Corporate Law Notes
70417
Autumn 2012
Contextual and Theoretical Issues .......................................................................................................... 3
What is Corporate Law? Corporations Act 2001 (Cwlth) .................................................................. 3
Regulating Corporations ..................................................................................................................... 3
Data on Corporations .......................................................................................................................... 4
Nature of the Australian Capital Market ............................................................................................. 4
Clark’s 4 Stages of Capitalism (“The Four Stages of Capitalism: Reflections on Investment
Management Treatises” (1981)).......................................................................................................... 5
Contents
Shareholders- owners or merely shareholders?? ................................................................................. 6
The Control Implications of Institutional Share Ownership ............................................................... 6
Corporate Goals and Social Responsibilities ...................................................................................... 7
Theories of Corporate Law ................................................................................................................. 8
What is the purpose of corporate law? ............................................................................................ 9
Corporate Theory ................................................................................................................................ 9
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Contextual and Theoretical Issues
What is Corporate Law? Corporations Act 2001 (Cwlth)
! Corporate law covers (see s9):
o Registered companies (i.e. registered under the Corporations Act)
o Corporations (statutory and chartered) ! companies and corporations are different,
corporation is a broader term including registered companies and other statutory entities
o Other incorporated bodies? (co-ops, associations)- e.g. farming co-operatives and student
associations
o Managed investment schemes (MIS)- company on top of a trust
! Compare other business structures
o Trusts, partnerships, LLP, joint ventures
! Corporate law involves legal rules (general law and statutory) that regulate the internal
relationship between providers of capital (debt and equity) and the managers of that capital
! Not everything that a corporation does comes within the scope of ‘corporate law’- limited to
internal relations of corporations
! Compare shareholders v members (not all co have shares)
! Corporations have perpetual succession- they can exist forever
! Company Elements (once registered under the Corporations Act):
o separate person in the eyes of the law (its own legal entity affording it legal rights)considered a fiction
o “members” or shareholders where shares are distributed (may not be e.g. Non-profit or
sport association etc.)- those without shares are companies established by guarantee
o Board of Directors manages the company (or oversees the CEO, CFO managing
company) ! company is the real person is therefore liable for the actions of its managers
etc.
o Partnership: without company= the two partners are personally responsible
! Look at Part 1.2 and Part 9.4B (definitions and consequences), check out small business guide
Part 1.5 (summary), ASIC website! for companies! factsheets
Regulating Corporations
! Corporations Act 2001 (Cth)
o Corporations Regulations 2001 (Cth)
o Corporations (Court) Rules (uniform around Australia)
! Australian Securities and Investments Commission Act 2001 (Cth)
! ASIC is the primary regulator and covers:
o Procedural and administrative role (eg document lodgment)
o Substantive regulation (eg enforcement and sanctions)
o Civil v criminal enforcement
o Litigation v administrative action
! Other regulators:
o Takeovers Panel
o ASX (and other licensed financial markets)
o ACCC and ATO
o APRA and RBA (depending on type of co)
o Aust Financial Reporting Council and AASB
Data on Corporations
> 1.8 million registered companies (not corporations)
Approximately 760,000 companies lodge tax returns
Compare: 400,000 partnerships and 670,000 trusts
2,227 listed companies (on ASX)
o Not all public companies are listed on a licensed financial market
! Most companies are Pty Ltd (i.e. private companies)
! Contrast single companies with corporate groups (members of the company or other companies):
o Note definition of ‘subsidiary’ in s 46
o Ramsay and Stapledon 1998 study of ASX companies top 500:
" Almost 90% had at least 1 controlled entity
" Average of 28 controlled entities
" Some companies have hundreds of controlled entities
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Nature of the Australian Capital Market
! Capital market: marketplace where companies raise money! two different ways to raise money:
1. Issuing shares to investors (members), 2. borrowing from creditors (issuing debt or equity
securities)
! Binary divide between
o concentrated share ownership (block holder) and
o dispersed share ownership systems
! Majority controller or ‘block holder’ the world norm outside US, UK & Aust
o Typically, families, financial institutions or the State
o They run business / monitor management
o Smaller and more illiquid capital markets
o More reliance on bank or block holder funding
o Bank role in corporate governance
o Limits on hostile takeovers (market for corporate control)
! concentrated share ownership: individual share holders have large volumes of shares to influence
the activities of the company
! dispersed share ownership: where individual entities hold lower percentages of shares in the
company (lots of shareholders- happens in Australia)
! Dispersed systems: Mainly common law countries
! Focus on capital markets rather than bank funding
! High disclosure and market transparency
! Stronger investor protection that permits investor reliance on liquidity:
o Voice less important than exit
o Common law vs civil law countries
! Shareholder oriented model (‘top-down governance’)
! Focus on market regulation of management (also with ASIC regulation)
! Bulker rule- puts a curb on the proprietary activities of the banks (mostly US)
! In Aus banks often hold stakes in companies for nominated purposes (hedging other activities or
on behalf of clients)! not holding for their own benefit
! Derivatives:
o equity swap derivative for example can be between a bank acting on behalf of a client
(large company). They enter into a contract with the bank to say that they will pay
relative to the closing share price- the way the bank protects itself against risk of the
shares going up, they purchase the shares in the actual company and use the difference to
pay the client at the end of the month- tey profit from this by charging fees
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! Companies rely on capital markets a lot more ! corporate law is shaped around the
confidence in these markets. Corporate law regulates the market by disclosure (enforces
disclosure of practices)- this way if they are doing the wrong thing, the market will decrease the
value of their securities and reflects badly on the executives of the company (may result in a
hostile takeover)
! ASX is 8th largest by market cap ($1.2 Trillion)
! Aust publicly listed companies have some blockholders but most have dispersed shareholders
! Largest shareholders usually banks, insurance companies and superannuation funds
! Note phenomenon of ‘empty owners’-use of nominees, and derivative instruments (eg equity
swaps) to separate economic interests from legal title to shares
! Compare debt and equity capital markets
! The importance of credit rating agencies
! Compare different types of investors:
o Retail (‘mum and dad’-privatisation of govt co, demutualisation-Telstra, Qantas, CBA,
AMP etc)- small unsophisticated investors ! investing for own purposes with lower
stakes (they are low in individual stakes but high in volume)
o 43% of Aust adults own shares (direct and indirect), increasing SMSF
o Institutional (banks, insurance co, super funds)
" Note banks may hold shares through proprietary trading or as nominees
o Private equity (seek to take public company private or fund new ventures)
o Hedge funds (seek to beat the market through arbitrage)- try to get information that others
don’t see, play off companies in different markets to get a better return
o Sovereign wealth funds (SWF)
o State sponsored entities- largest controlling shareholders are companies sponsored by a
state (not necessarily owned by state but are backed by state based entities)
! Compare investment time horizons and level of activism
! These differing members pose a challenge to Corporate law because their wants and needs as
shareholders change according to their nature (different shareholders want different outcomes)
! Over the past century the registered company has become the principal mechanism for
aggregating private investment capital for large-scale commercial enterprise in most
developed countries
! Corporate form offers equity investors inducements of freedom from active participation in
the management of the pooled fund and limited personal liability for losses arising from
trading.
! Corporate personality gives the fund institutional continuity even with flux in membership
! Organised securities markets offer liquidity for investments traded upon those markets
Clark’s 4 Stages of Capitalism (“The Four Stages of Capitalism: Reflections on
Investment Management Treatises” (1981))
1. Entrepreneur
! Owner/managers
! Small scale became larger through mergers and ‘trusts’
! Rise of the corporation as a form of business organization= increase in incporation statutes
and “enabling” laws
! Companies financed by debt, low levels of share ownership or trading
! Up to end of 19th Century
2. Managerial
! Size of businesses required professional managers
! Separation of ownership and control (Berle & Means)
! Increasing share trading and size of stock markets
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3.
4.
!
!
! ‘New Deal’ reforms to securities law-increasing focus on investors and disclosure aiming to
keep managers accountable to public investors
! Modern conception of corporate law- focus on relationships of corporations and their
fiduciaries to public security holders
Financial
! Post WW2, rise in institutional investors, hedge funds become more popular
! Separation between supply and investment of capital (financial intermediation)
! Saw the emergence of the portfolio manager in the form of institutional investor or financial
intermediary- this stage split ownership into capital supplying and investment and
professionalized the investment function.
Savings
! Group control over savings decision and management
Effects of globalization, inter-dependence of financial institutions (‘contagion’), increasing use of
financial derivatives
The financial citizen (super choice, personal trading accounts)
o Rights v responsibilities (e.g. financial literacy)
o Investor class actions
Shareholders- owners or merely shareholders??
! Berle and Means examined the largest 200 non-financial corporations in the US and adopted the
definition of control:
‘control lies in the hands of the individual or group who have actual power to select the board of
directors (or its majority) with by mobilising the legal right to choose them- ‘controlling’ a
majority of the votes directly or through some legal device- or by exerting pressure which
influences their choice’
! Three controlling species were established:
o Private ownership (control through almost complete ownership) 6% by number and 4%
by wealth
o Majority control (control through ownership of a majority of issued capital) 5% by
number and 2% by wealth
o Control through a legal device- 21% in number and 22% in wealth
! In two remaining control types the legal nexus between corporate ownership and control is
severed:
o Minority control: 23% number and 14% by wealth
o Management control: 44 per cent by number and 58% by wealth
The Control Implications of Institutional Share Ownership
! Shares in publicly held corporations can be used for liquidity gains at the expense of diminished
shareholder controls over management, the loss reflecting the different logic of individual and
collective action
! For a dissatisfied shareholder exit through the stock market will usually be far easier than
exercising the protective remedies of company law, the exercise of voice
! Institutional share ownership puts enormous investment power in the hands of a relatively small
number of fund managers
! Where shares are held by a fund manager the standard management agreement generally assigns
voting rights attached to the shares to the fund manager.
! As a result, cost of organising collective action by institutional shareholders should be lower but
the benefits of exit are diminished
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! Institutions will be forced to monitor management of their own interest and indirectly to
advantage the shareholders generally but informed voting in company meetings and informal
senior management discussion
! But in practice there are strong disincentives against institutional shareholders monitoring
investee companies- 1. Investment institutions are under intense performance review pressure
from those who have committed funds to their management, 2. Small investment communities
such as Australia there are numerous financial relationships with fund sponsors, clients and
investee companies which may inhibit direct intervention for poor performance or too close an
examination of portfolio company management, 3. The gains from institutional monitoring and
intervention are shared with other shareholders who bear none of the expenditure of effort and
cost
! The efficient capital market hypothesis assumes that stock markets work efficiently to impound
quickly into the price of a security all available information affecting its value
! The logic of this is that over the medium and long-term fund managers cannot beat the market by
active trading and that comparable returns can be achieved, at lower cost, by simply ‘holding’ the
market, that is, by holding an investment portfolio whose composition matches that of the stock
market as a whole or the desired subset of that market, usually the largest “blue chip companies.
Corporate Goals and Social Responsibilities
Positions and Practices
! Managerialism stressed that corporate management owes duties to interests beyond the
corporations formal legal constituents to the labour, capital, management and the community- also
to others in modern times including government, suppliers and consumers
! The management function under this model is the allocation of corporate resources between the
competing interests groups to achieve corporate and public goals, while treating shareholders and
other constituent groups as an interest external to the firm.
What is the purpose of a corporation?
! Shareholder primacy model- shareholders are the residual risk bearers in the corporation.
Corporations must first satisfy fixed costs out of the revenue that is made- the board of directors
decides what to do with the money including further acquisitions etc. and also payment of
dividends to shareholders which is the final payment. The idea of shareholder primacy is that they
are the only members who do not have a limited claim- they are the only member that have
economic benefit
! Compare stakeholder perspectives- focus more on the stakeholders- benefit to all
! Consider Berle v Dodd debate
! For whom are the board of directors agents?
o Investors
o Other capital providers
o Broader constituents
! Managerialism-a co is more than merely the sum of its capital, it is an independent institution that
management (as professionals) have a responsibility to run for the benefit of stakeholders (i.e. let
management get on with it)
o Separation between ownership and control
o What about agency costs?
Do companies have social obligations?
! Corporate social responsibility is a concept with no settled meaning. It may involve:
! Permitting directors to have regard to non-shareholder interests
! Impose a duty on management towards other parties than shareholders such as
employees, consumers and the community
! Issues is whether directors should have a licence or a duty to sacrifice shareholder interests for the
common good or that of third parties
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! Companies are ‘persons’ and are bound by legal obligations
! It is possible to legislate social obligations (eg environmental law)
Shareholder Primacy
! Accepted purpose of corporate activity and measure of performance is the maximisation of
shareholder value as expressed in the price of shares
! Assumption is made that the duty of management is to maximise the wealth of their principals,
the shareholder “owners” of the firm, and that the function of corporate law is to promote that end
! Shareholders are considered “owners” because:
o They are ultimate risk bearers in the firm as they are postponed to creditors in the event of
a wind up
o Their entitlement to surplus income of the firm during its lifetime gives them a vested
interest in ensuring that resources are used with maximum effectiveness to a societal
advantage
o Monopoly of voting rights- right to sell control through disposal of shares and monopoly
of rights to bring suit for wrongs by the company which it has not sought to vindicate
! Charitable donations as an example
! James Hardie example—took assets offshore to protect the shareholder’s interest when they found
out their product was harmful
Pluralist (or multifiduciary) Models
! Alternative to shareholder primacy model
! Creates a multifiduciary duty requiring directors and managers to run the company in the interest
of all those with a stake in its success, balancing, one against the other, the claims of shareholders,
employees, suppliers, the community and other stakeholders
! Based on a theory of the corporation as community that responds to the harm to which other
stakeholders are exposed by a management focus solely upon shareholder interests
! This model has been adopted in a majority of States in US
! Problems with plurist model:
o Hard to properly allocate between competing interest without clearly defined and
enforceable responsibilities
o Questionable as to the legitimacy of management powers- are corporate managers better
able to make these decisions – does this weaken accountability mechanisms
Corporate social responsibility and directors’ duties
! Case Study: James Hardie group of companies
o James Hardie restricted its companies, severing the asbestos producing subsidiaries
(which they are not liable for even if the parent company holds the whole of its share
capital)
o James Hardie’s lawyers advised that their duties as directors was to their shareholders
solely and not to those suffering from the asbestos operations of the former subsidiaries
o Both the PJC and CAMAC who reported on the inquiry into corporate social
responsibility took the view that the current state of corporate law in Australia allowed
directors to take into account the interests of non-shareholder stakeholders and broader
community considerations but they could do so at their own business’ self-interest and
should not be obliged to respond to social concerns
Theories of Corporate Law
Is it a real thing or not?
! Yes:
o Managerialist (growth of conglomerates which used internal capital and product
markets)
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o
o
o
o
o
Concession theory (created by state authorisation)
Aggregate /natural entity (more than the sum of its shareholders)
Communitarian (company as a social institution)
Political institution (company as an expression of social power)
Feminist (company as a social institution founded on gender bias, inequality,
exploitation of property rights and conflict)
o
Contractarian (economic)-a corporation is a nexus of contracts
" Consider Cost theory of the firm (firms arise when the cost of producing
goods and services is cheaper than obtaining these through markets)
Team production model (TPM)-corporation as a mediating hierarchy that is designed
to lock capital into the enterprise
! No:
o
What is the purpose of corporate law?
! Public v private
! Is a corporation anything more than the exploitation of private property rights (see s 1070 A)
! Should corporate law be used to address bargaining and wealth inequalities?
! Shareholder primacy revisited (eg TPM)
o Are shareholders really the residual risk bearers?
o Communitarian v economic perspectives
! Mixed goals:
o Investor protection
o Managing agency costs
o Reducing transaction costs (including the competition for capital)
o Efficiency v equity
! Feminist critique-corporate law entrenches conflict, separation and existing hierarchy, individuals
valued over groups, economic gains valued over other benefits
! Alternative foundations: trust, legitimate expectations and mutual responsibilities, the corporation
as custodian
Corporate Theory
READING: Redmond [2.210]-[2.240]
Managerialist Theories of the Corporation
! Assert the institutional personality of the corporation and an evolving corporation conscience to
legitimate the power resting with management
! Management hierarchy that monitored and coordinated activities of a number of business units
more efficiently than market mechanisms
! Views the corporation essentially as hierarchy and senior management, at the apex of the
hierarchy as the principal subject of legal regulation
! Legitimacy of management power is sustained by assertions of management professionalism, of
an evolving corporate conscience and business utility and expertise.
! There was a movement of strengthening of legal duties imposed upon directors and senior
management and the requirement of shareholder approval for a wider range of corporate
transactions = law reform in North America, UK and Aus for most of 20th C
The Corporation as Contract
! Corporation is deconstructed to reveal a ‘nexus of contracting relationships’ between
shareholders, managers, employees, lenders, suppliers and other stakeholders
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