7 diciembre, 2020

Por Paúl Noboa Velasco

Corporate law should address the conflicts of interests arising among the different parties involved in a corporation. These conflicts, usually referred to as ‘agency problems’, arise because the company’s insiders can influence and control the outsiders’ property and wellbeing (Armour, Enriques et al., 2017).

Generally, the Latin American corporate framework is characterized by the existence of a controlling shareholder who can directly or indirectly monitor and control the company’s management. According to the OECD“in Latin American firms, corporate control is tightly exercised by majority shareholders.” Unlike jurisdictions with a more dispersed shareholding pattern (e.g., USA, UK), at least in the context of public companies, Latin American shareholders usually have more stakes in their companies and, as a result, more incentives to assume a more active role monitoring directors. As a result, as some authors have argued, in the typical Latin American company (and Ecuador is not an exception), controlling shareholders appoint, remove, pay and closely monitor the directors. In fact, controlling shareholders often serve as corporate directors themselves. Therefore, there is an alignment of incentives between directors and shareholders.

Thus, in countries like Ecuador, the agency problem that arises among shareholders (as principals) and directors (as agents), is not as relevant as the conflict of interests between controlling and non-controlling shareholders – especially, the risk of opportunism of controlling members vis-à-vis minority shareholders. In this relationship, controlling shareholders, as agents of non-controlling members, could abuse their position of dominance for their principals’ prejudice (Armour, Enriques et al., 2017). In countries with concentrated shareholding patterns, corporate law should establish mechanisms to mitigate this conflict of interest, with the ultimate objective of protecting non-controlling shareholders. In a recent paper, I explore different mechanisms to address those agency problems, typically existing in an Ecuadorian company.

First, controlling shareholders could take advantage of their dominant position to approve the issuance of new shares and, as a result, increase their stake on the company. When new shares are allotted, non-controlling shareholders face the risk of losing some or all of their voting power (Ventoruzzo, 2013). Besides, the value of the minority’s investment may also decrease. Company law should protect non-controlling shareholders from dilution (Ferran and Chan Ho, 2014). Pre-emptive rights, which are applied when a public or a closely-held company decides to allot new shares, offer adequate protection to non-controlling shareholders. According to this rule, when a company’s general meeting resolves to issue new shares, current shareholders should have priority to acquire them.

Despite its protective role for the benefit of non-controlling members, pre-emption rights may be costly and time-consuming. Therefore, this ex-ante protection should be balanced with the company’s ability to receive fresh capital to finance its operational activities. Based on an opt-out provision, shareholders of private companies should have the alternative of disapplying this regime. The recent regulation of the Simplified Corporation (or SAS, following their Spanish acronym) is a clear example of this approach in Latin-America. Concerning the Simplified Share Companies, pre-emptive rights apply unless the company’s shareholders have expressly decided to waive them. Besides, shareholders of an Ecuadorian SAS are required to cast their vote for the company’s benefit. According to the Ecuadorian Companies Act, shareholders are prohibited from voting to cause unfair prejudice to other shareholders (Ecuadorian Companies Act, unnumbered article entitled the abuse of the right to vote). Therefore, if the issuance of new shares was decided with the sole intention of diluting non-controlling shareholders, they are allowed to request the invalidation of the mentioned allotment. Through this provision, the Ecuadorian Companies Act protects minority shareholders from the so-called equity tunneling to the same extent than the pre-emptive regime does.

Second, controlling shareholders may transfer the company’s assets to themselves through self-dealing transactions. (Johnson, La Porta, et al., 2000). Some authors have argued that controlling shareholders can divert the company’s wealth for their benefit in several ways. For example, controlling shareholders may engage in undervalued transactions by acquiring the company’s property for less than its market value (asset tunneling out). Besides, controlling shareholders may celebrate overvalued dealings with the company, by selling their personal property to the company for more than its market value (asset tunneling in). Third, controlling shareholders may divert the company’s cash flow for their benefit (for example, through authorizing a loan in a general meeting). These transactions may be detrimental to non-controlling members, since majority shareholders have the opportunity of approving, by themselves, dealings that may allow them to expropriate the company’s resources and property.

There are different mechanisms to deal with related party transactions that can destroy or opportunistically divert value from the company. One of them is the approval of a related party transaction by shareholders who do not have any stake in the operation. According to the Ecuadorian Corporate Modernization Bill and the Corporate Governance Code, property transactions with a controlling shareholder should be approved, in a general meeting, only by members who are not a related party. Therefore, controlling shareholders directly or indirectly interested in the operation cannot take part in the transactions’ approval. This procedure prevents controlling related parties from abusing their position of dominance and limits abusive extractions of value from the company.

Considering its pattern of concentration of capital, the shareholding agency problem is the most relevant corporate agency problem in Latin-America. Controlling shareholders may take advantage of their dominance position to oppress non-controlling members or expropriate the company’s resources for their benefit, without any supervision or control. Regulating transactions among controlling shareholders and the company could mitigate the conflicts of interests between controlling shareholders (as agents) and non-controlling shareholders (as principals).