The Rising Tension between Shareholder and Director Power in the Common Law World

• Author: Jennifer G. Hill
• Published date: 01 July 2010
• Date: 01 July 2010
• DOI: http://doi.org/10.1111/j.1467-8683.2010.00804.x

The Rising Tension between Shareholder and

Director Power in the Common Law World

Jennifer G. Hill*

ABSTRACT

Manuscript Type: Conceptual

Research Question/Issue: This article explores the rising tension between shareholder and director power in the common

law world. First, the article analyzes key arguments in the shareholder empowerment debate, and current US reform

proposals to grant shareholders stronger rights, from a comparative corporate law perspective, examining how traditional

US legal rules diverge from other common law jurisdictions. Secondly, the article discusses power shifts in the opposite

direction – namely toward the board – in some parts of the common law world. It considers the potential friction between

legal rules designed to enhance shareholder power and commercial practices designed to subvert it.

Research Findings/Insights: The article shows that US shareholders have traditionally had unusually restricted rights

compared to their counterparts in common law jurisdictions, such as the UK and Australia. The article challenges a number

of arguments supporting this traditional US approach, by showing that the arguments are often US-specif‌ic, and are less

persuasive from a comparative corporate governance perspective. The article also identif‌ies an important tension between

legal rules designed to enhance shareholder power and commercial practices designed to subvert it. It shows how the

dynamic nature of regulation, and the strategic response of regulated parties, can affect the operation of legal rules.

Theoretical/Academic Implications: The article broadens the scope of the US shareholder empowerment debate, by means

of a comparative law analysis. It challenges an evolutionary/managerialist theory of US corporate governance, by showing

that other jurisdictions havemade different choices concerning the allocation of power between shareholders and the board.

The article also shows the importance in comparative corporate governance scholarship of focusing not only on the terms

of specif‌ic laws, but also on the commercial responses of parties subject to those laws.corg_804344..359

Practitioner/Policy Implications: The article assesses the role of shareholder participation as a regulatory mechanism to

enhance corporate governance legitimacy. The global f‌inancial crisis has highlighted some of the dangers of untramelled

managerial power and under-regulation. The article provides important regulatory insights to policy makers, concerning

the appropriate balance of power between shareholders and the board of directors.

Keywords: Corporate Governance, Shareholders, Accountability, Regulation, Strategic Response to Regulation

INTRODUCTION

“We fear to grant power and are unwilling to recognize it

when it exists” (Oliver Wendell Holmes [Tyson & Bro.-

United Theatre Ticket Off‌ices vs. Banton, 1927:445]).

US corporate law is undergoing a seismic shift in relation to

shareholder power. Although shareholders have tradition-

ally held restricted participatory rights under US corporate

law, this paradigm has been challenged in recent times.

The shareholder empowerment debate raised shareholder

power as a serious subject for corporate law reform, and the

Committee on Capital Markets Regulation (“Paulson Com-

mittee”) recommended increased shareholder rights as an

alternative regulatory technique to a more stringent rules-

based approach (Paulson Committee, 2006).

The global f‌inancial crisis has given further impetus to

shareholder empowerment (Bainbridge, 2009; Bratton &

Wachter, 2010). The crisis highlighted some of the dangers

of untrammelled managerial power and under-regulation

(Burgess, 2008a; Coffee, 2008); business once again has “a

legitimacy problem” (Plender, 2008a). The issue of whether

shareholders should be afforded stronger powers as a

check on managerial control has been a major theme in

*Address for correspondence: Jennifer G. Hill, University of Sydney, Law, 2006,

Sydney, New South Wales, Australia. Tel: 9351-0280; E-mail: jennifer.hill@

sydney.edu.au

344

Corporate Governance: An International Review, 2010, 18(4): 344–359

© 2010 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2010.00804.x

international regulatory responses to the crisis (Burgess,

2008b). It has been argued that any response will be “incom-

plete if it fails to address this basic issue of shareholder

rights” (Plender, 2008b). The International Corporate Gover-

nance Network (ICGN) also warned that shareholder rights

need to be made integral to reforms associated with the UK

bank bailout (Burgess, 2008a).

It now appears likely that US corporate law will indeed

address this issue, and that stronger shareholder rights may

soon become a reality. An unprecedented array of reforms

and proposals to increase shareholder powers are on the

table in the United States.These developments are consistent

with the current zeitgeist of international corporate gover-

nance (Nathan, 2009); they are, nonetheless, extremely con-

troversial in the US.

Although shareholder protection has traditionally been a

mantra of US corporate law, shareholder empowerment has

not (Chandler & Strine, 2003; Hill, 2008). Yet, empowerment

is an important aspect of investor protection, providing

shareholders with a corporate governance self-help mecha-

nism. Shareholder power is also closely correlated with

investor activism (Bainbridge, 2008), which encompasses a

broad spectrum of possible conduct (Gillan & Starks, 2007),

and may or may not be publicly observable (Becht, Franks,

Mayer, & Rossi, 2009; Black & Coffee, 1994). The relationship

between shareholder empowerment and activism is of

growing importance in a range of corporate governance

areas, such as executive compensation (Balachandran, Ferri,

& Maber, 2007). Some scholars have argued that the rise of

shareholder power should be coupled with the introduction

of f‌iduciary duties for activist shareholders, akin to those

traditionally imposed upon directors and off‌icers (Anabtawi

& Stout, 2008; Plender, 2008c).

As this article demonstrates, there are a number of impor-

tant differences in the balance of power between sharehold-

ers and directors in the United States and the United

Kingdom, which have arguably produced different levels of

shareholder activism in these countries. Despite some rela-

tively recent increases in collective action by institutional

shareholders, shareholder activism has historically been

limited in the US (Thompson & Davis, 1997), in contrast with

other common law countries. It has been suggested, for

example, that the willingness of UK companies to engage

privately with institutional investors is due to the “potent

threat” that investors may convene an extraordinary share-

holders’ meeting (Becht et al., 2009:3096). It has also been

argued that a higher level of shareholder power wasrespon-

sible for greaterinvestor activism in shaping takeover rules in

the UK than was possible in the US, where a pro-managerial

takeover regime prevails (Armour & Skeel, 2007).

The inf‌luential “lawmatters” hypothesis identif‌ied impor-

tant corporate governance differences between common law

and civil law jurisdictions (La Porta, Lopez-de-Silanes, Shlei-

fer, & Vishny, 1998), yet tended to obscure interesting dif-

ferences regarding shareholder rights within the common

law world itself. A recurring criticism of the study is that it

assessed “law on the books,” rather than law in action

(Enriques, 2002; Skeel, 2004:1543). This theme is continued

in recent scholarship that emphasizes the relevance of

enforcement intensity in assessing the quality of legal pro-

tection (Coffee, 2007; Jackson, 2007). Another methodologi-

cal criticism of the “law matters” study asserts that it

overlooked the fact that context also matters in corporate

governance. According to this critique, the impact of even

“law on the books” may vary depending on the applicable

underlying corporate ownership structures (Bebchuk &

Hamdani, 2009; Hopt, 2009).

The goal of this article is to explore the rising tension

between shareholder and director power in the common law

world. This tension can result in the strengthening of power

in either direction. First, the article examines current propos-

als in the US to increase shareholder rights. It critically ana-

lyzes the US shareholder empowerment debate, and current

reformatory zeal in this regard, through a comparative cor-

porate governance lens. The article highlights specif‌ic ways

in which US shareholders have traditionally possessed sig-

nif‌icantly less power than their counterparts in other

common law jurisdictions, examining particular legal rules

that have contributed to this divergence.

Secondly, the article discusses power shifts in the opposite

direction – namely toward the board – in some other parts of

the common law world. Recent enforcement literature has

stressed the dynamic operation of legal regulation (Coffee,

2007; Jackson, 2007), a dynamism which includes the strate-

gic response of regulated parties (Milhaupt & Pistor, 2008;

Skeel, 2008). The article considers the effect of such strategic

responses in the form of commercial pushback to regulation.

It examines the potential friction between legal rules

designed to enhance shareholder power, and commercial

practices designed to subvert it. Much comparative corpo-

rate governance debate has focused on the role of legal rules

in increasing shareholder rights. Yet, as this discussion dem-

onstrates, commercial norms and practices may be equally,

or more, important (Eisenberg, 1999), and may operate to

shift power away from shareholders, toward the board of

directors.

The article shows how, even in common law countries

such as Australia, where legal rules accord shareholders

strong participatory rights in corporate governance, the stra-

tegic response of regulated parties may curb such involve-

ment. This form of commercial pushback is noteworthy

because it demonstrates how some Australian companies

have tried to create a de facto corporate governance regime,

which mimics certain aspects of traditional Delaware law, by

restricting shareholder rights. This suggests that, even if, as

now appears likely on the basis of current reform proposals,

US shareholder powers are signif‌icantly strengthened, that

will by no means be the end of the story.

The structure of the article is as follows. First,it considers,

from a theoretical perspective, a range of evolving, and

sometimes conf‌licting, images of the shareholder in corpo-

rate governance. These varying images have signif‌icant

implications for the appropriate allocation of power

between shareholders and the board of directors. The article

then examines current US developments, including the

shareholder empowerment debate and reform proposals to

strengthen shareholder rights vis-à-vis the board. It identi-

f‌ies legal rules that have contributed to the divergence of

shareholder rights across jurisdictions, discussing why US

shareholders have traditionally possessed less power than

their counterparts in other common law countries. The

article then examines the role of commercial practice in

RISING TENSION BETWEEN SHAREHOLDER AND DIRECTOR POWER 345

Volume 18 Number 4 July 2010© 2010 Blackwell Publishing Ltd