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The Basic Governance Structure:
Minority Shareholders
and Non-​Shareholder Constituencies
Luca Enriques, Henry Hansmann, Reinier Kraakman,
and Mariana Pargendler

The corporate governance system principally supports the interests of shareholders

as a class. Nevertheless, corporate law can—​and to some degree must—​also address
the agency conflicts jeopardizing the interests of minority shareholder and non-​
shareholder contractual constituencies. And herein lies the rub. To mitigate either
the minority shareholder or the non-​shareholder agency problems, a governance
regime must necessarily constrain the power of the shareholder majority and thereby
aggravate the managerial agency problem. Conversely, governance arrangements that
reduce managerial agency costs by empowering the shareholder majority are likely to
exacerbate the agency problems faced by minority shareholders and non-​shareholders
at the hands of controlling shareholders.
In this chapter, we first address the protection of minority shareholders, and then
turn to governance arrangements that protect the firm’s employees—​the principal non-​
shareholder constituency to enjoy such protections as a matter of right in some juris-
dictions. In Chapter 5, we address the protections granted to corporate creditors.
While corporate law mostly deals with the relationship between the corporation
and its contractual counterparties, it is sometimes called upon to protect the interests
of constituencies external to the corporate form as well.1 The final part of this chapter
explores how the legal strategies of corporate law can also be directed to serve the inter-
ests of non-​contractual stakeholders.

4.1 Protecting Minority Shareholders

It is well-​documented by empirical research that dominant shareholders enjoy “private
benefits of control”—​that is, disproportionate returns—​often at the expense of minor-
ity shareholders.2 These benefits are impounded in the control premia charged for
controlling blocks and in the price differentials that obtain between publicly traded

1 See Chapter 1.5.

2 See Tatiana Nenova, The Value of Corporate Voting Rights and Control: A Cross-​Country Analysis, 68
Journal of Financial Economics 325, 336 (2003) (employing share price differentials for dual class
firms to calculate private benefits); Alexander Dyck and Luigi Zingales, Private Benefits of Control: An
International Comparison, 59 Journal of Finance 537, 551 (2004) (employing control premia in
sales of control blocks to calculate private benefits).
The Anatomy of Corporate Law. Third Edition. Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann,
Gerard Hertig, Klaus Hopt, Hideki Kanda, Mariana Pargendler, Wolf-Georg Ringe, and Edward Rock. Chapter 4 © Luca
Enriques, Henry Hansmann, Reinier Kraakman, and Mariana Pargendler, 2017. Published 2017 by Oxford University Press.
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80 Minority Shareholders and Non-Shareholder Constituencies

high-​and low-​vote shares in the same companies. Both measures are often assumed to
be rough indicators of the extent of minority shareholder expropriation.3 The varying
degrees of protection accorded to minority shareholders by differing corporate gover-

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nance systems explain at least some of the variation in these indicators.

4.1.1 Shareholder appointment rights and deviations

from one-​share–​one-​vote
One way to protect minority shareholders is by granting them the right to appoint one
or more directors. Specifically, company law can enhance minority appointment rights
by reserving board seats for minority shareholders or over-​weighting minority votes in
the election of directors. Even if they only select a fraction of the board, a minority can
still benefit from access to information and, in some cases, the opportunity to form coali-
tions with independent directors. Of course, shareholder agreements or charters can—​and
sometimes do—​require the appointment of minority directors for individual firms. The
law can achieve a similar result on a broader scale by mandating cumulative or propor-
tional voting, which allow relatively large blocks of minority shares to elect one or more
directors. Moreover, lawmakers can further increase the power of minority directors by
assigning them key committee roles or by permitting them to exercise veto powers over
certain classes of board decisions.4
Significantly, however, general corporate law rules granting minority board repre-
sentation are relatively uncommon among our core jurisdictions. Italy mandates board
representation for minority shareholders in listed companies.5 Brazil grants minority
shareholders who hold more than a 10 or 15 percent stake (of preferred or common
stock, respectively) the right to appoint a board member, as well as cumulative voting at
the request of shareholders representing at least 10 percent of voting capital.6 However,
the high coordination costs associated with these thresholds mean that generally only
blockholders, rather than dispersed minority shareholders, benefit from the associated
rights. Cumulative voting is the statutory default in Japan,7 but it is routinely avoided
by charter provisions. In France, the UK, and the U.S. firms may adopt a cumulative
voting rule, but publicly traded firms rarely do so;8 and in Germany, commentators
dispute whether cumulative voting is permissible at all in public corporations.9 In the

3 See note 136 and accompanying text.

4 For example, Art. 78 Russian Joint-​Stock Companies Law requires that major transactions,
including those that implicate the interests of controlling shareholders, be unanimously approved
by directors. Consequently, “disinterested” minority directors can block major transactions between
the company and its controlling shareholders or managers. In Brazil, directors elected by minority
shareholders have veto rights over the appointment and removal of independent auditors: Art. 142,
§ 2º Lei das Sociedades por Ações.
5 Art. 147-​3 Consolidated Act on Financial Intermediation (requiring that at least one director be
elected by minority shareholders).
6 Art. 141 Lei das Sociedades por Ações. If neither group satisfies the relevant threshold, they may
pool votes to make a joint board appointment. See also Art. 239 (granting minority shareholders the
right to elect one board member in government-​controlled firms).
7 Art. 342 Companies Act.
8 At the turn of the twentieth century, cumulative voting was common in the U.S. See e.g. Jeffrey
N. Gordon, Institutions as Relational Investors: A New Look at Cumulative Voting, 94 Columbia Law
Review 124 (1994); cf. §§ 708(a) and 301.5(a) California Corporation Code (respectively mandating
cumulative voting and authorizing opt-​out from cumulative voting for listed companies).
9 See Mathias Siems, Convergence in Shareholder Law 172 (2008). Even though the majority
agrees that proportional voting is permissible, no important German corporation has included such
a charter provision. See also Paul L. Davies and Klaus J. Hopt, Boards in Europe—​Accountability and
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Protecting Minority Shareholders 81

UK, the new premium listing rules for companies with controlling shareholders grant
minority investors what may be called an “expressive” veto on the appointment of
independent directors. Their appointment is initially subject to separate approval by

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all shareholders and minority shareholders. If such approval is not obtained, then the
shareholder majority can determine the election after a “cooling-​off” period, between
90 and 120 days later.10
While the use of appointment rights directly to protect minorities is rare, all juris-
dictions regulate the apportionment of voting rights in relation to share ownership—​a
central mechanism that affects both the appointment and decision rights of share-
holders. Corporate laws generally embrace a default rule that each share carries one
vote. Awarding voting rights in direct proportion to share ownership has the benefit
of aligning economic exposure and control within the firm, but may leave minor-
ity shareholders vulnerable to opportunistic behavior by controlling shareholders. At
the same time, where the value of incumbents’ control is high—​whether because the
law fails to restrict dominant shareholders’ opportunism or because, in the absence
of a dominant shareholder, managerial agency costs would be high—​proportionality
between cash-​flow and voting rights may impair a company’s ability to raise further
equity finance and secure profitable investment opportunities.11 Consequently, our
jurisdictions often contemplate adjustments to shareholder appointment and decision
rights in both directions, that is, both by limiting the power of dominant shareholders
and by allowing them to enhance it in various ways.
All jurisdictions permit at least some deviations from the one-​share–​one-​vote norm
to let dominant shareholders enhance their control over the corporation. These mecha-
nisms include dual-​class equity structures with disparate voting rights, circular share-
holdings, and pyramidal ownership structures. While our core jurisdictions universally
restrict circular shareholding schemes12 and vote-​buying by parties antagonistic to the
interests of shareholders as a class,13 they diverge with respect to the availability and
use of other similar devices.
Germany and Brazil go furthest in limiting deviations from one-​share–​one-​vote that
increase the power of controlling shareholders: both countries ban shares with multiple

Convergence, 61 American Journal of Comparative Law 301 (2013) (noting that cumulative vot-
ing has failed to gain much traction in Europe).
10 UK Listing Rules, 9.2.2E and 9.2.2F.
11 See e.g. Kristian Rydkvist, Dual-​class Shares: A Review, 8 Oxford Review of Economic Policy
45 (1992).
12 Most jurisdictions forbid subsidiaries from voting the shares of their parent companies: Art.
L. 233–​31 Code de commerce (France); Art. 2359–​II Civil Code (Italy); Art. 308(1) Companies Act
(Japan); § 160(c) Delaware General Corporation Law; § 135 Companies Act 2006 (UK). German,
Brazilian, and Japanese laws bar subsidiaries from owning shares of their parents except in special cir-
cumstances (§71d AktG; Art. 244 Lei das Sociedades por Ações; Art. 135 Companies Act). A number
of countries, such as Italy, France, and Germany, also ban voting in the case of cross-​shareholdings
by companies that are in no parent-​ subsidiary relationship. See Shearman & Sterling, LLP,
Proportionality Between Ownership and Control in EU Listed Companies: Comparative
Legal Study 17 (2007) at [Link]
13 A less traditional example of separating control rights from cash-​flow rights is so-​called “empty
voting,” in which investors use stock lending, equity swaps, or other derivatives to acquire “naked”
votes in corporations in which they may even hold a negative economic interest (i.e. gain if the stock
price goes down rather than up). See Henry T.C. Hu and Bernard Black, The New Vote Buying: Empty
Voting and Hidden (Morphable) Ownership, 79 Southern California Law Review 811 (2006).
Empty voting, like vote buying, can be used to undermine shareholder welfare. Despite efforts at
increasing transparency over economic interests, as opposed to formal ownership rights, no jurisdic-
tion provides for ownership disclosure rules that are geared for disclosure of empty voting per se. See
Wolf-Georg Ringe, The Deconstruction of Equity 162–​99 (2016).
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82 Minority Shareholders and Non-Shareholder Constituencies

votes and cap the issuance of non-​voting or limited-​voting preference shares to 50 per-
cent of outstanding shares.14 In Brazil, where dual-​class firms were historically com-
mon, non-​voting shares are prohibited outright in the Novo Mercado, the premium

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corporate governance segment of the São Paulo Stock Exchange.15 Even these juris-
dictions, however, do not regulate pyramidal ownership structures (where company
A owns a majority of the voting shares of company B, which in turn owns a majority of
the voting shares of company C, and so on),16 which have identical effects to dual-​class
shares in separating cash flow and voting rights.17 The U.S., by contrast, goes furthest
in banning or discouraging the use of pyramidal structures through holding company
regulations and the taxation of inter-​corporate distributions.18
Similarly, some European jurisdictions permit the issuance of so-​called fidelity shares,
which condition the award of additional voting rights on a minimum holding period as
a shareholder. For instance, Italian law recently enabled corporations to award double
voting rights to shareholders who have held onto their shares for at least two years.19
This mechanism had long been available in France on an opt-​in basis, but in 2014, as
part of an openly protectionist law on takeovers, it became the default rule for listed
companies. Unless such companies opt out, their shares spawn double voting rights
after two years in the same hands.20 Although such “tenure voting” systems are usually
justified as protecting the interests of long-​term over short-​term shareholders,21 they
tend also to embed the power of controlling shareholders relative to outside investors.
The U.S. and UK permit different classes of shares to carry any combination of cash
flow and voting rights, but U.S. and Japanese exchange listing rules bar recapitaliza-
tions that dilute the voting rights of outstanding shares.22 While the New York Stock

14 See §§ 12 II and 139 II Aktiengesetz AktG (Germany); and Arts. 15, § 2o, and 110, § 2o, Lei
das Sociedades por Ações (Brazil). In Brazil, however, companies have recently circumvented the ban
on multi-​voting stock by adopting a functionally equivalent dual-​class structure where the public float
carries economic rights that are a multiple of those granted to insiders. Brazil’s Securities Commission
(CVM) blessed this structure in the Azul case in 2013. France caps the issue of non-​voting shares by
listed companies at 25 percent of all outstanding shares. Arts. L. 228–​11 to L. 228–​20 Code de com-
merce. In 2014, Italy partially repealed the ban on multiple voting shares: it now allows non-​listed
companies to issue shares with up to three votes. Such companies may later go public, but cannot
subsequently increase the proportion of multiple voting shares. The 50 percent cap on non-​voting and
limited voting shares has, instead, been maintained. See Art. 2351 Civil Code, as amended (Italy).
Similarly to Germany and Brazil, Japan imposes a 50 percent cap on non-​voting and limited voting
shares: Arts. 108(1)(iii) and 115 Companies Act.
15 For a discussion, see Ronald J. Gilson, Henry Hansmann, and Mariana Pargendler, Regulatory
Dualism as a Development Strategy: Corporate Reform in Brazil, the United States, and the European
Union, 63 Stanford Law Review 475, 489–​90 (2011).
16 As a result, pyramidal firms have emerged in Brazil’s Novo Mercado, as elsewhere.
17 See e.g. Lucian A. Bebchuk, Reinier Kraakman, and George Triantis, Pyramids, Cross-​Ownership,
and Dual Class Equity: The Mechanisms and Agency Costs of Separating Control from Cash-​Flow Rights,
in Concentrated Corporate Ownership 445 (Randall K. Morck ed., 2000).
18 See Steven A. Bank and Brian R. Cheffins, The Corporate Pyramid Fable, 84 Business History
Review 435 (2010); Eugene Kandel, Konstantin Kosenko, Randall Morck, and Yishay Yafeh,
The Great Pyramids of America: A Revised History of US Business Groups, Corporate Ownership and
Regulation, 1930–​1950, NBER Working Paper No w19691 (2015).
19 Art. 129-​V Consolidated Act on Financial Intermediation, as amended in 2014. This mecha-
nism may actually serve to enhance the power of the state as shareholder.
20 Art. L. 225-​123 Code de commerce, as amended by Loi. No. 2014-​384 of 29 March 2014
(known as the “Loi Florange”). See also Chapter 8.2.3.
21 See Chapter 3.2.
22 See Rule 313 NYSE Listed Company Manual and Rule 4351 NASDAQ Marketplace Rules
(voting rights of existing shareholders of publicly traded common stock cannot be disparately reduced
or restricted through any corporate action or issuance). See also Tokyo Stock Exchange, Securities
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Protecting Minority Shareholders 83

Exchange (NYSE) listing rules banned deviations from proportional voting for most
of the twentieth century, dual-​class shares have recently enjoyed something of a renais-
sance in media and hi-​tech corporations.23 The U.S. has even attracted high profile

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dual-​class companies from abroad: for instance, Chinese e-​commerce giant Alibaba
opted to go public on the NYSE after being unable to list on the Hong Kong Stock
Exchange, which still adheres to a strict one-​share–​one-​vote rule. In the UK, where
institutional investors had successfully discouraged dual-class shares altogether,24 the
Premium market segment is now exclusively for companies listing classes of shares with
proportionate voting rights.25 Thus, although legal support for a one-​share–​one-​vote
norm is limited, all our core jurisdictions restrict some ways of leveraging voting rights
that are regarded as particularly harmful.
Much rarer than devices that empower a certain group of shareholders are legal
devices that simply dilute the voting power of large shareholders, to benefit small
shareholders. Perhaps the best known technique of this sort is “vote capping,” that is,
imposing a ceiling on the control rights of large shareholders and correlatively inflating
the voting power of small shareholders. For example, a stipulation that no shareholder
may cast more than 5 percent of the votes reallocates 75 percent of the control rights
that a 20 percent shareholder would otherwise exercise to shareholders with stakes of
less than 5 percent.
Except for Germany and Japan,26 all our core jurisdictions permit publicly traded
corporations to opt into voting caps by charter provision. Today, however, the real
motivation for voting caps is more likely to be the deterrence of takeovers than the
protection of minority investors. They are more commonly adopted where no control-
ling block exists, to dissuade the building of one, rather than to constrain the voting
power of an existing block-​holder. Voting caps survive today chiefly in France and, to
a lesser extent, in Italy and Brazil.27

Listing Regulations, Rule 601(1)(xvii) and Enforcement Rules for Securities Listing Regulations, Rule
601(4)(xiv) (prohibiting unreasonable ex post restrictions on shareholder voting rights).
23 Prominent examples include News Corporation, Google (now Alphabet), Facebook, and
LinkedIn, where the use of “super-​voting” shares has allowed the founding shareholders, who arguably
have a strategic role in the value of the company, to keep control of the corporation without holding
the majority of the share capital.
24 See Julian Franks, Colin Mayer, and Stefano Rossi, Spending Less Time with the Family: The
Decline of Family Ownership in the United Kingdom, in A History of Corporate Governance
Around the World 581, 604 (Randall K. Morck ed., 2005).
25 UK Listing Rule 7.2.1A, Premium Listing Principle 4.
26 Voting caps were banned for German publicly traded (listed) companies in 1998. See § 134 I
Aktiengesetz (AktG) (as amended by KonTraG). Still, there was one important exception: Volkswagen
AG, which is regulated by a special law, was subject to a 20 percent voting cap. The European Court
of Justice ruled that the voting cap (together with other provisions of the VW Act) impeded the
free movement of capital which was guaranteed by Art. 56(1) EC Treaty (now Art. 63 TFEU); see
Case C-​112/​05, Commission v. Germany, Judgment of 23 October 2007, European Court Reports
[2007] I‐8995. Japan adopts the rule of one-​share, one-vote and does not allow voting caps. See Art.
308(1) Companies Act. Italy banned voting caps from 2003 to 2014 (other than for privatized com-
panies). See Art. 2351 Civil Code, as amended (Italy).
27 For France see Art. L. 225-​125 Code de commerce; Art. 231-​54 Règlement Général de l’AMF
(declaring, however, voting caps ineffective at the first general meeting after a bidder has acquired
two thirds or more of the voting shares). For Brazil, see Art. 110, § 1º Lei das Sociedades por Ações,
(permitting voting caps); Novo Mercado Regulations, Art. 3.1.1 (prohibiting voting caps below 5
percent, except as required by privatization laws or industry regulations). Although extremely rare in
the UK and the U.S. today, voting caps were common in the nineteenth century in the U.S., Europe,
and Brazil. See Mariana Pargendler and Henry Hansmann, A New View of Shareholder Voting in the
Nineteenth Century, 55 Business History 585 (2013).
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84 Minority Shareholders and Non-Shareholder Constituencies

4.1.2 Minority shareholder decision rights

As in the case of appointment rights, the law sometimes protects minority sharehold-
ers by enhancing their direct decision rights. Minority decision rights are strongest

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when the law entrusts individual shareholders (or a small minority of them) with the
power to make a corporate decision. Such is the case for instance when the law allows
individual shareholders, or a small shareholder minority, to bring suit in the corpora-
tion’s name against directors or other parties against whom the corporation may have
a cause of action.28 Granting decision rights to a majority of minority shareholders is
also an effective governance strategy. For this reason, corporate laws sometimes impose
a majority-​of-​the-​minority approval requirement on transactions between controlling
shareholders and their corporations.29
In addition, all our core jurisdictions fortify minority decision rights over funda-
mental corporate decisions by imposing special majority or supermajority approval
requirements. As we discuss in Chapter 7, the range of significant decisions subject
to shareholder voting varies, as does the particular voting threshold required for
approval.30 As a practical matter, however, the relevant threshold is almost always
higher than the simple majority of the votes cast at a general shareholders’ meeting.
Arguably, then, most jurisdictions use decision rights to protect large blocks of minor-
ity shares against expropriation effected via major transactions such as mergers.
Several European jurisdictions pursue this end explicitly by awarding the holders of
a sufficient percentage of minority shares (25 percent or more of voting shares) a statu-
tory blocking right—​to prevent a “bare” majority from trumping the will of a “near”
majority.31 Most U.S. states and Brazil require a majority of the outstanding shares to
approve fundamental transactions such as mergers, which implies a supermajority of
the votes that are actually cast.32 The size of the supermajority in this case depends on
the percentage of shares represented at the meeting, which, in turn, reflects the salience
of the transaction for minority shareholders. Nevertheless, requirement of approval
by a majority of the outstanding shares is no protection for minority investors if the
controlling shareholder enjoys such a majority.33

4.1.3 The incentive strategy: Trusteeship and equal treatment

The incentive strategy for protecting minority shareholders takes two forms. One is
the familiar device of populating boards and key board committees with indepen-
dent directors. As noted in Chapter 3, lawmakers seem to view independent direc-
tors as a kind of broad-​spectrum prophylactic, suitable for treating both the agency
problems of minority shareholders and those of shareholders as a class. The second
mode of protecting minority shareholders is strong enforcement of the equal treat-
ment norm, particularly with respect to distribution and voting rights. This norm
applies to both closely held and publicly traded firms, and blurs into an aspect of
the constraints strategy: a fiduciary duty of loyalty to the corporation that implicitly
extends towards minority shareholders and perhaps other corporate constituencies
as well.

28 See Chapter 3.2.3 and Chapter [Link]. 29 See Chapter 6.2.3 and Chapter [Link].
30 See Chapter 7.7. 31 See Chapter 7.2 and 7.4.
32 See e.g. § 251 Delaware General Corporation Law (merger); § 242 (charter amendment);
Art. 136 Lei das Sociedades por Ações.
33 Such levels of control are common in Brazil, for example.
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Protecting Minority Shareholders 85

[Link] The trusteeship strategy and independent directors

The addition of independent directors to the board is a popular device, not only as a
solution to shareholder–​manager agency problems,34 but also for protecting minor-

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ity shareholders and non-​shareholder constituencies. Lawmakers implicitly assume
that independent directors—​motivated by “low-​powered incentives”—​namely, moral-
ity, professionalism, and personal reputation—​will stand up to controlling sharehold-
ers in the interest of the enterprise as a whole,35 including its minority shareholders
and, to varying degrees, its non-​shareholder constituencies. Strong forms of trusteeship
reduce the possibility of controlling the board by shareholders (or by anyone else). In
the extreme case, no constituency, including shareholders, can directly appoint repre-
sentatives to the company’s board. This was the core principle of the Netherlands’ old
“structure regime,”36 under which the boards of some large companies became self-​
appointing organs, much like the boards of many nonprofit corporations or founda-
tions. Alternatively, investors themselves may contract to give one or more mutually
selected independent directors the decisive voice on the board as a governance solution
to intra-​shareholder opportunism. This pattern is common in venture capital-​backed
firms.37
In our core jurisdictions, however, most “independent” directors are neither self-​
appointing nor rigorously screened for independence by savvy investors. Instead, direc-
tor “independence” typically means at most financial and familial independence from
controlling shareholders (as well as from the company and its top corporate officers).38
A director qualifies as independent under such a definition even if she is vetted and
approved by the company’s controlling shareholder—​and even if she has social ties to
the controller—​as long as she has no close family or financial ties, such as an employ-
ment position or a consulting relationship, with the controller. A conventional exam-
ple is that an officer of an unrelated, third-​party company qualifies as an independent
director of the corporation, but an officer of a holding company with a controlling
block of stock in the corporation does not. Moreover, the fact that in many jurisdic-
tions shareholders have the right to remove directors (including independent directors)
at any time further exacerbates concerns about the lack of actual independence in
controlled firms.
Finally, the most modest and basic form of a director-​based trusteeship strategy
abandons all pretense to independence and simply requires board approval for impor-
tant company decisions. For example, the authority to initiate proposals to merge the
company can be vested exclusively in the board of directors under U.S. and Italian
law.39 Alternatively, shareholders may be barred from directly making any decisions

34 See Chapter 3.3.1.

35 For a critical assessment, see Wolf-​Georg Ringe, Independent Directors: After the Crisis, 14
European Business Organization Law Review 401 (2013).
36 See e.g. Edo Groenewald, Corporate Governance in the Netherlands: From the Verdam Report of
1964 to the Tabaksblat Code of 2003, 6 European Business Organization Law Review 291 (2005).
37 See Jesse M. Fried and Mira Ganor, Agency Costs of Venture Capitalist Control in Startups, 81
New York University Law Review 967, 988 (2006).
38 And, according to the listing rules of U.S. stock exchanges, not even that: they only require
independence from the company and top management. Jurisdictions with concentrated owner-
ship structures, however, usually impose some form of independence from controlling sharehold-
ers. For a comprehensive survey, see Dan W. Puchniak and Luh Luh Lan, Independent Directors in
Singapore: Puzzling Compliance Requiring Explanation, American Journal of Comparative Law
(forthcoming).
39 See § 251 (b) Delaware General Corporation Law; Chapter 3.4; Art. 2367 Civil Code (Italy).
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86 Minority Shareholders and Non-Shareholder Constituencies

about the company’s business without the board’s invitation, as under German law.40
These measures constrain the controlling shareholder to pursue her policies through
directors who, although appointed by her, nevertheless face different responsibilities,

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incentives, and potential liabilities from controlling shareholders.
Of course, how well the director-​based trusteeship strategy works, even when some
or most directors are financially independent of controlling shareholders, remains an
open question. We have already expressed our skepticism about the efficacy of these
directors as trustees for minority shareholders.41 Nevertheless, U.S. case law provides
anecdotal evidence that independent boards or committees can make a difference in
cash-​out mergers,42 or when controlling shareholders egregiously overreach.43

[Link] The equal treatment norm

The equal treatment of shares (and shareholders) of the same class is a fundamental
norm of corporate law. Although this norm can be viewed as a rule-​based constraint
on corporate controllers, it can also be seen as a species of the incentive strategy. To
the extent that it effectively binds the controlling shareholder, it motivates her to act in
the interests of shareholders as a class, which includes the interests of minority share-
holders. As with all abstract norms, however, its functioning is subject to at least two
important qualifications. The first concerns the range of corporate decisions or share-
holder actions that trigger this norm. The second qualification concerns the meaning
of the norm itself. For example, are two shareholders treated equally when a corporate
decision has the same formal implications for each, even though it favors the distribu-
tion or the risk preferences of the controlling shareholder over those of the minor-
ity shareholder? Insofar as shareholder preferences are heterogeneous and controlling
shareholders have legitimate power to shape corporate policy, some level of unequal
treatment seems endemic to the corporate form.44
Our core jurisdictions differ with respect to these qualifications of the equal treat-
ment norm. In general, civil law jurisdictions—​and particularly those that have been

40 § 119 II AktG (shareholders may only vote on management issues if asked by the management
board). But see Chapter 7.6 for the case law on implicit shareholders’ meeting prerogatives (the so-​
called Holzmüller doctrine).
41 See Chapter 3.3.1. See also Ringe, note 35. For a broad discussion of the value of indepen-
dent directors in U.S. family controlled listed companies see Deborah A. DeMott, Guests at the
Table: Independent Directors in Family-​Influenced Public Companies, 33 Journal of Corporation
Law 819 (2008).
42 See Chapter 7.4.2.
43 An example is the Hollinger case, in which the Delaware Chancery Court backed a majority
of independent directors who ousted the dominant shareholder from the board, and prevented him
from disposing of his controlling stake in the company as he wished. See Hollinger Int’l, Inc. v. Black,
844 Atlantic Reporter 2d 1022 (Del. Ch. 2004). The independent directors in Hollinger acted,
however, only after the controlling shareholder’s misdeeds were already under investigation by the
Securities and Exchange Commission (SEC), and the controller had openly violated a contract with
the board as a whole to promote the sale of the company in a fashion that would benefit all sharehold-
ers rather than the controller alone. See also Chapter 8.4.
44 For an instructive U.S. example on the point, compare Donahue v. Rodd Electrotype Co., 328
North Eastern Reporter 2d 505 (Mass. 1975), in which the court mandates that closely held
corporations must purchase shares pro rata from minority and controlling shareholders, with Wilkes
v. Springside Nursing Home, Inc., 353 North Eastern Reporter 2d 637 (Mass. 1976), in which the
same court recognizes that controlling shareholders may pursue their right of “selfish ownership” at a
cost to minority shareholders as long as they have a legitimate business purpose.
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Protecting Minority Shareholders 87

heavily influenced by German law—​tend to view equal treatment as a broad principle

(or source of law) that suffuses all aspects of corporate law. Germany and Japan also
frame the principle of equal treatment as a general statutory provision.45 By contrast,

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the common law jurisdictions—​the U.S. and UK—​specify equal treatment by case
law or statute in particular contexts, but are less inclined to embrace a general legal
standard of equal treatment as distinct from constraint-​like standards such as the con-
trolling shareholder’s duty to act fairly vis-​à-​vis minority shareholders.46
These jurisdictional differences in the deference accorded to equal treatment
have important consequences in a number of corporate law areas. As we discuss in
Chapter 8, respect for equal treatment makes American-​style poison pills more difficult
to implement in jurisdictions that discourage companies from distinguishing among
shareholders in awarding benefits, including stock purchase rights.47 Indeed, it is argu-
able that the law in the U.S.—​or at least Delaware—​accords the widest latitude for
unequal treatment of identical shares among all of our core jurisdictions, though there
are some isolated areas in which it enforces the equal treatment norm with exceptional
vigor. Although most jurisdictions enforce the equal treatment norm most strongly in
the area of corporate distributions (that is, dividends and share repurchases) and share
issues, U.S. law in practice limits categorical enforcement only to the payment of divi-
dends. In general, targeted share repurchases, even at prices above market, are permis-
sible in the U.S., and companies may issue shares to third parties without providing
preemption rights to incumbent shareholders.
Another area in which deference to the equal treatment norm has important impli-
cations is the law of corporate groups (i.e. groups of companies under the common
control of another company, often managed as a single, integrated business). As we
discuss in Chapters 5 and 6, some jurisdictions—​such as Germany, France, Italy, and
Brazil—​provide for special regulation in this area, permitting judicial evaluation of
intra-​group transactions in aggregate.48 Equal treatment is thus interpreted as applying
not to individual transactions, but to aggregates of transactions.
To conclude, the reach of the equality norm varies greatly, both within and between
jurisdictions. However, all our jurisdictions rely on this device, in at least some circum-
stances, to align the incentives of controlling and minority shareholders.

45 § 53a Aktiengesetz (Germany) and Art. 109(1) Companies Act (Japan). There is also a gray area
in German law when it comes to the preferential provision of information to blockholders vis-​à-​vis
other shareholders. A number of EU directives provisions more or less broadly impose the equal treat-
ment principle upon EU publicly traded companies as well. See Art. 46 Directive 2012/​30/​EU, 2012
O.J. (L 315) 74; Art. 3(1)(a) Directive 2004/​25/​EC, 2004 O.J. (L 345) 64; Art. 17(1) Directive 2004/​
109/​EC, 2004 O.J. (L 390) 38; Art. 4 Directive 2007/​36/​EC, 2007 O.J. (L 184) 17.
46 Under Delaware law, equal treatment of minority shareholders determines whether a given
transaction is conceived as self-​dealing and scrutinized as such. Insofar as minority shareholders have
received formally equal treatment (i.e. controlling shareholders have not benefited at the minority’s
expense), the business judgment rule applies. Sinclair Oil Corp. v. Levien, 280 Atlantic Reporter
2d 717 (Del 1971). On the treatment of related-​party transactions by controlling shareholders, see
Chapter 6.2.2 and 6.2.5.
47 Given Japan’s strong statutory provision enshrining the equal treatment norm, the evolving
Japanese case law on warrant-​based takeover defenses is particularly interesting in this regard. See
Bull-​dog Sauce v. Steel Partners, Minshu 61–​5-​2215 (Japan. S. Ct. 2007) (permitting a discriminatory
distribution of warrants where the warrant plan, overwhelmingly approved by an informed share-
holder vote, provided compensation for discriminatory treatment to the defeated tender offeror). See
Chapter 8.2.3.
48 See Chapter [Link] and [Link], and Chapter [Link].
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88 Minority Shareholders and Non-Shareholder Constituencies

4.1.4 Constraints and affiliation rights

We group together the remaining strategies for protecting minority shareholders
because there is less to say about them in a chapter devoted to the governance system.

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Legal constraints—​principally in the form of standards such as the duty of loyalty,
the oppression standard, and abuse of majority voting—​are widely used to protect
the interests of minority shareholders. In fact, these standards are often specific appli-
cations of the equal treatment norm, as when courts allow only “fair” transactions
between companies and their controllers—​meaning, in effect, that controlling share-
holders cannot accept unauthorized distributions from the corporate treasury at the
expense of the firm’s minority shareholders. We examine these standards more closely
in Chapters 6 and 7, although we must stress here that they may help minority share-
holders in settings involving neither a related-​party transaction nor a fundamental
change.49
Finally, the affiliation strategy, in the guise of mandatory disclosure, is at least
as important for protecting minority shareholders as it is for protecting share-
holders as a class. To the extent that disclosure, as a condition for entering and
trading in the public markets, reveals controlling shareholder structures and con-
flicted transactions, market prices may bring home to controllers the costs of their
opportunism.50 Moreover, mandatory disclosure provides the information neces-
sary to protect minority shareholders through other mechanisms, such as voting or
litigation.51
By contrast, the exit strategy goes only so far in protecting minority shareholders.
On the one hand, free transferability of shares, one of the five key elements of the busi-
ness corporation, is helpful but incomplete as a minority protection tool. It permits
dissatisfied minority shareholders to sell their shares on the market, but only if there is
a market for the company’s shares, and even then, usually at a price that already reflects
the controlling shareholder’s abuses.52 On the other hand, minority shareholders are
generally unable to exit the firm by taking with them their proportional share of the
corporation’s assets. After all, permanency of investment is a hallmark of the corporate
form. As we address in Chapters 6, 7, and 8, corporate law sometimes does provide
stronger exit rights, in particular for closely held companies, but usually only upon
egregious abuse of power by a controlling shareholder or in conjunction with a major
transformation of the enterprise. Examples include the availability of appraisal rights
(essentially, a put option) upon the occurrence of a fundamental transaction in many
jurisdictions;53 or the mandatory bid rule triggered by a sale of control and sell-​out
rights in Europe and Brazil.54

49 For instance, in some jurisdictions a minority shareholder in a closely held firm may challenge
as oppressive or abusive a controlling shareholder’s decision to discharge the minority shareholder as
an employee or to remove her from the board when all of the company’s distributions to shareholders
take the form of employee or director compensation.
50 See Chapter [Link]. 51 See Chapter [Link].
52 Informed blockholders can also use the threat of exit, and its impact on stock price, to disci-
pline managers, thereby improving firm governance ex ante—​although this mechanism is likely to be
more effective in firms lacking a controlling shareholder. See Alex Edmans, Blockholders and Corporate
Governance, 6 Annual Review of Financial Economics 23 (2014) (reviewing the use of exit by
blockholders as a governance device).
53 See Chapter 7.2.2 and [Link]. 54 See Chapter 8.3.4.
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Protecting Employees 89

4.2 Protecting Employees

In addition to protecting minority shareholders, the corporate governance system

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extends important protections to non-​shareholder constituencies in a contractual rela-
tionship with the corporation. Corporate law in all jurisdictions provides specialized
protections to corporate creditors, which we consider separately in Chapter 5. Here we
focus principally on the governance protections accorded to employees.
As contractual counterparties to the corporation, employees may deserve the protec-
tion of corporate law insofar as they are particularly susceptible to exploitation by the
firm—​and labor law regulations are held to be insufficient to protect workers or costlier
to implement. From an economic perspective, this vulnerability emerges from the spe-
cific nature of the human capital investments that workers may make in their employer’s
business, such as by learning to use the firm’s technology or relocating to a remote region
where a particular facility is located.55 When these investments are firm-​specific (in
the sense that they are useful only in the context of this employment), a profit-​seeking
corporation may subsequently exploit an employee’s lack of outside options to “hold
up” the employee.56 This could be done by renegotiating the employment contract
to transfer surplus from the worker to the firm, for example by decreasing wages and
benefits, or worsening working conditions. To the extent that employees are able to
foresee the prospect of such opportunistic behavior by the firm, they will be less willing
to undertake firm-​specific investments to begin with, thus ultimately harming profits.57
Our core jurisdictions differ profoundly in the extent to which they rely on corpor­
ate law for the protection of employees. Where they do, appointment rights, decision
rights, and incentives are the principal strategies of choice. Of course, employees may
also benefit indirectly from strategies designed to protect shareholders and creditors.
For instance, mandated financial disclosures can assist employees, as well as investors,
in their affiliation decisions. Disclosure rules have recently been harnessed to protect
employees in a different way: labor unions in the U.S. have pushed for a rule requiring
companies to disclose the “pay ratio” between the CEO and the median worker, a fig-
ure that might arguably help their bargaining position in wage negotiations.58 Finally,
a recent legal change in the UK also purports to rely on corporate law as a substitute
for the labor law protections by permitting the elimination of various labor rights for
“employee shareholders” having received a grant of at least £2,000 in company stock.59

55 Moreover, employees may also have firm-​specific financial investments in the form of unfunded
defined-​benefit pension obligations, which are more common in Germany and Japan. See Martin
Gelter, The Pension System and the Rise of Shareholder Primacy, 43 Seton Hall Law Review 909, 966
(2013).
56 See generally Margaret M. Blair, Ownership and Control: Rethinking Corporate
Governance for the Twenty-​first Century (1995); Paul L. Davies, Efficiency Arguments for the
Collective Representation of Workers: A Sketch, in The Autonomy of Labour Law 367 (Alan Bogg
et al. eds., 2015).
57 For a thorough articulation of the view that corporate law should protect parties making
specific investments in the firm, see Margaret Blair and Lynn Stout, A Team Production Theory of
Corporate Law, 85 Virginia Law Review 247 (1999); Martin Gelter, The Dark Side of Shareholder
Influence: Managerial Autonomy and Stakeholder Orientation in Comparative Corporate Governance, 50
Harvard International Law Journal 129 (2009).
58 On the “pay ratio” rule, see Section 4.3.1.
59 See s. 205A, Employment Rights Act 1996, as introduced by the Growth and Infrastructure
Act 2013 (s. 31).
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90 Minority Shareholders and Non-Shareholder Constituencies

A minority shareholding in the employer is, however, an implausible substitute: an

undiversified position only compounds workers’ vulnerability to firm-​specific risks and
opportunism.

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4.2.1 Appointment and decision rights strategies
The widespread introduction of employee-​appointed directors to the boards of large
European corporations is one of the most remarkable experiments in corporate gov-
ernance of the twentieth century. Many European countries now mandate employee-​
appointed directors in at least some large companies,60 although our core jurisdictions
are not fully representative in this respect. The U.S., UK, Italy, and Japan do not man-
date employee board participation. Even French requirements are tame by the stan-
dards of most other countries imposing worker participation, which typically require
that employee representatives constitute one-​third of the board.61 France requires some
employee board representation for listed companies in which employees own more
than 3 percent of the shares.62 Since 2013, large companies must also stipulate in their
articles of association that one or two directors will be appointed as employee repre-
sentatives.63 However, in the majority of French companies (with over 50 employees)
employees may only select two (sometimes four) non-​voting representatives to attend
board meetings.64 Employee participation requirements are also mild in Brazil: they
apply solely to firms controlled by the federal government and mandate the appoint-
ment of only one employee representative, who is not permitted to vote on labor-​
related matters.65
By contrast, German law establishes “quasi-​ parity codetermination,” in which
employee directors comprise half the members of supervisory boards in German
companies with over 2,000 (German-​based) employees.66 Just as importantly, some
of these labor directors must be union nominees, who generally come from outside
the enterprise.67 Moreover, only German-​based employees and German trade unions
have a right to appoint labor directors—​though such differential treatment of foreign
employees has recently become questionable under EU law.68
Although shareholders and workers appoint equal numbers of directors to the supervi-
sory boards of large German companies (as the term “quasi-​parity” denotes), this does not
mean that they share power equally as a formal legal matter, since the supervisory board’s

60 The only EU countries that have not introduced any significant form of worker board represen-
tation are Belgium, Bulgaria, Cyprus, Estonia, Italy, Latvia, Lithuania, Malta, Romania, and the UK.
Many countries, however, provide for employee board representation only in state-​owned companies.
See [Link]-​[Link]/​.
61 This is the case for instance in Austria, Denmark, Luxembourg, and Hungary. See Aline
Conchon, Board-​level Employee Representation Rights in Europe: Facts and Trends, European Trade
Union Institute Report No. 121 (2011), [Link].
62 Arts. L. 225-​23 and L. 225-​71 Code de commerce (for a one-​tier board and a supervisory board
respectively).
63 Arts. L. 225-​27-​1 and L. 225-​79-​2 Code de commerce (for one-​tier boards and supervisory
boards respectively), introduced by Loi No. 2013-​504 of 14 June 2013.
64 Art. L. 432-​6 Code du travail. 65 Lei 12.353, de 28 de dezembro de 2010 (Braz.).
66 §§ 1 and 7 Mitbestimmungsgesetz. German companies with between 500 and 2,000 employees
must grant one-​third of their board seats to employees. §§ 1 and 4 Drittelbeteiligungsgesetz.
67 In the largest companies seven members are elected by employees and three are appointed by
trade unions. § 7 II Mitbestimmungsgesetz.
68 See Kammergericht, decision of 16 October 2015, 14 W 89/​ 15, Zeitschrift für
Wirtschaftsrecht 2172 (2015) (requesting a preliminary ruling by the Court of Justice of the
European Union on the issue. As of our writing, the case is still pending).
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Protecting Employees 91

chairman, who is elected from among the shareholder representatives, has the statutory
right to cast a tie-​breaking vote in a second round of balloting in case of deadlock.69
Nevertheless, employee representatives retain considerable power, formally through a

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statutory right to veto nominees to the management board,70 and informally, because
they are in a position to disrupt the proceedings of the supervisory board. In addition,
the German codetermination statute allocates one seat on the management board to a
“human resources director,” who often has close ties with unions and employees.71 Thus,
German codetermination gives labor significant leverage over corporate policy by accord-
ing it influence over the composition of the management board, access to information,
and the power to withhold consent from contentious company decisions. This latter
point is especially critical, because the usual practice of supervisory boards is to take deci-
sions by consensus and because the shareholder bench of the supervisory board may not
act monolithically, owing to the presence of independent board members.72
With the exception of Germany, whose laws permit works councils to co-​decide
(with management) on a number of employee-​sensitive matters,73 corporate laws never
confer direct decision-​making rights on workers. EU directives on works councils do
provide employee information and consultation (but not decision) rights on matters
of particular employee concern, such as the prospective trend of employment, any
substantial change in a firm’s organization, collective redundancies or sales of under-
takings.74 Such rights give labor lead time to organize resistance, make its case, or
otherwise protect employees’ interests. Even if works councils cannot influence major
corporate decisions, the information flow that they provide, from top management to
the shop floor and vice versa, arguably creates as much trust between companies and
their employees as mandatory employee representation on the board, especially since
labor representatives on works councils are typically the firm’s own employees rather
than outside union appointees.75

4.2.2 The incentives and constraints strategies

Incentive devices are less important in protecting employees than they are in protect-
ing minority shareholders. Consider the trusteeship strategy first. Of course indepen-
dent directors appointed by shareholders may function as weak trustees on behalf of
employees, just as they do for minority shareholders, if law and local business culture
motivate them to do so. And to some extent the law does facilitate such weak trustee-
ship even in the U.S., where many states other than Delaware permit—​but do not

69 § 29 II Mitbestimmungsgesetz.
70 Election to the management board is by a two-​thirds majority vote of the supervisory board
(§ 31 II Mitbestimmungsgesetz). If there is no two-​thirds majority for a candidate, lengthy proceed-
ings are instituted which finally award the tie-​breaking vote in a simple majority vote to the chairman
of the supervisory board.
71 § 33 Mitbestimmungsgesetz. (Germany). 72 See Chapter 3.3.1.
73 §§ 87 et seq. Betriebsverfassungsgesetz (Germany).
74 See European Works Council Directive (Recast Directive 2009/​38/​EC, 2009 O.J. (L 122) 28);
Art. 4 General Framework Directive (Directive 2002/​14/​EC, 2002 O.J. (L 80) 29); Art. 2 Collective
Redundancies Directive (Council Directive 98/​ 59/​
EC, 1998 O.J. (L 224) 16); Art. 7 Sale of
Undertakings Directive (Council Directive 2001/​23/​EC, 2001 O.J. (L 82) 16).
75 Works councils can provide a better framework for information-​sharing than the supervisory
board also because, unlike trade unions, they are usually not involved in negotiations of employment
terms: see Annette Van Den Berg, The Contribution of Work Representation to Solving the Governance
Structure Problem, 8 Journal of Management and Governance 129 (2004). See also Davies,
note 56.
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92 Minority Shareholders and Non-Shareholder Constituencies

require—​directors to consider the interests of employees and other non-​shareholder

constituencies in making important decisions, especially in the context of a hostile
takeover.76

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Unlike minority shareholders, non-​shareholder contractual constituencies do not—​
and usually cannot—​enjoy the protection of the equal sharing norm. Employees, lend-
ers, and suppliers generally receive the bulk of their compensation as fixed payments
rather than volatile claims on the net income of the firm as a whole. Where employees
invest in developing firm-​specific human capital, such fixed payments may be the firm’s
dominant risk-​sharing arrangement, as the stockholders are generally able to diversify
their financial investments across firms.
Employee stock ownership might seem to be a weak variant of the equal sharing
device. Some jurisdictions encourage firms to share equity ownership with employees,
on the theory that this will improve corporate governance and diminish tensions within
the firm.77 Yet share ownership entails different, and less satisfactory, consequences for
employees than for outside investors with diversified portfolios. For employees, owner-
ship of their firm’s shares increases the already large—​and largely undiversified—​firm-​
specific risk that they bear. Moreover, it is unclear whether employee share ownership
serves to protect the interests of employees as a class, as employee-​shareholders gener-
ally remain a minority, without significant governance rights. Nevertheless, the grant of
stock options to lower-​level employees is surprisingly frequent in practice, especially in
high-​tech industries: stock options can help alleviate financing and capital constraints
facing the firm, as well as promote retention and the sorting of optimistic employees.78
Finally, the constraints strategy for protecting employees is largely embodied in ded-
icated regulatory structures, such as labor law, which, for reasons of space, we exclude
from the purview of this book except in the context of fundamental corporate deci-
sions, addressed in Chapter 7 below.79 Otherwise, the laws that permit or mandate cor-
porate directors to have regard to non-​shareholder constituencies typically encompass
the interests of employees as well.80 Nevertheless, these other corporate law constraints
for protecting non-​shareholder constituencies are usually toothless or narrowly tar-
geted, as discussed further below.

4.3 Protecting External Constituencies

Corporate laws everywhere focus primarily on the relationships between the corpor­
ation and its contractual constituencies—​notably, managers and shareholders, but also
creditors and employees. Yet there is no doubt that the corporation’s economic rel-
evance and impact go well beyond its relationships with contractual counterparties.

76 See Chapter [Link]. For a trustee-​like analysis of the U.S. board, see Blair and Stout, note 57.
77 There are also instances of the reward strategy in the form of legally sanctioned sharing regimes.
For example, the U.S. has tax-​favored employee stock ownership plans: see Henry Hansmann, The
Ownership of Enterprise 87 (1996). France mandates both extensive information and limited
employee profit-​sharing rights in all firms with more than 50 workers. See Arts. L. 2322-​1, 2323-​6 to
2323-​23-​60, 3322-​2, 3324-​1 and 3324-​10 Code du travail.
78 See e.g. John E. Core and Wayne R. Guay, Stock Option Plans for Non-​executive Employees, 61
Journal of Financial Economics 253 (2001) (finding an association between the use of stock
options and financing and capital constraints); Paul Oyer and Scott Schaefer, Why Do Some Firms
Give Stock Options to All Employees? An Empirical Examination of Alternative Theories, 76 Journal
of Financial Economics 99 (2005) (attributing the widespread use of stock options to sorting and
retention goals, rather than incentives).
79 See Chapter [Link]. 80 See Section 4.3.3.
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Protecting External Constituencies 93

Left unchecked, corporations may engage in socially harmful behavior, such as envi-
ronmental degradation, violations of human rights, anticompetitive behavior, or prac-
tices that pose systemic risk to the economy. The recent scandal involving German

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car manufacturer Volkswagen—​which designed its cars’ software to cheat emissions
tests—​illustrates this concern. The company’s relentless pursuit of growth, which ini-
tially benefited both shareholders and workers, encouraged managerial choices that
clearly conflicted with the wider interests of society.
Of course, corporations have no monopoly on socially harmful activities: individu-
als and other organizational forms engage in them as well. Yet because the corporate
form is particularly conducive to large-​scale enterprise, the social harms it engenders
are correspondingly large-​scale. Moreover, limited liability—​an essential feature of the
corporate form—​serves to compound the problem, by permitting shareholders to bear
only a fraction of the costs their companies’ activities cause for third parties.81 And
precisely because they cannot protect themselves through contract, the corporation’s
non-​contractual stakeholders have a greater need for legal protection than do its con-
tractual constituencies.
The crucial question is not whether the corporation’s non-​contractual stakeholders
deserve legal protection of some sort—​they clearly do—​but whether corporate law is
the proper channel through which to deliver this. A simple answer is that protection of
interests extraneous to the firm should come from other areas of law, such as environ-
mental law, human rights law, antitrust law, or financial regulation. Indeed, the use of
legal rules and standards—​the constraints strategy—​to promote interests extraneous
to the corporate form is, almost by definition, not corporate law, but the application to
corporations—​as legal persons—​of norms from other fields of law.
On occasion, however, regulators from our core jurisdictions resort to the same gov-
ernance strategies and incentive strategies outlined in Chapter 2, not (only) to mitigate
agency problems within the firm, but (also) to achieve broader societal objectives. Such
an approach may be necessitated when—​owing to regulators’ information gaps or to
successful industry lobbying—​more direct regulatory responses to externalities and
other social problems are not feasible.82 On the other hand, corporate law may become
an easy target of populist or misguided reform efforts that can easily decrease the effi-
ciency of its regime without generating any meaningful gains for other constituencies.
The use of corporate law to protect external constituencies is by no means new.
Historically, the very availability of incorporation was conditioned on the showing of
a specific public benefit resulting from the enterprise. Other features of early corporate
laws were specifically devised to mitigate monopoly problems or otherwise protect the
interests of consumers.83 In fact, the historical and contemporary uses of corporate
law to protect non-​contractual stakeholders are too numerous to describe in full.84 It
is worth noting, however, that in recent years—​and in particular, in the wake of the
recent financial crisis—​there has been a visible resurgence in the use of legal strategies
that shape the internal governance of business corporations, in particular in the finan-
cial sector, to tackle broader social and economic problems.

81 See Chapter 1.2.2 and Chapter [Link].

82 See Mariana Pargendler, The Corporate Governance Obsession, 42 Journal of Corporation
Law 101 (2016).
83 Henry Hansmann and Mariana Pargendler, The Evolution of Shareholder Voting Rights: Separation
of Ownership and Consumption, 123 Yale Law Journal 948 (2014).
84 This is particularly conspicuous with respect to takeover regulation, which is often shaped by the
interests of labor, local communities, and the national economy. For examples, see Chapter 8.
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94 Minority Shareholders and Non-Shareholder Constituencies

Before proceeding, one caveat is necessary. Most attempts to protect external

interests—​from gender equality in the boardroom to the reduction of systemic risk
and the protection of human rights—​can be, and have been, rationalized in terms of

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promoting long-​term shareholder value. Nevertheless, while the long-​term interests of
shareholders may at times coincide with those of society at large, perfect alignment in
all circumstances is implausible. In the following discussion, we consider instances in
which the legal strategies of corporate law are deployed with the interests of external
constituencies in mind, without taking a firm stance on the extent to which they also
benefit investors.

4.3.1 Affiliation strategies
The vast majority of the disclosure requirements imposed on publicly traded com-
panies concern factual matters that assist investors in evaluating the corporation’s
financial condition and, to a lesser extent, in exercising their governance rights.85 By
increasing the quality and quantity of information available to the public, mandating
such disclosures enhances the efficiency of stock prices and supports financially moti-
vated affiliation (and, to a lesser extent, voting) decisions by shareholders as a class.
In recent years, however, there has been a rise in the use of “non-​financial” or “social”
disclosure requirements.86 These new obligations relate to information that, while
arguably valuable from a social standpoint, may not always be relevant for shareholder
affiliation decisions motivated solely by financial considerations. Rather, their goal
is to facilitate entry and exit decisions by shareholders (and consumers) on socially
minded criteria and, where such decisions are taken on a sufficiently large scale, to
shape substantive corporate conduct. For instance, the U.S. Dodd-​Frank Act of 2010
requires publicly traded companies to disclose their use of conflict minerals from the
Democratic Republic of the Congo—​a rule intended ultimately to discourage the use
of such minerals and thereby alleviate the humanitarian crisis in the region.87 Similarly,
a new SEC requirement that U.S. public companies must disclose the extent to which
they consider diversity in director nominations is at least partly motivated by fairness
concerns towards women and minorities.
The Dodd-​Frank Act also includes a provision mandating disclosure of the ratio
of CEO compensation to that of their company’s median employee. This rule is best
understood as a response to growing apprehension about inequality, rather than as a
metric for evaluating corporate financial performance. In Japan, too, new executive
compensation disclosure obligations in part reflect growing unease about pay gaps
between CEOs and their average employees.88 For the first time, Japan now requires
individualized reporting of executive compensation packages, but only for those execu-
tives whose annual pay exceeds ¥100 million (approximately US$1 million)—​a high
threshold that is not met in most Japanese companies.89

85 See Chapter 3.4.2 and Chapter 9.

86 See e.g. Donald C. Langevoort and Robert B. Thompson, “Publicness” in Contemporary Securities
Regulation after the JOBS Act, 101 Georgetown Law Journal 337 (2013).
87 The D.C. Circuit has found that the portion of such a rule requiring a company to report that
its products have not been found to be “DRC conflict free” violates freedom of speech under the U.S.
Constitution: Nat’l Ass’n of Mfrs. v. SEC, 2014 Westlaw 1408274 (D.C. Cir., Apr. 14, 2014).
88 See Robert J. Jackson, Jr. and Curtis J. Milhaupt, Corporate Governance and Executive
Compensation: Evidence from Japan, 2014 Columbia Business Law Review 111, 129.
89 Cabinet Office Ordinance on Disclosure of Corporate Affairs, Form 2 (Precautions for
Recording (57)d) and Form 3 (Precautions for Recording (37)).
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Protecting External Constituencies 95

Non-​ financial disclosure has also gained particular traction in the EU. The
Accounting Directive now requires companies that operate in extractive industries to
publish details on payments they make to local governments in the countries in which

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they operate.90 Moreover, a 2014 directive mandates disclosure of non-​financial infor-
mation in management reports, including the company’s policy and performance with
respect to “environmental, social and employee matters, respect for human rights, anti-​
corruption and bribery matters.”91 These new reporting requirements have a broad
footprint: they apply to all large “public interest entities,” a category which includes
not only listed companies, but also large closely held banks and insurance firms with
more than 500 employees. The goal is presumably to focus pressure from shareholders,
consumers, and civil society at large so as to steer corporations towards socially desir-
able outcomes. In Japan, there is relatively little mandatory disclosure of non-​financial
information to protect external constituencies, although the Tokyo Stock Exchange
requires companies to describe how they respect the interests of various stakeholders in
their governance reports.
Whether disclosure is an appropriate means to accomplish these ambitious goals
remains an open question, which we consider further below.

4.3.2 Appointment and decision rights strategies

The interests of external constituencies could in theory also be advanced through the allo-
cation of appointment and decision rights. Although reformers have argued for “con-
stituency directors” at various points in time (especially in the 1970s),92 none of our core
jurisdictions confers general appointment rights on non-​shareholder constituencies other
than employees. The only exception is the appointment rights conferred by certain “golden
shares”—​such as France’s action spécifique—​which permit governments to appoint board
representatives in privatized firms.93
Yet most jurisdictions have director qualification requirements that constrain share-
holders’ choice of appointees in view of broader economic or social purposes. A classical
example is the prohibition, in countries such as the U.S., Germany, and Italy, of inter-
locking directorates across financial institutions, which aims to preserve competition by
preventing directors from simultaneously serving on the boards of rival firms.94
More recently, Germany, Italy, and France and other countries have instituted man-
datory minimum quotas on corporate boards,95 and Japan has concurrently introduced
voluntary targets. Gender quotas are best viewed as a constraint on the exercise of

90 See Arts. 41–​8 Directive 2013/​34/​EU, 2013 O.J. (L 182) 19. “Extractive industries” encompass
the exploration and extraction of minerals, oil, natural gas deposits, or other materials. The disclosure
provisions also apply to firms engaged in logging activity in primary forests (Art. 41).
91 Directive 2014/​95/​EU, 2014 O.J. (L 330) 4, which inserted Art. 19A to Directive 2013/​34/​EU.
92 See e.g. Ralph Nader, Mark Green, and Joel Seligman, Taming the Giant Corporation 125
(1976) (advocating the presence of an informed representative on the board for each public concern,
such as environmental matters, consumer interests, compliance, among others).
93 Art. 31-​1 Ordonnance No. 2014-​948 of 20 August 2014, inserted by Loi No. 2015-​990 of 6
August 2015.
94 Section 8 of the Clayton Act (U.S.); § 100 section 2 No. 3 AktG (Germany); Art. 36, Decree-​
Law 6 December 2011, No. 201 (Italy).
95 Aktiengesetz § 96(2) (30 percent of supervisory board seats for the largest companies with
employee board representation); Arts. 225-​18-​1 and 225-​69-​1 Code de commerce (in force, respec-
tively, as of 1 January 2017 and 2020); Art. 147-​III Consolidated Act on Financial Intermediation
(Italy) (one-​third of board seats). The Italian law on gender quota only applies to three board elections
following its entry into force in 2012.
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96 Minority Shareholders and Non-Shareholder Constituencies

appointment rights that seeks to further more than simply the interests of shareholders.
The empirical literature does not evidence any clear link between board diversity and
corporate performance.96 While a similar absence of evidence has not stopped inde-

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pendent directors being promoted as a means of securing shareholders’ interests,97 a
likely alternative motivation for these new quota requirements is the political desire to
promote gender fairness. Perhaps also, they may seek to further the interests of non-​
shareholder constituencies, as some studies suggest that female directors exhibit differ-
ent preferences from male directors with respect to risk-​taking and the protection of
stakeholders.98
Decision rights are also occasionally used to protect the interests of non-​
shareholder constituencies. This is not done directly, at least in our core jurisdic-
tions, but indirectly, by conferring decision rights on the state. An example is the
retention by governments of “golden shares” in privatized firms. These first emerged
in the UK during privatizations in the 1980s, and then spread to Brazil, France,
Germany, and Italy.99 Golden shares grant the state veto rights over certain fun-
damental corporate decisions (such as mergers, dissolutions, and sales of assets)
disproportionately to, or sometimes irrespective of, any ownership interest in the
firm. Governments with golden shares can be “shareholders” in name only—​they
are not necessarily investors in, or beneficial owners of, the firm.100 The rationale
for awarding such outsize decision rights to governments is presumably to protect
the public interest at large.101
Golden shares are not the only instrument by which governments can exercise direct
corporate power to promote social objectives. Another is direct state ownership of
enterprise, either via majority stakes or significant blockholdings.102 Despite waves of

96 See e.g. Deborah H. Rhode and Amanda Packel, Diversity on Boards: How Much Difference Does
Difference Make? 39 Delaware Journal of Corporate Law 363 (2014) (reviewing the empirical lit-
erature on female participation on boards and concluding that “the relationship between diversity and
financial performance has not been convincingly established”); Renee B. Adams, Women on Boards:
The Superheroes of Tomorrow?, ECGI Finance WP No 466/​2016 (2016) (similar).
97 See Chapter 3.2.
98 See e.g. George R. Franke, Deborah F. Crown, and Deborah F. Spake, Gender Differences in
Ethical Perceptions of Business Practices, 82 Journal of Applied Psychology 920 (1997) (women
more likely than men to perceive certain business practices unethical); Renée B. Adams and Daniel
Ferreira, Women in the Boardroom and Their Impact on Governance and Performance, 94 Journal
of Financial Economics 291 (2009) (diverse boards devote more effort to monitoring); David
A. Matsa and Amalia R. Miller, A Female Style in Corporate Leadership? Evidence from Quotas, 5
American Economic Journal: Applied Economics 136 (2013) (boards subject to gender quotas
increased relative labor costs and made fewer workforce reductions). But see Renée B. Adams and
Vanitha Ragunathan, Lehman Sisters, Working Paper (2015), at [Link] (banks with more women
directors no less prone to risk-​taking).
99 However, golden shares have been successfully challenged in the EU as an impediment to the
free movement of capital. See e.g. Wolf-​Georg Ringe, Company Law and Free Movement of Capital, 69
Cambridge Law Journal 378 (2010).
100 Whether golden shares entitle governments to cash-​flow rights varies by jurisdiction. Even
where they do, the associated decision rights are disproportionately powerful.
101 However, corporate income taxation makes the government a residual claimant of sorts in all firms
in a way that serves to align the interests of the government with those of shareholders. Indeed, a high
rate of tax compliance is associated with lower private benefits of control. See Dyck and Zingales, note 2.
102 Bernardo Bortolotti and Mara Faccio, Government Control of Privatized Firms, 22 Review of
Financial Studies 2907, 2924 (2009) (common law governments resort to golden shares more fre-
quently; civil law governments relying more on continued equity ownership in privatized firms); Aldo
Musacchio and Sergio G. Lazzarini, Leviathan in Business, Brazil and Beyond (2014) (examining
different varieties of state capitalism).
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Protecting External Constituencies 97

privatizations, significant state ownership persists in several of our core jurisdictions—​

most conspicuously in France, Germany, Italy, and Brazil.103 By exercising appointment
and voting rights through its role as shareholder, the state may steer the firm to achieve

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political objectives, even at the expense of financial returns. State-​owned enterprises
(SOEs) are usually subject to the same corporate law regime applicable to private firms,
which generally affords the state as controlling shareholder wide discretion to pursue
public goals.104 For example, Brazil’s corporations statute applies to the state the same
fiduciary duties applicable to private controlling shareholders, but otherwise specifically
authorizes it to pursue the public interest that justified an SOE’s creation.105
Finally, scholars and policymakers have at times expressed hope that shareholders
themselves might exercise decision rights in ways that promote the interests of society
at large. The basic premise is that the rise in institutional investors pursuing index-
ing strategies entailing economy-​wide exposure, together with the broader spread of
equity ownership across various segments of society in some jurisdictions (especially
the U.S.), created a natural alignment between the interests of these “universal own-
ers” and the public interest.106 The expansion of shareholder rights following the 2008
financial crisis—​as exemplified by the rise of “say on pay” around the globe—​is at least
partly premised on this assumption.107

4.3.3 The incentives and constraints strategies

As discussed above, the widespread use of the constraints strategy to protect the inter-
ests of external constituencies is usually thought to happen beyond the perimeter of
“corporate law.” There are, however, limited exceptions to this. First, other areas of law
can harness the mechanisms and enforcement tools of corporate law to pursue their
goals, which can make disciplinary boundaries more porous. For example, the U.S.
Foreign Corrupt Practices Act of 1977 (FCPA) on accounting and internal control
rules, on the one hand, and on SEC enforcement against public issuers, on the other,
in the pursuit of corruption.
Another exception is the imposition on directors of duties to consider the interests
of constituencies other than shareholders—​an expression of the standards strategy. The
corporate laws of many jurisdictions provide that directors owe their duty of loyalty to
the company rather than to any of its constituencies.108 Such a duty is most naturally
understood as an exhortation to maximize the net aggregate returns (pecuniary and
non-​pecuniary) of all corporate constituencies.

103 See Mariana Pargendler, State Ownership and Corporate Governance, 80 Fordham Law Review
2917 (2012).
104 Marcel Kahan and Edward Rock, When the Government is the Controlling Shareholder, 89 Texas
Law Review 1293 (2011); Mariana Pargendler, Governing State Capitalism: The Case of Brazil, in
Chinese State Capitalism and Institutional Change: Domestic and Global Implications
385 (Curtis J. Milhaupt and Benjamin Liebman eds., 2015).
105 Art. 4º § 1º Lei 10.303, de 30 de junho de 2016 (Braz.).
106 See e.g. Robert A. G. Monks and Nell Minow, Watching the Watchers 121 (1996); James
P. Hawley and Andrew T. Williams, The Rise of Fiduciary Capitalism (2000); Gelter, The Pension
System, note 55.
107 The same idea has inspired recent proposals to employ the constraints strategy to impose more
stringent liability standards on managers of systemically important firms. See John Armour and Jeffrey
N. Gordon, Systemic Harms and Shareholder Value, 6 Journal of Legal Analysis 35 (2014) (suggest-
ing diversified shareholders would act “as a proxy for society” in enforcing such liability).
108 E.g. Germany: §§ 76 I and 93 I 2 AktG; Japan: Art. 355 Companies Act.
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98 Minority Shareholders and Non-Shareholder Constituencies

In theory, implementing this obligation might (or might not) require division of
company surplus between shareholders and non-​shareholder constituencies such as
employees, in order to maximize the aggregate private welfare of all corporate constitu-

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encies.109 In practice, however, courts are not well-​placed to determine which policies
maximize aggregate private welfare. This explains why, even where it is spelt out, a duty
to pursue the corporation’s interest (in this broad sense) is unenforceable. Even fair-​
minded directors are unlikely to know how best to distribute surplus among multiple
corporate constituencies. Thus, the exhortation to boards to pursue their corporations’
interests is less an equal sharing norm than, at best, a vague counsel of virtue, and, at
worst, a smokescreen for board pursuit of their own interests. For instance, the UK
Companies Act 2006 requires directors to seek to promote “the benefit of [the compa-
ny’s] members as a whole, and in doing so [to] have regard (amongst other matters) to …
the interests of the company’s employees, … [and] the impact of the company’s opera-
tions on the community and the environment.”110 However, the obligation is framed
subjectively, extending only to “act[ing] in the way he considers, in good faith” would
bring about that result, which encourages judicial deference to directors. Moreover,
third parties have no standing to enforce the duty. Similarly, Brazil’s corporations stat-
ute provides that directors should act in the best interests of the company, “subject to
the exigencies of public good and the social function of enterprise”; controlling share-
holders, in turn, have duties and responsibilities towards “the remaining shareholders,
workers, and the community in which [the company] operates.”111 Yet this type of
language appears to have no constraining force, much like similar language in the typi-
cal American constituency statute.112
None of our core jurisdictions deploy duties to advance the interests of non-​
shareholder constituencies with quite such ambition as the new regime introduced by
India’s Companies Act of 2013. This requires companies to create a corporate social
responsibility committee and spend at least 2 percent of average net profits on pro-
moting their “corporate social responsibility policy”—​preferably in local areas—​or to
explain their reasons for noncompliance. The Indian statute’s definition of “corporate
social responsibility” is particularly broad, encompassing not only social objectives
closely related to the firms’ primary activities, but also general humanitarian goals
such as the eradication of extreme hunger and poverty, reducing child mortality, and
combating various diseases.113 Unsurprisingly, given its ambition, the effectiveness of
this regime remains very much open to question.
Yet while our core jurisdictions do not compel spending on social causes, they do
not prohibit it, either. A number of them explicitly sanction corporations’ ability to
make reasonable charitable contributions.114 Legal systems may also encourage corpor­
ate charitable contributions through various tax deductions. And even in the United
States, where fiduciary duties to shareholders are formally perhaps the strongest,115

109 Note that maximizing the private welfare of all of the firm’s current constituencies is not equiva-
lent to maximizing overall social welfare, which would include, for example, the welfare of potential
employees who are never hired because the high wages of current employees limit firm expansion.
110 § 172 Companies Act 2006 (UK).
111 Arts. 164 and 116 Lei das Sociedades por Ações. 112 See Chapter 8.5.
113 Companies Act 2013 (India), Art. 135 and Schedule VII.
114 See e.g. § 122(9) Delaware General Corporation Law; Art. 154, § 4º Lei das Sociedades
por Ações.
115 The most famous articulation of the shareholder primacy ideal comes from the case of Dodge
v. Ford Motor Company, 170 NW 668 (Mich. 1919) (“it is not within the lawful powers of a board
of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of
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Protecting External Constituencies 99

in practice directors enjoy wide latitude to further the interests of non-​shareholder

constituencies so long as the decision is framed in terms of promoting long-​term share-
holder value.116

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Corporate law may also indirectly protect non-​shareholder constituencies through the
imposition of oversight liability on directors for failures to implement and monitor inter-
nal systems of compliance against illegal activity. By making it likelier that illegal activities
will be detected and their effects contained, such oversight obligations, which we touched
upon briefly in Section 3.4.1, can also protect external constituencies.117 Some jurisdic-
tions also impose liability for damages caused to third parties by the directors’ negligence
(or gross negligence) in breaching a duty to the corporation.118 In practice, however, this
duty is principally read to protect the creditors of closely held corporations.119
Finally, another (blunt) use of the constraints strategy to protect the interests of
external constituencies is through the imposition of personal liability on directors and
officers—​or even shareholders—​for violations of law.120 All of our core jurisdictions
occasionally deviate from the general rule that only the corporation—​as a distinct legal
person—​is liable for its actions to accommodate the deterrence and compensation
goals of other branches of law, such as product liability, social securities law, tax law,
patent law, environmental law, labor law, antitrust law, and financial regulation.121
These include both direct sanctions for intentional or reckless violations of law and
secondary liability to pay damages to third parties if the firm becomes insolvent.
Irrespective of the scope and content of corporate fiduciary duties, the trusteeship
strategy in the form of independent directors—​as the “broad-​spectrum prophylac-
tic” previously mentioned—​is also used to protect both contractual constituencies
and stakeholders external to the firm.122 For instance, the New York Stock Exchange
first required the inclusion of independent directors in audit committees in the late
1970s as a response to the corruption scandals of that era, even though corporate
corruption can easily serve the financial interests of investors (if to the detriment of
society at large). Indeed, one may argue that such ambiguity with respect to the func-
tion served by independent directors—​the protection of shareholders as a class, of
minority shareholders, of non-​shareholder contractual constituencies, or of external

shareholders and for the primary purpose of benefiting others”). See, more recently, eBay Domestic
Holdings, Inc. v. Newmark, 16 Atlantic Reporter 3d 1, 33 (Del. Ch. 2010) (“Promoting, protect-
ing, or pursuing non-​stockholder considerations must lead at some point to value for stockholders”).
116 Einer Elhauge, Sacrificing Corporate Profits in the Public Interest, 80 New York University
Law Review 733 (2005) (business judgment rule deference entails significant managerial discretion
to sacrifice profits in the public interest).
117 Claire Hill and Brett McDonnell, Reconsidering Board Oversight Duties after the Financial Crisis,
University of Illinois Law Review 859, 866–​7 (2013).
118 Art. 429(1) Companies Act (Japan); Art. 2395 Civil Code (Italy); Art. L. 225-​251 Code de
commerce (France). However, French courts virtually never impose liability on directors on behalf of
third parties as long as the company is solvent. See Maurice Cozian et al., Droit des sociétés 179
(28th edn., 2015).
119 See Chapter [Link].
120 See Reinier H. Kraakman, Corporate Liability Strategies and the Costs of Legal Controls, 93 Yale
Law Journal 857 (1984).
121 See e.g. Klaus J. Hopt and Markus Roth, Sorgfaltspflicht und Verantwortlichkeit der
Vorstandsmitglieder, in Aktiengesetz: Grosskommentar (Heribert Hirte et al. eds., 5th edn., 2015),
§ 93 comments 656 et seq (discussing controversial imposition of personal liability on corporate direc-
tors in Germany for product liability cases).
122 See e.g. Victor Brudney, The Independent Director—​Heavenly City or Potemkin Village? 95
Harvard Law Review 597, 597 (1981–​2) (“Numerous observers have argued that the addition of
independent directors to corporate boards would solve the problem of corporate social responsibility
without incurring the costs of external regulation”).
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100 Minority Shareholders and Non-Shareholder Constituencies

stakeholders—​has in fact facilitated political consensus and contributed to the spread

of this mechanism in our core jurisdictions over time.123 The reward strategy has also
been increasingly deployed to protect the interests of non-​shareholder constituencies.

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Rather than attempting to tie executive remuneration to benefits conferred by the
corporation on society as a whole—​which would clearly be impractical—​the reward
strategy has rather been used to discourage certain practices considered to be especially
harmful from a social standpoint.
In the wake of the financial crisis, there has been considerable concern that, by tying
executive remuneration to short-​term returns, compensation packages in financial
institutions contributed to the system’s collapse by encouraging managers to take risks
that were excessive from a social standpoint.124 In systemically important financial
institutions, the interests of undiversified shareholders conflict with those of society as
a whole—​both because financial crises have disastrous macroeconomic consequences
and because taxpayers are left to pick up the bill to bail out failing banks.
Yet, given the countervailing advantages of equity-​based compensation, none of our
core jurisdictions has completely banned its use in financial institutions, though the EU
has capped the variable component at twice fixed pay.125 Nor has there been any per-
manent imposition of ceilings on the level of compensation, notwithstanding populist
demands and growing concern about inequality. Except for the EU’s cap on variable pay,
most reforms in this area took the form of decision strategies, as in the global spread of
the “say on pay” rule,126 of trusteeship strategies, as in the most stringent independence
requirements for members of compensation committees imposed in the U.S,127 and of
affiliation strategies, as in the greater disclosure requirements in the U.S. and Japan.128

4.4 Explaining Jurisdictional Differences and Similarities

As with our discussion of the primary manager–​ shareholder agency problem in
Chapter 3, we first assess our core jurisdictions according to the protection that sub-
stantive law offers to minority shareholders, employees, and external stakeholders,
respectively, and then according to the protection that these constituencies enjoy in
practice, considering not only corporate law but also societal and legal institutions
more generally.

4.4.1 The law-​on-​the-​books
The substantive law-​on-​the-​books gives little guidance as to which jurisdictions place
more emphasis on protecting minority shareholders and external constituencies. It
does, however, provide an indication of which countries go furthest to protect employ-
ees through corporate law.

123 Pargendler, note 82.

124 See e.g. Lucian A. Bebchuk and Holger Spamann, Regulating Bankers’ Pay, 98 Georgetown
Law Journal 247 (2010).
125 Art. 94(1)(g) Capital Requirements Directive IV, 2013 O.J. (L 176) 338. The basic cap is set
at 100 percent of fixed pay, which may be increased to 200 percent with shareholder approval. See
generally John Armour et al., Principles of Financial Regulation 380–​8 (2016). Moreover, the
supervisory board members of most large German firms no longer receive stock options, though their
fixed salary has increased considerably.
126 See Section 4.3.2 and Chapter 6.2.3. 127 See Chapter 3.3.1.
128 See Section 4.3.1.
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Explaining Jurisdictional Differences and Similarities 101

Consider minority shareholders first. Our analysis has shown that only Brazil and
Italy among our core jurisdictions rely on appointment rights, in the form of minority-​
elected board members, to protect minority shareholders. Elsewhere the long-​term

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trend is in the opposite direction—​ namely, away from minority empowerment
through devices such as cumulative voting and strong supermajority voting rules.129
Why do so few jurisdictions mandate minority-​friendly appointment rights for
listed companies? One answer is that “partisan” representation of minority share-
holders in controlled companies can be costly, by introducing conflict in board
meetings, discouraging candid business discussions, and, at its worst, providing
competitors with access to sensitive information.130 Another answer is that minor-
ity shareholders in publicly traded corporations are a heterogeneous group. On the
one hand, retail investors are the most vulnerable minority but, as a consequence
of collective action problems, are also the group least able to pursue their interests
effectively through appointment and decision rights. This is especially so under
the high ownership percentage thresholds required for the exercise of such rights
in Brazil and Italy. On the other hand, the minority shareholders best able to use
appointment rights are large-​block investors, who are also best able to contract for
governance protections (e.g. in a shareholder agreement) even without the addition
of mandatory terms in the law.
Board representation for minority shareholders might make more sense if, as is
relatively often the case in Brazil and Italy for the largest companies,131 institutional
investors, as opposed to other blockholders, nominate minority directors. At least in
the U.S., however, stringent laws on insider trading and onerous ownership disclosure
rules that prevent coordination among shareholders132 historically discouraged most
institutional investors from exercising appointment rights, making this strategy less
appealing. For activist investors such as hedge funds, however, board representation
for minority investors has proved to be a potent tool, even in the U.S.—​especially in
light of the growing collaboration between hedge funds and traditional institutional
investors.133
What, then, of other legal strategies for protecting minority investors? Among our
core jurisdictions the U.S., followed by the UK, appears to rely most extensively on
independent directors (in publicly traded companies), even more so after the Sarbanes-​
Oxley and Dodd-​Frank Acts enhanced their role. But since independent directors may
be appointed by controlling shareholders, even in the U.S. and the UK, their allegiance
is always suspect unless their interest in maintaining a good reputation among outside
shareholders at large is greater than their desire to be re-​elected in a particular firm
(or in other firms with controlling shareholders). The U.S., however, complements
the trusteeship strategy with the strongest mandatory disclosure system of all our core
jurisdictions.134

129 See Chapter 3.2.1 and Chapter 4.1.1.

130 See e.g. Gordon, note 8, at 167 (discussing traditional critiques of cumulative voting).
131 Institutional investors nominate around one-​third of the minority-​appointed directors in
companies voluntarily providing such information. See Assonime, Corporate Governance in
Italy: Compliance with the CG Code and Directors’ remuneration (Year 2012) 62–​70
(2013), at [Link]
132 See Mark J. Roe, Strong Managers, Weak Owners: The Political Roots of American
Corporate Finance 273 (1994).
133 See Kobi Kastiel, Against All Odds: Shareholder Activism in Controlled Companies, 2016
Columbia Business Law Review 60.
134 See Chapter [Link] and Chapter 9.
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102 Minority Shareholders and Non-Shareholder Constituencies

Alternatively, consider the equal treatment norm as a minority safeguard. Here,

Japan—​followed by continental European jurisdictions and Brazil—​is the country with
the most stringent standards, at least on-​the-​books. The UK also gives substance to the

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equal treatment norm in the form of preemption rights and minority-​protective takeover
rules, while Delaware appears to rely on it the least. Put differently, all we know from
reviewing the law-​on-​the-​books is that jurisdictions pursue different strategies to protect
minority interests. How well these strategies work in practice is a totally different story.
When it comes to governance strategies that protect labor’s interest, Germany’s sys-
tem of quasi-​parity codetermination, coupled with works council co-​decision rights,
clearly stands out.135 France follows, a considerable distance behind Germany, by man-
dating a far more attenuated labor presence on company boards and, for companies
with more than fifty employees, a works council with mere information and consul-
tation rights.136 But France, like Japan, Germany, Italy, and Brazil, has strong labor
law rules governing basic employee interests, ranging from pension rights to terms of
dismissal.137 The U.S., followed by the UK, is the least protective of our core jurisdic-
tions, both in direct regulation of employee rights and in structuring the corporate
governance system to reflect employee interests. Overall, the observed pattern seems
consistent with the view that the presence of powerful shareholders increases the risk
of exploitation of workers.138
Conversely, different jurisdictions embrace a variety of strategies with respect to the
protection of external constituencies, making it difficult to establish a clear pecking
order. The use of the affiliation strategy through mandatory disclosure of non-​financial
information is currently most extensive in EU countries, and least so in Brazil. Whether
explicitly or implicitly, all jurisdictions require or at least permit the board to take into
account the interests of non-​shareholder constituencies.139
State influence through ownership or golden shares is strongest in Brazil, France,
and Italy, and again weakest in the U.S., with other jurisdictions falling somewhere
in between. On the other hand, the decision rights of shareholders are weakest in the
U.S., thus arguably insulating boards from shareholder pressure and enabling them, if
only de facto, to promote a broader set of interests.140

4.4.2 The law in practice

As we argue above, the law-​on-​the-​books provides an imperfect measure of the protec-
tion accorded to corporate constituencies. This is particularly the case for minority
shareholders.

135 For reviews of the empirical literature on these mechanisms, see John T. Addison and Claus
Schnabel, Worker Directors: A German Product that Did Not Export, 50 Industrial Relations 354,
354 (2011); Davies, note 56.
136 See Rebecca Gumbrell-​McCormick and Richard Hyman, Embedded Collectivism? Workplace
Representation in France and Germany, 37 Industrial Relations Journal 473, 482 (2006).
137 See e.g. Juan C. Botero, Simeon Djankov, Rafael La Porta, Florencio Lopez-​de-​Silanes, and
Andrei Shleifer, The Regulation of Labor, 119 Quarterly Journal of Economics 1339 (2004)
(France’s labor law is most restrictive among our jurisdictions).
138 Gelter, The Dark Side, note 57. But see Mark J. Roe, Political Preconditions to Separating
Ownership from Control, 53 Stanford Law Review 539 (2000) (for the different view that social
democracies induce concentrated ownership in order to counterbalance the influence of labor in firm
management).
139 See notes 111–​12 and accompanying text.
140 See Chapter 3.4. See also Christopher M. Bruner, Corporate Governance in the Common
Law World 105 (2013).
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Explaining Jurisdictional Differences and Similarities 103

[Link] Minority shareholders
Two prominent empirical papers, applying different methodologies to data from the
1990s, suggest that controlling shareholders obtained private benefits that ranged from

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small to negligible in the UK, U.S., and Japan respectively, through moderately larger
in Germany (approximately 10 percent), very large in Italy (30 percent or more) and
France (28 percent), to extraordinarily large (65 percent) in Brazil.141 Thus, to the
extent that private benefits of control measure the severity of the majority–​minority
shareholder agency problem, our core jurisdictions differed dramatically in the extent
of protection that they offered to minority shareholders, even if these differences were
not evident a priori from the law-​on-​the-​books.142
Moreover, these variations followed a clear pattern. The three jurisdictions in which
large corporations ordinarily have dispersed ownership also had low private benefits
of control, while the three countries in which concentrated ownership dominates had
moderate to large private benefits.
This association between dispersed ownership and low private benefits of control
is not accidental. In fact, widely held firms can only thrive in contexts where private
bene­fits of control are relatively small. Whenever private benefits of control are suffi-
ciently large, dispersed ownership becomes inherently unstable, since a potential raider
would have much to gain from acquiring a controlling block and expropriating the
remaining minority.143
Nevertheless, the numerous corporate reforms implemented in our core jurisdic-
tions since the 1990s, combined with the modest rise in ownership dispersion in some
contexts (Brazil)144 and the reduction of the wedge between ownership and control in
others (Italy),145 cast doubt on the continued accuracy of these earlier measurements
of private benefits of control. Strikingly, there are no cross-​country studies that update
the earlier estimates of private benefits of control—​which would be a critical element
in assessing whether and how the recent wave of corporate law reforms mattered.
In any case, the data from the 1990s suggest that the award of appointment rights
to minority shareholders in Italy and Brazil was a response—​albeit not necessarily a
solution—​to the mistreatment of minority shareholders. Moreover, it indicates that
the strong equal treatment norms found in civil law jurisdictions did not necessar-
ily protect minority shareholders, nor did a relatively low percentage of independent
directors (as in Japan) necessarily inflate private benefits of control. Even domination
by a controlling shareholder is not a reliable predictor, since Scandinavian jurisdictions

141 The two papers are Nenova, note 2, at 336 (employing share price differentials for dual-class
firms to calculate private benefits) and Dyck and Zingales, note 2 (employing control premia in sales
of control blocks to calculate private benefits). Although these two papers present similar results across
all other jurisdictions, they differ sharply for France (2 percent vs. 28 percent). Here Nenova’s finding
of 28 percent is more plausible because it is based on nine observations of French firms, while Dyck
and Zingales have only four observations of French control transactions.
142 But see Sofie Cools, The Real Difference in Corporate Law Between the United States and
Continental Europe: Distribution of Powers, 30 Delaware Journal of Corporate Law 697, 760–​1
(2005) (the sizeable difference in scope of shareholder voting rights across jurisdictions may lead to
different values of control, even without private benefits).
143 See e.g. Lucian Bebchuk and Mark Roe, A Theory of Path Dependence in Corporate Ownership
and Governance, 52 Stanford Law Review 127 (1999).
144 Érica Gorga, Changing the Paradigm of Stock Ownership from Concentrated Towards Dispersed
Ownership? Evidence from Brazil and Consequences for Emerging Countries, 29 Northwestern
Journal of International Law and Business 439 (2009).
145 Massimo Belcredi and Luca Enriques, in Research Handbook on Shareholder Power 383,
385 (Jennifer G. Hill and Randall S. Thomas eds., 2015).
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104 Minority Shareholders and Non-Shareholder Constituencies

generally manifested low levels of private benefits despite concentrated ownership

structures.146
What, then, predicts the efficacy of minority shareholder protections and, by impli-

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cation, the extent of private benefits of control? The literature suggests that many dis-
parate factors matter, including legal rules, the general business culture, and even the
competitiveness of the product markets.147
In line with the analysis of Chapter 3, we suggest that ownership structures, on
the one hand, and legal protection of minority shareholders, on the other, are mutu-
ally reinforcing.148 In jurisdictions where concentrated ownership prevails, controlling
shareholders tend to block the enactment of laws that could curb their private benefits.
By contrast, in jurisdictions where ownership is dispersed, institutions and the invest-
ing public are likely to have greater political clout in pushing for reforms that reduce
minority expropriation. Our core jurisdictions seem to confirm this pattern.
In the UK, the interests of institutional shareholders dominate the institutions of
lawmaking and enforcement, such as the Financial Conduct Authority (as UK Listing
Authority), the Financial Reporting Council and the Takeover Panel. Large institu-
tional investors are normally hands-​off shareholders with every reason to oppose any
form of suspected favoritism toward corporate controllers.
In the U.S., political influence is more evenly balanced between institutional inves-
tors and professional managers. But again, neither managers and institutional investors
nor state courts and the SEC have reason to treat controlling shareholders with kid
gloves. Stringent U.S. disclosure requirements, holding company regulations,149 and
taxation of intra-​corporate distributions150 are all indications of the comparative weak-
ness of controlling shareholders under U.S. law. Delaware courts also take a tougher
stance toward self-​dealing by controlling shareholders than by officers and directors.151
Finally, shareholder class actions and enforcement by the SEC are, respectively, very
common and increasingly severe.
The case of Japan would seem to be similar in one respect. As we argue in Chapter 3,
while a large percentage of shares of listed companies still lies in the hands of stable
corporate shareholders, the amount held by each is usually small. As there is no con-
trolling shareholder in these companies, the equal treatment norm is accepted without
much opposition.152
By contrast, in jurisdictions such as France, Italy, and Brazil, where large shareholders
control most listed companies, one assumes that controlling shareholders are a potent
political influence. The fact that the state is a major shareholder in many companies
in these countries—​and is often a member of the controlling coalition in the compa-
nies in which it holds a non-​controlling stake—​further compounds the influence of

146 See Ronald J. Gilson, Controlling Shareholders and Corporate Governance: Complicating the
Comparative Taxonomy, 119 Harvard Law Review 1641 (2006).
147 See Dyck and Zingales, note 2. 148 See also Bebchuk and Roe, note 143.
149 Roe, Strong Managers, Weak Owners, note 132, at 98.
150 Randall Morck and Bernard Yeung, Dividend Taxation and Corporate Governance, 19 Journal
of Economic Perspectives 163 (2005).
151 See Chapter 6.2.5.
152 Note, however, that managers who dominate listed companies do have an interest in providing
benefits to friendly shareholders in order to maintain their support. For example, a company may
financially assist employees’ purchases of the company’s shares. Provided there is a reasonable motiva-
tion (such as promotion of employees’ welfare), this is not prevented by the equal treatment norm.
Also, once hostile acquirers become a significant threat despite friendly shareholder support, managers
gain an interest in discriminating among shareholders in order to facilitate warrant or rights-​based
takeover defenses. See Chapter [Link].
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Explaining Jurisdictional Differences and Similarities 105

controlling shareholders, as we noted in Chapter 3. Anecdotal evidence concords with

the existing (albeit dated) empirical evidence to suggest that the minority–​majority
agency problem remains severe in these jurisdictions, despite legal efforts to mitigate it

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through increased mandatory disclosure, appointment rights for minority shareholders
in Italy and Brazil, and pressure to add independent directors arising from listing stan-
dards or codes of best practice.153

[Link] Employee protection
In contrast to the weak correlation between formal law and minority shareholder protec-
tion, the correlation between law and employee protection is strong. German company
law does, in fact, reallocate corporate power to unions and works councils through quasi-​
parity codetermination and co-​decision rights.
The question then becomes: how effective is co​determination as an employee protec-
tion tool? In other words, what exactly can labor directors accomplish apart from the nar-
row goal of enhancing labor’s bargaining power? In Germany they can influence business
policies.154 There is also evidence that codetermination may provide valuable insurance
to skilled workers, protecting them against layoffs due to external shocks in exchange for
lower wages.155 But in addition to this, labor directors may also play an important infor-
mational role, at least in theory. Mutually wasteful bargaining behavior such as strikes and
lock-​outs result in part from distrust between firms and employees.156 By credibly inform-
ing employees, labor directors might limit such costly bargaining behavior. Likewise, by
revealing the firm’s intentions, labor directors can alert workers about possible future plant
closings and related layoffs. Whether employee representation at the board level actually
improves industrial relations based on trust between labor and shareholders is impossible
to say in the absence of econometric studies on the issue.
An alternative theory, with some empirical support in the literature, argues that
codetermination can provide German supervisory boards with “valuable first-​hand
operational knowledge” that improves board decision-​making and increases firm value
in the subset of firms in which the need for intra-​firm coordination is greatest.157 Yet
there is also evidence that quasi-​parity codetermination in larger German firms reduces
firm value158—​and still other, non-​comparable, studies finding that codetermination
increases employee productivity or firm profitability.159

153 See Chapter 3.3.1, and Sections 4.1.1 and [Link]. 154 See Chapter 3.5.
155 E. Han Kim, Ernst Maug, and Christoph Schneider, Labor Representation in Governance as
an Insurance Mechanism, Working Paper (2016), at [Link] (skilled workers in German firms with
quasi-​parity codetermination receive wages that are 3.5 percent lower in exchange for protection
against layoffs).
156 See R.B. Freeman and E.P. Lazear, An Economic Analysis of Works Councils, in Works
Councils: Consultation, Representation and Cooperation in Industrial Relations 27
(J. Roger and W. Streek eds., 1995). See generally John Kennan and Robert Wilson, Bargaining with
Incomplete Information, 31 Journal of Economic Literature 45 (1993).
157 Larry Fauver and Michael E. Fuerst, Does Good Corporate Governance Include Employee
Representation? Evidence from German Corporate Boards, 82 Journal of Financial Economics 673,
679 (2006).
158 See ibid. at 698–​701; Gary Gorton and Frank A. Schmid, Capital, Labor, and the Firm: A Study
of German Codetermination, 2 Journal of the European Economic Association 863 (2004).
159 For a useful if partisan review, see Simon Renaud, Dynamic Efficiency of Supervisory Board
Codetermination in Germany, 21 Labour 689 (2007). Renaud’s strongly positive findings about the
effects of quasi-​parity codetermination on profitability and productivity are suspect because they rely
on balance sheet data and fail to include the range of control variables found in the finance-​oriented
literature such as Fauver and Fuerst, note 157.
106

106 Minority Shareholders and Non-Shareholder Constituencies

Moreover, the question remains: if large efficiencies result from codetermination,

why do the parties fail to contract for labor directors voluntarily and divide the surplus?
Why do we seldom see labor directors where they are not mandated by law? And if

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mandatory law is needed to overcome collective action problems associated with the
introduction of voluntary codetermination, why is mandatory regulation necessary to
sustain codetermination once it has been introduced? Although commentators have
offered speculative economic answers to these questions,160 the empirical literature
again remains sparse.
There may also be ideological or cultural explanations for the dearth of employee
directors outside of continental Europe. But a competing explanation is that the costs
of labor representation exceed its benefits, or at least are feared to do so. One source
of concern is the difficulty of bridging the sharply divergent interests of the board’s
constituent groups of employees and shareholders, or even among employees them-
selves, in framing policy or supervising management. Voting is a highly imperfect way
of making decisions in the presence of such conflicts. Majority decision-​making by
a divided board risks opportunistic outcomes that diminish the value of the firm as
a whole,161 and is also likely to make for a costly and cumbersome decision-​making
process.162
In addition, strong labor representation on the board may exacerbate the agency
conflict between managers and shareholders as a class. Managerial discretion plausi-
bly increases if shareholder and labor directors split over corporate policy, or if large
and divided supervisory boards lack the institutional capacity to monitor managers
closely.163 Indeed, managers may withhold information from boards with the acquies-
cence of shareholders to limit leaks to employees and competitors.164 Strong labor may
benefit managers, just as strong managers have proven to be loyal protectors of labor’s
interests in large Japanese companies, even without a regime of codetermination.165

160 See e.g. Fauver and Fuerst, note 157, at 679 (proposing that firms may be deterred from adopt-
ing codetermination voluntarily by adverse selection in recruiting employees and managers, even if
codetermination would increase firm value).
161 Perhaps for this reason, the double voting right of the chairman of the supervisory board of
co​determined corporations in Germany is very rarely used (its use is thought to undermine labor
relations).
162 It is nearly always the case that, in any given firm (whether investor-​, employee-​, customer-​, or
supplier-​owned), the group of persons sharing ownership is remarkable for its homogeneity of inter-
est. Even within investor-​owned firms, for example, it is highly unusual for both preferred and com-
mon shareholders to share significant voting rights. Likewise, within entirely employee-​owned firms it
is rare for both managerial and line employees to share control (and voting rights are often given to the
line employees, who tend to be more homogeneous). See Hansmann, note 75, at 62–​4 and 91–​2. This
suggests that the appointment strategy is not easily adapted to resolve significant conflicts of interest.
163 But see Fauver and Fuerst, note 157 (in some instances employee board representation may
increase supervisory boards’ monitoring capacity and thereby reduce agency costs).
164 See Katharina Pistor, Co-​Determination in Germany: A Socio Political Model with Governance
Externalities, in Employees and Corporate Governance 163, 188–​91 (Margaret M. Blair and
Mark J. Roe eds., 1999). Pistor also provides an illuminating account of the practice of codetermina-
tion in German firms as forcing segmentation of the supervisory board into employee and manage-
ment “benches,” which meet separately prior to board meetings (a practice that the German Corporate
Governance Code, in the one and only provision addressing codetermination, endorses) and always
present a common front in formal meetings of the supervisory board. The common practice of for­
cing supervisory boards to review the auditor’s report at the board meeting, but not permitting board
members to receive a copy for close review, is emblematic of the informational restrictions placed by
the management board on the supervisory board (ibid, 191).
165 See Masahiko Aoki, Toward an Economic Model of the Japanese Firm, 28 Journal of Economic
Literature 1 (1990).
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Explaining Jurisdictional Differences and Similarities 107

Most directors in Japanese firms are managers who were promoted from within the
ranks of the companies, and they tend to take the interests of core employees to heart.
So which side of the ledger dominates, the costs or the benefits of codetermina-

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tion? At least in the case of German-​style codetermination, the empirical literature is,
as hinted, surprisingly mixed. Certainly large German firms survive and even flour-
ish under the quasi-​parity regime of employee representation, and it seems intuitively
likely that codetermination has contributed to the heavy orientation of the German
economy toward manufacturing exports. Nevertheless, it is difficult to tease out
the opportunity costs suffered by the German economy as a result of strong-​form
codetermination.

[Link] External constituencies
Evaluating the correlation between formal law and the actual protection of non-​con-
tractual constituencies is exceedingly difficult. The interests of different stakeholders
might conflict with one another, and measuring the impact of various strategies on
overall social welfare is simply impossible. Moreover, the desirability of using corporate
law to protect non-​contractual constituencies hinges not only on its ability to protect
stakeholders, but also on how it fares compared with regulation by other fields of law.
As a result, any normative assessment of existing approaches to corporate law in differ-
ent jurisdictions will be tentative at best.
There is good reason to be cautious about the use of corporate law to tackle broad
social problems. Sometimes such attempts simply lack teeth. When fiduciary duties
are enlarged to encompass non-​contractual constituencies, they are usually unenforce-
able by those constituencies. Not only are there procedural constraints to enforce-
ability (non-​shareholders usually lack standing to sue), but even determining what
general social welfare requires at any point in time is an insurmountable task even for
directors—​let alone for courts.
By contrast, state influence in corporate governance (by means of state ownership
and, to a lesser extent, golden shares) is far more consequential. SOEs often pursue
social (usually political) objectives that conflict with shareholder wealth maximization.
Yet the effects of state ownership on overall social welfare are dubious, especially when
regulatory alternatives are taken into account.166
More recently, policymakers have hoped that institutional investors, as “universal
owners” exposed to the entire market, will act as stewards of the public good.167 The
new non-​financial disclosure requirements, as well as recent reforms leading to greater
shareholder empowerment in executive compensation decisions and otherwise, are at
least partly premised (or at least gained further political traction based) on this assump-
tion. However, diversified institutional shareholders usually lack both the knowledge
and the incentives necessary for such interventions. And the undiversified shareholders

166 See e.g. World Bank, Bureaucrats in Business: The Economics and Politics of
Government Ownership (1995) (finding that state-​owned factories pollute more than private fac-
tories); Andrei Shleifer, State Versus Private Ownership, 34 Journal of Economic Perspectives 133
(1998) (arguing that social goals are usually best addressed by government contracting and regulation).
167 See e.g. European Commission, Green Paper: The EU Corporate Governance Framework
(2011); [Link] John Kay, The Kay Review of UK Equity Markets and Long-​Term
Decision Making: Final Report 74 (2012) (“institutional investors acting in the best interest of
their clients should consider the environmental and social impact of companies’ activities and associ-
ated risks among a range of factors which might impact on the performance of a company, or the
wider interests of savers, in the long-​term”).
108

108 Minority Shareholders and Non-Shareholder Constituencies

who are more likely to be influential, such as hedge funds, are usually uninterested in
promoting goals other than financial returns.168 In fact, a study on the reputational
consequences for firms found liable of financial regulation violations in the UK found

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that breaches of rules designed to protect third parties actually resulted in a positive
stock market reaction for the companies, suggesting the shareholders like firms to push
the boundaries.169
Nevertheless, there seems to be a clear recent trend toward employing the legal
strategies of corporate law to tackle broad social problems. Whether this is a functional
response to government failures in addressing externalities, or merely window-​dressing
to deflect more fundamental regulatory reforms, remains an open question.170 There is,
however, reason to be skeptical about the ability of corporate law to significantly tackle
concerns which reach far beyond the agency problems that form its core competency.

168 Edward B. Rock, Institutional Investors in Corporate Governance, in Oxford Handbook of

Corporate Law and Governance (Jeffrey N. Gordon and Wolf-​Georg Ringe eds., 2016).
169 John Armour, Colin Mayer, and Andrea Polo, Regulatory Sanctions and Reputational Damage in
Financial Markets, Working Paper (2015), at [Link].
170 Pargendler, note 82.