CORPORATE LAW - theory

CORPORATE LAW Corporations and the Law Reference to textbook’s Chapters 1-2 lecture 1 A firm and a company mean different things. There's always a firm behind the company but the firm can exist even without a company. A firm is an aggregation of individuals and resources, an organized combination of inputs (money, labor, managerial skills, know-how) to produce outputs (goods, services) The top ranking managers, for example, decide to put together inputs to produce outputs. Firms (centralized organization) exist for different reasons: • transaction-cost hypothesis: Firms as an alternative to market transactions between independent parties. A solution to opportunism, informational asymmetries and transaction-specific assets. Inputs could be combined even with independent transactions with no dependence between individuals but it would be extremely costly ex: imagine if a manager had to negotiate everyday the condition of work of its employees. firms arose when humans started to put together complex businesses which needed stable inputs. In addition there are people who are unreasonable in negotiating, there’s the risk that the other party would act opportunistically (an employee could say like “i’m not coming to work unless you raise my wage); you can’t claim about the counterpart negotiation so there’s informational asymmetries. • it’s a way to assemble your possible counterparty in order to avoid unfavourable or unreasonable contracts conditions arising from the other party (negotiations are not easy) (think about the example of tesla trying to mine its own lithium) • Another risk arises from property rights which are very powerful and generally enforceable. Contract rights can only be enforced over contractual parties. A firm with property rights on its assets has greater power in terms of control of the assets than those that could arise from the sign of a contract (as in case of everyday negotiation). Contracts are somehow incomplete because without property rights on assets you can only do what is established by the contract without having any illimitate power on them. Firm or Corporation/Company? Firm is an economic concept, it doesn’t tell what legal type we’re dealing with, in fact firms have different legal shapes. A company is one of the many legal forms we can use to identify a firm. So there’s no corporation without a firm. A firm can also be run by an only person, it could be run through a partnership that is a very simple organization between 2 individuals who take friendly shared decisions without legal regulation (ex: 2 friends running a fruit shop); that could be ineffective for big businesses because coordination costs would become too expensive. Even the state can run a business as it happened frequently in the last century through the corporate form. What’s the difference? -Firm is an economic concept -Corporation is a legal concept -With the concept of firm we focus on the organization of individuals and resources regardless of its legal implications -With the concept of corporation we focus on the legal tools provided by the law to give legal recognition and consideration to such an organization as a legal entity A corporation always is meant to run a firm: It is a legal vehicle to run a firm On the contrary, a firm can be run without a corporation: A firm can be run by an individual entrepreneur, a partnership, a corporation, the State, a municipality, and/or other legal institutions Main corporate actors Beyond the legal entity there are obviously people standing behind it: • Shareholders: the main investors (without them the company could not exist); they pay initial capital or any subsequent capital. Shares give rise to ownership rights on the company • Debtholders (banks): not only shareholders pay money for companies. • Employees: on one hand they offer their services to the company but they're also debtholders (the company is in debt of their wage) • Directors and officers (highest ranking managers) make financing decisions, investment decisions.. they run the business • Internal or external supervisors (e.g. auditors) Let’s think about the company as a pyramid: • at the base we have shareholders and debtholders • at the top we have highest ranking managers • in the middle we have employees Companies are so complex that all these individuals need to be supervised through supervisors who can be internal or external. This is to supervise the correct functioning of the company, because, for example, they could cheat on the accounts and provide manipulated information (in this case we need auditors). How does a company come to exist? A multi-step process The steps to form a company are similar almost everywhere. 1. Companies arise from contracts (corporate charter) even if it’s not the only possibility; however, this means that every person in the world is able to sign a contract for the creation of a company. The parties of the contract are shareholders and directors. By doing so, shareholders and directors enter into a corporate contract binding on them 2. The corporate charter contains provisions regulating the functioning of the company and the relationships between its constituencies. Many contracts start being binding and effective by the time the parties place their signature on the contract because unlike for ex. sale or supply contracts not giving rise to an organization, public authorities want to look further into it. 3. The corporate charter is then filed with the competent local administrative authority (e.g., a chamber of commerce) 4. The local authority enters the name of the company in a companies’ register publicly available for inspection by everyone. This is to collect information about the company (financial statements, owners, corporate charter, emails, contacts..)ex:company laundering of money were blocked 5. The company now has come to life (i.e. has acquired legal personality, see next) Main Legal Characteristics of the Public Company: (1) Legal Personality A legal person is an entity that has a different corpus separated from those who signed the contract. Corporations enjoy full-blown legal personality and, as a result, all the rights and powers that a jurisdiction ties to the concept of legal personality. Corporations, in particular, are provided with: legal capacity is the capacity that a jurisdiction recognizes and it allows you to become subject of rights and obligation and also to stand before a court. This enables the company to deal with counterparties avoiding related costs. This is fundamental especially for big companies. Strong-form entity shielding There are consequences: 1. Company managers are allowed by the law to enter into (all kinds of) contracts, sue third parties in court and be sued, in the name and on behalf of the company. 2. It is the company that becomes directly liable for contractual obligations entered into in its name and face trial in court for breach of contract and for damages following torts inflicted on third parties, -Contracts are materially undersigned by the authorized managers, but rights and obligations accrue to the company -Tortious acts may materially be committed by its managers or employees, but it is the company that becomes liable to those who get damaged this as product of centuries of legal development Strong-form entity shielding: Priority Rule Priority rule is a conventional phrase describing a specific feature of the entity shielding applicable to companies and shared by most jurisdictions. All the assets of the company are under property rights, but beyond that, who actually has ownership rights on those assets? We use the priority rule to answer this question: It is a set of rules according to which company’s creditors are given claims on company’s assets that are prior (or senior) to the concurring claims of the individual owners and those of their personal creditors. In a few words, the priority rule establishes who has right and so can claim against the assets of the company (for example in case of liquidation) through a rank. The senior rights in the company are held by the creditors (debtholders) who have prior claims on the assets. -The firm’s assets are by law pledged as a security for the firm’s debts. -Owners and their personal creditors cannot seek satisfaction on the company’s assets, whether directly or indirectly, before the firm's creditors are, or may fully be satisfied. rule of law→ arbitror between conflicting interests priority rule→ business creditors (providers of debt) It stops shareholders and creditors of them from claiming for the assets of the company in case of failure. Shareholders risk more for this rule, however if the business is successful they have high return. Those who are more risk averse will be more involved into buying debt instruments rather than shares. Lecture 2 - 23/09/2021 (((you can dispose of things through property rights or contracts right (asking someone else to use an asset). In an ideal world there would be no differences between the two; however there are differences in → in the first case we have no restrictions (except legal); in the second case we have costs related to negotiations, in terms of money, time, legal costs to hire lawyers.. (irrational behaviour, monopolists, change in prices). The second case is less efficient in economic terms. Think about Tesla and lithium. This is one of the reasons why companies emerged as entities owning assets in order to replace market dealings and avoid contractual rights. This is related to the legal person concept (legal person is able to hold assets). ))) owners=shareholders Strong-form entity shielding: Liquidation protection rule Liquidation protection rule is a conventional phrase to describing another specific feature of the entity shielding applicable to companies and shared by most jurisdictions Liquidation protection rule: -It is a set of rules which establish to what extent shareholders are allowed to withdraw from (i.e., exit) the organization before its expiry so as to obtain the monetary equivalent of their equity holding’s value from the entity itself. -At the same time, it is a set of rules also establishing, should the personal assets of the debtor-shareholder be insufficient to meet his/her personal debt obligations, what actions his/her personal creditors are allowed to take, or barred from taking in respect of the firm assets. As a shareholder in debt with a bank with my house as a collateral, when things are going bad, logically I could ask for liquidation in order to pay the bank before getting homeless. It is a set of rules which establish to what extent shareholders are allowed to withdraw from (i.e., exit) the organization before its expiry so as to obtain the monetary equivalent of their equity holding’s value from the entity itself. At the same time, it is a set of rules also establishing, should the personal assets of the debtor-shareholder be insufficient to meet his/her personal debt obligations, what actions his/her personal creditors are allowed to take, or barred from taking in respect of the firm assets. The liquidation protection rule limits my property rights on the company. Shareholders are free to join the company but have limits in case of withdrawal from the company, this happens in order to protect other stakeholders (who are not only shareholders, think about banks who are the heart of economic financial systems. Banks are of public interest) These rules are to protect creditors for the company itself; it’s only by favouring creditors (who have money to invest) that you can convince them to enter in relation with debtors. To protect debtors you need first to favour creditors. The losers of today will be the winners of tomorrow. 1. Limiting shareholders' right to withdraw→ they usually can withdraw only with an objective motivation.The law generally provides shareholders with a very limited right of withdrawal (exit): -No jurisdiction allows withdrawal at will. -A few jurisdictions allow withdrawal for just cause -Most jurisdictions set out very limited circumstances under which withdrawal becomes available: Usually these circumstances regard fundamental changes to the corporate contract or major corporate reorganizations (transformations, mergers, divisions) from which the individual shareholder dissents. Creditors can count on this because it avoids that assets of the company go to liquidating shareholders. 2. What about personal creditors (of shareholders)? Personal creditors’ rights: Personal creditors can never seek a direct satisfaction on them. Personal creditors are barred from directly attacking firm’s assets. Assets are securities for firm creditors. The law protects firms and can do this limiting the shareholders withdrawal (claim on assets) and also stating that any action taken by personal creditors must leave the corporation indifferent and unaffected by the personal liabilities of its shareholders. Personal creditors of shareholders can act on the shares of the shareholder (which is the only legal person with a relationship with them). In different ways: • Obtaining a charging order for the collection of cash distributions For example, the bank could get the shareholder’s dividends. • Foreclosing on the shareholding itself (i.e., the shares) → If there are no dividends the bank can get the shares of the shareholders and: • seek satisfaction by withholding the profits it generates annually, if any, or upon reimbursement of the shareholding • sell them on the market to any interested third party,Usually this happens through a formal court-led auction in order to elicit as many bids as possible and the shareholding is awarded to the highest bidder • Should the sale be infeasible for lack of interested parties or reasonable offers, they may take that shareholding for themselves and replace the former owners, thereby becoming new shareholders. → if they can’t find any buyer, the bank becomes itself a shareholder (this even if the shares’ price drop). The ownership of the company changes, however the assets are unchanged. Priority and liquidation rules try to balance and find compromises between different stakes in case of failure of businesses to allocate losses. !! In no jurisdiction can personal creditors of a public company’s shareholders force a liquidation of the shareholding upon their debtor-shareholder and the corporation !! The company is a legal entity, independent from its owner, that’s why personal creditors have absolutely no claim on the company assets. Case law- relationship between holding and subsidiaries (it’s common practice to set subsidiaries to benefit from the legal capacity of legal persons, in that case a company can become a shareholder of other companies) In which cases the subsidiaries’ counterparty can overcome it and deal with the holding company? For example what happens in case of dangerous activities which can cause diseases to employees of a subsidiary? (see case law). Can the holding company be sued? Case law states that legal personality is valid in order to separate different entities, however the holding is responsible because: • manager of holding and subsidiary are the same • the holding directly ordered the activities performed by the subsidiary (it’s like if subsidiary employees are under the holding control in term of the activities they have to perform) According to the case law, the court assessment comes up with an abuse of legal personality→ abuse of separation principle In circumstances where there are interferences with subsidiaries activities or managerial relationship between them, there’s a limit to legal personality. (2) Shareholders limited liability If creditors are only partially paid back in case of failure, shareholders are protected by limited liability. Their risk of loss is limited to the capital they invested. We recall that shareholders have no priority (priority rule) in case of failure, so they’re the first to bear losses, however, their investment risk is capped. Limited liability is the other side of the medal (compared to priority and liquidation rules). Shareholders enjoy limited liability, which means they are not liable for corporate debts and obligations -To put it differently, their liability is limited to what they have contributed to the corporation and no more. -They are not made guarantors of the corporate debts in case of corporate insolvency. -If the corporation goes bankrupt, they are under no duty to pay off corporate creditors, nor do they suffer from other personal consequences in case of corporate default (no risk of personal bankruptcy). -They cannot lose more than they invested in it. Their investment risk is capped. Limited liability has become an essential point with the industrial revolution because investments for the building of infrastructures were risky but necessary ( Building of railways from the East coast, which was already well developed, to the far savage and natives-inhabited West in the USA). read the paper. Multinationals benefit from a combination of limited liability and priority rules setting up subsidiaries. Corporate creditors may only rely on corporate assets to get paid back. -However, there are rules on formation and maintenance of equity capital for creditor protection. -Besides, if insolvency arises from managers’ wrongdoing, corporate creditors may hold managers directly liable for damages. REMINDER EIKON→ sito di dati intermediaries (duomenų tarpininkų svetainė) Lecture 3 - 28/09/2021 (3) Transferability and Tradability of Shares Shares: until 25 years ago they were paper shares, then they became electronic. The logic is the same. The company begins with a contract signed by shareholders (multilateral contract including potentially illimitate parties, independent by one another different from bilateral agreements like purchasing contracts). Usually, if there’s a third party who wants to replace you in a contract you need the unanime consent of all the parties of the contract (surviving parties). This is because historically contracts had few contractual parties, but what about contracts with a multitude of contractual parties (thousands of shareholders)? The unanime consent of all other parties wouldn’t be possible, that’s why we have Transferability and Tradability. The legal tool used to change the proceeding was the shift of the focus from contract law to property law. Property law states that if I sell a thing of my property I only need the consent of the buyer and the seller. That’s why shares were invented: to make tangible property rights (and obligations arising from it) on parts of companies. What about moving from tangible to intangible shares? That’s simply part of the technological progress (a lot of assets have become intangible). In principle, ownership interests in a company may be represented by percentage interests out of the total equity capital or by shares (hence the term shareholders) and such shares are made freely transferable, which means that their owners are free to dispose of them without need of anyone else’s consent. -Although the sale of shares entails the sale of the position of party to the corporate contract from the seller to the buyer, which results in a modification of the original parties to the corporate contract, the law chooses not to apply the rules ordinarily applicable to the modification of contracts . -By incorporating shares into tangible paper documents, the law fictitiously treats shares as a movable property and applies to the circulation of shares the very same rules usually applicable to the circulation of movables. -In other words, the law turns what would be a sale of a contract commanding the application of ordinary contract law into a sale of movables commanding the application of ordinary property law. -As a result, the transferability of shares is made subject solely to the consent of the seller and the buyer, without the need of the consent of all other counterparties to the corporate contract (i.e., the other shareholders). The law, however, permits corporate charter to provide for restrictions in the sale of shares, for instances conditioning the sale on the prior consent of a majority of the other shareholders, or requiring the potential seller to first offer his shares to the other shareholders to see if they match the third party offer (“right of first refusal”) Transferability is a default feature: it’s a rule that applies unless the parties wish otherwise. Families with big business groups→ owned by family members with no transferability→ they don’t want external members (outsiders) to enter ownership of the business and somehow ruin the familiar atmosphere of the management. In this case we can talk about limited transferability. Since it’s a default principle, many clauses are applicable, for example, asking the consent of the surviving members. Or also, if you receive an offer from another party, before closing the sale, you have to give an option to the surviving parties to buy from you at the same conditions→ you’re free to leave but with a preference channel in favour of the surviving parties. Transferability doesn’t mean that shares are tradable on the stock market. Transferability is necessary for tradability, but not vice versa. To be traded, shares need to be transferable and, in addition, in compliance with stock market requirements. Different from and beyond the concept of free transferability is that of free tradability -Shares are freely tradable if they can be listed on stock exchanges and as a result be bought and sold daily on these public markets. -In order to be freely tradable, shares must first be freely transferable. -But in addition to free transferability, shares must meet the specific listing requirements depending on the stock exchange. Difference between public and private companies • Public companies or open companies have transferable and tradable shares. • Private companies have shares which are not freely tradable because their transferability is subject to limits or because their tradability is somewhat restricted for other reasons are called “statutory close corporations” or “private companies” The difference between the two has nothing to do with the public and private sector. A public company it’s not a state owned company. Public and private companies are all private legal persons regulated by private law. Listed/Unlisted companies What if shares are not only potentially tradable but also ACTUALLY tradable in the stock market? We talk about listed or publicly traded corporations (of course they have to be public companies for definition). Corporations whose shares are fully transferable and freely tradable may then demand that their shares be admitted for listing on organized stock exchanges. -Only after admission to listing, their shares can be daily negotiated on stock exchanges. -Corporations whose shares are listed on organized stock exchanges are called “listed or publicly-traded corporations”. -Corporations whose shares are not listed, though fully and freely transferable and tradable, are called “unlisted or privately-held corporations” Unlisted or privately-held corporations are public companies with shares not traded in the stock exchanges→ usually family members own all the shares (Ferrero, barilla). Ownership is in the hands of a few family members. Warning! Distinguish between the concept of a statutory close or private corporation from that of a privately-held public corporation, the first referring to the existence of legal restrictions to the tradability of its shares while the second focusing on the fact of its shares not being traded in spite of the absence of any legal impediment. Widely/Closely held companies Public companies list their shares to expand the shareholder base→ widely held, which means, held by many shareholders. Closely held→ held by few -It does not refer to restrictions on transferability/tradability of shares. -It does not refer to their shares being admitted on a stock exchange or not. -It solely refers to the fragmentation/dispersion or, on the contrary, the concentration of the share ownership, i.e. total number of shareholders and relative size of their shareholdings. • When the number of shareholders is large and each of them holds a small shareholding so that share ownership is widely diffused, the corporation is said to be widely-held • When the number of shareholders is small so that each or some of them possesses a large shareholding, the share ownership becomes concentrated in the hands of few members, and the corporation is termed closely-held Publicly traded companies can be closely held if for example, only a small percentage of shares is tradable, while the vast majority is owned by few people. Public companies tend to be listed and widely held Private companies tend to remain unlisted and closely held (since its shares don’t circulate) • The same corporation may simultaneously be: - open or public to the extent its shares are freely tradable. -listed or publicly traded to the extent its shares are admitted to listing on a public market, but also -closely-held to the extent its shareholder base is made up of a small number of highly concentrated shareholders. (A few Italian listed corporations (“società per azioni quotate”) display these features). • The opposite may be true as well. The same corporation may simultaneously be: -private or close to the extent its shares are not freely tradable -unlisted or privately-held to the extent its shares are not admitted to listing on a public market, but also -widely-held because the shareholder base is made up of a very large number of shareholders, each owning a tiny fraction of the equity capital. Example: cooperative corporations (limited by shares). However, there are unlisted private companies which are widely held→ cooperative companies. You can become a shareholder buying a card to have discounts for example (coop). That’s why cooperative companies are the most widely held companies even if they’re usually unlisted. On the other hand, most of the listed companies are actually closely held for the reasons mentioned before. The creation of the legal personality and the other features we saw, are about division of assets. Creditors have the claim on firms assets (it would be impossible to attack each single shareholder in large conglomerates) and they specialize in different types of lendings. (4) Delegated management under a board structure All public companies have a delegated management: • We have a board of directors powered by the law to make decisions about the company. • Despite the fact that investors are shareholders, they don’t take business decisions. They delegate the board of directors. Shareholders are left with very limited managerial powers. They mostly have control powers. • The board of directors is formed by way of periodic elections. Director membership isn’t per se an attribute of share ownership. There are large shareholders left outside of the directorship (or no). • In a company we have separation between ownership and management. When business people were only merchants, we had small businesses composed of a few merchants putting together small capital. With the colonial empires (uk,spain,portugal), the development of trade with colonies pushed people to set up big businesses which needed a big amount of capital→ joint-stock companies. People with capital and people with expertise or managerial skills started to put together their resources. • Corporate law typically vests principal authority over corporate affairs in a board of directors (“consiglio di amministrazione”), a formal corporate organ that is periodically elected, exclusively or primarily, by the firm’s shareholders. • Art. 2380-bis, Italian Civil Code (ICC): “The management of a [società per azioni] is vested exclusively in the company’s directors, who are empowered to take all necessary decisions to pursue the corporate objectives.” The objectives of a company are written in the corporate chart. Usually when you set up a company you don’t specify objectives, but you only specify the economic sector where your company is going to operate, this to avoid constraints to managerial power in case of the rise of new business opportunities. In italy it's an essential principle, • § 141(a), Delaware General Corporation Law: “The business and affairs of every corporation shall be managed by or under the direction of a board of directors, except as may be otherwise provided by the law or in its certificate of incorporation”. In the USA it's a default principle. • Par. 76(1), German Corporate Law (Aktiengesetz): “The managing board [board of managing directors] manages the company under its own responsibility” There’s a managerial hierarchy→ high ranking manager, low ranking manager In all systems the board of directors nominates the top management team, and this in turn appoints the lower management. • It selects the chief executive officer (CEO), who becomes the head of the operative management. He runs the business everyday, he’s considered s the boss and he’s also the one who’ll be criminally charged in case, for example, of scandals and disasters • It usually selects other high-ranking executive officers, such as the chief operating officer (COO) in charge of the daily operation of the company (number two in the ranking), the chief financial officer (CFO) in charge of the financial affairs and financial statements, the chief administrative officer (CAO) in charge of managing human resources, the chief compliance officer (CCO), primarily responsible for legal and regulatory compliance issues within an organization. They often are referred to as the “C-Suite” to signal their prominent status within the firm. • The board may appoint its own members as chief executives, as often is the case in Italy: the Italian CEO is typically the “amministratore delegato” • Chief executives then appoint lower managers and so on.. • You can be both a member of the directorate and an executive officer (elon musk) Corporate law deals with the base or the top of the pyramid (except for limited circumstances): shareholders and top executives. Why do we need such a separation?Suppose a widely held listed company→ shareholders might be disinterested in the management of the company and only interested in trading in the stock market for speculation. The law must stabilize the company even if the shareholder base can change everyday. It would be impossible to include shareholders in decision making. Once we have created a legal person separated from the shareholders we need somebody empowered with the authority to manage the company and take decisions to run the business. Shareholders are necessary for the company but not in the decision making process (5) Shareholder ownership of a public company Who actually owns the company? Shareholders. Shareholders are NOT more important than others. Companies cannot survive without employees, suppliers, capital... It’s not a matter of importance. The law gives to shareholders specific exclusive rights because of EFFICIENCY. The rights associated with shares are of two types: corporate/administrative rights(voting) and economic rights(profits) Since the shareholders have these two sets of rights they are the owners of the company. What about property rights? -the right to dispose of a thing -the right to earn the fruits of it (financial fruits of a security, the rents from the ownership of a flat, the fruits of an apple tree) Talking about an intangible business organization, shareholders have the most similar set of rights to the traditional notion of property rights. Shareholders are residual claimants (they are the first to lose in case of loss and the first to benefit from profits) and this incentivizes them to optimally perform their voting rights→ they have to make the best choice to avoid losses and generate profit. Shareholders’ rights are given on a proportional basis. Why? If you have 10% of economic rights and 51% of voting rights you wouldn’t mind properly exercising your voting rights because your loss and profits will be limited. Nevertheless, proportionality is not mandatory. The law allows the charter to assign shareholders rights being more than, or less than, proportionate to the size of their holding. It’s a default principle. Lecture 4-30/09/2021 Variations to Shareholder Ownership Exception to the rule of control rights only to shareholders: The case of the German codetermination (“Mitbestimmung”) • After WW2 in Germany a law was passed to grant employees of large firms rights similar to those of shareholders. We talk about codetermination because the running of the firm is affected by both shareholders and employees • Under German law, large firms must grant employees the right to appoint a number of their representatives to the supervisory board along with those of the shareholders. We’ll discuss it next Exception to the rule of proportionality to equity capital: The case of cooperative corporations • In a cooperative, economic benefits do not come in the form of pro rata profits but rather in that of low-price goods and services for the members of the firm or higher salaries for them. • Also, each shareholder is usually entitled to only one vote regardless of the size of his shareholding. No shareholder alone can exercise control over the company. Any rationale here? In cooperative corporations Each shareholder has only one vote despite the amount of shares. This is because cooperatives aim at having dealings with members (if you open an account in a cooperative bank, it offers you to become a shareholder. Sometimes, when companies pass through hard times they can be saved through the creation of a cooperative company, this because a cooperative can give economic benefit to members (the goal is not to have profit but to have an opportunity that you could not get elsewhere). e.g. Cooperative in the agricultural sector→ if you are a small farmer you can't deal with big firms which can buy your products. If a lot of small farmers form a cooperative gain bargaining power in negotiations with big firms. So the members of the cooperative have an economic advantage which doesn’t come in the form of profit. Economic advantages are not allocated on a share basis, thus it makes no sense investing in 30% shares of a cooperative company. (one person, one vote). Private Limited Liability Company They pose very little barriers to entry. Lawmakers were forced to make available other business forms different from public companies. • The private LLC is a type of company that shares many but not all features with the public company/corporation • It has all the advantages of public companies in terms of protection of shareholders, the most important is limited liability. • In particular, it shares with corporations most rules that generate positive or externalities on third parties. • But there’s much greater flexibility in designing the management of the company. • Private companies are meant for smaller (medium-small-micro) businesses rather than public companies. That’s why they’re so popular. Members have very similar ownership rights. Similarities with Public Company • LLC enjoys full legal personality in the form of possession of both legal capacity and the strong-form entity shielding If the priority rule works the same, on the contrary the liquidation protection rule is weaker, since the right to withdraw from the company is permitted to a larger extent than in the public company. • Members of the LLC benefit from personal limited liability as do shareholders of the public company. But the LLC is subject to rules regarding formation and maintenance of equity capital. • Members of the LLC retain ownership rights (right to profits and to control the company) as do shareholders of the public company. However, there is more flexibility in allocating these rights among its members. Deviations from Public Company 1. Ownership interests are not represented by shares because private companies don’t issue shares. To have interest you need to have your contract with you which can’t be treated as a financial security by the law. This to avoid the mislead of the public. • Although they are freely transferable in principle, they are not meant to be systematically traded and, in particular, they usually are not admitted to trading on public markets. • Their transferability is by law subject to formal requirements that raise obstacles to their trading on a continuous basis. Limitations to circulation of ownership interests→ this because they’re meant to remain private. • Besides, free transferability of such ownership interests can be constrained to a larger extent or excluded altogether. 2. The managerial structure is much simpler, very similar to a partnership. • As with the public company, the management is formally separate from the membership (membership doesn’t entitle per se to be a managing member or director of the company) • However, unless the contract provides otherwise, the management must usually be vested in one or more of its members • Members of the directorate in a private company are likely to remain there for an indefinite term. Private companies are likely to run family businesses. • Public companies have supervisors because they’re of public interest (they involve a lot of stakeholders, thus their demise could create issues for large sectors of the economy) While in PLLC all factors that could make the activity slower, more complicated or costly are avoided, the supervision is one of these. • Thus, the management is not ordinarily subject to monitoring by internal or external supervisors Public companies have higher costs but more protection, private companies have small circulation of ownership but flexibility in the structure and lower protection. Non-corporate alternative business forms They don't cover a substantial portion of economic activity, however they play roles in small sectors of the market. • Limited liability partnership (us uk which are much more flexible because of the legal tradition). In other countries they’re not recognised because the law has a paternalistic approach (once the definition of corporation is given, other forms are not admitted). -Partnerships have unlimited liability in other countries (France, Germany, Italy). If you’re a startupper you could choose partnership as a more flexible form but with unlimited liability while the corporation form is a bit more complicated to be set up but it entails limited liability. Yes: Weak-form entity shielding [though it can be made stronger by contract]; Limited liability No: Free transferability and tradability of ownership interests on securities markets; formal separation of management from ownership [though achievable by contract] In the US and UK they let the market decide. Different types of philosophical attitudes distinguish the anglo saxon world with Europe. Statutory business trust A trust is a legal tool to separate ownership rights between two classes of individuals. Beneficiaries and trustees have different rights. (Think about the father who has a business company and is going to die soon→ he signs a trust to delegate some people to run the company and his children will gain from this as beneficiaries) Economic rights to beneficiaries and governance rights to trustees. This is applied to special businesses. Think about Black Rock→ Small investors who decide to invest in funds are beneficiaries and professional asset managers are trustees (which receive a fee). It looks a bit like a public company. Yes: Legal personality (strong-form entity shielding); limited liability of beneficiaries; transferability and tradability of interests of beneficial owners (trust units); separation of management (trustees) from ownership (beneficiaries) Forces Shaping Corporate Law Worldwide Major Forces shaping corporate law worldwide 1. Patterns (modeliai) of corporate ownership 2. International competition in the product, labor and capital markets. 3. Regulatory competition 4. Regulatory harmonization (1) Listed Companies’ Ownership Pattern • Concentrated share ownership (Typical of continental Europe (Italy, Germany, France, Spain); Asia except for Japan (China, India, Thailand, Indonesia, Malaysia, Singapore); South America (Brazil, Argentina); Central America (Mexico); northern African countries (Egypt). -A single shareholder or a stable coalition of a number of shareholders hold enough voting rights to exert control over the firm by appointing and removing it’s directors and prevailing in shareholders’ meetings -He has control in the nomination of the board of directors. This usually happens when you own 51%. -It is still possible that you’re a majority shareholder even with a lower percentage of share: In largely capitalized businesses with millions of investors, 30%, for example, is a lot and it’s enough to challenge all the other shareholders. -This makes the company closely-held and yet it may still be publicly-traded on stock markets. Controlling shareholders are of different entities: Italy, France: families (see FCA, EssilorLuxottica, Atlantia and Autogrill, Mediaset; LVMH; L’Oréal) and the State (ENI, ENEL, Leonardo; EDF, Total, Gas de France, EADS; Peugeot-Citroën) Germany: families (BMW), commercial banks (Daimler-Mercedes) and/or regional Laender (Volkswagen) India: families (Tata Group) China: the State (China Petroleum and Chemical Corp; Industrial and Commercial Bank of China, China Mobile) What are the consequences: → Reduced size and less liquidity of stock markets → Relatively lower number of floating shares, i.e. shares free to change hands daily → Relatively lower number of minority investors → Management accountable to the controlling shareholder. → Potential conflicts of interest mainly between controlling shareholders and minority shareholders Reduces the level of liquidity and so the interest of investors This empowers controlling shareholders→ the management pursues the interests of controlling shareholders. • Dispersed share ownership Typical of United States, United Kingdom, Canada, Australia, and Japan -No shareholder, alone or together with others, holds enough voting rights to exert a stable control over the firm. -Where the one share/one vote standard applies, this also means that none holds a large fraction of equity capital (typically no one has more than 5-10% of the equity capital and voting rights) → If everybody has the same small amount of shares, none of them has control over others. -The company is widely held→ ownership (nuosavybė) fluctuates (svyruoja) so the management changes on a case by case basis. Who are the shareholders in these widely-held firms? -Usually, institutional investors such as mutual funds, pension funds, insurance companies, investment banks. -They may own blocks of shares up to 5% or 10%, but not with the aim of controlling the firm but rather profiting from their increase in value and the dividends they pay out. -In order to diversify their portfolio risk and because of the financial regulation applicable to them, their shareholdings must be confined (apribotas) to minority positions. -The financial regulation wants to avoid controlling positions. What are the consequences -Deep and liquid stock markets (US and UK stock exchanges are among the largest in the world) -High number of floating shares and high number of minority investors -Because of the small shareholding, no shareholder may have strong incentives to monitor management closely -Management relatively (palyginti) free to work unchecked and thus potential conflict of interests arise vìs-a-vìs the shareholder class as a whole. -Spreads between demands and supply are reduced -The management can take advantage (pranašumas) of shareholders. • This does not mean that there are no cross-sectional exceptions! -US-based Google, Oracle, Microsoft, Amazon possess a concentrated share ownership base. -After being privatized, Telecom Italia (now TIM) had long had dispersed shareholdings until it was ultimately taken over in 1999 How does the ownership pattern influence corporate law. Legal consequences: 2 types of effects Which of the two prevails depends on different factors. Distributional effects: -Negative -Excessive (perdidelis) empowerment (įgalinimas) of a group of stakeholders at the expense of all the others -Such empowerment becomes self-reinforcing in a downward spiral -More power, greater ability to influence lawmaking -More favorable laws, even greater power This effect causes the law to give preferences to some stakeholders rather than others. Controlling shareholders on one side and management on the other one. Associations of these groups push lawmakers to shape the law in their favour making them even more powerful. Efficiency effect -Positive -Excessive empowerment (įgalinimas) reaches a tipping (lūžio) point -Some bad-faith (nesąžiningos) stakeholders use their power recklessly (beatodairiškai) up to bankrupting their companies -Companies fail causing massive financial and social losses -Strong calls for regulatory reforms lead to a rebalancing Usually this spiral ends In case of a big demise of a company that can cause massive losses to investors, In that case (or more generally in case of crises -) lawmakers reverse the course of action. Distributional effect in concentrated ownership -Shareholders are relatively stronger than managers -Wealthy families form powerful interest groups that may lobby lawmakers to bend (lenkti) corporate laws in their favor, i.e. constraining managerial freedom of action and lowering the protection of minority shareholders -The State itself, as a controlling shareholder, may have interest in a tight control at the expense of professional managers and minority investors -We indeed observe laws more favorable to controlling shareholders than to managers or minority shareholders Controlling shareholder-centric approach in regulation -This, in turn, encourages the state and wealthy families to retain a controlling stake for as long as they can Distributional effect in dispersed ownership Business roundtable of most important CEOs of US companies. Laws tend to be more manager friendly than shareholder friendly (like in Europe). -Managers are relatively stronger than shareholders -They form potent interest groups lobbying lawmakers • See the Business Roundtable in the US -Laws tend to benefit them at the expense of the shareholders • Board-centric approach in regulation -Less managerial accountability: Managers may more easily take advantage of their shareholders -By empowering management and weakening shareholders, such laws reduce the value of keeping controlling shareholdings -Founders and controlling shareholders are encouraged to divest their controlling stakes and make their companies widely-held Efficiency effects Concentrated and dispersed ownership alike (panašiai) -Opportunistic behaviors of controlling shareholders and/or management often turn into corporate scandals and collapses. -This may spark a reaction to the status quo prompting regulatory reforms in the opposite direction to rebalance the focus of corporate law. -Since Enron and Worldcom (US corporate scandals in early 2000s→ not existing checks and balances and ineffective regulatory practices→ powerful reckless (neapgalvotas) CEOs), US law has weakened managers and strengthened shareholders -Since Parmalat failure 2003 (was politically connected→ controlling shareholders didn’t tell investors the real situation of the company, supervisors failed→ 18 billion dollars fraud evaporated in a month), Italian law has weakened controlling shareholders and strengthened minority shareholders -Scandals and collapses usually arise from unregulated behaviours. (2) International product and financing competition • When one company enjoys a monopolistic position within a country that zeroes any competition, such a company faces no pressure in ameliorating its status quo • But if there is a product competition that puts pressure from outside, things change • Such a company sells and gains market share at home and abroad if its products are more competitive because are more innovative or less costly • This requires investments in innovation, research, product development and a skillful management for which competitors compete as well on a global stage • This adds pressure to benefit from an efficient corporate law that attracts funding from investors and labor from skilled management • The trend toward global free trade weighs positively on domestic corporate laws around the world Lecture 5-05/10/2021 – (3) Regulatory competition between different national legal (teisinių) regimes (rėžimų) Firms can legally migrate from a jurisdiction to another. They usually do that to maximise profits. Jurisdiction can shape their rule system in order to attract firms. • Corporate law is like a product supplied by countries with their jurisdiction to firms which are consumers. (Corporate law can also be thought of as a product and firms can be seen as its consumers) • In a world of freedom of establishment (įsteigimas) of legal persons and free movement of capitals, firms will migrate to more favorable jurisdictions in search for the corporate law that best suits their needs. • This sparks competition among national jurisdictions to retain as many local firms and attract as many foreign firms as possible The first consequence is competition between jurisdictions to attract firms. Why? (Motivations behind Regulatory Competition) There are many reasons • Tax purposes: Taxes that firms pay: corporate income tax (direct tax on revenues), Vat (paid on goods and services provided). The first tax is applied depending on the headquarter (buveinė) of the firm (where the management work). The VAT is levied depending on where the business performs its activities. There’s a third type of chat which depends on the country of foundation of the firm: Franchise taxes: Corporation taxes levied on equity capital (number of shares the company is authorized to issue according to its own charter).This tax is extremely important in the US (while it’s been abolished in the EU). It’s annually paid (as companies increase they’re going to pay increasing taxes) • Other wealth-increasing fallouts: Demand for local legal services (legal counsel, arbitration chambers) and business tourism→ development of a large legal industry; business related legal industry implies (reiškia) that firms can become part of the law shaping process (UK). Arbitration chambers adjudicate conflicts between firms, they flourish where firms incorporate their businesses. • Overall national economic power: Creation of national champions. Just rhetoric? Stabilizing the economy during downturns; Directing production toward goals in the national interest in times of emergency (see Trump’s executive orders under the 1950 Defense Production Act to induce the military defense industry to create weapons for the US army); playing a role in trade wars? • Prestige: Race for the first anti-Covid 19 vaccine between healthcare companies from around the world Preconditions for Having a Regulatory Competition between States Two firms are competitors when consumers have to choose to buy one of the two products which are substitutes. With a single market a consumer has no barriers when switching from a product to another. • Competition in law, much like competition for other products, requires the existence of a single market, in which consumers can choose from among alternative laws to meet the same need. ◦ That is, consumers face no barriers and only little cost to switch from one legal product to another • This situation most intensely occurs in single markets organized as federal systems or political unions (we consider USA and EU), where more legislative powers may compete with each other in regulating the same subject.

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