Nordic Corporate Governance and Concentrated Ownership

Klaus Ilmonen is Partner and head of the Capital Markets practice at the Helsinki office of Hannes Snellman. This post is based on an article authored by Mr. Ilmonen.

The corporate governance implications of concentrated ownership have become topical with the success of companies with large controlling shareholders, such as Facebook, Google and Amazon. The debate on the perceived short-termism related to dispersed ownership has also increased interest in governance models based on monitoring by large shareholders. As a result, Nordic corporate governance models have been subject to increasing interest in the international corporate governance debate. The Nordic corporate environment has generally been characterized by a prevalence of concentrated ownership and by the use of control enhancing mechanisms by large shareholders. Yet private benefits of control extracted by controlling shareholders have been reported to be relatively low. This combination has been seen to reflect a competitive governance model.

Different possible explanations have been given for the low levels of private benefits in the Nordics. These have included the effect of social norms characteristic to the Nordic environment and the non-pecuniary nature of control benefits (such as social status associated with corporate ownership). It has also been suggested that lower crime levels and tax compliance in the Nordic countries help explain the behaviour of controlling shareholders. However, my paper, Explaining Nordic Corporate Governance: A Political Narrative, suggests that a political approach to corporate governance provides a more accurate explanation of regulatory developments in the Nordics. Corporate ownership and corporate governance outcomes are affected by industrial and political developments—also in the Nordic region. This paper provides a political narrative of Nordic corporate governance and argues that, in fact, private benefits of control in the Nordics have been limited mainly due to an export-driven industrial structure open to product market competition while economic crisis and the development of pension systems have decreased resistance to better investor protection. The paper argues that EU regulation has also had an impact on the development of investor protection in the Nordics.

This paper first describes the political background of corporate ownership and corporate governance in the Nordic region. The review demonstrates how the development of corporate governance regulation has reflected changes in the sources of corporate finance and in the bargaining power among corporate constituencies. The globalization of markets and increased international product market competition have particularly affected small export-reliant states, such as the Nordic countries, and restricted rents available from corporate enterprise. As the importance of equity as an investment form has increased, controlling shareholders and labor have come to accept better minority protection. The increase of foreign investment and changes in industrial structures and in pension systems have also facilitated minority protection.

The analysis also reveals how complementary institutions have supported existing ownership structures. Company law and related legal institutions support the ability of large shareholder to use control rights through general meetings, for example. The broader institutional framework also continues to support concentrated ownership. Large shareholders, for example, have been favoured through political structures, including tax regulation, so that there has been less pressure to extract private benefits. The analysis has also demonstrated the importance of control rights to large shareholders, who have successfully opposed initiatives to challenge them through both national and EU level regulatory reforms. Based on a review of how corporate governance mechanisms have evolved in the Nordic region it seems that controlling shareholders have been prepared to accept increased transparency of their relationship with the company they control, but have not been prepared to allow changes to corporate governance rules that would challenge their control rights.

The regulation of corporations has not solely been a national matter. Over the past decades, the impact of EU regulation has had a significant effect on Nordic company law. The EU has introduced new dimensions to corporate governance regulation that has affected the bargaining power of corporate constituencies. Institutional structures prevalent in smaller economies in the EU may also be more prone to change than structures that dominate in economies with more influence in EU decision making. For example, amendments are currently being negotiated to the Shareholders’ Rights Directive, which could directly affect the position of large shareholders in the Nordics.

Political approaches to corporate governance have often been descriptive and focused on explaining the reasons underlying ownership structures or regulatory outcomes. Yet these approaches also provide guidance for developing regulatory policy. Nordic corporate governance remains subject to the dynamics of the political economy. A review of the development of Nordic corporate governance regulation can provide useful insights into how legal strategies can be adapted to different systems of corporate governance. First, a functional approach to regulation remains warranted and regulatory mechanisms should be introduced that are effective and relevant in the institutional environment. Regulating board duties in takeover situations may be less relevant in companies with concentrated ownership, for example, as the incumbent shareholder will have a de facto veto on the transfer of control. Second, the review suggests that entrenchment of control is a more pervasive characteristic of corporations than is recognized, and legal strategies may be needed to specifically counter entrenchment. With the availability of control enhancing mechanisms and favorable tax treatment, in relative terms, the costs for maintaining control by large shareholders are low in the Nordics. This can decrease the incentive to transfer control where such transfers would otherwise be warranted. It is important to identify the relative benefits of large shareholdings and seek to adjust these to promote efficient control transfers. Third, political opposition to regulatory initiatives can be decreased by the choice of legal strategies and regulatory mechanisms. Control has been a critical factor for incumbent shareholders whereas they have been more willing to subject the nature of their dealings to increased scrutiny. In designing legal strategies it may be important to recognize the key concerns of important constituencies and to structure regulation accordingly. Where concentrated ownership is prevalent it may not be politically feasible (and may be counterproductive) to introduce minority protection mechanisms that directly challenge control rights (such as veto-rights). However, there may be less resistance to other mechanisms with the same goals, such as introducing fiduciary duties for large shareholders, or enhancing cash-flow rights of minority shareholders. These propositions are particularly topical as the amendments to the Shareholders’ Rights Directive are being negotiated at the EU level.

An article based on the working paper has been published in the European Company and Financial Law Review (ECFR 4/2015).

The full paper is available for download here.

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