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The Efficiency of Controlling Corporate Self-Dealing: Theory Meets Reality |
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Zohar Goshen |
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| Corporate self-dealing may be controlled either by legal rules or by the unconstrained forces of the market. The regulatory options include an absolute prohibition on self-dealing, a prohibition on voting with conflicting interests (the "majority of the minority" requirement), and an imposition of fairness duties (the "fairness test"). Using an economic analysis, this Article presents a unique theoretical framework for evaluating the relative efficiency of the attempts to control self-dealing adopted by five countries: The United States (Delaware in particular), the United Kingdom, Canada, Germany, and Italy. The Article's analysis of the self-dealing problem is based on the novel theory that legal protections can be classified into "property rules" or "liability rules" not only in the context of individual rights but also in the context of group rights. Applying this theory to self-dealing transactions, in which the "group" is composed of the minority shareholders, the author demonstrates that each of the two most effective solutions to the self-dealing problem can be classified as either a property rule or a liability rule. The requirement of a majority-of-the-minority vote, which prevents any transaction from proceeding without the minority group's consent, can be defined as a property rule. The fairness test, which allows transactions to be imposed on an unwilling minority group but ensures that the minority receives adequate compensation in objective market-value terms, can be defined as a liability rule. The Article then analyzes the choice between these two solutions as a choice between a property rule and a liability rule. The author shows that the choice between the two types of rules-property or liability-is a function of the total transaction costs in a particular legal system. These transaction costs include the negotiation costs arising from a property rule, the adjudication costs associated with a liability rule, and several jurisdiction-specific factors, including the efficacy of the judicial system and the efficiency of market mechanisms (for example, the market for corporate control, the efficiency of the capital market, and the type of investors active in the market). The Article arrives at three principal conclusions. First, extending the property-rule/liability-rule framework to group rights demonstrates that the choice between the rules controlling self-dealing affects the division of the transaction's surplus between minority and majority. Second, Delaware's rules governing self-dealing, which were believed to be indeterminate and opaque, are shown, for the first time, to be efficient and coherent. Third, because of the transaction costs associated with each means of legal protection, there is no single efficient solution suitable for every jurisdiction; any solution chosen to cope with the self-dealing problem must take into account the relevant local conditions. | |
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Copyright
© 2003 by California Law Review, Inc. |
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