May 27, 2014

Director Versus Shareholder Primacy in New Zealand Company Law as Compared to U.S.A. Corporate Law

Stephen Bainbridge

UCLA School of Law

The Means and Ends of Corporate Governance

Stakeholders Corporate Objective Shareholders

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Team ProductionCommunitarians

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The Means and Ends of Corporate Governance

Stakeholders Corporate Objective Shareholders

Sha

reho

lder

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C

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Dire

ctor

sShareholder Primacy

Team ProductionCommunitarians

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“A new theory of the firm has emerged that appears more complete than its predecessors:Professor Stephen M. Bainbridge’s model of director primacy.” Seth W. Ashby, 2005 U. ILL. L. REV. 521, 533

Part I

How Do Shareholder Primacy and Director Primacy Differ?

“Allen is one of the most respected jurists on corporate governance. When he writes, lawyers listen.”• James Lyons, Conflicting Interests, Forbes,

Mar. 30, 1992, at 48

“It is the obligation for directors to attempt, within the law, to maximize the long-run interests of the corporation’s stockholders.”• Katz v. Oak Indus., Inc. (Del. Ch. 1989)

“The theory of our corporation law confers power upon directors as the agents of the shareholders; it does not create Platonic masters.”• Blasius Industries, Inc. v. Atlas Corp. (Del. Ch.

1988)

The Shareholder Primacy Model

“The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors” DGCL 141(a)

• The board’s powers are “original and undelegated” - Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918)– Shareholders have “the regular opportunity to elect the members of the

board, but during the directors’ terms, the board has the power, informed by each director’s decisions in the exercise of his or her fiduciary duties, to direct and oversee the pursuit of the board’s vision of what is best for the corporation.” (ABA 2010)– Shareholder control rights limited

– Voting rights limited to review of a few fundamental decisions– Proxy system and 13(d) restrictions on shareholder voting and communication– Derivative litigation burdened by procedural barriers and BJR– Market for corporate control hampered by combination of poison pill and

classified boards

The director primacy model

The ABA Committee on Corporate Laws (2010)Hollinger Inc. v. Hollinger Intern., Inc. (Del.Ch.2004)

Klaassen v. Allegro Development Corporation (Del. Ch. 2013) Kevin L. Turner, 57 ALA. L. REV. 907

Larry Ribstein, 1 BERKELEY BUS. L.J. 183 In re CNX Gas Corp. S'holders Litig. (Del.Ch.2010)

Cases and Commentators

“[D]irector primacy remains the centerpiece of Delaware law, even when a controlling stockholder is present.”

Noting “the bedrock statutory principle of director primacy established by Section 141(a) of the DGCL.”

“It is through … centralized management that stockholder wealth is largely created.”

“Corporate governance is best characterized as based on ‘director primacy.’”

“Delaware jurisprudence favors director primacy in terms of the definitive decision-making power …”

Reaffirmed MBCA policy of vesting “the power to direct and oversee the management of the corporation in the board of directors, rather than in the shareholders.”

Kamin v. American Express (N.Y. Sup. Ct. 1976)

“The directors’ room rather than the courtroom is the appropriate forum for thrashing out purely business questions which will have an impact on profits, market prices, competitive situations, or tax advantages.”

Bayer v. Beran (N.Y. Sup. Ct. 1944)

“To encourage freedom of action on the part of directors, or to put it another way, to discourage interference with the exercise of their free and independent judgment, there has grown up what is known as the business judgment rule.”

Marx v. Axers (N.Y. 1996).

“By their very nature, shareholder derivative actions infringe upon the managerial discretion of corporate boards. . . . Consequently, we have historically been reluctant to permit shareholder derivative suits, noting that the power of courts to direct the management of a corporation’s affairs should be exercised with restraint”

Smith v. Van Gorkom (Del. 1985).

“The business judgment rule is the offspring of the fundamental … that the business and affairs of a Delaware corporation are managed by or under its board of directors. ... The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors.”

Illustration: The Business Judgment Rule

Part II

Is Director Primacy Descriptive?Comparing New Zealand and US Law

USA New Zealand

Dodge v. Ford Motor Co. (Mich. 1919):

• “A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.”

Companies Act § 131 provides that “a director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.” • Peter Watts (2012): “While there

is no duty on directors to maximize profit, there is also nothing to prevent them doing so.”

• P.M. Vasudev (2012): “The company statute in New Zealand retains more or less the traditional principle of shareholder primacy.”

The Corporate Objective

NZ USA

Allows shareholders to give “themselves the right to select the company’s CEO” (Watts 2012)

CEO selection a board prerogative. (MBCA § 8.40)

Comparing New Zealand Company Law to U.S. Corporate Law

NZ USA

Allows shareholders to remove “from directorial control the majority, if not all parts, of business decision making” (Watts 2012)

Limits on board managerial power allowed in closely held corporations buy only by unanimous shareholder agreement. (MBCA § 8.01)

Comparing New Zealand Company Law to U.S. Corporate Law

NZ USA

Requires shareholder approval of “major transactions.” (§ 129)

Shareholder approval only of fundamental transactions (e.g., mergers or sales of substantially all assets).

Comparing New Zealand Company Law to U.S. Corporate Law

NZ USA

Shareholders with > 5% of voting power can call a special meeting. (§ 121)

Shareholders can petition court to order special meeting. (§ 123)

Shareholders with > 10% of voting power can call a special meeting. (MBCA § 7.02)• Threshold can be raised to 25%• Delaware allows elimination of

shareholder right to call a special meeting.

Court can only order special meeting if annual meeting has not been held within 15 months of last meeting. (MBCA § 7.03)

Comparing New Zealand Company Law to U.S. Corporate Law

NZ USA

If constitution of company so provides, shareholders can pass binding resolutions relating to management of company. (§ 109)

Shareholder resolutions on ordinary business matters can be excluded from proxy statement. (SEC Rule 14a-8)• Shareholder resolutions

infringing on substantive managerial power improper. CA v. AFSCME (Del. 2010)

Comparing New Zealand Company Law to U.S. Corporate Law

NZ USA

Takeovers Code Rule 38(1):

“If a code company has received a takeover notice or has reason to believe that a bona fide offer is imminent, the directors of the company must not take or permit any action, in relation to the affairs of the code company, that could effectively result in—(a) an offer being frustrated; or(b) the holders of equity securities of the

code company being denied an opportunity to decide on the merits of an offer.

Unitrin, Inc. v. American General Corp. (Del. 1995):

“When a corporation is not for sale, the board of directors is the defender of the metaphorical medieval corporate bastion and the protector of the corporation's shareholders. The fact that a defensive action must not be coercive or preclusive does not prevent a board from responding defensively before a bidder is at the corporate bastion's gate.”

Comparing New Zealand Company Law to U.S. Corporate Law

Part III

The Normative Case for Director Primacy

Kenneth Arrow

• The Limits of Organization (1974)

Michael Dooley

• Two Models of Corporate Governance, 47 Bus. Law. 461 (1992)

Director primacy

• Authority versus accountability

• The case for authority

Key waypoints

Consensus Authority

Arrow’s models

Collective decision making• E.g., partnerships

Central decision making body• E.g., public corporation

“Cheaper and more efficient to transmit all the

pieces of information to a

central place” that makes “the

collective choice and transmit it

rather than retransmit all the

information on which the

decision is based”

Asymmetric information

Divergent interests

Collective action problems

When to opt for authority

Arrow:

• Accountability mechanisms “must be capable of correcting errors but should not be such as to destroy the genuine values of authority”

• “If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B”

• Constraints on shareholder powers both with respect to voting and litigation follow.

But what about agency costs?

Part IV

Choosing Sides

The domain of director primacy is principally public corporations

The domain of director primacy is defined by separation of ownership and control

Assume shareholder primacy is “alive and well” in New Zealand company law (Watts 2012): The domain of director primacy

New Zealand only has about 150 listed companies (i.e., public corporations).• 95% of listed companies are small or medium-sized enterprises.

New Zealand companies characterized by concentrated ownership:• “Majority control companies increased from 7% in 1974 to 22.1% in 1981,

and management control companies decreased from 48.8% to 30.4% over the same period.” (Fox et al. 2012)

‒ Contemporaneous with adoption of Companies Act 1993

Assume shareholder primacy is “alive and well” in New Zealand company law (Watts 2012): The role of competitive federalism

Assume shareholder primacy is “alive and well” in New Zealand company law (Watts 2012): The role of competitive federalism

Choosing

Director Primacy, if:Many large public corporations

Dispersed shareholders

Shareholder Primacy, if:Few large public corporations

Concentrated shareholders