The recent issue regarding the allocation of power between shareholders and directors in public corporations has attracted much attention from legal scholars internationally. It is a controversial debate which concerns the amendment of the Corporations Act to increase shareholder powers.
The recent call for shareholder empowerment stemmed from the assumption that directors do not always act with the best interests of shareholders in mind. Supporters of the ‘shareholder primacy’ propose that shareholder interests should take centre stage in corporate governance and thus shareholders should have more authority in the modern corporation. However, there are opponents who do not agree with the concept of enhanced shareholder power and supports the current status quo and traditional theory ‘director primacy’ – with the directors being the ‘platonic guardians’ of the corporation. It is believed that directors have the experience and knowledge of company and industry to successfully implement strategy and policies to make sure the successful and wealth maximisation is achieved.
According to director primacists, the corporation is a fiction, and thus incapable of being owned; therefore shareholders are not owners and not automatically entitled to participatory rights. Rather, participatory rights for shareholders, instead of other stakeholders, are built into the corporate contract.
Despite having opposing viewpoints, both proponents and opponents of shareholder empowerment are approaching the issue in the same way. They both support the notion of improved company performance.
A comparison between the US and Australia, shows that what the shareholder primacists are trying to pursue in the US in terms of increasing shareholder rights are largely enjoyed by Australian shareholders already. Therefore, the contention of this discussion paper will be focused on the disadvantages in allowing shareholder participation. As a result, to amend the Corporations Act to allow shareholders to possess more power (more than they already have) is an unnecessary and counterproductive.
The discussion paper will start off with a section outlining how the powers between shareholders and directors are divided in the modern corporations under the Corporations Act. Accordingly, the two sides to the debate on whether shareholder rights should be increased: ‘Shareholder primacy’ and ‘Director Primacy’ will be discussed below.
Current legal framework on Corporate Power
Under Section 198A of the Corporations Act, writes that the business of the corporation should be managed by the directors. This rule is commonly referred to as the “default rule” in corporate governance. Additionally, the directors also have the authority to delegate its powers to executives, employees and other persons to whom he/she sees fit. (s 198D)
In Australia, under Section 249D(1) shareholders can request an extraordinary meeting with as little as 100 members or 5 percent of the voting shares. This is a substantial right for Australian shareholders when compared to other nations that are not as specific, especially in the US, where shareholder rights are “limited to the election of directors and approval or bylaw amendments, mergers, sales of substantially all of the corporation’s assets, and voluntary dissolution.”
Accordingly, as Section 249D gives a minimum of 100 voting shareholders the right to requisition the calling of an extraordinary general meeting even though they may hold only a tiny proportion of the votes and may have no interest in the prospect of their notions being passed. The company also bears the cost of arranging the meeting and in large listed companies with thousands of shareholders, these expenses are significant.
As stated under Section 249F, shareholders can arrange their own general meeting without the notifying or applying first to the directors with the requirement of at least 5 per cent of voting shares. This right is similar to Section 249D, however, the difference is that there are no 100 members rule and that the members have to bear the expenses incurred for calling the meeting. In accordance with the rule, shareholders are to be notified 21 days prior to a meeting with details stating the proposed special resolutions. They also have the right to provide the company notice of a resolution for which they can put forward at the meeting. This allows them to communicate their concern or matter to other shareholders and seek support before they decide whether to attend the meeting or how to complete their proxies. (s 249N(1))
Voting on resolutions is carried out by a show of hands or by a poll. On a show of hands, each shareholder has one vote and on a poll each shareholder has one vote for each share held: s 250E(1)
Shareholders in public corporations are able to decide whether to remove directors as well as having the right to a non-binding vote in relation to executive remuneration arrangements. That is, the power to vote against extreme pay rises of board members.
As articulated by James McConvill in the article Shareholders the power behind the throne:
“Australia, while in the midst of its own debate on allocation of power, is one of the rare examples of a rich and successful economy that is home to some great corporations, while at the same time has in place a national corporate law regime that provides for relatively strong shareholder empowerment.”
Moreover, shareholders also possess a few remedies under the Corporations Act which empowers their relationship with the corporation. There are a variety of ways in which shareholders may seek a remedy where the directors of a company act unfairly. This usually arises where the shareholders are no longer able to work together.
Section 232 of the Corporations Act allows the court to provide members with a wide range of remedies if they can show that the conduct of a company’s affairs is contrary to the best interests of the members as a whole, oppressive, unfairly prejudicial or unfairly discriminatory. The company’s affairs include conduct of the directors, majority shareholders and substantial shareholders, as well as the company itself.
Oppression, unfair prejudice and unfair discrimination deal with commercial unfairness. It is to be determined objectively, so that the conduct will be regarded as oppressive or unfair if no reasonable director would have acted in that particular way. (wayde v nsw rugby league ltd 1985). In addition to this question is whether the conduct in which a member complains may affect them in their capacity as a member or in another capacity: section 234(a)(ii). Due to the wide range of orders listed under section 233 which are available to a shareholder, this is often an attractive remedy.
Furthermore, under the Corporations Act, Part 2F 1.A, section 236 provides a statutory derivative action which enables shareholders and other eligible applicants to bring legal proceedings on behalf of a corporation where the company is unwilling or unable to do so itself. The purpose of this section is to provide more effective mechanisms and encourage appropriate governance by directors.
However, in order for this legal action to proceed, the pursuing applicant must obtain a leave of the court. The reason for this rule is that there would be too many inappropriate actions brought by applicants. Therefore, the leave of court will be granted once the court is satisfied that the action is adequate.
The criteria under Section 237(2) must be satisfied in order for shareholders to put in proceedings on behalf of the company. These include:
(a) it is probably that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; and
(b) the applicant is acting in good faith,
(c) it is in the best interests of the company that the applicant be granted leave,
(d) there is a serious question to be tried, and
(e) the applicant gave notice of the company at least 14 days before making the application of the intention to apply for leave and the reasons for applying, or it is appropriate to grant leave even though notice was not given.
Additionally, under section 237(3), shareholders need to demonstrate why the contract is not in the best interest of the company. One thing to keep in mind when utilizing Section 237 is that there is another section in relation to the costs awarded to the person who applied or granted leave or other party to the proceedings.
As the grounds for obtaining leave are quite extensive, it would be easier to apply for oppressive or as a person whose interests are affected, under Section 1324. This will bring them into personal capacity rather than the company.
Section 1324 injunctions:
A member or shareholder can apply for an injunction or damages under this section when their interests are affected. Under Section 1324(1), the court has discretion to grant an injunction, on terms the Court thinks appropriate, restraining a person from engaging in the conduct that contravenes the Corporations Act. Furthermore, under Section 1324(4), the court may grant an interim injunction (where desirable), restraining particular conduct, before determining the application under subsection (1). This allows the applicant to obtain a speedy order with the case pending and to be decided at a later time. Under subsection 10, the court may also order that the person acting in contravention to pay damages to any other person.
With an overview of the current corporations law in Australia, including certain remedies for which shareholders can empower their relationship with the company, the next section will discuss the current debate, which outlines both sides involving ‘shareholder primacy’ and ‘director primacy’.
Views of two sides
The debate on whether shareholders should be given more power has attracted many legal commentators, with some proponents who believe that by allowing shareholders to participate in the corporation will ultimately make them happier and therefore improve the overall performance of the corporation. On the other hand, opponents of this debate contend that current framework is working effectively with the board of directors holding the most responsibility and control of the corporation.
In order to further understand both sides of the debate, the following discussion will outline the viewpoints of shareholder primacy and director primacy, in which the latter, will be the main focus of this report and the “default rule” shouldn’t be changed.
Supporters of the ‘shareholder primacy’ norm contend that shareholders are the owners of the corporation, and thus, should have the ultimate control of the overall operation of the corporation. As articulated by Millon, who proposes that shareholders does influence corporate decision-making:
“Shareholder primacy mandates that management – the corporation’s directors and senior officers – devote its energies to the advancement of shareholder interests. If pursuit of this objective conflicts with the interests of one or more of the corporation’s non-shareholder constituencies, management is to disregard such competing considerations.”
Consistently, Lorraine E. Talbot articulates that: “…By shareholder primacy I mean a corporate governance orientation which, like shareholder entitlement, promotes the interests of shareholders as being primary corporate objective…”
Additionally, in acting in the best interests of shareholders, directors and executives are expected to increase profits and maximise wealth and distribute dividends to shareholders. Moreover, many proponents of shareholder empowerment also believe that by allowing shareholder participation would increase the effective performance of corporations. Therefore, it is necessary to empower shareholders (for those wishing to participate) in the corporation. This notion is supported by Bebchuk, who contends that by upholding shareholder power will force directors to take account shareholder interests and thus, voluntarily adopt policy changes themselves.
As articulated by Bebchuk in his article, ‘Why shareholders must have more power: “Shareholder power to replace directors is supposed to supply a critical safety valve, preventing directors from straying from shareholder interests.”
According to both McConvill and Bebchuk, shareholder empowerment shouldn’t be viewed as “an end in and of itself”. The overall aim of this norm should be to improve corporate performance. Additionally, many legal commentators like Bebchuk believe that the interests of shareholders within the corporation may not always be taken into consideration by directors and managers. Due to the size and divergent ownership of modern corporations, managers may be inattentive to shareholder interests. In other words, the interests between shareholders and management are not aligned. As quoted by Bebchuk:
“Without adequate constraints and incentives, management might divert resources through excessive pay, self-dealing, or other means; reject beneficial acquisition offers to maintain its independence and private benefits of control…”
Therefore, by enhancing shareholder power could improve the performance of the corporation as well as create a more effective corporate governance system.
In the article Shareholder empowerment as an end in itself: A new perspective on allocation of power in the modern corporation by James McConvill, who is a supporter of shareholder primacy, provides a different stance on the debate of allocation of powers in corporate law. McConvill applies “psychonomics” research, which claims that there is a link between participation and happiness. Furthermore, McConvill contends that shareholder “participatory experiences” over economic returns will make people happier
In further discussing the debate on the allocation of powers between shareholders and directors, the next section will outline the diverging views of director primacy for which they believe that it is unnecessary to promote shareholder empowerment as it does not improve the overall performance of the corporation.
Director primacy, a theory established by Professor S Bainbridge contends that the corporation is nothing more than a ‘nexus’ of contracts in which parties are to perform according to their various bargained positions.
“A bond indenture thus is a contract between the corporation and its creditors, an employment agreement is a contract between the corporation and its workers, and a collective bargaining agreement is between the corporation and the union representing its workers.” Pg 25 the new corporate governance in theory and practice by S Bainbridge
Thus, what Bainbridge points out is that the corporation as an “entity-based” cannot be owned. Instead its sole purpose is to cater for the transferability of contracts. “…the various constituencies thus must be (and are) linked to the nexus… between directors, shareholders, customers, suppliers, creditors…” Therefore, director primacists do not believe that the participation of shareholders will improve the performance of corporation.
Additionally, Lorraine E also has a similar view on the director primacy norm. She contends: “In this model shareholders contract with managers to perform the task of maximising shareholder interest. Managers are contractually bound to pursue shareholder value and would be in breach if they pursued other stakeholder concerns with which they have no contractual relationship.”
Furthermore, shareholder participation would be impossible as it is hard to effectively come to an agreement between shareholders and management when disputing on a particular decision. As articulated by S Bainbridge in his article Director Primacy: The Means and Ends of Corporate Governance, quoted: “At the most basic level, the mechanical difficulties of achieving consensus amongst thousands of decision-makers impede shareholders from taking an active role.” Consistent to this is that various shareholders may have different views and interests which would be difficult to collectively compile one major view when deciding on a particular issue.
“As to the former, while neoclassical economics assumes that shareholders come to the corporation with wealth maximisation as their goal… once uncertainty is introduced it would be surprising if shareholder opinions did not differ on which course will maximise share value.”
In other words, shareholder views on particular strategies either short-term or long-term may vary, therefore, lead to disagreements amongst members. When compared to the talents and skills of directors, shareholders lack the resource of valuable information that is necessary to effectively participate in decision-making and thus are “rationally apathetic”. (page 16 of director primacy article by s Bainbridge)
Accordingly, advocates of the director primacy norm believe that the current “default rule” which employs an authority based decision-making system should be kept as it is. Directors should be able to specialize in things that are related to the effective decision making and thus, all other constituents and issues should be dealt with by other players of the corporation.
“This must be so, because neither shareholders, employees, nor any other constituency have the information or the incentives necessary to make sound decisions on either operational or policy questions.” Pg 15 – Director primacy article Bainbridge.
Overall, the debate on whether shareholder powers should be expanded under the Corporations Act has shown to attract many legal theorists and commentators. However, with many opposing views between ‘shareholder primacists’ and ‘director primacists’, both of these groups do have a similar view; that is, on improving corporate performance. In the last section of this discussion paper will contend that the shareholders should not be given more power and that their participation would not likely improve corporate governance.
Shareholder Participation is costly
With the recent debate on whether shareholders should be given more rights within the modern public corporations has attracted much attention from legal commentators. As discussed above, there are opposing views to the debate on increasing shareholder rights; however, both groups do have the same objective, that is, to improve the overall corporate performance.
Other views in regards to shareholder power shows that shareholders has only one objective in mind when purchasing shares, and that is to potentially make money in their original investment. As previously stated, there are also views that the current framework should be kept the way it is and not changed. Accordingly, shareholders should endure and pursue other means of activities instead of buying shares in hopes of participation. Therefore, this further supports the notion that decision-making and overall operation of corporations should be left with the high-end players of the corporations and with limited shareholder interference.
Ownership & Control in the Modern Corporation
Proponents of ‘shareholder primacy’ have always believed that shareholders are ultimately the ‘owners’ of the corporation. However, recent disputes by various legal commentators have shown that this is not the case. As modern corporations are growing and due to share dispersal in large corporations had resulted in revolutionary changes in ownership and control. Berl, in The Modern Corporation viewed that the separation of ownership and control has transformed corporations, which has resulted in shareholders being “passive” owners who doesn’t contribute to the business of the corporation. Accordingly, with the establishment of ‘limited liability’, shows that unlike owners of tangible items or property, owners of shares bore no further responsibility for their property than their original investment.
“..however, their limited relationship and responsibility for their property meant that shareholders could no longer demand the extensive rights generally attributed to private property…Stock property was in its nature more social than private and its owners could no longer claim private property rights.”
Due to shareholders having lack of interest and responsibility, this has led a change in both the nature of ownership and the company itself. They have detached themselves and allowing the company to become an independent entity. (pg 9 warwick law school article)
“The company takes an objective existence; it has a un-owned-ness. And as an entity that was inherently un-owned it has the potential to exist for the interests of many other groups connected with the company; the workers who ‘create’ and the managers who ‘control’ and the ‘owners’ who contribute capital.”
As in the article by James McConvill, “the argument runs that it is rational for shareholders to be apathetic”. That is, given the size of corporations nowadays and the diverse numbers of shareholders, it is difficult for shareholders to try and participate in the corporation as it is highly unlikely that shareholders are able to get their views across such a large corporation. Consistently, as directors and managers are already obliged under law to act in the best interests of shareholders, shareholders will most likely sit back and enjoy collecting their dividends.
Furthermore, Bainbridge in his book: The Future of Corporate Governance: Director or Shareholder Primacy; writes in regards to the limited role of shareholders in corporations.
“A rational shareholder will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs. Given the length and complexity of proxy statements…. the opportunity cost entailed in reading the proxy statements before voting is quite high and very apparent. Finally, shareholder’s holdings are too small to have any significant effect on the vote’s outcome.”
The costs associated with Shareholder Participation
As the main contention of this paper is to allow directors to have the ultimate power with limited shareholder participation, it is important to outline how the current powers within the Corporations Act in relation to the “100 members rule” and how it can expose large corporations to significant costs.
Shareholders in Australia have vast amounts of rights that allow them to get their views across and try to influence the corporate decisions. With only a few as 100 members, shareholders can demand for an extraordinary meeting that allows them to propose changes. The issue here is that given the size of large corporations nowadays, it would pose significant costs to the corporation when only a few 100 members demand for a general meeting. A concern here is that the rule would allow certain groups to threaten the imposition of large corporations and unnecessary costs on companies, for either gaining media attention or to negotiate with the company. This would have detrimental effects on the majority of members. The 100 member rule poses unreasonable influences on minority members, including failing to recognise the substantial size differences between companies and for being too specific when compared with laws in other countries.
An avid supporter of shareholder participation and increasing their rights is by Dr James McConvill who asserts that shareholder participation should be encouraged in corporations where shareholders invest because participation, rather than economic return, makes people happy.
By employing researches that are outside of the classical norm of economics, McConvill claims that with “psychonomics” proves that there is a correlation between participation and happiness. Pg 14
However, there are doubts towards McConvill’s view on allowing shareholder participation. In this 2009 article, Harry G. Hutchinson and fellow professors assert:
“…accurately calibrating the precise amount of participation that would increase happiness the most is an optimizing problem, not a maximising problem. While we concede that the proper role of shareholders is not always clear, more participation is not necessarily better.” Pg 6
In promoting shareholder participation there can be conflicts in regards to McConvill’s proposal to change corporate culture. As shareholders are not the only constituencies in the corporation, other stakeholders such as employees and customers may also want to reap the benefits of participating in decision-making if given the opportunity.
Additionally, there are doubts as to whether individual shareholders will actually be happy once uncertainty and conflicts arise. That is, as there are various shareholders within the corporation, it would be hard to reach a common view when deciding on a solution. In other words, shareholders may have different goals and objectives towards collecting dividends, and opposing views on potential projects. It would be difficult in terms of determining whether shareholders are truly happy when participating in decision-making as their views are so diverse and thus can cause conflict amongst members. Pg 947 – 8
As stated above, due to there being a range of different shareholders, their level of expertise on holding and buying shares do not always match up. This therefore shows that their investing experience and willingness to participate may discourage some members from actually participating with directors and other executives in decision-making. Furthermore, experienced investors may also not be as enthusiastic in participating as their main goal in investing is to maximise profit. Consistent with this view is that new shareholders who do not have the necessary experience when compared to professional investors may have detrimental effects on the decision-making process with their “empty-voting”.
Accordingly, the theory of ‘rational apathy’ raised by Bainbridge, which claims that shareholders may be satisfied with passing the power over to management to carry out duties and decision-making. That is, as discussed above, with shareholders lacking valuable resources that are necessary to participate in decision-making, they would ultimately sit back and let the key players of the corporation deal with it. Unless, the benefits of participating are advantageous to a particular shareholder, the costs in terms of time and effort would most likely discourage them from taking part. (Pg 202 of chapter 5 printed article) Therefore, they are likely to make less informed decisions than managers of the corporation.
Additionally, day-to-day management would require participating shareholders to sacrifice most of their time and effort to engage in corporate decision making, this would ultimately mean that shareholders would incur ‘opportunity costs’ as they would have to give up other activities in order to participate in decision-making. The opportunity costs would involve spending less time with their families and friends.
Furthermore, corporations may bear more externalized costs that are associated with allowing shareholder participation. Not only do the participatory investors will be affected but other shareholders will also incur costs. As discussed previously, it is difficult to achieve consensus about what policies are appropriate for the corporation when there is dispersed control. That is, when complex issues arise it may affect individual shareholders and their abilities to decide on what is best for the corporation. It would be more effective and efficient for the corporation to gather all information and decide on a solution in one place instead of making decisions based on the gatherings of other shareholders and stakeholder inputs. This would be time-consuming as decisions would have to go through a process of review every time a decision is required. Additionally, in James McConvill’s article, he suggests that shareholders should be encouraged to participate only to the extent that it does not disrupt management. However, shareholder disruption is inevitable as shareholders are expected to review business decisions and get involved if they disagree on certain issues. Even though these interventions may never occur, the mere presence of enhanced participation by shareholders is likely to disrupt managers who know that any decisions they make may be second-guessed or be reviewed again by shareholders who do not bear the full costs of such intervention. These disruptions would have psychological costs, such as increase the stress levels of managers, reduced well-being, as well as time-delays.
By increasing shareholder participation, another cost for which corporations may have is to educate investors. There can be professional investors who have vast amounts of experience but amateur and new investors may have limited knowledge in the realm of shares and financial literacy. In McConvill’s proposal of allowing participation for only those shareholders who wishes to participate; the costs of educating these shareholders would increase with the numbers of decision-makers involved.
By implementing corporate governance that allows for shareholder participation would give rise to risks for the corporation. As most shareholders are employees or managers of the corporation, there can be risks in terms of the information provided to one another. In addition to there being fraudulent behaviours, by further disclosing private inside information to other stakeholders may give rise to the disclosure of such information to the workforce (industry), and even competitors. Such leaks could have detrimental effects on the corporation in terms of their profit going down as workers may use ‘blackmail’ to intentionally demand for higher wages and competitors may respond in a strategic manner from utilizing the private information. Not only would this behaviour have detriment effects on the corporation but also for those investors who are genuinely interested in profits, and not engaging in any fraudulent conducts.
Consistent with this view is that the more shareholder participation in the corporation, the less accountable managers and directors are for their responsibility. That is, as the knowledge and responsibilities shift with shareholder primacy, managers may not always bear the full extent of their misbehaviour. It would allow for managers to avert attention from their errors by concentrating on the errors of participatory shareholders. This would also give rise to managers pursuing their own interests by putting the views of employees and shareholders against each other.
All in all, the question on whether shareholder powers should be increased has attracted many legal commentators. Supporting views for shareholder primacy has expressed that shareholders are the ultimate owners of the corporation by the purchase of their shares. However, legal scholars like Bainbridge has disagreed with this notion in saying that; as a corporation is nothing more than a ‘nexus’ of contracts in which parties are to perform according to their various bargain positions. In other words it is an entity based that is incapable of being owned.