bainbridge then went on to devote some time trying to convince his (it may be said, somewhat unconvinced) audience of New Zealanders of the possible advantages of a more director-predominant approach. In his view, director primacy is an ideal of a more “efficient system of corporate governance”, leading him to query, “So why hasn’t New Zealand embraced it?”
The theory of director primacy grew out of the work of Nobel Prize winner Kenneth Arrow and the late Professor Michael Dooley. Arrow’s focus was on how organisations make decisions. At one end there is the “town meeting” style of consensus or “participatory democracy”; at the other extreme is “authority”, where a central decision-making body can make binding decisions on the whole even though the constituents have not participated in the process. If consensus is the desired modus operandi, Professor Bainbridge suggests that, in the US, one should use a general partnership, because US public corporations very definitely follow the “authority” model (where ownership is clearly separated from control).
Why would the law separate out ownership and control? Professor Bainbridge suggested that there are three conditions that lead to this kind of centralised decision-making:
- “asymmetric information” – shareholders traditionally have less information available to them than the directors, although with the advent of the internet this is being redressed somewhat;
- “divergence of interests” – while most shareholders have the desire to make money, some may be more interested in “values investing” (i.e. “vegans don’t invest in companies that make hot dogs”); and
- “collective action problems” – “if a company has three million shareholders who all need to participate in a meeting, you’re going to need a really large room”.
In Professor Bainbridge’s view, the “authority” approach works in the US because of the large proportion of big, public corporations with large numbers of shareholders, necessitating a separation of ownership and control so that decisions can actually be made. He acknowledges the “authority” approach does lead to tension with the concept of “accountability” – with that degree of directorial control, how do you ensure the directors are spending the shareholders’ money wisely? However, he believes that ultimately, authority and accountability cannot easily be reconciled – at some point you have to make a choice which one your legal system is going to favour. By and large, the US has made that choice in favour of authority.
Public versus private companies
Professor Bainbridge recognises that, unlike the US, shareholder primacy appears to be “alive and well” in New Zealand. Partly, he thinks this is because director primacy sits better in the context of large public companies without a controlling shareholder, as are found in the US. By comparison, New Zealand only has around 150 listed companies, with most of these being SMEs. Further, our Companies Act is largely predicated on companies with concentrated ownership giving majority control to one shareholder or group of shareholders. “So New Zealand has never had to deal with the kind of companies for which director primacy would be optimal,” he theorises.
His other theory has to do with the differences between a federal and non-federal system. Delaware’s dominance over corporate law in the US is well-recognised, with around 60% of publicly-traded companies and Fortune 500 companies being incorporated there. Whether this is a good or a bad thing, the incentives to Delaware to have efficient corporate laws that attract entities to incorporate there are clear – around 20% of its annual revenues come from “franchise taxes” payable by Delaware-incorporated companies.
Jurisdictions without a federal system possibly do not have the same sort of economic incentives for legislatures to “get it right” in terms of delivering highly efficient corporate law, as there is not the same level of competitiveness or return. Accordingly, Professor Bainbridge concluded that director primacy will dominate in jurisdictions with many public corporations with dispersed shareholders, particularly where there is a federal system in place. Shareholder primacy will be the trend if a country has fewer large public corporations and more concentrated shareholdings.
Professor Bainbridge says he will be interested to see where New Zealand heads in the next few years – whether we continue on the path of shareholder primacy or veer towards a more director-centric approach. While providing much food for thought and highly interesting insights into the approach taken by our US cousins, from the challenging nature of the questions posed to him at the conclusion of his talk, it seems likely that our current model will remain to the fore in New Zealand for the foreseeable future.