Forces Shaping Corporate Law

Worldwide
References to textbook’s Chapter 1

Class V
Alessandro Pomelli

Subject to copyright. Do not reproduce or circulate without the Author’s consent 1

 Major Forces Shaping Corporate Law
Worldwide

1. Patterns of corporate ownership

2. International competition in the product, labor and

capital markets.

3. Regulatory competition

4. Regulatory harmonization

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 Listed Companies’ Ownership Patterns
1. Concentrated share ownership
– Typical of continental Europe (Italy, Germany, France, Spain);
Asia except for Japan (China, India, Thailand, Indonesia, Malaysia,
Singapore); South America (Brazil, Argentina); Central America
(Mexico); northern African countries (Egypt).
2. Dispersed share ownership
– Typical of United States, United Kingdom, Canada, Australia, and
Japan
 This does not mean that there are no cross-sectional
exceptions!
– US-based Google, Oracle, Microsoft, Amazon possess a
concentrated share ownership base.
– After being privatized, Telecom Italia (now TIM) had long had
dispersed shareholdings until it was ultimately taken over in 1999
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 Concentrated Share Ownership

 What Does It Mean?

 A single shareholder or a stable coalition of a number
of shareholders hold enough voting rights to exert
control over the firm by appointing and removing its
directors and prevailing in shareholders’ meetings.
 Where the one share – one vote standard applies, this
means that such a single shareholder or such stable
coalition of shareholders hold a large fraction of voting
equity capital (typically, 30% or more)
 This makes the company closely-held and yet it may
still be publicly-traded on stock markets.

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 Who are the controlling shareholders in large listed
companies where there is concentrated ownership?
 It varies from country to country
 Italy, France: families (see FCA, EssilorLuxottica,
Atlantia and Autogrill, Mediaset; LVMH; L’Oréal) and
the State (ENI, ENEL, Leonardo; EDF, Total, Gas de
France, EADS; Peugeot-Citroën)
 Germany: families (BMW), commercial banks (Daimler-
Mercedes) and/or regional Laender (Volkswagen)
 India: families (Tata Group)
 China: the State (China Petroleum and Chemical Corp;
Industrial and Commercial Bank of China, China Mobile)
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 What are the consequences?

 Reduced size and less liquidity of stock markets

 Relatively lower number of floating shares, i.e. shares
free to change hands daily
 Relatively lower number of minority investors
 Management accountable to the controlling
shareholder.
 Potential conflicts of interest mainly between
controlling shareholders and minority shareholders

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 Dispersed Share Ownership
 What does it mean?
 No shareholder, alone or together with others, hold
enough voting rights to exert a stable control over the
firm.
 Where the one share/one vote standard applies, this
also means that none holds a large fraction of equity
capital
– Typically, noone has more than 5-10% of the equity capital
and voting rights.
 This makes the company widely-held

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 Who are the shareholders in these widely-held firms?
 Usually, institutional investors such as mutual funds,
pension funds, insurance companies, investment
banks.
 They may own blocks of shares up until 5% or 10%, but
not with the aim of controlling the firm but rather
profiting from their increase in value and the dividends
they pay out.
 In order to diversify their portfolio risk and because of
the financial regulation applicable to them, their
shareholdings must be confined to minority positions.
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 What are the consequences?
 Deep and liquid stock markets (US and UK stock
exchanges are among the largest in the world)
 High number of floating shares and high number of
minority investors
 Because of the small shareholding, no shareholder
may have strong incentives to monitor management
closely
 Management relatively free to work unchecked and
thus potential conflict of interests arise vìs-a-vìs the
shareholder class as a whole.
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 How Does the Ownership Pattern
Influence Corporate Law?

 (Negative) “Distributional” effects

– Where ownership is concentrated, shareholders are
relatively stronger than managers.
– Wealthy families form powerful interest groups that may
lobby lawmakers to bend corporate laws in their favor, i.e.
constraining managerial freedom of action and lowering the
protection of minority shareholders
– The state itself, as a controlling shareholder itself, may have
interest in a tight control at the expense of professional
managers and minority investors.

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– Where ownership is concentrated, we indeed observe laws
more favorable to controlling shareholders than to managers
or minority shareholders
– This, in turn, encourages the state and wealthy families to
retain a controlling stake for as long as they can
– The reverse is true where ownership is dispersed
– Managers are relatively stronger than shareholders
– They form potent interest groups lobbying lawmakers
– Laws tend to benefit them at the expense of the shareholders

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 (Positive) “Efficiency” Effects.
– Opportunistic behaviors of controlling shareholders and/or
management often turn into corporate scandals and
collapses.
– This may spark a reaction to the status quo prompting
regulatory reforms in the opposite direction to rebalance
the focus of corporate law.
– Since Enron and Worldcom (US corporate scandals in early
2000s), US law has weakened managers and strengthened
shareholders
– Since Parmalat failure (2003), Italian law has weakened
controlling shareholders and strengthened minority
shareholders.
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International Product and Financing Competition
 When one company enjoys a monopolistic position within a
country that zeroes any competition, such a company faces no
pressure in ameliorating its status quo.
 But if there is a product competition that puts pressure from
outside, things change.
– Such a company sells and gains market share at home and abroad
if its products are more competitive because are more innovative
or less costly.
– This requires investments in innovation, research, product
development and a skillful management for which competitors
compete as well on a global stage.
– This adds pressure to benefit from an efficient corporate law that
attracts funding from investors and labor from skilled
management.
 The trend toward global free trade weighs positively on
domestic corporate laws around the world. 13
 Regulatory Competition

 Corporate law can also be thought of as a product and

firms can be seen as its consumers.
 In a world of freedom of establishment and free
movement of capitals, firms will migrate to more
favorable jurisdictions in search for the corporate law
that best suits their needs.
 This sparks competition among national jurisdictions to
retain as many local firms and attract as many foreign
firms as possible

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 Motivations behind Regulatory Competition
 Tax purposes
– I refer neither to direct taxes such as the corporate income tax nor to indirect taxes
such as V.A.T.
– I refer to franchise taxes (or incorporation taxes) levied on a company based on the
number of shares it has issued
• Important as between US States; abolished in the EU
 Other wealth-increasing fallouts:
– Demand for local legal services (legal counsel, arbitration chambers) and business
tourism
 Overall national economic power
– Creation of national champions
• Just a rhetoric? Or to be used in trade wars? Or to stabilize the economy during
downturns?
 Prestige
– Race for the first anti-Covid 19 vaccine between healthcare companies from around
the world

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 Competition in law, much like competition for other
products, requires the existence of a single market, in
which consumers can choose from among alternative
laws to meet the same need.
 This situation most intensely occurs in single markets
organized as federal systems or political unions, where
more legislative powers may compete with each other
in regulating the same subject.
 Most prominent examples: The United States and the
European Union

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 Distinguish between the notion of registered office (or
“legal seat”) and that of principal place of business (or
center of the administration or “real seat”).
 The registered office or legal seat is the place where the
company has been formed by filing of all the necessary
foundational documents with the competent local authorities.
 The principal place of business or real seat is where the
company has established its headquarters, i.e. the
management is primarily located (e.g. where the board of
directors meets).
 Regulatory competition among different jurisdictions is
mostly triggered when companies are given the chance to
place the real seat in one jurisdiction and the legal seat in
another jurisdiction!
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 Legal Seat Principle v Real Seat Principle

 Jurisdictions may embrace the legal seat

(incorporation) principle or, as an alternative, the real
seat (or company seat) principle
 Legal seat or incorporation principle
– A company’s nationality (and hence the applicable
corporate law) is determined by the location of the
registered office only (regardless of where its principal
place of business is located)
 Real seat or company seat principle
– A company’s nationality (and hence the applicable
corporate law) is determined by the location of the central
administration or principal place of business (regardless of
where its registered office is located)
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 Regulatory Framework and Competition
in The United States

 The US is a federal country comprised of 50 States.

 Each State in the US has its own corporate law.

 According to the “internal affairs” doctrine, the law of

the internal affairs of a corporation, basically the
whole corporate law, is state law, not federal law.

 Federal law regulates only what matters for interstate

commerce.
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 What is federal in the US is thus securities law, i.e. the law
that governs:
– The issuance of securities (shares, bonds) to the public
and trading of those securities on public markets (stock
exchanges)
– Protection of investors buying, holding and selling
those securities:
• Listed company’s disclosure requirements of
sensitive information;
• Listed company’s financial statements and their
auditing;
• Punishment of market abuses such as insider trading
and market manipulation
• Public tender offers (takeovers) for listed securities
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 Privately-held corporations are therefore governed by
state law only because they do not issue securities to
the general public.

 Publicly-traded corporations are governed by state law

with respect to their corporate structure and
governance but by federal law with respect to
issuance, trading of securities and investor protection.

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 (US) State Competition in Corporate Law
 State law in the US embraces the incorporation
principle!
 Each company can choose whichever state for
incorporation (by registering with the competent
authorities) while doing business freely in every other
state.
 According to many US scholars, this freedom of
establishment has for ever sparked competition among
the 50 States in attracting as many firms as possible for
the reasons seen above. Is there any winner?

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 In 1890, New York sought leadership by abandoning minimum
capital requirements for newly formed corporations.
 However, by 1894 New Jersey was arguably the favorite state
for incorporation.
– Other States began to compete in a “race” to deregulate and
overtake New Jersey.
 In 1899, Delaware gained a dominant position which it has
consolidated ever since:
– By 1965, 35% of corporations listed on the NYSE were
incorporated in Delaware; by 1973, this number had risen to
40%; by 2000, approximately 50%; by 2007, figures stand at
60% of US publicly-traded corporations and 60% of Fortune 500
companies (largest companies by market capitalization).
 New York, which ranks 2nd, attracts fewer than 5% of public
firms
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 Delaware (“The First State”)

 Area: Delaware is 96 miles long and ranges from 9 to 35

miles across, totaling 1,954 square miles and making it
the second-smallest state in the United States after
Rhode Island.

 Population: 864,764 (2007 est.); Ranked 45th in the US

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 Reasons Behind Delaware’s Leadership
 Highly flexible corporate law being constantly updated by
highly qualified legislative committees.
 High quality of its judiciary specializing in corporate issues.
– Its judges developed an unparalleled expertise in corporate law
 Predictability of courts’ decisions: Certainty of applicable
law
– Extensiveness and familiarity of Delaware case law reduce costs of
planning transactions, obtaining legal advice and assessing their value
 Expertise of the “corporate bar” (legal advisors)
 Legislature shielded from “constituencies” (stakeholders)
other than managers and shareholders and from other
politically-motivated interest group pressures and
lobbying.

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 Regulatory Competition
within The European Union

 The EU is comprised of 28 Member States, which

means 28 different corporate jurisdictions.
 What is the relationship between them?
 Do they compete with one another?
 Are there forces in play against regulatory
competition?
 If any competition exists, where does competition lead
to? Convergence of laws or divergence of laws?

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 Treaty on the Functioning of European Union
 Creation of an internal market based on four,
fundamental freedoms
– Art. 26(1) TFEU: “The Union shall adopt measures with the
aim of establishing or ensuring the functioning of the
internal market, in accordance with the relevant provisions
of the Treaties.
– Art. 26(2) TFEU: “The internal markets hall comprise an
area without internal frontiers in which the free movement
of goods, persons, services and capital is ensured in
accordance with the provisions of the Treaties.”

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 Before 1999, most Member States had adopted the real
seat or company seat principle
– Most EU countries used to embrace the real seat principle:
France, Germany, Italy, Austria
– Very few countries used to embrace the legal seat principle: The
UK, Ireland, Luxembourg
 After a number of cases decided by the European Court of
Justice in application of the freedom of movement of
persons (Centros 1999, Überseering 2002, Inspire Art 2003),
all Member States had to switch to the legal seat or
incorporation principle relative to EU companies (just like
the federal States did in the US)
– The ECJ rulings do not affect the standing of extra-EU companies.
MSs are free to keep them under the “real seat” principle.
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 Implications
1. Forum shopping
– EU companies are free to go shopping for the company
law of the EU Member State that best suits their needs!
2. Regulatory arbitrage
– A company may now escape domestic restrictive rules by
simply choosing to place the legal seat in the Member
State of choice at time of formation or later regardless of
where the real seat is
3. (Defensive) regulatory competition
– Member states compete to avoid that domestic
companies incorporate or reincorporate abroad and to
attract firms originally incorporated abroad
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 Regulatory Harmonization
 Opposite to regulatory competition, which in any event
requires freedom to make one country’s laws as that
country pleases, is harmonization of laws of different
countries.
 Harmonization can occur spontaneously when lagging
jurisdictions want to imitate more successful
jurisdictions.
– Some US states imitate Delaware law with mixed results,
though.
 Harmonization can also be forced upon countries when
they belong to the same political union and that political
union is entitled to adopt rules and set goals applicable
to each member state whether it like it or not.
– Again, this is the case of the European Union 30
 European authorities (European Commission,
European Council, European Parliament) exercise their
tasks of harmonizing Member States’ jurisdictions by
means of the following legal instruments (Art. 288
TFEU):
1. Regulations [binding, and meaningful for corporate law]
2. Directives [binding, and meaningful for corporate law]
3. Decisions [binding, but usually insignificant for corporate
law]
4. Recommendations [non-binding, and yet meaningful for
corporate law]
5. Opinions [non-binding and having low impact on corporate
law]
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 How to reconcile forces pushing toward regulatory
competition and forces pushing toward regulatory
harmonization?

 Trend toward regulatory harmonization with regard to

public companies and even a stronger one with regard
to publicly-traded companies

 Trend toward preserving regulatory competition with

regard to private companies except for few
harmonized issues
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 The State of the Art in the EU:
Public Companies (listed and unlisted)
 There is a good deal of harmonization of the law of public
companies through directives and regulations.
– To date, approximately 40 directives have come into force
– Of these, about 10 specifically regulate listed companies
– Why such harmonization concerns for public companies and
even bigger ones for listed companies?
 Fewer, but equally important, regulations:
– Statute for a European company (a type of public company
directly conceived by EU law);
– Statute for a European cooperative company (a type of
cooperative company directly conceived by EU law);
– International accounting standards.
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 The State of the Art in the EU:
Private Companies
 As of now very little harmonization has occurred. Member states have
been left mostly free to regulate as they please. Why?
 Trend towards more flexible national statutes applicable to private
companies in order to attract as many European companies as possible
in a fashion similar to that seen among the states in the US at the close
of the 19th century. See:
– Italian company law reform of 2003;
– French company law reform of 2004;
– New Swedish company law of 2005;
– New UK Companies Act of 2006;
– Reform of German private company in 2008;
– New Spanish company law of 2010;
– New Dutch private company law of 2012;
– Italian company law reform of 2012-2014.
 Any winner? United Kingdom, Luxembourg, The Netherlands (but not
as much as is Delaware in the US)
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