The Law of Corporate Finance: General Principles and EU Law: Volume III: Funding, Exit, Takeovers

5.4 The Legal Capital Regime Under EU Company Law 153

holders’ perceived risk. The quality of investor protection is generally assumed

to have a favourable effect on the price that investors are prepared to pay for

shares and on the firm’s funding costs.

• Management of information (signalling and screening). In a compliance cul-
  ture, mandatory provisions of law setting out both substantive constraints and
  effective sanctions for their breach can reduce the risk of a market for “lemons”
  by signalling to external investors that a company will be likely to comply with
  a certain standard and that compliance has been verified by members of the
  corporate bodies of the company, its statutory auditors, at least some of its
  shareholders, or – in some cases – supervisory authorities.^107 This benefit is not
  limited to the legal capital regime; other mandatory requirements such as the
  Basel II or the equity-insolvency test work in the same way.


• Protection of creditors. Indirectly, creditors benefit from increased monitoring
  and better governance. Like debt covenants, the staggered constraints on distri-
  butions ex ante can increase time required for distributions, provide information
  to creditors, act as an early warning system, and reduce creditors’ perceived
  risk. This could in principle influence the pricing of claims and the cost of debt
  funding.

On the other hand, the legal capital regime has its failings. A legal capital regime
typically focuses on distributions to shareholders and transactions involving shares
but fails to cover business transactions in a general manner. A complementing eq-
uity-insolvency test might help to solve this problem (as in Swedish and Finnish
company law or the German GmbHG as amended by the MoMiG). Instead of an
equity-insolvency test, financial institutions are subject to minimum capital re-
quirements based on their risk exposure.
IFRS can be combined with a legal capital regime. The amount of distributable
assets can be determined even on the basis of IFRS.^108 However, the primary pur-
pose of IFRS is to “provide information about the financial position, performance
and changes in financial position of an entity that is useful to a wide range of users
in making economic decisions”^109 and not to provide a basis for any other investor
protection regime. For example, fair-value accounting can increase the volatility
of the amounts of distributable assets. A complementing equity-insolvency test or
other constraints restrictions might mitigate problems caused by IFRS and fair-
value accounting.^110

(^107) Kuhner C, Zur Zukunft der Kapitalerhaltung durch bilanzielle Ausschüttungssperren im
Gesellschaftsrecht der Staaten Europas, ZGR 2005 pp 763.
(^108) Pellens B, Sellhorn T, Zukunft des bilanziellen Kapitalschutzes. In: Lutter M (ed), Das
Kapital der Aktiengesellschaft in Europa, ZGR, Sonderheft 17. De Gruyter Recht, Berlin
(2006) p 460.
(^109) Framework F.12. See also IAS 1.13.
(^110) Lutter M, Das (feste Grund-)Kapital der Aktiengesellschaft in Europa, Zusammen-
fassung der Überlegungen des Arbeitskreises „Kapital in Europa“. In: Lutter M (ed), op
cit, pp 10–12. Pellens B, Sellhorn T, Zukunft des bilanziellen Kapitalschutzes. In: Lutter
M (ed), op cit, pp 460–461 and 467–468.