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E-MailAnne Lafarre is Assistant Professor at Tilburg Law School; Christoph Van der Elst is Professor of Business Law and Economics at Tilburg Law School and Ghent University. This post is based on their recent paper.
Although the hype around the buzzword “blockchain” is currently still largely focused on speculation with virtual currencies like bitcoins, blockchain is a state-of-the-art technology that can offer smart solutions for classical inefficiencies in the corporate governance field. In our recent paper, Blockchain Technology for Corporate Governance and Shareholder Activism, we look into the applications of blockchain technology in the field of corporate governance, paying special attention to the restructuring of the old-fashioned and rigid Annual General Meeting of Shareholders (the AGM). We explore the AGM’s (lack of) performance and make a strong plea for blockchain-based AGM.
Agency theory in corporate law aims to optimize the contractual framework that governs the relationship between directors and shareholders. Despite all (scholarly) efforts, following the seminal theory of Jensen and Meckling, agency costs can never be fully excluded, unless the fundamental corporate characteristic of a delegated management structure can be removed. Blockchain technology can mitigate the salient agency problem and its related costs. Nonetheless, The DAO—which was a completely decentralized blockchain based association—shows that the lack of a centralized authority can create a sub-optimal situation, too.
Despite the failure of The DAO, blockchain offers new possibilities to facilitate the agency relationship between corporate actors, thereby creating trust and transparency. In particular, we see possibilities for reducing the agency costs for both shareholders and companies through the optimisation and modernization of the AGM. The AGM plays an important theoretical role in shareholder monitoring and corporate bonding, but in practice, it is considered a dull mandatory ritual, which classical outline remained unchanged for centuries. In contrast, corporate life has moved on and pays only lip service to the old-fashioned legal requirements of AGMs. As we show in the paper, all three theoretical functions of the AGM—the information, forum and decision-making function—are currently at least partially hollowed and strict procedural requirements hinder fast and flexible decision-making. For example, economic theory predicts that, in particular, small shareholders have low incentives to engage in decision-making as their voting costs are generally higher than their voting benefits. Reducing these costs can increase (the willingness of) small shareholders participation, improving participation rates and thus the validity of the AGM’s decision-making function.
The slow decision-making process can be illustrated with the practice of co-optation that is for example present in Belgium. If a director resigns, her position can directly be taken by another director, co-opted by the board. The next general meeting of shareholders must approve the election of the co-opted director, but practice shows that some co-opted directors already have resigned before the AGM had even approved their election. We claim that the very existence of this corporate law mechanism of co-optation and subsequent AGM’s shareholder approval shows that also legislators recognize that the AGM is too static. Moreover, the general meeting-tool for fast shareholder decision-making is not efficient either, as the premature resignation of the co-opted directors illustrates.
There are other, even more fundamental procedural flaws that undermine the AGM’s functioning in practice. Shares are usually held through complex chains of intermediaries, especially in the case of cross-border voting. These intermediaries not only add transaction costs to shareholder participation per se, there is also high uncertainty that information, including the record of shareholder votes, is correctly channelled between ultimate shareholders and companies in remote participation. Nonetheless, remote voting has proven to be the most common way of shareholder AGM participation to date.
The presence of these substantial practical flaws makes it worthwhile to investigate the possibilities of blockchain technology for AGMs. In a private blockchain, managed by the company only accessible for shareholders for example on the Hyperledger of IBM, the company and shareholders that hold sufficient shares can place proposals. Smart contracting allows for the private ledger to be structured so that all relevant information including majority rules and access rights that are contained in the articles of association and the law are taken into account. Once a certain proposal is placed in the blockchain, shareholders that hold shares in the company are immediately notified and can exercise their voting rights during a short period. The voting results may become instantly available after a cut-off point, and majority requirements, necessary to render the decision binding and verifiable, need to be reached in a specified timeframe. Shareholders can verify their own transactions, but none of the shareholders should be able to determine what voting decision was taken by other shareholders. Since institutional investors in Europe need to publicly disclose information about the implementation of their engagement policy in the near future pursuant to the new Shareholder Rights Directive ((EU) 2017/828), for these shareholders it may actually be beneficial that other shareholders can see their voting decision in the blockchain in a trustworthy and transparent way.
With this blockchain technology shareholder voting transaction costs can be reduced substantially. We claim that it may also offer opportunities for enhancing the AGM’s forum function, in contrast to what opponents of virtual meetings advocate. Moreover, blockchain can also decrease the organisation costs for companies and increase the speed of decision-making, making the AGM a fast and lean corporate organ. The main problems with the current chains of intermediaries and the current remote voting system have to do with transparency, verification and identification—issues that are directly linked to the advantages of blockchain technology.
The recent prototypes of blockchain-based AGMs that we discuss in our paper, of which some are already launched in practice, show that this modernization of the AGM is indeed practically feasible and perhaps just around the corner. Given the large opportunities we expect more initiatives to be launched soon, probably before our contribution’s ink is dry. Nonetheless, it is important to recognize that the blockchain-based AGM would also raise important corporate legal questions, including whether it is desirable to abolish the physical classical AGM. And if it is desirable to organize decentralized blockchain-only AGMs, how much of the forum function would then be incorporated in this technology?
The complete paper is available for download here.
