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separation between shareholders and managers

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separation between shareholders and managers


In the modern cooperation, there is principle is separation between shareholders and managers (Burkart et al., 1998,173), an important minority stockholders in companies have little control on managing the company, so the common law ensured that they are treated fairly. So this research treat protection imparted by statue and common law for minority in companies in the light of international experiences to extract remedies for shortage points in national company law. Most of these widely controlling shareholders firms are concentrated in a few advanced markets, especially the United Kingdom, Japan, and the United States. This type of firms take form of family firms (1).

Definition of minority shareholding

Expression of minority shareholding indicates to positions in which a shareholder holds less than 50% of the voting rights attached to the equity of another company (so-called target company). Generally, under the corporate governance rules, this expression refers to the ownership of shares or securities in a company. But this expression not refer whether the owner of the minority stake is entitled to exercise control over the target company or otherwise influence its business conduct (2).

Minority shareholders not usually has passive as minority shareholder can exercise some form of control or influence over the target company (so called active minority shareholding) (3).

Origin of Controlling major shareholders

Controlling major shareholders may attributed to their more controlling rights than cash flow rights, this state can be termed controlling minority shareholders (CMSs) (4), as controlling shareholders occur exist in juridical systems dose not provide protection for minority shareholders from majority shareholders’ oppression and achieving personal profits on the account of other minority shareholders (5).

Majority shareholder is characterized either as having the motives to participate in the strategic direction of a company and achieve personal profits on account of other minority shareholders, thus fairness principle is negated (6).

Power of minority in the company is limited by CMSs and legal restrictions, which increase agency costs (7), as Bebchuk et al., (2001) supposed that controlling minority will increase agency costs.

Anglo-Saxon markets are characterized by their greater protection of minority shareholders and the importance of the classic agency conflict between shareholders. However, the principal agency conflict in continental Europe and many other countries focuses on the expropriation of minority shareholders’ wealth by the controlling shareholders. Therefore, it is necessary to analyze the relationship between institutional ownership and defense in this type of context, where both the predominant agency conflict and the institutional environment differ from those in the Anglo-Saxon markets (8).

Kinkki, (2008,) defined that problem of minority control lies in that both controlling shareholders and managers have the authority to gain personal profit at the cost of minority shareholders (9). Also reported that controlling shareholders can effectively determine decisions made by mangers in the company , and obtain personal profits of that control are not shared with other shareholders in the company.

Minority shareholder may benefit from conflict between interests of management and controlling shareholders, as legally base minority protection affect the company cash dividend whereas concentration of shareholders is high.

Literature indicated that minority shareholders, have limited influence on company decisions, but empirical reality indicated that minority shareholders preferences can be an important determinant of company policy (10).

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In reality separation of ownership and control generates strong incentives for the controlling shareholder to divert resources between companies in the group (11).

In companies, whereas legal system do not provide protection for minority, these companies characterized with several features as:

(a) the value of majority shares is significantly greater than minority shares; and (b) amount of private benefits achieved by majority on the account of minority shareholders will decrease with the amount of monitoring on majority performance. So these benefits depend on percentage of control and percentage of equity (12).

Controlling shareholders on minority interest can be attributed to agency problem that resulted from the separation of ownership and control. This problem is the target of governance devices like hostile takeovers and independent directors (13).

But the question may be raised how minority shareholders can prove oppression to the court?

Minority Shareholders can prove injustice through the management of the company by presenting evidence that controlling directors treated the company in unfair way or controlling directors showed a loyal conducts towards other rival companies (see S C W S Ltd v. Meyer, 1963) (14).

In the case of Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657 (Mass. 1976), the Supreme Judicial Court of Massachusetts ruled that the minority shareholders can demonstrate oppressive conduct of controlling shareholders in the company through demonstrating that “the same legitimate objective could have been achieved through an alternative course of action less harmful to the minority’s interest.”, and considered this oppressive conduct can result in the “effective confiscation” of the minority’s investment, and that oppressive conduct allows the majority to use the minority’s investment for the majority’s own purposes (15).

Minority shareholders in the company may exposed to prejudice and oppression from controlling shareholders and appeal to the competent judge to take an action against directors and demand for compensation for damages they incurred if his oppression and prejudice is evident. But the court considered loss of confidence of minority shareholders in controlling shareholders not enough to justify oppression or prejudice against minority and demanding for compensation (in this regard, see Elder v. Elder, 1952, S C 49), but it may be unfairness of special kind (16). In the case of Harmer, the court motivated it judgment that:

“These allegations suggest that Mr. Evison is unwise , inefficient and careless in the performance of his duties as managing director and chairman of board of the company, but it can not be said that he acted in un fair way towards the petitioner or any member in the company”.

Control of majority on minority, as defined by the British court in the case Prudential Assurance Com Ltd v. Newman industries Ltd, 1980, 2 WLR 339 as procedure matter has elastic significance, not necessary means fraud (17).

Some researcher indicated to positive aspects of controlling shareholder, as shareholders will prefer a controlling shareholder as long as the profits from the decreasing in managerial agency costs exceed the detriment of the controlling shareholder’s extraction of private benefits (18). This the reason for adopting controlling shareholders in companies that operate the New York Times, the Washington Post, and the Wall Street Journal have controlling shareholders (19).

In an efficient controlling shareholder system, concentration of control operates as a cost-effective response to the managerial agency cost problem (20).

Ehrhardt and Nowak, (2001) numerated benefits obtained from controlling shareholders as high salaries, self-dealing or looting, tailoring company policy to one’s personal interests, psychological utility from running the company, ability to freeze out minority shareholders below market value, perquisites of control, and the diversion of resources (21).

Definition of control in company

Leech, (1999,) defined control of a company as the right to exercise whatever discretion in strategic decision making exists, and generally the power of a shareholding is the extent to which the votes it commands can influence a decision taken by shareholders under majority voting. whereas London Stock Exchange Yellow Book defined a controlling shareholding as one which controls 30 percent or more of the votes at a company meeting (22).

Generally, minority control differs from majority control in that it depends on a range of factors apart from voting power alone.

Controlling shareholders in environment characterized with low minority shareholder protection oblige minority shareholders to pay costs of investments without obtaining a fair part of benefits (23).

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Controlling shareholders may differ according to circumstances of every company and every activity carried out by that questionable company, as controlling structure is superior in some of these companies than other companies (24).

Controlling shareholders justified their oppression towards minority as their control impair competition in the market, whereas there are relatively few cases where the acquisition of a minority shareholding has been challenged as anti-competitive. Consistently with economic theory, there appears to be a general agreement amongst antitrust enforcers that the acquisition of a minority shareholding does not amount in itself to a restriction of competition and therefore should not be viewed as illegal (the European Court of Justice in Joint Cases 142 and 156/84, British American Tobacco and Reynolds v. Commission, 1987, ECR 4487) (25).

Discount on Minority Shareholder Shares

Controlling shareholders generally argue that because the minority shareholder can only elect a minority of directors (if any) and cannot control the actions of the corporation, the minority shareholder should sell at a substantial discount. In fact, minority shareholder equity stakes generally sell at a 26-33% discount to market value.

After acquisition, majority or the new controlling side can make pressures on minority to make use of resources of the company for achieving personal profits and maximizing their gains on the account of this minority (26), as they recognize that eliminating their control will reduce if not remove all their personal profits, so they try hard by all instrument to maintain this control (27).

With regard to oppression of controlling majority for minority shares, if price at which these shares are traded on the stock market reflects the value for minority shareholders, this indicates that there are significant private benefits for the controlling shareholders on the account of the minority shareholders. This phenomenon been labeled tunneling (28).

In modern companies laws, the legislator took necessary measures to protect minority interests in the companies, which attributed mainly to abuse majority for their competence, weakness of legislative fame in the country generally and companies act specially.

Minority shareholders that do not bargain up-front for protective contractual arrangements may find that their minority interest is worth very little despite the value of the company or its assets.

Minority shareholders see that majority of shareholders will be an obstacle when monitoring and firing board, so presence of (independent) external directors is a guarantee for non bias of majority against them (29). Researchers supported appointing external directors, but found that companies with serious business are more likely to appoint internal directors who acquitted with affairs of the company.

Zou et al., (2008) considered concentration majority of shares in hands of little members in the company is expropriation of minority interests. This problem illustrated mainly in companies where minority control tradable stocks, whereas majority control non tradable stocks, which raised many problems in government corporate (30).

Relation ship between minority control and firm value

Study of Cronqvist and Nelsson, (2003,) found a negative relation between vote ownership by controlling owners and firm value (31), and associated positively with agency costs. From model presented by Gome, 2000, it seams that maintaining controlling share votes share empower managers to obtain a good fame that they treat non controlling shareholders well, and obtain higher prices when selling these stocks in the future, as this treatment gives an impression that their control is a guarantee for not loss of minority shareholders, as it is expected to sell mores shares in the future with higher prices, as managers in these firms found that using dual class shares will make this instrument more effective (32).

From analysis features of controlling shareholder systems , it was found that these systems characterized by weak equity markets – too much liquidity tied up in control blocks – and by large differences in the value of controlling and minority blocks as a result of private benefit extraction by the controlling shareholder (33) demonstrated that higher valuation of firms in countries adopt minority shareholders procedures.

In brief, the is an adverse between the quality of law and controlling shareholder regimes (34).

Maug, (2006,) pointed out that economic ability sometimes increased when minority stocks receive less than essential value of these shares. If the freeze out rule provides for a higher payment to minority shareholders, then some value-enhancing freeze outs will not take place. This problem exists as long as freeze out provide an opportunity to majority shareholders who have then discretion over exercising it depending on their valuation of the company (35). This result implied that a narrow focus on the interests of minority shareholders may decrease economic prosperity if the rule then reduces the incentives of large shareholders to take companies private.

Introducing rules for protection minorities from majority in companies has a positive role, as Kirkbride and Letza, (2009, 207) stated that introducing rules for protection minority interests in the companies will increase confidence in the company management, as companies with little rules for minority protection will embrace higher standers and attract high valuation premium (36).

Empirical studies found that countries with controlling shareholder systems cause different levels of private benefit extraction. As instance, Mexican controlling shareholders are said to expropriate more than a third of the value of the company, while expropriation by their Swedish counterparts is limited to 1 % of company value (37).

In efficient controlling shareholder systems, the value of controlling shares will surpass that of minority shares by a much smaller amount than in inefficient controlling shareholder systems (38).

Minority shareholders protection system has positive effect on value of firm shares, as number of studies showed that the market estimates the same cash flows differently when produced by a company with an inefficient controlling share- holder as opposed to an efficient controlling shareholder. The difference is pecuniary private benefits of control (39).

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Also Reese and Weisbach, (2002) reported that increase in shareholder protection system creates two separate effects. The first is a decrease in the private benefits accruing to managers and an increase in the public value of the firm (40).

From adopting measures for minority shareholders protection and control concentration, it can be said that:

Minority shareholders have the legal protection use that power to decrease agency costs.

Controlling shareholders must put in consideration legal system for minority protection when putting forward dividend suggestion.

Minority shareholders can make a confederation to reach at minority protection, and increase their allocations of dividend. Results of Kinkki, (2008) found that through negative profits, absence of minority protection, controlling shareholder enhance dividend overlook (41).

Minority Shareholder Rights

Minority shareholders have the same rights determined by the law. Company law, gave basic protection for minority shareholders in terms of equal treatment principle, which mean that shareholders have the rights, especially to the profits and the capital of the company, as stated by-laws.

Kim et al., (2007) stated that protection of shareholders and independence of management in the company related positively, the best board in the company is that concern with interests of minority as its concern with interests of majority, and rights of stockholders must enable minority to take part in formation of management (42).

Shareholders in companies, among them minority have several rights, these rights are enjoyed under corporation laws (43).

Corporations are governed by state law and shareholder rights are set out in the corporate statute of the company’s state of incorporation. These standard rights enjoyed by minority and other stockholders are:

The right to convene general assembly according to the article 368 of societies law, if those members possess 10% of stocks have voting rights.

The right to be convened for attending meetings of general assembly of the company before holding this meeting with reasonable time, by registered letter illustrated in it the solution will be discussed and agenda of the meeting (44).

The right to convene extra ordinary assembly.

The right to elect directors and appointing and removing auditor.

Holding stocks in general gives its owner the right to attend sessions of general assembly either annual or extraordinary.

Stockholders have the right to vote in meetings of general assembly on important subjected advocated in the assembly, as directors elections. But we must distinguish between the right of attending these meetings and the right of voting.

Minority shareholders have the right to receive the same per share dividend as insiders (45).

Have the right to sue the company for wrong acts and damages they incurred due to directors’ wrong decisions (46), as it is possible to challenge a decision by the annual general meeting (AGM) for example due to its violation of the “equality principle” (47). This explain why majority and director do their best to formulate formula of decisions made in annual general meeting. Company law criminalized illegal distribution of assets, and authorized shareholders to appeal to police station to turn back missing assets.

Company law imparted shareholders(of them minority shareholders) sufficient criminal tools to protect their interest in the front of majority abuse and oppression of controlling shareholders. Of these tools are criminal litigation against directors for some acts as giving false or misleading information to registrar of company (48).

Company law gave minority shareholders to turn back from company assets they presented to company in the case of violation of companies act terms. Also this company obliged board to compensate shareholders for non returned assets (49).

The right to amend corporate law.

The right to inspect books and records and the list of shareholders, and to get a photo copy of process-verbal of meeting after paying determined fees.

right to vote on major corporate events such as mergers, liquidation, or the sale of substantially all the corporation’s assets.

The right to take action through a written consent.

The right redemption: as company law provided that minority has the right to demand redemption of minority shares and the right to demand redemption of one’s shares in the case of a merger or acquisition. Company law regulated redemption right, as stipulated that in the case of a merger, those shareholders who oppose the merger and who demand redemption shall have their shares redeemed at a market price. In the case of conflict about redeemed shares price, the redemption price shall be referred to arbitrators to be settled. In absence of some shareholders, the competent court order to appoint a trustee to care interests of absent shareholders (50).

However, minority shareholders may find that they are unable to exercise their rights due to majority shareholders control on the company. Minority shareholders should address this issue by exercising their freedom to contractually secure greater rights than the corporate statute explicitly allows. In some states, “close corporation” statutes allow minority shareholders greater flexibility to preserve minority shareholder rights through contracts such as Buysell and Shareholder Agreements.

Members of companies who possess 50-70% of company’s stocks can pass resolutions, but minority stockholders have negative control on management of the company. As their stocks in the company don not give them the authority to pass or impair decisions made by general assembly (51).

Minority of stockholders in the company find their situation in the company vulnerable by majority. Majority may abuse their power in the company to injure interests of the company of interests of minority. The common rule in the companies is minority could not suite case on the behave of the company or on the behave of the internal management of the company. The law put forward several procedures for protecting minority of stockholders in the companies if the majority committed a fraud on the minority, prejudice or biased against minority. As majority can deprive minority from management of the company and from appointing mangers (52).

Power abuse of the majority for minority of fraud on minority is considered breaching for legitimate expectation of minority.

Johnson et al., (2000) indicated that there are a number of methods in which majority shareholders can transfer the firm’s wealth to themselves, including outright theft or fraud, asset (53).

Sales or transfer pricing arrangements benefiting the majority shareholders, excessive executive compensation or loan guarantees from the firm. In addition, there are many ways in which a majority shareholder can increase his position in the firm at the expense of minority shareholders through dilative share issues, minority freeze outs, insider trading, creeping acquisitions, or other financial transactions that discriminate against minority shareholders (54) .we ca discuss forms of fraud practices by majority in company as following.

Minority shareholders are exposed to stealing from controlling shareholders. We can differentiate between two ways for stealing from minority are ordinary and extraordinary ways. Ordinary ways indicate to transferring pricing and cheap debts into personal benefits or to other traded company controlling shareholders are loyal to them (55).

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Extraordinary ways indicated to ways involve changes in arrangements of shareholders groups in the company. As controlling shareholders can steal by forcing minority shareholders to pay their money for investment will not gain profit from it, and transferring money of the company for their private company, or obtaining financial subsidiaries from the company to by stocks for their private companies (56).

Forms of fraud minority: Defraud for minority not usually defraud for all company. Fraud on minority took several forms can be deduced from suit cases as following:

Passing a solution or transaction the company has no interest in it, but it would be useful for the majority (case of Cook v. Deeks, 1916, 1 AC 554).

Depriving the minority form management of the company or from appointed mangers. in the case of (Balvik v. Sylvester, 411 N.W.2d 383, 388 (N.D. 1987), where when Sylvester removed Balvik as a director and officer of the corporation (57).

Depriving minority shareholders form returns on their investments. in observing that a close corporation minority shareholder who expects to receive a return on investment through salary faces the risk that, after a falling out among the participants, the directors will terminate the minority shareholder’s employment and depriving that investor of any return on the investment in the corporation (Naito v. Naito, 35 P.3d 1068, 1072 (Or. Ct. App. 2001) (58).

wrongful use of a discretionary power (Ultra vires) Smith v Croft (No 2) and Cockburn v. Newbridge Sanitary Steam Laundry Co. [1915] 1 IR 237, 252-59 for the illegality point.

Breaching director the principle of due care towards the company (59).

If the majority bought some stocks of their company (Alexander v. Automatic Telephone Company, 1990, 2Ch 56, court of appeal).

If one member in the company seduce the other to buy their stocks to wound up the company under the article number 122 of insolvency act (the case of Ebrahimi v. Westbourne Galleries 1972, 2 WLR 1289).

If the majority of stockholders and directors issued new stocks for them selves and for some special employees in the company to pass resolutions they desire in (Clemens V. Clemens Bros Ltd 1976, 2 All ER 268).

If the majority took some actions to wound up interests of their company (the case of Menier v Hooper’ Telegraph work, 1874, LR 9 Ch app 350).

Majority in the company can use financial information in the company to justify less prices of this company than outer stockholders, so minority accept to sell their shares with prices than fair value (60).

If the majority sold stocks of the company with prices less than faire equity, committing fraud or dishonest, as selling a mine less than estimated price as in the case of Pavlides v Jensen, 1956, 2All Er 518, and case of selling the director land by price less than its real price to his wife, cause prejudice for minority of the company (Prudential Assurance Com Ltd v Newman industries, No2, 1981, Ch257). In this case for solving conflict between the majority and minority, the law obligated delegating an independent expert for evaluating the faire value of sold stocks.

Using the company as guarantors for bank loans (61).

Disclosure false information related to equity issues to raise prices of stocks of the company. This form of fraud is an object for litigations in many countries, or issuing fraud financial reports (62).

Minority shareholders often exposed to annoyance from majority of members in the company, so this majority could purchase their stock lesser than faire value. This annoyance may be in form of the forced merger or acquisition of the company, or exploiting special family situation for minority stockholders. In the case of Kiriakides v. Atlas Food Sys. & Servs., Inc., 541 S.E.2d 257, 267 (S.C. 2001) the court ruled that ” This unequal balance of power often leads to a ‘squeeze out’ or ‘freeze out’ of the minority by the majority shareholders” (63). Company law considered oppression practiced by the controlling shareholder on minority sharhloders as reason for involuntary liquefaction of the company in this regard see Kiriakides v. Atlas Food Sys. & Servs., Inc., 541 S.E.2d 257, 265-66 (S.C. 2001) (64).

Loyalty to other company :In the case of Donahue v. Rodd Electrotype Co., the Massachusetts Supreme Judicial Court adopted such a standard, and ruled that :” controlling shareholders may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation (65).

Obtaining majority for financial relief, and paying back these relief from company resources (see Re Bellador silk Ltd, (66).

17- Conflicting interests of company with interests of minority: Through this control of the board, the majority shareholder has the ability to take actions that are harmful to the minority shareholder’s interests. As Zou et al., (2008) reported that Chinese courts judged for the sake of defraud minority in companies in many sectors, and bias of majority against interests of minority resulted from weak legal protection (67).

The British court pointed out in motives of the case (Estmanco Ltd v. Greater London Council 1982, 1WLR2, p.12) meaning abuse of power usage and fraud as said that:

Fraud in this phrase ” fraud in the minority ” seems to be used as comprising not only fraud at common law, but also as fraud in the wider equitable sense of that term” .

Interests of majority many conflict with interests on minority, the required is to balance the interests among the variety of stockholders, so the law put forward several legal procedures and guarantees for protection minority of stockholders against majority control, and their appropriate execution. Kirkbride and Letza, (2009) defined these legal procedures as a group of instruments by which minority could protect themselves from majority control, oppressive or prejudice of management board. Legal protection minority considered a viable investment strategy. All over the world, states paid more attention for legal protection minority stockholders’ interests through encoding controlling shareholders regulations (68).

In this regard, The court of Lyon ruled that making decisions conflict with interests of minorities is considered a form of minorities’ rights (Lyon 20 dec 1084, D.) (69).

The American court ruled in the case of Orchard v. Covelli, 590 F. Supp. 1548, 1557 (W.D. Pa. 1984); Meiselman v. Meiselman, 309 N.C. 279, 290, 307 S.E.2d 551, 558 (1983) (When the personal relationships among the participants break down, the majority shareholder, because of his greater voting power, is in a position to terminate the minority shareholder’s employment and to exclude him from participation in management decisions (70).

Also the court ruled in the case of Fix v. Fix Material Co., 538 S.W.2d 351, 358 (Mo. Ct. App. 1976) (“In the instant case, a group of four shareholders, acting in concert, control a majority of the outstanding stock, though no single shareholder owns 51%. Because this control carries the power to destroy or impair the interests of minority owners, the law imposes equitable limitations on the rights of dominant shareholders to act in their own self interest.

Making decisions without deliberation with minority: The court of Lyon stated that taking a decision without deliberation with some stockholders considered abuse of minorities rights (Lyon, 25 Juin, 1987) (71).

Aggression on shareholders rights: Pender v Lushington (1877) 6 Ch D 70, per Jessel MR, Edwards v Halliwell [1950] 2 All ER 1064).

Minority shareholders protection by different statutes.

Different companies acts included provisions for protection minority shareholders, Different countries’ legal systems evolved in a number of ways, falling into two main categories: common law and civil law.

Companies in the world characterized with rapid competition recognized importance of fairness principle for minority and caring their interests. For instance article 19 China Securities Regulatory Commission (CSRC) provided that ” The controlling shareholders owe a duty of good faith toward the listed company and other shareholders. The controlling shareholders of a listed company shall strictly comply with laws and regulations while exercising their rights as investors, and shall be prevented from damaging the listed company’s or other

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