Corporate Ostracism: Freezing Out Controlling Shareholders

One of the most central questions of corporate law is how to deal with controlling shareholders. On the one hand, the presence of a controlling shareholder can benefit the corporation, particularly by subjecting managers to better monitoring. On the other hand, there is always the risk that the controller will abuse his influence and enrich himself at the expense of the other shareholders. Traditionally, corporate law has tried to solve this dilemma by focusing on individual transactions suspected of being unfair. However, such a transaction-centered approach has significant drawbacks. Most importantly, it strikes the wrong balance between the interests of the controller and those of the other shareholders. From an efficiency perspective, the amount of benefits that the controller should be able to extract from the corporation depends both on how valuable his presence is to the corporation and on the extent to which the controller bears costs of control that he cannot share with the other shareholders. However, the transaction-centered approach fails to take these factors into account because it only focuses on the fairness of individual transactions. As a result, the level of benefit extraction is bound to be too high in some corporations while being too low in others. The present article, therefore, presents an alternative to the transaction-centered approach: Minority shareholders should be given the right to expel the controller, and at the same time, corporations should be allowed to opt out of the transaction-centered protections that existing law imposes. The proposed regime would ensure that controllers cannot extract benefits in excess of what their presence yields. Moreover, it would allow controllers to receive sufficient compensation for those costs of control that they cannot presently share with the other shareholders.