Beyond Beholden

Da Lin is Lecturer on Law at Harvard Law School. This post is based on her recent article, forthcoming in the Journal of Corporation Law. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

Corporate law has long been concerned with director independence. In controlled companies, the perceived problem is that directors might feel pressured to reciprocate a past kindness from the controlling shareholder or fear retaliation. As a result, the conventional marker of independence is the absence of substantial prior or ongoing relationships to the controlling shareholder.

In my forthcoming article, Beyond Beholden, I challenge that standard narrative. I argue that the prospect of future rewards from the controlling shareholder also influences director behavior. Simply put, directors may be motivated to be on good terms with controlling shareholders because controlling shareholders may reward them in return.

I explore this aspect of independent director incentives using an original dataset of nominally independent directors who served on a special committee and negotiated with the controlling shareholder over a freezeout transaction between 2000 and 2014. My dataset reveals the professional connections—specifically, directorship and employment relationships—between those directors and the controlling shareholders. I demonstrate how controlling shareholders can reappoint nominally independent directors with whom they get along to executive positions and directorships at other firms under their control. In fact, 36 percent of the controlling shareholders (28 of 77) in my data have reappointed at least one director in this way. Illustrating this point from a different angle, 20 percent of the directors (45 of 222) in my data have served on the board or as an executive in at least two different companies controlled by the same controlling shareholder.

The well-known MFW freezeout illustrates this pattern of behavior. M&F Worldwide formed a special committee of four nominally independent directors to negotiate and review the offer from MacAndrews & Forbes and its controlling shareholder, Ronald Perelman. Just three months after the deal closed, the chairman of the special committee, Paul Meister, was invited to be an independent director of Scientific Games, which at the time was 34 percent owned by Perelman. Meister also subsequently became the president of MacAndrews & Forbes in 2014 and joined the boards of two other Perelman-controlled companies, vTv Therapeutics and Revlon, Inc. Another special committee member, Viet Dinh, became an independent director of Revlon in June 2012, less than a year after the MFW freezeout. In 2017, Dinh left Revlon to join the board of Scientific Games as an independent director.

I also show that some types of controlling shareholders engage in reappointment behavior far more regularly than others. In particular, among controlling shareholders who are single natural persons (as opposed to, for example, family groups) and control a portfolio of public firms, 87 percent had repeat relationships with at least one member of the special committee. The variation in controlling shareholders’ power and willingness to influence director behavior rarely appears in existing scholarship or jurisprudence. My article exposes this heterogeneity and argues that the likelihood of reappointment by the controlling shareholder depends on two factors: the controlling shareholder’s base of controlled entities and the concentration of its decision-making authority.

Base refers to the size of the network of companies over which a controlling shareholder has control. Empire builders—heads of holding companies like Alphabet and National Amusements—are examples of controllers with a wide base of control. Companies that routinely retain control blocks in a portfolio of firms, such as venture capital and private equity funds, fall into this category as well. Controllers with a wider base have greater ability to reward or sanction because they have power over more resources and more boards.

Concentration refers to the number of actors that share the power to control within the controlling shareholder. When decision-making power is concentrated in the hands of a single actor, he has more power because he can successfully secure his preferred outcomes. By contrast, when the authority to control is divided among several actors, no actor can independently impose his will. Instead of giving commands, each must bargain, cajole, appeal, reason or litigate against others to influence decision outcomes. Scope of influence also plays a role: all else equal, an actor with plenary authority over the firm is more able to exercise influence than one who has power over only a subset of decisions.

Ultimately, I recommend that Delaware courts should move toward tailoring their scrutiny of independent directors’ decisions to how much pressure a controlling shareholder can exert. While it may not be possible for courts to neatly separate the wheat from the chaff, my findings suggest some simple cues that courts can consider when assessing whether to defer to directors’ judgements or cast a hard look. This approach would not be novel to corporate law; in other contexts, Delaware courts already use intermediate standards of review for “specific, recurring, and readily identifiable situations” where the “realities of the decision-making context can subtly undermine the decisions of even independent and disinterested directors.”

The full article is available here.

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