A. Overview of the Legal Origins Debate

The legal origins debate emerged in the 1990s with the pioneering work of La Porta et al.Footnote ⁹ These authors argue that the regulatory style of a particular country is principally influenced by its legal origins. The legal origins debate identifies at least four important legal families: common law systems originating in England; civil law systems derived from France; civil law systems derived from Germany; and socialist legal systems.Footnote ¹⁰ Legal families are categorized into either common law or civil law legal origins in much of the empirical work and secondary literature. Another categorization that is commonly used in the legal origins literature is that of ‘transplant countries’, which are those countries where a European model legal system was adopted, either voluntarily or through conquest.Footnote ¹¹

Countries that take on a legal tradition or have one imposed on them may alter and adapt the legal tradition to suit the cultural values and other local circumstances of the adoptive country. However, legal origins theory posits that the underlying style of regulation that is associated with the originating country will persist over time, despite any changes that may be made. A certain ‘path dependency’ occurs as a result of the complementarity that exists between legal and economic institutions.Footnote ¹² This ensures that distinct differences that are associated with the different types of legal system remain, despite alterations made to take account of local conditions.Footnote ¹³

Two arguments have been advanced to explain the relationship between a country's legal origins and its regulatory style.Footnote ¹⁴ The first is that the common law is more able to adapt to changing economic circumstances than civil law because it relies more on judicial decision-making than on legislation. The second is that the concept of judicial independence that underpins the common law means that the common law is less susceptible to regulatory capture than the civil law, which relies more on legislative change.

The legal origins debate is not purely a theoretical exercise. Scholars have utilized the legal families categorization to explain key differences that arise between countries in a broad range of legal and economic institutions.Footnote ¹⁵ For example, one of the findings of the legal origins literature is that countries with a common law legal origin have a less interventionist form of regulation than do civil law countries. Common law countries rely more on markets and dealings at arm's length than do civil law countries. Civil law countries, on the other hand, are subject to more extensive and restrictive regulation than are common law countries.Footnote ¹⁶ Legal origins theory suggests that the performance of a national economy is influenced by the style of its legal system and, in particular, by the way in which its legal system deals with market failures.

La Porta et al have drawn several conclusions about the relative merits of common law and civil law systems. They have deduced that the interventionist regulatory style found in civil law countries tends to have an adverse impact on business enterprises and markets, leading to lower productivity and economic growth and higher unemployment. Rules and regulations produced by common law countries, on the other hand, are more responsive to market conditions because they are better able to protect property rights and provide for the enforcement of contracts. Across a range of factors, it is more likely that common law countries will have efficient rules for establishing and regulating markets than will countries of civil law origin.Footnote ¹⁷ La Porta et al summarize the implications of their findings in the following way:

These findings have been highly influential and have been drawn upon in the World Bank's policy recommendations for economic reforms in developing and transition countries.Footnote ¹⁹ Legal origins theory has also proved controversial, however. There has been an ongoing debate about its core propositions and the arguments that have developed based on the theory. Furthermore, there have been questions raised about the validity of its methodologies.Footnote ²⁰

B. Shareholder and Creditor Protection and the Legal Origins Debate

One of the earliest attempts to quantify the law protecting shareholders was the coding exercise undertaken by La Porta et al.Footnote ²¹ Their measure of shareholder protection consisted of eight items, each capturing a legal attribute that they believed indicative of shareholder protection. The authors examined 49 countries and coded the existence or otherwise of each of the eight items at a given point in time. The results were compared across countries according to the legal family in which the country fell.

La Porta et al found that the strongest protection for shareholders existed in common law countries and that the weakest protection existed in French civil law countries.Footnote ²² Minority shareholders faced a greater threat of having their shares expropriated by majority shareholders in civil law countries than they did in common law countries. The authors also identified a negative relationship between the level of shareholder protection provided by a given legal system and the concentration of share ownership in large public companies. In other words, countries with high share ownership concentration tend to have lower levels of shareholder protection provided by the legal system compared with countries where share ownership is less concentrated. The authors also argued that the level of protection available to shareholders is a strong predictor of financial development.Footnote ²³

The coding techniques used by La Porta et al have been applied and adapted by other researchers. Pistor, Raiser and Gelfer extended the scope of the measure of shareholder protection for transition countries by increasing the number of items used to measure the quality of the law.Footnote ²⁴ In a later study, Berkowitz, Pistor and Richard expanded the earlier project to include 49 countries.Footnote ²⁵ They found that, in transition countries, the effectiveness of legal institutions had a stronger impact than did the law on the books with respect to improved shareholder rights. More recently, Lele and Siems have noted that the index developed by La Porta et al has been subject to criticism for a variety of reasons. The number of items used to measure the law was limited and the study examined shareholder protection at a single point in time only.Footnote ²⁶ In addition, Armour et al have noted that ‘the broad brush descriptions [that La Porta et al] provide of common law and civilian regulatory “style” are over-stylized to the point of being inaccurate’.Footnote ²⁷

In order to capture the significant aspects of the law protecting shareholders more fully, Lele and Siems developed a new shareholder protection index containing 60 items, which they coded longitudinally for five countries (Germany, France, the UK, the US and India) over a period of 35 years (1970 to 2005).Footnote ²⁸ They discovered that shareholder protection improved between 1970 and 2005 in the five countries studied, with the US providing the weakest level of protection. The protection of minority shareholders against the majority was stronger in France, Germany and India. They also found that since 1993 there had been an increasing convergence in shareholder protection. Unlike La Porta et al, Lele and Siems did not find strong support for the hypothesis that the strength of shareholder protection was dependent on legal origins.Footnote ²⁹

In 2009, Armour et al published the results of a further study in which shareholder protection consisted of 10 items. This enabled them to measure shareholder protection for a sample of 20 countries over the ten-year period 1995 to 2005.Footnote ³⁰ The countries examined included developed, developing and transition countries. The authors chose the period of the study because it was a time during which many countries were undergoing a move to liberalize their economies and when law reform for the purpose of strengthening shareholder protection was on the agenda.Footnote ³¹ While these authors found some evidence to support the argument that the content of a country's substantive law is affected by its legal origins, with common law countries having stronger shareholder protection, they discovered that the civil law countries examined were catching up. They did not find evidence to support the claim by La Porta et al that strong legal protection of shareholders is important for financial development.Footnote ³²

Creditor protection has also been coded in a series of leximetric studies. The 1997 La Porta et al study employed a four-item index, aggregating the rights of creditors in liquidation and reorganization.Footnote ³³ In 2007, Djankov et al gathered data on 133 countries.Footnote ³⁴ They followed the La Porta et al methodology, with minor differences relating to the coding of insolvency procedures. The analysis of creditor protection presents special difficulties. As La Porta et al pointed out, secured and unsecured creditors have different interests, so protecting the rights of one may diminish the rights of others.Footnote ³⁵ Creditor rights come to the fore at times of liquidation and reorganization, which can see a shift between the priorities accorded to secured and unsecured creditors, especially where reorganization is predicated on a stay on the rights to repossess security. La Porta et al found that both liquidation and reorganization are used to some extent in almost all the countries they surveyed,Footnote ³⁶ so a creditor rights index must accommodate a diversity of protections. A weakness in one form of protection is often found to be compensated for by strength in another: for example, La Porta et al observed that the legal reserve requirement, which triggers an automatic liquidation for the benefit of unsecured creditors when breached, is a substitute for other weaker unsecured creditor protections in civil law countries.Footnote ³⁷ Similarly, a strong ex post insolvency system could act as a substitute for ex ante weakness, for example, in terms of the ability to contract with valuable information.Footnote ³⁸

In a second article published in 2009, Armour et al consolidated earlier work and reported on time-series evidence of trends in both shareholder protection and creditor protection.Footnote ³⁹ The authors examined 10 items to measure the law for the period 1995–2005 in 25 developed, developing and transitional countries, and also examined 60 items for the period 1970–2005 for France, Germany, India, the UK and the US. They discovered that the legal origins theory provides little help in explaining trends in the law with respect to shareholder protection. Time-series analysis does not support the argument of La Porta et al that financial development is fostered by an increase in shareholder rights. Nor does it support the suggestion that a country's legal origins operates as an external force that shapes the content of its laws and its economic outcomes. Rather, in relation to shareholder protection, Armour et al found that the legal system evolves in parallel with economic and structural changes. However, in the context of developments in the law with respect to creditor protection, the classification of legal systems into origin-based families had greater explanatory force.Footnote ⁴⁰

A. Shareholder Protection

As noted above, the shareholder protection index is divided into two sub-indices—the first measures shareholder protection against various forms of expropriation by boards of directors and management and the second measures the protection that shareholders have against other shareholders. The first consists of 42 items that measure the power of shareholders in the general meeting to amend the articles of association/company constitution and to approve or disapprove of mergers, divisions, increases or decreases in share capital, the sale of substantial assets of the company and the payment of dividends. This sub-index also measures whether shareholders have pre-emptive rights in relation to new share issues, are required to approve directors’ remuneration, and have the ability to appoint and remove directors, demand extraordinary general meetings, put items on the agenda for meetings of shareholders, appoint proxies, obtain information and communicate with other shareholders. It moreover measures the division of power between the board and shareholders, the duration of director's appointments, the imposition of directors’ duties, the applicability of corporate governance codes and the level of public enforcement of corporate law. Each item is given an equal weight in the aggregate index measure.

Figure 1 represents the level of shareholder protection against boards in Australia and the five other countries that were the subject of the 2007 study by Lele and Siems.Footnote ⁴⁸ It indicates an upward trend in the level of shareholder protection against boards in all six countries over the period of the study. Australia had the highest level of protection in 1970, followed by India. From the mid 1970s until the early 1980s the level of protection in India increased to be equal to that of Australia. France, Germany, the UK and the US had similar levels of shareholder protection against boards from 1970 until the early 1980s. Apart from a period in the late 1970s and early 1980s when France had the lowest level of protection, Germany and the US recorded the lowest levels of protection of all of the six countries examined during the entire period of the study. In the mid 1980s the level of protection in the UK and France rose significantly and exceeded the level of protection in Australia until the early 2000s. By 2005 the UK and Australia had the highest level of protection, followed closely by France. India had the next highest level of shareholder protection, followed by Germany and the US.

Figure 1.

Protection Against Boards (42 Items), Six-country Comparison, 1970–2005

The second sub-index in the longitudinal shareholder protection index measures the protection that shareholders have against other shareholders. It contains 18 items that measure a number of matters relating to meetings of shareholders, including shareholder's rights to vote, quorums, supermajority requirements and cumulative voting rights. The items also measure whether shareholders are required to disclose major share ownership, whether minority shareholders are able to be squeezed out by majority shareholders, whether appraisal rights exist following mergers or alterations of the articles of association/company constitution, and if there is a remedy available for oppressed minority shareholders. The sub-index also measures whether shareholder protection is mandatory (for example, whether it is possible to exclude the duty of care owed by directors).

Figure 2 displays the level of shareholder protection against other shareholders in Australia and the other five countries. Unlike Figure 1, it shows no overall sustained upward trend. The level of shareholder protection against other shareholders in Australia and the UK was stable during the period of the study, with similar levels of protection being available in 1970 and 2005. However, this is the only similarity between the two countries. The level of protection in Australia was the highest of all six countries examined in 1970 and the UK was the lowest. In 2005 the level of protection in Australia was the second highest, behind Germany, and the level of protection in the UK was the second lowest, ahead of the US.

Figure 2.

Protection Against Other Shareholders (18 Items), Six-country Comparison, 1970–2005

Compared with Australia and the UK, there was greater variation in the level of protection over the period of the study in France, India and the US. In Germany, the level of protection was stable until the late 1990s when it commenced an upward trend, culminating in 2005 in the highest level of protection of all six countries. The level of protection afforded to shareholders in the US was similar to that in France in 1970 and both countries were situated at the mid level when compared to the four other comparator countries. The level of protection in France remained at a moderate level, whereas in the US the level of protection dropped to the lowest level by 2005. The US is the only country in which the level of protection afforded to shareholders against other shareholders was lower in 2005 than it was in 1970.

In their 2007 article, Lele and Siems note that, while the level of protection afforded to shareholders against boards had risen significantly in the five countries that they examined, the level of protection against other shareholders had not done so. They reason that this may have been caused by a growth in the importance of capital markets during this period, which in turn led to increased diversity of share ownership. They argue that diversity in share ownership would have led to increased pressure for greater levels of shareholder protection against boards.Footnote ⁴⁹ Conversely, diversity in share ownership would have decreased the need for protection against other shareholders.

Lele and Siems argue that the need for protection against other shareholders is greatest in countries where public companies are dominated by holders of large blocks of shares who may be inclined to exploit minority shareholders.Footnote ⁵⁰ They argue that public companies in India, France and Germany are often dominated in this way and it is therefore not surprising that those countries performed better in relation to shareholder protection against other shareholders than did the UK and the US, where dispersed shareholder ownership is more common.Footnote ⁵¹ However, in more recent published research on these same five countries, Armour et al observe that, while India, France and Germany (where blockholder ownership is prevalent) all exhibit higher levels of protection against other shareholders than is the case for the US and the UK, the difference between these countries in terms of the level of protection is modest.Footnote ⁵²

Armour et al also refer to the argument that in countries where dispersed share ownership is the norm it would be expected that the level of protection against boards would receive greater attention than it would in countries where dispersed share ownership is not the norm.Footnote ⁵³ They note, however, that the data indicate that this expectation had not been realized. While the UK exhibited high levels of protection against boards, the US was consistently near or at the bottom of the five countries examined. Armour et al observe that ‘[t]his seems to run contrary to the claim in the law and finance literature that strong protection against boards of directors is associated with dispersed stock ownership’.Footnote ⁵⁴

Figure 3 reports the aggregate index of shareholder protection against both boards and other shareholders in the six countries examined. Apart from a short period of time in the late 1980s and early 1990s when the level of protection in France exceeded that in Australia, the highest level of protection was found in Australia. The level of protection in the UK in 1970 was the lowest of all of the countries examined. However, by 2005 it had risen to be almost equal to that of France and Germany, which were situated immediately below Australia. In 1970 the level of protection afforded to shareholders in the US exceeded that in the UK and India, but by 2005 the figures for the US were the lowest of the six countries examined.

Figure 3.

Aggregate Shareholder Protection Index (60 Items), Six-country Comparison, 1970–2005

In their 2007 study, Lele and Siems noted that the overall level of shareholder protection had improved between 1970 and 2005 in all the countries that they had considered.Footnote ⁵⁵ The same has occurred in Australia. Lele and Siems noted that there had been particular improvement between 2000 and 2005, which they reasoned was not suprising given the attention paid to good corporate governance during this period. Australia, too, shows a sharp rise in the level of protection of shareholders in this same period. Lele and Siems noted that, although there was a general upward trend, for several of the countries examined there were periods in which the aggregate level of protection afforded to shareholders decreased, notably in the 1980s and 1990s. This they attributed to ‘the desire to make law more flexible as it is believed to be more business friendly’.Footnote ⁵⁶ A fall in the level of shareholder protection was not evident in Australia in the 1980s and 1990s.

When compared to the other five countries for which we have comparable data, it is notable that Australia generally provided the highest level of protection to shareholders over the entire period. Even more striking is the high level of protection provided to shareholders in Australia against the actions of other shareholders when compared to other countries. The existing literature has noted the influential argument that countries with high blockholder levels of share ownership should have high levels of legal protection for minority shareholders who would otherwise be subject to possible exploitation by the blockholders.Footnote ⁵⁷ Australia therefore appears anomolous, given that it does not have the levels of blockholder share ownership that exist in countries such as Germany and France. There is research that indicates that Australia sits somewhere between countries regarded as having dispersed share ownership (the UK and the US) and those seen as having high levels of blockholder share ownership (Germany and France).Footnote ⁵⁸ However, Australia does not sit between these two country categories in terms of the level of protection provided to shareholders against the actions of other shareholders. Rather, for almost all of the period studied, it provides the highest level of such protection.

To illustrate the difference in shareholder protection in more detail, if we compare Australia and the US, it is undoubedly the case that shareholder protection is much stronger in Australia than in the US. When compared with shareholders of corporations incorporated in the State of Delaware, shareholders of Australian public companies have greater rights under the Corporations Act to:

• • call meetings of shareholders;

• • remove directors;

• • disapprove of transactions whereby directors receive financial benefits from the company;

• • disapprove of certain share capital transactions (such as reductions in share capital); and

• • participate in an advisory vote on the adoption of the remuneration report at the annual general meeting of a listed company.Footnote ⁵⁹

What explanation can be provided for the finding that, of the countries studied, Australia has the highest level of shareholder protection? Any possible explanation would need to focus on statutory changes rather than court judgments because, as we document below, the former, rather than the latter, have been the source of most of the changes in that protection.

Court judgments are not irrelevant, however. The coding that we have undertaken incorporates court judgments and we have observed differences between countries in some aspects of shareholder protection derived from court judgments. For example, when we compare shareholder protection in Australia and the UK, there are instances where Australian courts have provided superior protection to shareholders. Prior to the introduction of the shareholder's statutory derivative action in Australia,Footnote ⁶⁰ the circumstances when shareholders could commence litigation for claims that properly belonged to the company, such as a claim for breach of duty by a director, were governed by the English case of Foss v Harbottle Footnote ⁶¹ and the exceptions to the principle established in that case—that the company, rather than a shareholder, is the proper plaintiff to bring a legal action for a wrong done to it. A leading English company law scholar compared the approaches of both UK and Australian judges and found Australian judges to be more willing to allow shareholders to commence litigation under one of the exceptions to Foss v Harbottle.Footnote ⁶² This trend continued.Footnote ⁶³ However, despite some differences in shareholder protection based on court judgments, this is not where most differences occur, so we therefore return to considering statutory protection of shareholders.

This leads to a possible political explanation for the high shareholder protection in Australia when compared to the other countries included in our analysis. The Australian Parliament has, over an extended period of time, shown a strong inclination to protect the rights of shareholders, and this is evident when we consider both protection of shareholders against the board and protection of shareholders against the actions of other shareholders. However, it is important to note that this would not seem to be the result of influence by shareholders on the political process. Retail shareholders have not exercised strong political influence and they suffer a collective action problem, despite having a representative organization—the Australian Shareholders Association—that has worked to promote the interests of retail shareholders in recent years. In addition, the influence of insitutional shareholders has not been as prominent in Australia as in some other countries, although this is changing as representative organizations such as the Australian Council of Superannuation Investors and the Financial Services Council (previously the Investment and Financial Services Association) grow in influence.

So if the high level of shareholder protection in Australia is not the result of the political influence of shareholders, it might instead be the result of a notion underlying corporate law reform and adopted by Parliament that one way of responding to corporate collapses and failures in corporate governance is to empower shareholders. In other words, increasing the powers available to shareholders is seen as a means of constraining directors and majority shareholders, and this might in some circumstances prevent future corporate collapses and improve corporate governance. A trend of shareholder empowerment is seen in a number of countries,Footnote ⁶⁴ and it has generated controversy.Footnote ⁶⁵ However, our data suggest that this trend is stronger in Australia than in the other countries included in our study.

We see empowerment of shareholders as a theme of much Australian corporate law reform over the last two decades. These reforms include legislative amendments that, in certain circumstances, require financial benefits provided by public companies to their related parties—including directors and their associates—to be approved by shareholders.Footnote ⁶⁶ We also find this theme in the extensive legislative changes, extending over many years, that have increased the information required to be provided to shareholders.Footnote ⁶⁷ There are features of the Australian legislative framework protecting shareholders that are particularly distinctive. For example, 100 shareholders are entitled to have the directors call a meeting of shareholders and this right extends to shareholders in listed companies.Footnote ⁶⁸ A law reform body examined the right of shareholders to call meetings in 18 countries and in none of these countries did the law allow only 100 shareholders to call a meeting.Footnote ⁶⁹

The theme of empowerment of shareholders is evident in a series of influential law reform reports—some of them by Parliamentary Committees. In 1991, the House of Representatives Standing Committee on Legal and Constitutional Affairs published a report titled Corporate Practices and the Rights of Shareholders. In 2000, the Companies and Securities Advisory Committee (the federal government's independent corporate law reform advisory body) issued Shareholder Participation in the Modern Listed Company. In 2008, the Parliamentary Joint Committee on Corporations and Financial Services published Better Shareholders—Better Company: Shareholder Engagement and Participation in Australia. Each of these reports contained recommendations to enhance shareholder protection.Footnote ⁷⁰

There are several aspects to shareholder protection when examined as part of leximetric research. One of these is shareholder empowerment: that is, granting powers to shareholders, such as the power to approve or disapprove of certain corporate transactions. However, shareholders can also be protected without necessarily being granted specific powers. For example, corporate law might enhance the protection of shareholders by reducing the powers of directors in some way or by requiring directors to act in specific ways. In terms of corporate law reform in Australia, we have seen both these aspects of shareholder protection. It has been observed that favoured corporate law reform and corporate governance strategies in Australia in recent years have included linking managerial pay to company performance; using boards of independent directors to monitor managerial action; and facilitating an active market for corporate control (that is, takeovers) to sanction managers who fail to promote shareholder value.Footnote ⁷¹ These strategies have a strong shareholder focus.

Takeovers are a particularly important corporate transaction because they result in the change of control of the target company. The Australian Corporations Act provides strong protections for shareholders in the context of a takeover, for example by requiring a bid for outstanding shares when a shareholder acquires more than 20 per cent of the existing shares unless there is a statutory exemption, and by imposing disclosure requirements on both the bidder and the target company. These requirements can operate as a significant constraint on blockholder shareholders who are considering acquiring the shares of others.

An important difference between Australia and the US in relation to the balance of power between shareholders and directors, and to shareholder protection, exists in the context of takeovers. In particular, directors of US companies have much greater freedom than Australian directors to implement defensive tactics against hostile takeovers. With regard to the US, Roe observes that in the 1980s the hostile takeover became popular as a means of aligning the interests of shareholders and directors/managers—a board that was not performing could be dismissed by new owners following a hostile takeover.Footnote ⁷² However, US managers were able to thwart this development by lobbying to have laws enacted to stop hostile takeovers and by implementing changes to the corporate structure that raised the costs of hostile takeovers, such as poison pills and staggered boards of directors.Footnote ⁷³ In Australia, by contrast, there are strong limits on the defensive tactics that can be employed by directors who have the intention of thwarting a hostile takeover. For example, Australian Securities Exchange Listing Rule 7.9 deals with issues of shares during a takeover. A defensive tactic when confronted with a hostile takeover is for the board of the target company to issue shares to someone who is friendly to the board—a so called ‘white knight’. However, Listing Rule 7.9 provides that a listed company must not issue or agree to issue shares without the approval of existing shareholders in the company for three months after the company is told in writing that a person is making, or proposes to make, a takeover.Footnote ⁷⁴ In the US, directors of target companies have broad powers to commence litigation to thwart a hostile takeover. In Australia, on the other hand, concerns about litigation being used as a defensive tactic by target company directors led to the establishment of the Takeovers Panel, which decides matters promptly—generally in a matter of days—and access to the courts is usually not permitted while a takeover is underway.Footnote ⁷⁵

In summary, it might be the case that an explanation for the high level of shareholder protection in Australia lies with the pull of shareholder empowerment as an important theme of corporate law reform. However, to say that shareholder empowerment is a theme of Australian corporate law reform leaves unanswered the question of why this might be the case. Might it have something to do with the type of democracy that exists in Australia? Locating explanations for particular types of corporate governance laws or systems in the sphere of politics and the types of democracy that exist around the world has been explored by Roe.Footnote ⁷⁶ He has argued that ‘social democracies’ (which he defines as countries committed to private property but whose governments (1) have a large role in the economy, (2) emphasize distributional considerations, and (3) prioritize employees over investors of capital when the two conflict) are typically countries in which the interests of shareholders are downplayed.Footnote ⁷⁷ He writes that ‘[s]trong social democracies raise the pressure on managers to abandon their shareholders and side with employees to do what managers want to do all along: expand, avoid risk, and avoid rapid change’ and ‘the institutions that would help shareholders—securities laws, corporate laws, and stock exchanges—have not commanded such governments’ attention as important to strengthen’.Footnote ⁷⁸ In these countries, shareholders have sought to control managers by block ownership of shares.Footnote ⁷⁹

Roe tests his theory by examining data for the world's 16 richest democracies, including Australia, and finds a correlation between the political placement of the countries (on what he terms a left to right scale) and share ownership concentration for the largest 20 public companies in these countries. In other words, left-leaning countries tend to have more concentrated share ownership. However, the data for Australia raise questions. Roe classifies Australia as the third most left-wing of the 16 countries. As Cheffins observes, for anyone familiar with Australia's political situation, this ‘looks odd’.Footnote ⁸⁰ Cheffins also questions whether Roe underestimates the extent of share ownership concentration in Australia.Footnote ⁸¹ In addition, Roe's theory has been questioned in terms of its application to the UK.Footnote ⁸²

An alternative theory has been advanced by Christopher Bruner to explain why shareholders are more powerful (or, to use the phrase we have employed for this article, have more protection) in the UK than in the US.Footnote ⁸³ He argues that stronger social welfare policies in the UK that protected the interests of employees and other stakeholders allowed the corporate governance system to promote the interests of shareholders without giving rise to a political backlash. By contrast, in the US, pressure was brought to bear on companies to provide social welfare, and this restricted the promotion of the interest of shareholders. He summarizes his argument as follows:

We can see how this contrast with Roe's thesis. According to Roe, left-leaning countries are associated with a corporate governance system that downplays the interests of shareholders. In contrast, Bruner argues that the left-leaning policies of the UK in the post-war period resulted in a shareholder-focused corporate governance system.

As we conduct further research for this project and, in particular, combine the results of our research with that of colleagues who have been conducting leximetric research on Australian labour law,Footnote ⁸⁵ we expect to be able to evaluate these competing theories in the context of Australia. However, some preliminary observations can be made. Australia had a conservative federal government from 1949 to 1972, from 1975 to 1983 and from 1996 to 2007. It had a Labor government from 1972 to 1975, from 1983 to 1996 and from late 2007 to the time of writing. There were several important corporate law reforms passed in the first half of the 1990s by the Labor government that strengthened shareholder protection.Footnote ⁸⁶ In addition, the Takeovers Panel was established under the Labor government.Footnote ⁸⁷ However, much corporate law reform strengthening shareholder protection occurred under the conservative government that was in power from 1996 to 2007.Footnote ⁸⁸ The conservative government also amended the Corporations Act to protect the entitlements of a company's employees from agreements and transactions intended to defeat recovery of those entitlements.Footnote ⁸⁹ There is therefore no obvious relationship between the political party in power and corporate law reform that increases shareholder protection. However, more detailed research that we are currently undertaking on the history of shareholder protection in Australia may shed light on this issue.

B. Creditor Protection

The creditor protection index is divided into three sub-indices: restrictions on debtor activities, creditor contract rights and creditor rights in insolvency.

1. Restriction on debtor activities

The first sub-index relating to creditor protection measures the extent to which rules restrict or deter debtor companies from entering into transactions that might harm creditors’ interests while the company is a going concern. It has 15 items and these include minimum capital requirements, dividend restrictions, equitable subordination, piercing the corporate veil, transaction avoidance, directors’ liability and public enforcement.

Figure 4 reports the results of the six-country comparison for the restrictions on debtor activities index. It shows that Australia is second only to Germany in these restrictions, indicating its strength against other countries. It also shows relative stability over the period. Australia's comparative strength and stability is in contrast to other common law countries. The UK has clearly improved significantly, with both legislative changes and judicial decision-making responsible. The US, which began more strongly than the UK, has also improved significantly, but remained weaker than the UK at the end of the period for which we have comparative data. India, while quite stable over the period, began weakest and remained so through to 2005. The civil law countries—France and Germany—show much smaller changes than the US and the UK, but the difference between these two countries in terms of our measure of restrictions on debtor activity remained large for the entire period of the study.Footnote ⁹⁰

Figure 4.

Restrictions on Debtor Activities (15 Items), Six-country Comparison, 1970–2005

Some examples illustrate the variations, both between and within families of law and over time. A requirement that a company maintain a minimum share capital has been used extensively in European civil law countries,Footnote ⁹¹ but Australia has no such requirement. However, this distinction is not clear-cut: private and public companies generally have separate and dissimilar rules. For example, in France the law changed in 2003, removing the requirement for a private company to maintain a minimum capital,Footnote ⁹² whereas other civil law systems have retained or improved their capital maintenance requirements.

The US has consistently had weak laws in relation to maintenance of capital.Footnote ⁹³ In contrast, in the UK capital maintenance has been contentious over the past decade. The Department of Trade and Industry White Paper entitled Company Law Reform considered capital maintenance ‘largely irrelevant’ for private companies and their creditors.Footnote ⁹⁴ The Companies Act 2006 (UK) saw a significant relaxation of the requirements in relation to reductions of share capital for private companies, although their obligations with respect to legal capital under article 6 of the Second Company Law Directive restrain any further changes for public companies.Footnote ⁹⁵

Even within legal families, significant variation can occur. An example is the insolvent trading liability of holding companies. In Australia, section 588V of the Corporations Act renders a holding company liable for the subsidiary's debt when the subsidiary has traded while insolvent, where the holding company's directors were aware or should have been aware of reasonable grounds for suspecting insolvency. This change to the law in 1992 was not based on an equivalent English provision, as the Cork Report in 1982 had refused to recommend holding company liability in such circumstances. Cork's reluctance was due to fears about effects on entrepreneurship and apportionment of liability. In addition, there were fears that such a duty might expose directors of the holding company to a position of conflict between their duties to their own company and their responsibilities to other companies in the group.

Australia's new dividend definition also differs from the present English law. The new section 254T of the Corporations Act prohibits a public or proprietary company from paying a dividend unless its assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend. Further, the payment of the dividend must be fair and reasonable to the company's shareholders as a whole and not materially prejudice the company's ability to pay its creditors. This wording is similar to the creditor protection tests in other capital maintenance provisions in the Corporations Act. Prior to this, Australian law had required only that the dividend be paid from profit, leaving the definition of profit to a generous and sometimes contradictory common law. In contrast, the Companies Act 2006 (UK) retains the general permission to pay dividends from profits but then provides statutory guidelines for its definition that resemble some of the Australian common law tests. However, in relation to public companies, further restrictions apply. These are based on the company's net assets, and a variety of calculations are required, taking into account uncalled capital and undistributable reserves. These reserves include the share premium account, a concept that was made redundant in Australia with the abolition of par value in 1995.Footnote ⁹⁶

The lack of influence of legal origin is apparent with regard to equitable subordination of shareholder loans to the company. Equitable subordination occurs where the payment of debts owed by a company to shareholders is deferred behind the payment of outside creditors. Both the US and Germany adhere to this doctrine. Its origins in the US lie in the leading 1939 cases of Taylor v Standard Gas & Electric,Footnote ⁹⁷ known as the ‘Deep Rock’ case, and Pepper v Litton.Footnote ⁹⁸ The doctrine was codified in 1978.Footnote ⁹⁹ German courts have also permitted the subordination of shareholder debtFootnote ¹⁰⁰ since the late 1950s,Footnote ¹⁰¹ and Germany's rules on equitable subordination were then codified in 1980.Footnote ¹⁰² However, despite the apparent similarities between these two jurisdictions, the substance of their laws differs.Footnote ¹⁰³ The other jurisdictions under consideration do not allow for the subordination of shareholder debt. The UK Cork ReportFootnote ¹⁰⁴ advocated subordination in a limited form,Footnote ¹⁰⁵ but this proposal was not implemented.Footnote ¹⁰⁶

2. Creditor contract rights

The second index measures creditor contract rules. It has 10 items and these include set-off, enforcement of contracts, the availability of security interests and retention of title. Figure 5 represents changes in creditors’ mechanisms for self-protection outside of insolvency proceedings, either under the law or through their own contracts with the debtor. Generally creditors may self-protect through a variety of non-possessory security interests and can appoint a receiver to enforce their claims. This has been a relatively stable area of the law over the survey period. The graph shows the results of the six-country comparison for the creditor contract rights index. Australia is again seen to perform strongly over time and in comparison to the other countries studied. France begins and remains the weakest of all the jurisdictions. Armour et al account for France's result as an outlier rather than an indication of inherent weakness in civil law countries, although they recognize that Germany, which was very stable throughout the period, also ends weaker than the common law countries.Footnote ¹⁰⁷ The comparative strength of the common law countries is not, however, attributable to the legal origin effect. The reduction in the US score is explained by the introduction of the US Bankruptcy Code in 1978,Footnote ¹⁰⁸ which made a number of adverse changes, for example to set-off rights.Footnote ¹⁰⁹ On the other hand, the improvement in India's score is attributable to two pieces of legislation to improve recovery of debts.Footnote ¹¹⁰

Figure 5.

Creditor Contract Rights (10 Items), Six-country Comparison, 1970–2005

The changeability of the UK position is explained by a number of court judgments, principally in relation to retention of title (RoT) clauses. The 1976 Romalpa decisionFootnote ¹¹¹ was responsible for the upward movement in its index. As in Australia, subsequent decisions moderated its application. However, in Australia the question has now been settled with the passage of the Personal Property Securities Act 2009, which introduced the registration of some RoT clauses. The Act was based on legislation in New Zealand that was itself copied, almost verbatim, from Canadian laws. In the UK, on the other hand, RoT clauses do not have to be registered. A series of committees has considered the matter: in 1982, the Cork Report recommended a disclosure requirement for some of the terms of an RoT clause; in 2001, the Company Law Review Steering Group suggested that complex RoT clauses should be registered in a proposed notice-filing system for registrable charges. However, the 2005 Law Commission Report deferred consideration of registration of RoT clauses.

3. Creditor rights in insolvency

This index consists of 19 items, including structure (does the law provide for both liquidation and rehabilitation), trigger mechanisms, the parties in control, voting on exit and the subordination of priorities.

Figure 6 shows the results of the six-country comparison for the creditor rights in insolvency index. It is characterized by a series of downward turns, with the exception of Australia and Germany, which both begin strongly and end up more highly placed. The increase in the level of protection that occurred in Australia in 1993 is explained by the introduction of voluntary administrationFootnote ¹¹² as an alternative to liquidation. The UK completes the trio at the top of the index.Footnote ¹¹³ Again, the influence of legal origin is not apparent. The ranking of the US as weakest reflects its pro-debtor, anti-creditor stance in times of insolvency as a result of the automatic stay on assets, preventing secured creditors from taking possession of their security. However, this can improve the chances of successful reorganization to the benefit of unsecured creditors, and exemplifies the challenges of a leximetric analysis of creditor protection. The right of management to seek Chapter 11 protectionFootnote ¹¹⁴ without the consent of creditors and to remain in charge of the company while reorganization is attempted also thwarts the secured creditors. However, it may ultimately advantage unsecured creditors if management's familiarity with the affairs of the company assists them in their attempts to rescue the business.Footnote ¹¹⁵ In contrast, Australia's rescue mechanisms displace management; while there has been a statutory moratorium on enforcement of security without administrator permission or leave of the court since 1993,Footnote ¹¹⁶ the administration period is relatively short.

Figure 6.

Creditor Rights in Insolvency Index (19 Items), Six-country Comparison, 1970–2005

The significant decline in the French position is explained by the enactment of its insolvency laws in 1985.Footnote ¹¹⁷ These are now codified in the Commercial Code and are expressly designed to save workers’ jobs using creditors’ money.Footnote ¹¹⁸ Despite the different legal families, the French laws have a similar underlying philosophy to India's Sick Industrial Companies Act 1985 (SICA), which aims to save the company by severely restricting the rights of creditors to enforce their claims.Footnote ¹¹⁹ Thus the US finds itself closely positioned with France and India on the index, despite the US laws being underpinned by a different rationale.

C. Concluding Observations Regarding Shareholder and Creditor Protection

Our findings do not offer support for legal origins theory. In relation to the level of shareholder protection against boards, despite Australia and the US being in the same legal origin category, over the 35-year period of study Australia had the highest protection for shareholders and the US had the lowest. Despite being in different legal origin categories, Australia and France had the highest protection for shareholders. When we examine the level of protection of shareholders against other shareholders, despite being in different legal origin categories, Australia and Germany had the highest protection for shareholders. Although Australia, the US and the UK are in the same legal origin category, over the period of study Australia had the highest protection for shareholders yet the US and the UK generally had the lowest level of protection. When all 60 shareholder protection items are combined, over the period of the study Australia generally had the highest level of shareholder protection and the US the lowest, despite both counties being in the same legal origin category.

In relation to creditor protection, Armour et al and Siems make a number of observations about the creditor protection data of the five countries they surveyed and these will only be summarized here briefly. Siems observes ‘unambiguous differences’ between the UK and the US despite their common law legal category, which he explains by way of regulatory competition within the US.Footnote ¹²⁰ He cautions against finding a legal origin effect between the UK and India: while there are similarities between ‘law on the books’, these must be understood in the context of serious delays in the enforcement of creditor rights in India,Footnote ¹²¹ only partly remedied by the SARFAESI Act 2002. Siems notes the lack of similarities between the US and India, which is accounted for by the differing political and legal cultures of the two countries.Footnote ¹²²

What is striking about the aggregate index is the way in which the three groups of items ‘even out’ once combined. Armour et al observe ‘no clear pattern of difference … between the overall scores of civil and common law jurisdictions … [and] the nature of change over time again looks remarkably similar across the common law/civil law divide’.Footnote ¹²³ They further observe that ‘[o]nce the main indices are broken down into their component parts, we can see that countries can arrive at similar levels of protection overall, through different methods’.Footnote ¹²⁴

Figure 7, which is the aggregate creditor protection index for the six-country comparison, shows Australia as a leader in creditor protection with a persistently high ranking, but its score mirrors Germany more than it does the UK. Thus its relative strength is confirmed on an agreggate level, but not its adherence to, or convergence with, other countries in its legal origin category.

Figure 7.

Aggregate Creditor Protection Index (44 Items), Six-country Comparison, 1970–2005

When we consider both shareholder and creditor protection over the period of the study, there are increases in both shareholder protection and creditor protection in Australia, the UK and Germany. However, when we consider the other three countries—France, India and the US—although they each had stronger shareholder protection over the period of the study, the level of creditor protection declined. These findings do not support legal origins theory.