The Role of Representatives of Minority Shareholders in the System of Corporate Governance

In the Context of Corporate Governance in the US, EU and China

by Wenjia Yan (Author)
©2017 Thesis XLVII, 176 Pages


Due to the global influence of the shareholder-centered model of the US, both China and the EU have taken more measures to protect minority shareholders. In this respect, the representation of minority shareholders on the board, in particular the system of cumulative voting which was originally designed by the US to protect minority shareholders, has become a frequently-discussed issue in China and the EU. This study of comparative law is based upon the comparison of the attitudes among the US, China and the EU towards cumulative voting. By analyzing some empirical investigations and massive literatures of American academics as the theoretical foundation, it tries to demonstrate whether the convergence of corporate governance towards the shareholder-centered model is inevitable.

Table Of Contents

  • Cover
  • Title
  • Copyright
  • About the author
  • About the book
  • This eBook can be cited
  • Acknowledgements
  • Contents
  • Abbreviation
  • Bibliography
  • Literatures
  • Cases
  • Introduction
  • First Chapter: Increasing Minority Shareholders’ Protection in China and the EU
  • A. Concentrated Corporate Ownership and Rising Institutional Investors
  • I. China
  • II. European Union
  • B. Pressure of Developing a Capital Market
  • C. Increasing Minority Shareholders’ Protection in China and the EU
  • I. China
  • II. European Union
  • Second Chapter: Negative Attitudes towards Cumulative Voting in the US and the EU
  • A. Importance of Voting Right
  • B. Decline of Cumulative Voting and the Rise of Independent Directors in the US
  • I. Weakening of the Market for Corporate Control
  • II. Re-concentrated Corporate Ownership
  • C. Non-Adoption of Cumulative Voting in the EU
  • I. Non-executive or Supervisory Directors of Listed Companies
  • II. Proportional Voting and Slate Voting
  • Third Chapter: New Form of Cumulative Voting in China
  • A. Justification for the Adoption of Cumulative Voting
  • B. Justifications for the Legislation Form
  • C. Limitations of Cumulative Voting by the Company Law
  • I. Institutional Investors and Cumulative Voting
  • II. Adoption of Classified Board
  • III. Remove Minority Representatives with or without Cause
  • D. Independent Directors and Cumulative Voting
  • Fourth Chapter: Alternatives to Cumulative Voting – Controlling Related Party Transactions by Independent Directors
  • A. Definition of Related Party Transactions
  • B. Approval of Related Party Transactions by Independent Directors in the US
  • I. Independent Directors and Related Party Transactions
  • II. Independent Directors and Business Judgment Rule
  • III. Enhanced Judicial Review
  • C. Independent Advisors and Shareholder Approval
  • I. China
  • II. European Union
  • Fifth Chapter: Conflicts between Cumulative Voting and Long Governance
  • A. Weaknesses of Cumulative Voting
  • B. Criticism against Shareholder Primary
  • C. The Third Road of Corporate Governance in the US
  • D. Long-term Shareholder Engagement in the European Union
  • E. The Combination of Shareholder-centered and Stakeholder-centered Model in China
  • I. Adoption of Independent Directors in Addition to the Board of Supervisors
  • II. Functions of Independent Directors and Supervisors
  • Conclusion: Convergence of the Value and Diversity of the Approaches for Protecting Minority Shareholders

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First Chapter:  Increasing Minority Shareholders’ Protection in China and the EU

Due to the agency problem caused by controlling shareholders, the globalization of capital markets and the rise of institutional investors as well as greater shareholder activism, it is clear that the shareholder primacy theory – which became preeminent in corporation law in Anglo-American jurisdictions – is now the global dominant theory. Professor Stephen Bainbridge has helpfully divided the theory into two limbs, namely the objective of the corporation should be to maximize shareholder wealth and shareholders should have ultimate control of the corporation.25 The theory has been developed to the point where it now provides that directors are to manage the corporation in such a way that ensures the wealth of shareholders being maximized to the fullest. Put simply, this means that the directors will endeavor to make as much money as they can for the shareholders. Effectively, this can be seen as involving the directors in protecting and enhancing the investment of shareholders in the corporation.26 Both China and the EU have introduced several systems for protecting shareholders. This part focuses on the influence of such model, which constitutes the main reason for adopting cumulative voting in China and the discussion of minority representatives in the EU.

A.    Concentrated Corporate Ownership and Rising Institutional Investors

The influence of the shareholder-centered model first represents itself by the dispersed corporate ownership. The corporate governance stream in finance research has long established that a firm’s ownership structure – describing the relationships among the stakeholders – is the most significant factor influencing the system of corporate governance and performance.27 According to the German Stock Corporations ← 7 | 8 → Act (Aktiengesellschaftsrecht, hereinafter “AktG”), a majority stake of less than 75% allows wide control over the management of the corporation but is subject to a blocking minority, which is constituted by a minority stake greater than 25% and may be able to prevent issues of new shares or the dismissal of members of the supervisory board. For example, Article 182 (1) rules that a resolution to increase the share capital against contributions shall require a majority of not less than three-quarters of the share capital represented at the passing of the resolution. Furthermore, Article 202 (1) and (2) provide that the articles may authorize the management board – for a period not exceeding five years after registration of the company – to increase the share capital up to a specified par value (authorized capital) by issuing new shares against contributions. Such authorization may also be granted by amendment of the articles for a period not exceeding five years as from the date or registration of such amendment of the articles. The resolution of the shareholders’ meeting shall require a majority of not less than three-quarters of the share capital represented at the passing of the resolution. In addition, Article103 (1) stipulates that members of the supervisory board who have been elected by the shareholders’ meeting without being bound by nominations may be removed pursuant to the resolution of the shareholders’ meeting prior to the expiration of their term of office. Such a resolution shall require a majority of not less than three-quarters of the votes cast. Moreover, the blockholdings of smaller than 5 percent are classified as being widely held. For example, Article 327a(1) rules that upon request of a shareholder holding 95 percent of the share capital (principal shareholder), the shareholders meeting of a stock corporation or partnership limited by shares may resolve the transfer of the other shareholders’ (minority shareholders’) shares to the principal shareholder against the payment of adequate cash compensation. A common measure of ownership concentration is whether one shareholder owns at least 20 percent of a company’s voting rights, whereby such a shareholder is called a “controlling shareholder.”28

The controlling shareholder could control the development of companies29 because their large holdings justify an investment in monitoring30 and help them ← 8 | 9 → overcome the collective action problem as well as have an incentive to exercise their voice through activism, which is primarily a matter of campaigning and voting at shareholder meetings,31 while the concentrated ownership introduces secondary agency relations because large investors have the possibility – as well as an incentive – to expropriate minority shareholders by benefiting themselves from a disproportionately large share of the firm’s revenues.32 The structure combines the agency problem of the firm being controlled by an insider who owns a fraction of the equity with the agency problem of the firm being controlled by an insider who is insulated from the influence of other shareholders and the market of corporate control.33 The fundamental problem is that the large investors might try to treat themselves preferentially at the expense of other investors and employees. Their ability to do so is particularly strong if their control rights are significantly in excess of their cash flow rights.34 Bebchuk, Kraakman and Triantis show that such structures have the potential to create very large agency costs that are an order of magnitude larger than those associated with controlling shareholders who hold a majority of the cash flow rights ← 9 | 10 → in their companies.35 Such abuse of power may be carried out in various ways, including the extraction of direct private benefits through excessive pay and bonuses for employed family members and associates, inappropriate related party transactions, systematic bias in business decisions and changes in the capital structure through special issuance of shares favoring the controlling shareholder.36 Financial scandals in companies with concentrated ownership, like Parmalat, in which – unlike Enron – the family-controlled management and advisors structured the group’s various financial arrangements to enrich members of the Tanzi family at the expense of the shareholders and creditors.37 As the Article III A 2 of the OECD Principles rules, minority shareholders should be protected from abusive actions by – or in the interest of – controlling shareholders acting either directly or indirectly and should have effective means of redress.38

I.    China

It took just three decades for China to transform itself into the world’s second largest economy. The achievement of China’s economic results from its market-oriented economic reform, which started in 1978. During the economic reform, a major task was to transform the planned economy – which was previously dominated by state-owned enterprises (SOEs) – into a market-oriented one, whereby privately ← 10 | 11 → owned corporations and many novel governance structures and corporate law concepts have accompanied the shift from a closed, centralized system to a market-oriented economy.39 Through transforming SOEs into different kinds of limited liability companies or shareholding companies, both central and local governments would delegate more freedom to managers and continue to enhance productivity, helping the state to retain control through its status as the largest shareholder while shielding the state from the survival or loss of the enterprise.40 Today, the aggregate number of PLCs in China has reached more than 3,000. Moreover, as disclosed by the supervision and management meeting of the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) on January 10, 2013, there were 953 SOEs being PLCs in 2012, accounting for 38.5% of all A-share PLCs. Their market value reached 13.71 trillion RMB, accounting for 51.4% of total market capitalization of A-share PLCs.41 Therefore, after the reform, the SOEs still possess a dominant position within China’s economy.

The Chinese stock market can be classified into two broad categories according to their tradability on secondary markets before 2005. Non-tradable stocks include state shares, legal person shares and employee shares, while the tradable counterpart is held by diffuse shareholders. With respect to the official definition of the non-tradable part, state shares are held by government agencies or state-authorized organizations at either the central or local level, whereas legal person shares are those owned by domestic institutions and enterprises with a legal person status. This split-share system – which was a unique product from the very early stage of the Chinese stock market – was the result of a compromise between the need to privatize SOEs and the healthy, gradual development of the stock market by its nature.42 “What the split-share system created was basically a lock-in system which prohibited most shares from being traded but allowed a portion of ownership to be ← 11 | 12 → freely-transferable.”43 In the early stage of SOEs reform, the idea of this design was to set up a modern stock market with an appropriate amount of equity in the market, attract both domestic and foreign investors to invest and help transform SOEs into partially private companies.44 However, the distinction between tradable and non-tradable shares also created several serious issues. Limiting the tradability of shares controlled by the state meant that the state was locked into many enterprises. “The State still was responsible for their management and financial performance but could not enjoy the fruit of a company’s better performance.”45 From the viewpoint of private investors, the split-share structure led to their minority position always being subject to the majority’s mistreatment and prevented them from obtaining larger control to further influence their company.

As a result, in 2005, Chinese security authorities started an initiative to repeal the split-share system.46 This was achieved through a private negotiation among non-tradable shareholders and tradable share owners.47 Through providing certain forms of compensation to tradable share owners by non-transferable shareholders, both of them can reach an agreement based upon which securities authorities may lift the non-trading restriction of the non-tradable shares and allow those shares to be traded on the stock exchange.48 On December 25, 2006, more than 94% of listed companies on the Shanghai and Shenzhen stock exchanges had completed their negotiation and successfully repealed the non-trading restriction of non-tradable shares, while 74 companies were in the process of doing so.49 ← 12 | 13 →

Although the legal restriction of non-trading was repealed and the situation has been gradually improving through private investor participation and business competition development, the capital structure of many of the publicly traded Chinese companies is still concentrated in the hands of the state, local governments and rising wealthy entrepreneurs.50 According to the “Evaluation of Corporate Governance in Top 100 PLCs of China in 2012”, as the most important indicator judging ownership concentration, the average number of shareholdings of the largest shareholders remained to be more than 40%, despite having declined between 2010 and 2012, while the maximum shareholding ratio occupied by the top five shareholders reached 90% and the average number of shareholdings even hit 59%.51 In 2012, there were 84 listed corporations whose largest shareholder was the state, which was not only the second largest shareholder of 49 corporations, but also the third largest stockholder of 39 corporations, while only 13 corporations found their largest shareholders in private enterprises.52 Therefore, the remaining state capital power and its impact on corporate law and the economic development of China continue to be extensive.

State ownership of corporations leads to the phenomenon of “absent ownership” (suoyouzhe quewei): it is not the collective action problems, but rather the internal and organizational problems of the state as a shareholder, which in China is often represented by various government agencies, that prevent effective shareholder monitoring. “Specifically speaking, while the ultimate ownership of state-held shares rests with the central/local government, control and monitoring responsibilities are delegated to various government departments or agencies which normally hold voting rights but no cash flow rights, and as bureaucrats, they are unlikely to have sufficient incentives to closely monitor the operation of state-owned corporations under their control.”53 Consequently, the listed corporations are mainly controlled by top management and directors who can easily manipulate the board ← 13 | 14 → and plunder the assets of the corporation.54 Such a prominent complaint regarding the current regime governing the powers and responsibilities of enterprise managers is “insider control” (neibu ren kongzhi).

Private PLCs account for 90.2% in GEM (growth enterprise market) and occupy 77.59% in medium-sized and small PLCs, while they only take up 29.44% on the main boards of PLCs. In terms of the ownership structure, by the end of 2011 the average shareholding percentage of the largest shareholders – which always represent families or natural persons in the listed companies of GEM – reached 33.55%, rising to 37.10% in medium-sized and small PLCs.55 The presence of a controlling shareholder can reduce an agency problem by introducing closer monitoring of the management due to their larger stakes in a firm.56 With a controlling shareholder, the fundamental governance problem is not opportunism by executives and directors at the expense of public shareholders at large, but rather opportunism by the controlling shareholder at the expense of the minority shareholders.57

The current agency problem in PLCs in China is more complicated. Some public companies remain in the hands of the state, whereby the agency problem exists between management and minority shareholders with incidental and sporadic stewardship intervention by state controlling shareholders. Moreover, the growing number of private parties acquiring control of public companies also necessitates regulations addressing the controlling agency problem.58 Both controlling shareholders and managers may engage in self-beneficial trades, advancing personal, familial and political agendas that hamper corporate performance, “expropriating” the profits of lower-tier companies in a pyramid business group.59 In this respect, Chinese scholars and policy-makers have been concerned to search for new mechanisms of corporate governance – such as cumulative voting and independent directors – to protect minority shareholders. According to Article 1 para.2 of Independent Directors Opinion, pursuant to the requirements of the relevant laws and regulations, these Guiding Opinions and the company’s articles of association, an independent director should conscientiously perform his duties and responsibilities, safeguard ← 14 | 15 → the company’s overall interests and, in particular, pay attention to ensure that the lawful rights and interests of small and medium shareholders are not prejudiced.

II.    European Union

In close similarity with China, the corporations of many European continental countries have traditionally been seen as having more concentrated ownership, with groups of shareholders such as families, corporate groups or financial institutions owning significant percentages of shares.60 As the EU Green Paper of 2011 states, “Minority shareholder engagement is difficult in companies with controlling shareholders, which remain the predominant governance model in European companies.”61 For example, the German corporate ownership was traditionally known for its concentrated ownership and extensive cross holdings by banks, insurance companies and industrial conglomerates and is characterized by coalitions of active majority shareholders, which are primarily families and other companies,62 while the publicly traded shareholdings are also dispersed and often in the minority.63

Due to the globalization of the economy and the development of a European capital market, similar to China, the rise of institutional shareholdings,64 primarily insurance companies, pension funds and collective investment schemes as well as hedge funds reflects a significant development. Non-national shareholders hold some 44% of the shares in EU listed companies. Most of these investors are institutional investors and asset managers. It was reported that the first signs of shareholder activism were detected in 2010 when Hermes – an activist investor domiciled in the UK – tried to block the re-election of Claus Wucherer as chairperson of the management board of Infineon Technologies AG. Although only 27.5% of shareholders voted against his reappointment, it was seen as significant among public companies.65 Institutional shareholding is prevalent in some European countries, ← 15 | 16 → such as Sweden with 85% of the total shareholding in listed companies, in France with 40% of the CAC 40 companies, and similarly for the top-tier Swiss listed companies. In other European countries, institutional investment still lags behind owing to special factors: in Italy due to prevailing blockholder control and in Germany, where a lack of significant pension assets corresponds with a lack of deep capital markets, particularly given the labor’s dependence on the state old age retirement and pension system rather than on their own saving and investing. Pension assets in the United Kingdom, Switzerland and the Netherlands exceed their gross domestic product (GDP),66 while German pension assets only account for 498 billion Euro, significantly less than half of the total market capitalization of German equity.67 For example, the largest German public pension fund is the “Versorgungsanstalt des Bundes und der Länder”(hereinafter “VBL”), which provides occupational pensions for public employees at the federal and state levels and has over 16 billion Euro under management,68 compared to CalPERS with 257 billion Dollars.69

Despite domestic institutional investors playing a minor role in Germany, foreign institutional investors are assumed to hold the majority of shares in most German blue chips (DAX-30 companies),70 where foreign shareholding – in particular foreign institutional shareholding – is very considerable; an example is the Deutsche Börse AG, where the large private German banks sold out their shareholdings some years ago under a changed tax system. According to data from the Deutsche Bundesbank, considerably more than 40% of shares – in terms of market value – are in the hands of foreign investors.71 More generally, the Rhineland capitalism model with its close ← 16 | 17 → intertwining of German industry and banks has been disappearing over the years72 and foreign institutions potentially play more of a role in prompting changes in corporate governance practices compared with domestic institutions.73 With the increase in external funding of occupational pensions – mostly by DAX-30 companies – the employee representatives of the supervisory board can no longer be considered representatives of a “different form of capital”.74

Generally speaking, the German system of financing, managing and controlling enterprises has experienced profound transform in the past two decades. Globalization of the economy and liberalization of capital markets are drivers of the debate concerning corporate governance, since worldwide operating institutional investors have played an increasingly decisive role in financing German enterprises. If a company wants to acquire capital, it turns to the national and international capital market.75 The situation in Germany began to change with the increasing internationalization of capital markets that emerged in the mid-1980s. Some of the largest German corporations began to rely more on foreign investors. “It was mainly economic difficulties that attracted public attention in the 1980s when shareholders were rediscovered as investors, resulting in companies satisfying their financial needs by capital increases or the sale of a corporation’s common shares to public investors.”76 In recent years, global and European portfolio investors have played an increasing role in financing German enterprises and corporate governance.77 The ownership structure of the 30 largest public corporations has rapidly evolved towards the Anglo-American model of widely spread ownership in recent years. Between 2001 and 2009, the average proportion of shares held by diverse investors in DAX-Enterprises increased from 64.5% to 82.6%. Among the DAX-Enterprises, majority shareholders only exist in Beiersdorf AG (50.46% in possession of Maxinvest AG) and Volkswagen ← 17 | 18 → AG (50.74% in possession of Porsche Automobil Holding SE), where not the equity shares, but rather the preferred shares are represented in DAX-Enterprise, which is regarded as 100% shares being held by disperse investors.78

Despite the dramatic growth of dispersed ownership of German public corporations, according to the EU Green Paper of 2011, the corporation with controlling shareholders remains the dominant model in the EU and the ownership of companies is not so decentralized as being classified as the wide dispersion of stock ownership.79 Concentrated corporate ownership gives rise to its own particular agency problems or potential conflicts of interest, namely the agency problem of controlling shareholders taking advantage of the minority shareholders in publicly traded corporations. Furthermore, with increasingly dispersed ownership and the rise of institutional investors in continental European countries, there is clearly a rise of activism among institutional investors who are also concerned about the potential for exploitation, given the likelihood that – as minority owners and largely passive owners – they may be exploited by other more powerful owners with greater access to private information.80 Institutional investors may choose to communicate their views to other shareholders81 and provide an effective lobby group to advance the protections for minority shareholders in the jurisdictions with concentrated shareholders by promoting the independence of directors.82


XLVII, 176
ISBN (Softcover)
Publication date
2016 (December)
Cumulative voting Independent director Related-party transaction Long govenance Business judgment Hostile takeover
Frankfurt am Main, Bern, Bruxelles, New York, Oxford, Warszawa, Wien, 2017. XLVII, 176 pp.

Biographical notes

Wenjia Yan (Author)

Wenjia Yan studied Law and was awarded an LL.M. at the China University of Political Science and Law, Peking, and an LL.D. at the Faculty of Law of the University of Hamburg. Her research interests include Corporate Governance as well as Comparative Law.


Title: The Role of Representatives of Minority Shareholders in the System of Corporate Governance
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226 pages