Comparative Study on Economics, Law and Regulation of Corporate Groups

The following post comes to us from Klaus J. Hopt, a professor and director (emeritus) at the Max-Planck-Institute for Comparative and International Private Law, in Hamburg and was advisor inter alia for the European Commission, the German legislator and the Ministries of Finance and of Justice.

The phenomenon of the groups of companies is very common in modern corporate reality. The groups differ greatly as to structure, organization, and ownership. In the US, groups with 100-per cent-owned subsidiaries are common. In continental Europe, the parents usually own less of the subsidiaries, just enough to maintain control. In Germany and Italy pyramids are frequent, i.e., hierarchical groups with various layers of subsidiaries and subsidiaries of subsidiaries forming very complicated group nets. The empirical data on groups of companies are heterogeneous because they are collected for very different regulatory and other objectives, for example for antitrust and merger control regulation or for bank supervision.

Two main agency problems arise in groups of companies: between the controlling shareholder and the minority shareholders and between the shareholders viz. the controlling shareholder and the creditors. The USA and many other countries deal with these agency conflicts by imposing special duties on the controlling shareholder. Germany and other European countries have developed special rules for groups because they consider their agency conflicts to be special and unusually grave: Steering a group of companies implies making difficult business judgment decisions that may be appropriate or even necessary for the group though they are disadvantageous or even harmful for the subsidiary. Correspondingly the controlling shareholder in the subsidiary may act responsibly in the interest not only of the parent, but of the group as a whole.

There are three main regulatory models for dealing with groups of companies: regulation by general corporate and/or civil law (prototype: the USA and the UK); regulation by special group law (prototype: Germany); and regulation by areas of the law such as banking, competition, and tax law (to be found in many countries, either combined with the first or the second model). The main strategy for dealing with groups of companies is disclosure and group accounting (US GAAP and IAS/IFRS in the European Union and other countries). It is effectuated by special investigation with a group dimension and by the help of auditors and independent experts. In the Netherlands this has been said to be a “most effective mechanism”. A fair amount of international convergence, at least for listed companies, can be observed.

Related party transactions are regulated extensively by corporate law for directors and officers, but if they involve controlling shareholders they present special problems. This is even more true for groups of companies. Specific disclosure is usually combined with consent requirements: by the whole board or by independent directors; in important cases by the shareholders; and sometimes by the supervisory agency. In groups of companies, these consent requirements may not fully work because the board of the subsidiary is most often dependent on the parent, and consent resolutions by the general assembly are of little use if the parent is in control. Then the consent of independent directors or a decision of only the minority shareholders, as in Australia, may help. An interesting experiment is found in Italy where the minority needs to be represented on the board by a minority representative. There this seems to be more effective than independent directors. Following the example of the listing rules in the UK the European Commission is considering introducing a rule for related party transactions that would require the consent of the general assembly for transactions upon a threshold of five per cent of the assets of the company.

In addition, appropriate standards for directors and controlling shareholders for dealing with agency conflicts in groups of companies have been developed in many countries. The duty of loyalty is an open standard to be concretized ex post by the courts. Traditionally the duty of loyalty is very strict in the US, the UK, and other Commonwealth countries. One of the reasons for this is the fact that this duty of company directors has its origins in the strict fiduciary position of the trustee under old English trust law. Due to the particularities of US procedural law, a considerable amount of case law has emerged. The situation in continental Europe is very different because the duty of care has traditionally played a greater role than the duty of loyalty. There is some convergence, but many differences remain, in particular as far as specific standards for balancing the interests of member companies in groups are concerned. The strict, codified German group law standard stands against more flexible standards in Italy, France, and other countries.

Protection of creditors can be achieved to a certain degree by self-help and guarantees by the parent. But mandatory protection is still considered necessary. There are various national standards for the directors and controlling shareholder in the independent company as well as in groups of companies. These standards become stricter if insolvency is approaching. The concept of the shadow director plays an important role in extending liability to the controlling shareholder and the parent. There are various other mechanisms for creditor protection in the independent company and in the group of companies. Some of them, such as indemnification and veil-piercing, are used when the corporation is still doing well and is operating as a going concern. Others are mechanisms of insolvency law, such as subordination and substantive consolidation. Creditor protection is still very path-dependent, and convergence is much less advanced than in shareholder protection.

A special group of conflicted transactions besides related party transactions comprise control transactions, in particular public takeovers. Takeover law was first developed in the US and the UK and from there has moved into other countries. Takeover law grew up separately from group law and only arrived in countries with group law such as Germany at a very late stage. The mandatory bid rule of UK origin can be understood functionally as a group protection measure that allows the shareholders of the target to opt for an early exit at a fair price. There is some convergence in takeover regulation, in particular in Europe, but fundamental differences remain, both as to the anti-frustration rule (prototype: the UK) and the mandatory bid rule.

The full article is available for download here.


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