5.6 Legal Aspects of Equity Provided by Shareholders 165By managing shareholders’ economic rights, the firm can manage the
distribution of value created by the firm as well as the remuneration of its
stakeholders. In addition, the firm can ensure that its assets will not be
expropriated by shareholders.
The interests of the firm are not necessarily the same as the interests of its
shareholders (Volume I). The firm should therefore ensure that those economic
rights are constrained and that they will not endanger the long-term survival of the
firm.
In a limited-liability company, the distribution of assets to shareholders is usually
constrained by mandatory provisions of law or articles of association which provide: that
decisions on the distribution of assets to shareholders must be initiated by or require the
consent of the statutory board (allocation of power); that the distribution of profits to
shareholders may not exceed a certain amount (restrictions on distributable profits); or that
the distribution of assets is prohibited if the company is insolvent or if the distribution
would lead to its insolvency (equity-insolvency test). In a partnership, the distribution of
assets to partners is constrained by: the fact that distributions are based on a contract
between the partners and that any amendment of that contract usually requires consensus
(partners’ veto rights); and the partners’ unlimited liability for the obligations of the
partnership (alignment of interests).
As different shareholders have different preferences, the firm can manage their
remuneration and the cost of equity by creating different classes of shares.
In a limited-liability company, so-called preference shares typically give the owner the right
to collect a fixed dividend from the firm when funds are available for distribution, with
higher priority than regular shareholders. Better economic rights may be a compensation for
weaker governance rights. Preference shares often give the owners less voting power (often
no voting rights). In a partnership, the parties may agree on the allocation of profits
according to the partners’ preferences.
Management of governance rights. By managing the governance rights of
shareholders, the firm can manage the allocation of power in the firm. Through the
allocation of power, it can also manage the perceived risk exposure of
shareholders and the risk inherent in agency with the firm as principal and
shareholders as agents.
The perceived risk exposure of shareholders will affect the price that the firm
must pay for the use of capital provided by shareholders. If shareholders are given
a say in the management of the firm, their perceived risk might be reduced. This
might reduce the cost of equity capital for the firm.
For example, shareholders in listed German companies have traditionally enjoyed stronger
formal powers than shareholders in listed US companies.^143 (The valuation of listed US
(^143) See Cheffins BR, Mergers and Corporate Ownership Structure: The United States and
Germany at the Turn of the 20th Century, AJCL 51 (2003) pp 473–503; Bebchuk LA,
The Case for Increasing Shareholder Power, Harv L R 118 (2005) pp 833–914; Mänty-
saari P, Comparative Corporate Governance. Shareholders as a Rule-maker. Springer,
Berlin Heidelberg (2005) Chapter 6.