Controlling Controlling Shareholders

Abstract

The rules governing controlling shareholders sit at the intersection of the two facets of the agency problem at the core of public corporations law. The first is the familiar principal-agency problem that arises from the separation of ownership and control. With only this facet in mind, a large shareholder may better police management than the standard panoply of market-oriented techniques. The second is the agency problem that arises between controlling and non-controlling shareholders, which produces the potential for private benefits of control. There is, however, a point of tangency between these facets. Because there are costs associated with holding a concentrated position and with exercising the monitoring function, some private benefits of control may be necessary to induce a party to play that role. Thus, from the point of view of public shareholders, the two facets of the agency problem present a tradeoff. The presence of a controlling shareholder reduces the managerial agency problem, but at the cost of the private benefits agency problem. Non-controlling shareholders will prefer the presence of a controlling shareholder so long as the benefits from reduction in managerial agency costs are greater than the costs of private benefits of control. The terms of this tradeoff are determined by the origami of judicial doctrines that describe the fiduciary obligations of a controlling shareholder. In this article, we examine the doctrinal limits on the private benefits of control from a particular orientation. A controlling shareholder may extract private benefits of control in one of three ways: by taking a disproportionate amount of the corporation's ongoing earnings; by freezing out the minority; or by selling control. Our thesis is that the limits on these three methods of extraction must be symmetrical because they are in substantial respects substitutes. We then consider a series of recent Delaware Chancery Court decisions that we argue point in inconsistent directions: on the one hand reducing the extent to which a controlling shareholder can extract private benefits through selling control, and on the other increasing the extent to which private benefits can be extracted through freezing out non-controlling shareholders. While judicial doctrine is too coarse a tool to specify the perfect level of private benefits, we believe these cases get it backwards-the potential for efficiency gains are greater from sale of control than from freeze outs, so that a shift that favors freeze outs as opposed to sales of control is a move in the wrong direction. In particular we argue that the Delaware law of freeze outs can be best reunified by giving "business judgment rule" protection to a transaction that is approved by a genuinely independent special committee that has the power to "say no" to a freeze out merger, while also preserving what amounts to a class-based appraisal remedy for transactions that proceed by freeze out tender offer without a special committee approval.

Corporate Governance Provisions, Family Involvement, and Firm Performance in Publicly Traded Family Firms

“…The variant equity levels of the controlling family and minority shareholders can result in conflicts (Gilson and Gordon [55], Villalonga and Amit [2]). In large US corporations, founding families tend to be the only blockholders whose control rights exceed their cash-flow rights (Villalonga and Amit [56]).…”

Addressing Agency Costs Through Private Litigation in the U.S: Tensions, Disappointments, and Substitutes

“…However, other hedge funds and many less active institutional investors, including some who have direct investments in the lead hedge fund, will vote their shares in the target company in support of the lead hedge fund. 75 Corporate management and their supporters have a less rosy view of hedge fund activism:…”

Family Involvement in Publicly-Traded Firms and Firm Performance: A Meta-Analysis

“…Studies on publicly traded family firms mostly draw upon agency theory, suggesting that the equity level of the controlling family can influence the conflicts between family and non-family shareholders (Gilson and Gordon, 2003;Villalonga and Amit, 2006b). For example, in large US corporations, founding families appear to be the only blockholders whose control rights on average exceed their cash-flow rights (Villalonga and Amit, 2009b Gilson and Gordon (2003), non-controlling shareholders will continue to prefer the presence of a controlling shareholder so long as the benefits from reduction in principal-agent agency costs are greater than the costs of private benefits of control.…”

“…For example, in large US corporations, founding families appear to be the only blockholders whose control rights on average exceed their cash-flow rights (Villalonga and Amit, 2009b Gilson and Gordon (2003), non-controlling shareholders will continue to prefer the presence of a controlling shareholder so long as the benefits from reduction in principal-agent agency costs are greater than the costs of private benefits of control. Interestingly, the authors also suggest that some private benefits of control may be even necessary to encourage a party or a group to be the controlling shareholder, owing to the costs associated with holding a concentrated position and with monitoring, whereas a non-monitoring shareholder often enjoys the full benefits of the monitoring provided by a controlling shareholder without incurring any monitoring cost (Ang et al, 2000).…”