Corporate scandals do not surprise the public anymore. But when they happen, they still involve some unexpected elements. This is also the case with the recent Carlos Ghosn and Nissan saga. Apart from his Hollywoodesque escape from house arrest in Japan to Lebanon, what is striking is his alleged misdemeanours, namely some value-diverting related party transactions (‘RPTs’) (see here and here). RPTs are not unusual on their own. But they can be, especially when they are entered into by a director or manager (who is not a significant or controlling shareholder) in a company with a controlling shareholder. This occurred in the case of Carlos Ghosn who was the chairperson of the board of directors of Nissan which was controlled by another automobile company Renault SA (see here and here). This situation contradicts what would normally be expected in conventional corporate law theory which generally assumes that in controlled companies controlling shareholders have sufficient (financial) incentives and skills to monitor directors/managers and prevent their value-diverting activities (see, eg, Shleifer & Vishny 1997; Gilson 2006; Conac, Enriques & Gelter 2007).
In a recent article, I closely analyse the phenomenon of RPTs by directors/managers in controlled and dispersedly-owned companies with the help of hand-collected data. In terms of theory, I put forward four possible scenarios in controlled companies: (i) the conventional wisdom with its ‘strong-monitoring hypothesis’, (ii) a ‘weak-monitoring hypothesis’ according to which controlling shareholders can be weak monitors because, for example, they are captured by directors/managers or they have weak monitoring incentives and skills, (iii) a ‘quid pro quo hypothesis’ which deems managerial/directorial RPTs as a reward (or quid pro quo) by the controlling shareholder to offset the risks or losses directors/managers incur in turning a blind eye to or allowing the controlling shareholder’s own value-diverting activities, and lastly (iv) an ‘evasion hypothesis’ according to which controlling shareholders use directors/managers as a conduit by first allowing them to transact with the company and then transacting directly with them to acquire the relevant (company) asset in order to evade more stringent rules for controllers’ self-dealing or potential intensive media/regulatory/investor attention.
In dispersedly-owned companies, managerial/directorial RPTs are also generally downplayed. The conventional wisdom deems executive remuneration a more significant way to divert company value for directors/managers than (other types of) RPTs because, for example, directors/managers are considerably less likely to own significant business enterprises to which they can divert value from the public company they manage (see, eg, Bebchuk & Hamdani 2009; Gutiérrez & Sáez 2017). However, it can be claimed that, given the stricter regulatory regime executive remuneration may face and its eye-catching and controversial nature, directors/managers may prefer RPTs as a tunnelling technique.
In order to understand which of these hypotheses can be further supported by empirical evidence, I formed a dataset on RPTs entered into by directors/managers in companies listed on the prime standard of the German stock exchange for two consecutive years (2018 and 2019). These transactions include every type of transaction that was concluded with directors/managers who were not a significant or controlling shareholder, or with their related entities/persons, except for remuneration contracts and those whose value were under €10.000 (henceforth ‘relevant RPTs’). The dataset includes 301 companies in total along with descriptive statistics in terms of their shareholding structure.
Overall, for controlled companies, the data provide supporting indications for the above-explained hypotheses to different degrees. On the one hand, there is ‘strong’ support for the conventional wisdom’s ‘strong monitoring hypothesis’. Most of the companies did not report any relevant RPTs in two consecutive years. The types and values of RPTs also suggest, on their own, that they were not expropriating any substantial company value (especially when compared to materiality thresholds generally used in RPT regulations across different jurisdictions).
On the other hand, one can also find at least ‘intermediate’ support for two other hypotheses: the ‘quid pro quo hypothesis’ which expects collusion between managers/directors and controlling shareholders in terms of self-dealing, and the ‘weak monitoring hypothesis’ which holds (certain) controllers as weak monitors. Generally, a significant number of companies with large blockholders report RPTs with directors/managers (in both years) (between 30-40% depending on how one defines ‘large’ blockholder), which may have been employed to divert company value due to weak monitoring by the controller, or as a quid pro quo. Furthermore, the ‘quid pro quo’ hypothesis would predict that RPT values need not be conspicuously large; they should be just enough to cover any risks or losses directors/managers may face in acquiescing to abuse of control by the controlling shareholder. It would further predict that relevant RPTs should concentrate among directors tasked with the oversight in the company. Both predictions seem to be confirmed. Out of companies with concentrated ownership that reported relevant RPTs, for a significant number (around 61%), these RPTs involved supervisory board members directly or indirectly—the primary oversight body for most of the companies on the German stock exchange (see, eg, Hopt 2016). Moreover, the data show that, for supervisory board members, the value of an overwhelming number of RPTs is bigger than their remuneration. Thus, even RPTs of low value may be more valuable than compensation packages. In terms of the ‘weak monitoring hypothesis’, some relevant RPTs were reported by companies where controllers can be deemed as ‘weak monitors’ because of their identity, such as heirs (see, eg, Villalonga & Amit 2006) and dispersedly-owned companies, or because of their relatively low shareholding (between 10% and 25%) or pyramidal share-ownership structure which would dilute incentives to monitor due to reducing the economic stake. For the ‘evasion hypothesis’ which expects a two-step scheme of tunnelling first to the manager/director and from there to the controller, the data do not provide any supporting evidence. In contrast to what would be predicted by this hypothesis, the data show that in most companies which reported relevant RPTs with directors/managers, controllers also directly entered into RPTs with the company, which refutes any need or preference for an evasive scheme involving company directors/managers.
Finally, in terms of dispersedly-owned companies where executive remuneration is expected to dominate RPTs as a tunnelling method, a non-negligible part of these companies (33%) reported RPTs with directors/managers. What is further noteworthy is that the value of most of these RPTs was higher than the relevant remuneration for the director or manager, which shows that RPTs can provide larger benefits than remuneration packages. These transactions also confirm that venues exist for directors/managers to divert company value (such as transactions concerning sales of goods or the provision of services under, among others, consulting and financial agreements).
All in all, it is likely that the extent to which the abovementioned hypotheses reflect the actual situation vary in time and from one company to the other. For jurisdictions that are concerned with the problem of managerial/directorial RPTs in controlled companies, there are a few regulatory tweaks to make the RPT regime more robust. These would include for example (i) strengthening independent directors’ monitoring role and ensuring their independence from the controlling shareholder and (ii) excluding the controlling shareholder from the shareholder vote on RPTs with directors/managers even if he or she is not the (direct) conflicted party. One thing however is certain: there is great room for improvement regarding the RPT disclosure of listed companies which occasionally suffer from the lack of clarity in the information provided regarding the identities of related parties, transaction types and values.
Alperen Af?in Gözlügöl is a Junior Fellow at the Center for Advanced Studies on the Foundations of Law & Finance and prospective postdoctoral researcher at the Leibniz Institute for Financial Research SAFE, Frankfurt am Main.
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