Essays on law and corporate governance

ESSAYS ON LAW AND CORPORATE GOVERNANCE LAN LUH LUH NATIONAL UNIVERSITY OF SINGAPORE 2005 ESSAYS ON LAW AND CORPORATE GOVERNANCE LAN LUH LUH (LL.B. (Hons.), NUS; LL.M, Cantab.) A THESIS SUBMITTED FOR THE DEGREE OF DOCTOR OF PHILOSOPHY DEPARTMENT OF BUSINESS POLICY NATIONAL UNIVERSITY OF SINGAPORE 2005 ACKNOWLEDGEMENTS I would first like to express my deepest appreciation to my supervisor and colleague, Associate Professor Rachel Davis, who has been very helpful and supportive of this research in the last few years. This research would not have been possible without her encouragement and guidance. It has been a pleasure working with her. I am very grateful to the members of my dissertation committee, Associate Professor Mak Yuen Teen and Dr Loizos Heracleous. Dr Heracleous is now a Fellow in Strategy and Organization at Templeton College, Oxford University. They helped me to see corporate governance issues from the finance and organization perspectives and provided me with invaluable insights to the topic. Equally, I am indebted to the three examiners of this thesis, who took time off from their busy schedule to review close to two hundred pages of writings. Their very useful comments have been incorporated in this final draft. I would also like to thank my colleagues, Dr John Sequeira, Dr Srinivasan Sankaraguruswamy, Associate Professors Tan Hwee Hoon, Hui Tai Kee, Sum Chee Chuong and Chu Sing Fat who have helped me with the data analysis. I am especially indebted to John for guiding me through the use of EView and probit analysis and to Chee Chuong for helping me to think of the stories behind the numbers. My special thanks go to Dr Sai Yayavaram, Dr Ishtiaq P Mahmood, Dr Lim Kwang Hui, Associate Professor Tan Soo Jiuan and other friends and colleagues for their i helpful comments on the earlier draft of some of the chapters of this dissertation. I am also obliged to my ex-supervisors Professor Wee Chow Hou and Dr May Lwin who first encouraged me to pursue a cross-disciplinary research in this area. In addition, I would also like to show my appreciation to my students, Mr Oei Hsin Hsi, Mr Gary Chua, Mr Issac Yong, Ms Windy Roslinawati, Mr Ong Kang Lin, Mr Lim Ming Yi, Ms Caris Tay and a few others who have helped me in one way or another to collate the data and my department secretaries, Ms Teo Woo Kim and Ms Wendy Ng who helped me with the administrative matters. I would like to thank my wonderful husband, Larry, for his unfailing support and encouragement throughout these years. His steadfast love and sacrifice propelled me to carry on with the research even though the end might look grim at times. Above all, he has on many occasions gallantly taken over my role as a mother to our two children, Stephanie and Brandon, to help to ease the pressure on me. I am eternally grateful. Finally, and most importantly, I would want to thank and give praises to God for He has made all things possible. ii TABLE OF CONTENTS ACKNOWLEDGEMENT i TABLE OF CONTENTS iii TABLE OF CASES vi TABLE OF LEGISLATION viii LIST OF TABLES ix LIST OF FIGURES x LIST OF APPENDICES xi SUMMARY xii Chapter 1. 1.1. 1.2. 1.3. INTRODUCTION Overview and Motivation 1.1.1. Legal Theories and Models of Corporate Governance 1.1.2. Board as Mediating Hierarch – Determinants of Board Effectiveness 1.1.3. Litigating Challenges to Directors’ Duties – An Empirical Analysis Contributions Organizing Framework of the Dissertation 3 Chapter 2. LEGAL THEORIES AND MODELS OF CORPORATE GOVERNACE 2.1. Introduction 2.2. The Major Research Trends in Legal Theories on Corporation 10 and Corporate Governance 13 2.2.1. The Theories of the Corporation 25 2.2.2. The Models of Corporate Governance 2.3. Implications for Management Research 45 45 2.3.1. Pluralism 48 2.3.2. Theory Construction 49 2.3.3. Hypotheses Testing 2.4. Agenda for Future Research 51 52 2.4.1. Board Level iii 2.5. 2.4.2. Management and Employee Level 2.4.3. Stakeholder Level Conclusion 56 57 59 Chapter 3. BOARD AS MEDIATING HIERARCH – DETERMINANTS OF BOARD EFFECTIVENESS 3.1. Introduction 61 3.2. Agency Theory and Board as Monitor 64 65 3.2.1. The Board as Monitor 3.3. Team Production Theory and Board as Mediating Hierarch 69 74 3.3.1. The Board as Mediator 3.4. Determinants of Board Effectiveness 78 3.5. Directors’ Compensation 81 81 3.5.1. Directors’ Compensation under the Monitoring Board 82 3.5.2. Directors’ Compensation under the Mediating Board 3.6. Board Composition 86 86 3.6.1. Board Composition under the Monitoring Board 89 3.6.2. Board Composition under the Mediating Board 3.7. Trust 95 99 3.7.1. Ability 100 3.7.2. Benevolence 102 3.7.3. Integrity 3.7.4. Internalized Trust as a Determinant of Board 104 Effectiveness 3.8. Conclusion 105 3.9. Future Directions for Research 109 Chapter 4. LITIGATING CHALLENGES TO DIRECTORS’ DUTIES – AN EMPIRICAL ANALYSIS 4.1. Introduction 112 4.2. Factors Affecting the Outcome of Litigation 114 114 4.2.1. Identity of the Plaintiff or the Initiator of the Suit 116 4.2.2. Types of Breaches of Duties 118 4.2.3. Benefits Received 120 4.2.4. Nature of Corporation 4.3. Method and Sample Selection 121 121 4.3.1. Content Analysis 123 4.3.2. Sample Selection 124 4.3.3. Training of Coders 125 4.3.4. Sieving Process 128 4.3.5. Construction of Coding Scheme 4.4. Data Description and Discussion 130 4.4.1. Procedural Information Regarding the Cases in the 130 Database 135 4.4.2. Factors Affecting the Outcome of Litigation 151 4.4.3. Probability of the Plaintiff Winning iv 4.5. 4.4.4. Limitations Policy Implications and Future Research 4.5.1. Directors and Management 4.5.2. Shareholders and Institutional Investors 4.5.3. Policy Makers and the Courts 4.5.4. Future Research 160 161 161 164 165 167 BIBLIOGRAPHY 170 APPENDICES 190 v TABLE OF CASES A Alar v Mercy Memorial Hospital, (1995) Mich. App. LEXIS 24 Ayr Composition, Inc. v Fred Rosenberg, (1993) N.J. Super. LEXIS B Burden v Burden, 159 NY 287, 54 N.E. 17, 1899 N.Y. LEXIS 1002 C Clifford v Metropolitan Life Ins. Co., 264 App Div 168, 34 N.Y.S.2d 693, 1942 N.Y. App. Div. LEXIS 4095 Cohen v Beneficial Indus. Loan Corp., (1949) 337 US 541 Cooke v Fresh Express Foods Corporation, Inc., (2000) Ore. App. LEXIS 1128 D Dartmouth College v Woodward, 17 U. S. 518 (1819). Dodge v Ford Motor Co., 170 N.W. 668 (Mich. 1919) Dawson v Temps Plus, Inc., (1999) Ark. LEXIS 189 Disctronics Limited, et al. v Disc Manufacturing, Inc, (1996) Ala. LEXIS 499 128 126 95 95 115 149 15 29 127 125 E Emerald Partners v Ronald P Berlin et al and Hall Financial Group, (1999) Del. LEXIS 97 143 G Gab Business Services, Inc. v Lindsey & Newsom Claim Services, Inc., (2000) Cal. App. LEXIS 687 Gamboa v Shaw, (1997) Tex. App. LEXIS 5547 Golaman v Pogo.com Inc., (2002) Del. Ch. LEXIS 71 Good v Texaco, Inc., Del. Ch., C.A. No. 7501, 1985 Del. Ch. LEXIS 445 125 12 127 74 H Harris v McIntyre, (2000) Mass. Super. LEXIS 181 Havens v Attar, (1997) Del. Ch. LEXIS 147 126 127 I In Re Lukens Inc. Shareholders Litigation, (1999) Del. Ch. LEXIS 233 In Re RJR Nabisco, Inc. Shareholders Litigation 1989 Del. Ch. LEXIS 143 101 K Kahn v Roberts, (1994) Del. Ch. LEXIS 33 Kalmanash v. Smith, 291 NY 142, 51 N.E.2d 681, 1943 N.Y. LEXIS 1047 L 127 95 vi Leavy v American Federal Savings Bank (2000) Md. App. LEXIS 215 M MEI Salon Corp v Carl R. Pohlad, (1997) Minn. App. LEXIS 257 Mentor Graphics Corporation v Quickturn Design Systems, Inc., (1998) Del Ch. LEXIS 204 Midwest Janitorial Supply Corp. v Greenwood (2001) Iowa Sup. LEXIS 128 O Offshore Pipelines v Schooley, (1998) Tex. App. LEXIS 6377 Oliver v Boston University, (2002) Del. Ch. LEXIS 21 P People, The v Roberta Rita Castro, (2000) Cal. App. LEXIS 187 Pepper v Litton, 308 U.S. 295, 60 S. Ct. 238, 84 L. Ed. 281, 1939 U.S. LEXIS 971 152 126 149 157 128 126 126 95 S Salsitz v Nasser, et al., (2002) 208 F. R. D. 589; 2002 U.S. Dist. LEXIS 144 13973 Sanders v Wang and others (1999) Del. Ch. LEXIS 203 143 Sayyah v O'Farrell, (2001) Ohio App. LEXIS 1914 126 Schmidt v Magnetic Head Corporation, 101 A.D.2d 268, 476 N.Y.S.2d 151, 1984 N.Y. App. Div. LEXIS 17811 94 Shapiro v Greenfield (2000) Md. App. LEXIS 172 157 Smith v Marrone, (1994) Mass. Super. LEXIS 724 128 Smith v Van Gorkom, (1985) 488 A.2d 858 (Del. 1985) 118, 119, 164, 166 Sowell v Resolution Trust Corp, (1996) Tex. App. LEXIS 1862 12 St. Joseph's Regional Health Ctr. v Munos, (1996) Ark. 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Here, the party that initiated the action is defined as the complainant who seeks to enforce the duty of care and loyalty against the directors concerned. a) b) c) Board of Directors Shareholders (shareholding 50% or more) Minority Shareholders This qualification is necessary as some of the reported cases may be motions taken by the directors to dismiss claims brought by the shareholders rather than actions taken by the latter. 190 Appendix 2. What kind of common law has been breached? a) Duty of care b) g) Duty of loyalty - lack of good faith, not acting in the best interests of the firm Duty of loyalty – not exercising power with proper purpose; unfair practices Duty of loyalty – conflict of interest – self-dealing; interest in company contract Duty of loyalty – conflict of interest – accepting bribe/profiting at firm’s expense/excessive compensation Duty of loyalty – conflict of interest – competing with firm, usurping of corporate opportunity Misappropriation of company property/ waste h) Insider trading, deceptive disclosure and others c) d) e) f) 3. Did the director benefit from the alleged breach of duty? a) b) c) Yes - monetary Yes – non-monetary No or not observable from the case 4. What is the nature of the corporation involved in the case? a) b) Private or close corporation Public or listed corporation 5. Who won the case? State “1” if defendant or director won or “0” otherwise 6. Is the firm concerned a financial company, e.g. bank, insurance companies etc Notes: 191 [...]... legal theorists and organizational theorists The overall conclusion is that management research in corporate governance need not begin and end with agency theory and other accepted governance models 2.2 THE MAJOR RESEARCH TRENDS IN LEGAL THEORIES ON CORPORATION AND CORPORATE GOVERNANCE The research trends in legal theories on corporation and corporate governance are basically at two interconnected levels... the three essays, each with introduction, review of the relevant literature, discussion and conclusion Each chapter stands on its own and can be read separately without loss of understanding 6 Chapter 2 CHAPTER 2 LEGAL THEORIES AND MODELS OF CORPORATE GOVERNANCE 2.1 INTRODUCTION Research on corporate governance in management studies is generally dominated by theories rooted in economics and finance... theories on corporation and corporate governance that are relevant to social scientists It also explains how legal theories and models can contribute to management research, namely, pluralism, theory construction and hypotheses testing and sets out a framework for potential investigation in this area The second essay (Chapter 3) further explores the relationship between law and corporate governance. .. public view of corporate law and advocates for the protection of the stakeholders’ interests rather than mere shareholders’ interests (DeBow & Lee, 1993) The Corporation as an aggregation of contractual relationships – the Contractual/ Aggregation Theory Like the concession/fiction theory of the corporation, the growth of the contractual/ aggregation theory has also undergone two phases Long before the... long overdue This dissertation consists of three essays that intend to fill this lacuna in corporate governance literature Each essay constitutes a separate chapter and touches on 2 Chapter 1 various aspects of how law impacts corporate governance and vice versa The following sections provide a summary of the different chapters 1.1.1 Legal Theories and Models of Corporate Governance The first essay... view is long overdue The principal contribution of this research is plugging this lacuna in management literature This dissertation consists of three essays that explore the theoretical application of legal theories and models of corporation and corporate governance and provide empirical evidence to the importance of litigation in corporate governance Each essay constitutes a separate chapter The first... perspectives of the role of litigation in corporate governance research xiii Chapter 1 CHAPTER 1 INTRODUCTION This chapter introduces the dissertation, summarizes the contributions and provides an organizing framework for the rest of the chapters 1.1 OVERVIEW AND MOTIVATION Research on theories of corporate governance in management studies has come a long way Ever since Berle and Mean published their seminal... Figure 2-1 Relationship between the Legal Theories of the Corporation and the Models of Corporate Governance Theories of the Corporation Concession/ Fiction Theory Stakeholder/ Communitarian Contractual/ Aggregation Theory Shareholder Supremacy Realist/ Organic Theory Director Primacy Managerialism Models of Corporate Governance 2.2.1 The Theories of the Corporation A theory of the corporation has been... empirically One of the key features of the corporation is that upon incorporation, the corporation acquires a legal personality separate and distinct from the people who have invested and hold shares in it and the people who manage it The corporation can hold property in its name, be sued and take part in legal suits, and it continues to exist even though the shareholders, directors and managers may come and. .. personification of corporation has great importance in law because it (1) implies a single and unitary source of control 13 Chapter 2 over the collective property of the various participants of a corporation, (2) it defines, encourages and legitimates the corporation as an autonomous, creative, self-directed economic being, and (3) captures rights, including constitutional rights, for corporations . Expectation-Prediction (Classification) Table on Model 1 159 Table 4-15 Expectation-Prediction (Classification) Table on Model 2 159 Table 4-16 Expectation-Prediction (Classification) Table on. ESSAYS ON LAW AND CORPORATE GOVERNANCE LAN LUH LUH NATIONAL UNIVERSITY OF SINGAPORE 2005 ESSAYS ON LAW AND. literature. This dissertation consists of three essays that explore the theoretical application of legal theories and models of corporation and corporate governance and provide empirical evidence