166 5 Equity and Shareholders’ Capital
companies has nevertheless usually been higher than the valuation of listed German
companies.) In continental Europe, shareholders typically decide on the change of rights
attaching to shares, transactions that affect the number of shares or the share capital of the
company, distribution of assets to shareholders, and structural changes. The same principles
have been adopted in the Second Company Law Directive.^144
On the other hand, the allocation of power in the firm is also a question of how the
firm manages its agency relationships. As mentioned in Volume I, both
shareholders and managers can be regarded as the firm’s agents. The firm can
improve its survival chances by managing these agency relationships for example
in the following ways.
First, the firm can mitigate the risk of short-termism by limiting the powers of
short-term financial investors.
For example, small shareholders have traditionally been given weak formal powers in listed
US and UK companies. The firm can also try to mitigate the risk of expropriation of assets
by controlling shareholders by limiting their formal powers.
Second, the firm can ensure that the power to decide on ownership structure, the
issuing of new shares, share buybacks, and the redemption of shares is vested in a
corporate body that furthers the long-term interests of the firm (the board, see
Volume I).
In listed US companies, this is achieved through articles of association (by-laws) that vest
practically all powers in the board. In the EU, however, the Second Company Law
Directive vests important decision rights in the general meeting. In entities that resemble
partnerships, shareholders will not permit such decisions to be delegated to managers. For
example, the identity of other shareholders is crucial, if all shareholders are personally
liable for the debts of the entity or where ownership of the firm means a business
relationship with the firm’s other shareholders.
Third, the firm can also mitigate the risk of bad management decisions. This can
be done by separating decision management and decision control (Volume I). For
example, shareholders can be given veto rights over major transactions and
structural change as well as appointment rights; at the same, their initiation rights
can be restricted.
Fourth, the firm can use financial incentives to mitigate the agency problem
caused by the fact that controlling shareholders have large formal and de facto
governance powers which they can use for the benefit of the firm or for their own
benefit. For example, in addition to governance powers, controlling shareholders
can be given unlimited liability for the obligations of the entity, liability for loss in
the event of insolvency, or liability for any loss or damage sustained by the entity
through their actions. This is usually achieved through the choice of the business
form of the legal entity, through provisions in the entity’s rules or articles, or
contractually.
(^144) Directive 77/91/EEC (Second Company Law Directive). See Articles 11, 17, 19, 25, 29,
30, 31, 35, 36, 37, 38, and 41.