CENT R E FOR LA W A ND F INA NCE

CENT R O D I D IR IT T O E F INA NZ A

Working Paper Series

GUIDO FERRARINI
Shareholder Value
and the Modernisation of
European Corporate Law

WP 3-2000
1
Draft 28/9/00

Shareholder Value and the Modernisation of European Corporate Law

Guido Ferrarini
University of Genoa

I. Finance Theory and Corporate Law

Aims and Scope of the Paper

This paper will analyse some of the corporate law institutions and practices which offer
the organisational setting for the shareholder wealth creation process, such as those on board
of directors and executive remuneration; takeover regulation and defensive measures; financial
restructurings and share buy-backs. The focus on wealth maximisation is consistent with recent
“law and finance” research which analyses corporate law from an investor protection
perspective, concentrating on shareholders and creditors’ rights, and their enforcement 1. The
present work is concerned with rules which are functional to the increase of shareholder
value2, and often coincide with those on agency costs reduction3. The general question to be

1
See La Porta, Lopez-de-Silanes, Shleifer and Vishny, ‘Law and Finance’ (1998) 106 J. Pol.
Ec. 1113.
2
The rules on boards of directors are studied from a performance perspective in empirical
works of finance: for a recent review, see Lohn and Senbet, “Corporate Governance and Board
Effectiveness” (1998) 22 J. of Banking & Fin. 371, at 380 ff. ; see para. II below.
3
One of the central issues in corporate governance discussion is the agency costs’ problem,
which derives from the separation of ownership and control, and refers to the “difficulties
financiers have in assuring that their funds are not expropriated or wasted on unattractive
projects”: see Shleifer and Vishny, ‘A Survey of Corporate Governance’ (1997) 52 J. Fin. 737,
741. Corporate law provides ways to minimise such costs and indemnify the damaged investors.
More than shareholder value creation, it is the reduction of managerial opportunism that is
central to this area of the law. Indeed, the major problem dealt with by corporate law is “how to

2
asked is whether European corporate law is sufficiently responsive to the needs of
shareholder value creation4. I will try to answer that question with reference to a number of
aspects of European corporate law and to indicate lines for future research.
This paper is organised as follows. Firstly, the shareholder value approach will be
analysed and the convergence of the legal systems toward a shareholder model of corporate
law will be examined5. Secondly, the legal duties of managers with respect to shareholder
value creation shall be considered, looking at the European best practices. Moreover, the
controls and incentives applicable to managers will be examined from the internal governance
viewpoint, focusing on the board of directors’ role in corporate strategy formulation and in the
selection, monitoring and remuneration of management. Thirdly, the market for corporate
control will be discussed with regard to the defensive arsenal available to targets in the
American and European jurisdictions, and the use and limits of defensive measures and
alternative arrangements. The monitoring function of the market for corporate control is widely
acknowledged6, as is the fact that takeovers generally enhance corporate value: “since targets
gain and bidders do not lose, the evidence suggests that takeovers create value”7. Fourthly,
financial restructurings will be approached from a law and finance perspective, focusing on
share repurchases and the rules on financial assistance. I will argue that the design of corporate
law structure should be such as to reduce the cost of equity capital and provide techniques for

keep managers accountable to their other-directed duties while nonetheless allowing them great
discretionary power over appropriate matters” (Clark, Corporate Law, 1986, pp. 33-34).
4
Corporate law is concerned with shareholder value creation, despite the fact that the
corporation’s purpose is traditionally defined as profit maximisation which does not necessarily
coincide with shareholder wealth maximisation. American law and finance scholars tend to
consider profit maximisation as equivalent to shareholder value maximisation: see Easterbrook
and Fischel, The Economic Structure of Corporate Law, 1991, pp. 36 ff.; Romano, The
Genius of American Corporate Law, 1993, p. 2. Finance theory, however, makes a distinction
between the two concepts (see e.g. Ross, Westerfield and Jordan, Fundamentals of Corporate
Finance, 5th ed. 2000, p. 9 f.), as reflected by the shareholder value literature: see e.g.
Rappaport, Creating Shareholder Value, 2nd ed. 1998, pp. 13 ff.; see also note 11. As to
British law, see Davies, in this volume, p. …. , arguing that company law facilitates but does not
require or guarantee the maximisation of shareholder value.
5
On this convergence, see Hansmann and Kraakman, ‘The End of History for Corporate Law’,
Yale Law School, Law and Economics Working Paper No. 235, January 2000,
http://papers.ssrn.com/paper.tof?abstract_id=204528.
6
Manne, ‘Mergers and the Market for Corporate Control’ (1965) 73 J. Pol. Ec. 110;
Easterbrook and Fischel, op. cit., note 4, p. 171.

3
financial restructuring (spin-offs, debt-financed recapitalisations, leveraged buy-outs, etc.)
which promote shareholder value creation8.

The Shareholder Value Approach

If we adopt a corporate manager’s standpoint and ask what a good financial

management decision is, the answer given by a standard finance textbook is straightforward:
“the goal of financial management is to maximize the current value per share of the existing
stock”9. This statement requires some explanation. Clearly, firms should be managed so as to
make money or “add value” for their owners. The problem is to define this objective
adequately. Reference to profit maximisation is frequent, but lacks precision. First of all, it is
not clear whether we should refer to short-term, long-term or average profits10. Furthermore,
accounting earnings fail to measure changes in the economic value of the firm11. Under the
economic model of valuation, share prices are determined by investors looking at “about just
two things: the cash to be generated over the life of a business and the risk of the cash

7
Jensen and Ruback, ‘The Market for Corporate Control’ (1983) 11 J. Fin. Ec. 5, 22.
8
“The great mystery is how merely changing the financial or ownership structure can enhance
the value of assets residing on the other side of the balance sheet”: Stewart, The Quest for
Value. The EVA™ Management Guide, 1990, p. 9.
9
Ross, Westerfield and Jordan, op. cit., note 4, p. 11. Consequently, the object of corporate
finance as a field of study is defined by saying that “we need to learn how to identify those
investments and financing arrangements that favourably impact the value of the stock”. In other
words, corporate finance is “the study of the relationship between business decisions and the
value of the stock in the business”.
10
Ibid., p. 9. If we refer to short-run profits, then actions such as deferring maintenance will
tend to increase profits, but are not necessarily desirable. If we refer to long-run profits, then it is
not clear what the appropriate trade-off is between current and future profits.
11
See Rappaport, op. cit., note 4, pp. 1-2. There are three important reasons why earnings fail
to measure changes in the economic value of a firm: (i) alternative accounting methods may be
employed (prominent examples are the differences that arise from last-in, first-out (LIFO) and
first-in, first-out (FIFO) approaches to computing cost of sales, various methods of computing
depreciation, and purchase versus pooling-of-interests accounting for mergers and acquisitions);
(ii) investment requirements are excluded (to move from earnings to cash flow, two adjustments
are needed: firstly, the depreciation must be added back to earnings; secondly, capital
expenditures must be deducted from earnings); (iii) time value of money is ignored for earnings
calculation (whereas the economic value of an investment is the discounted value of the
anticipated cash flows). The author concludes that, in light of these differences “it should come

4
receipts”12. The appropriate goal for a firm, therefore, is to maximise the current value of the
stock. The criterion is unambiguous and does not pose any short-run versus long-run issue13.
Looking at corporate practice, the shareholder value philosophy has gained
widespread acceptance in the United States. Until the early eighties, management thinking was
largely governed by a short-term earnings orientation14. Subsequently, corporate raiders
provided an incentive for managers to focus on creating value. In the nineties, similar effects
were obtained by institutional investors who demanded long-term value creation15.
Furthermore, with the globalisation of both competition and capital markets along with the
wave of privatisations, shareholder value has been capturing the attention of executives in the
United Kingdom, Continental Europe, Australia and even Japan16.
Creating value is complex. The crucial rule is offered by the theory of finance and is
incorporated in the “net present value” approach to the capital budgeting decision (i.e. the
process of planning a firm’s long-term investments): “an investment should be accepted if the
net present value is positive and rejected if it is negative”17. If there is no market price for the
investment – as often happens – its net present value (NPV) needs to be estimated. The future
cash flows from the investment have to be estimated, in the first place18. Their present value
must then be calculated through a procedure called the discounted cash flow (DCF)
valuation19. If the result is negative, the investment in question is not a good one and should not
be undertaken20.

as no surprise that earnings growth does not necessarily lead to the creation of economic
value for shareholders”.
12
See Stewart, op. cit., note 8, p. 22, who adds: “The accounting model relies on two distinct
financial statements – an income statement and balance sheet – whereas the economic model
uses only one: sources and uses of cash” (p. 24).
13
Ross, Westerfield and Jordan, op. cit., note 4, p. 11.
14
Rappaport, op. cit., note 4, pp. 1-2.
15
Ibidem, p. 2.
16
Ibidem.
17
Ross, Westerfield and Jordan, op. cit., note 4, p. 247.
18
See Copeland, Koller and Murrin, Valuation. Measuring and Managing the Value of
Companies, 2nd ed. 1996, pp. 135 ff.
19
Ross, Westerfield and Jordan, op. cit., note 4, pp. 246 f., and chapters 5 and 6.
20
Ibidem, p. 247, where it is specified: “in the unlikely event that the net present value turned
out to be exactly zero, we would be indifferent between taking the investment and not taking it”.

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 Cash flows should be estimated both after taxes and after all reinvestment needs have
been met, but before interest and principal payments on debt (as the firm’s cash flows are
directed to both its equity and debt investors)21. The expected cash flows need to be
discounted back at a rate that reflects the cost of financing the investment. The relevant
concept is that of overall cost of capital, including both the cost of equity and the cost of
debt22. An equivalent concept is that of required return. If the cost of capital (or required
return) for an investment is 10 percent, the NPV is positive only if the investment’s return
exceeds 10 percent 23.
From the applied finance perspective, other criteria have been developed to assist
managers in the difficult task of creating value24. One of the most popular is defined as
economic value added (EVA), which is operating profits less the cost of all of the capital
employed to produce them25. Management should focus on maximising EVA, which “will
increase if operating profits can be made to grow without tying up any more capital, if new
capital can be invested in projects that will earn more than the full cost of the capital and if
capital can be diverted or liquidated from business activities that do not provide adequate
returns”26. In essence, EVA does not depart from conventional valuation analysis27. The net

21
See Damodaran, “Value Creation and Enhancement: Back to the Future” (1999) Columbia
University Finance Department Working Paper (FIN-99-018), pp. 4-5, suggesting the following
formula: EBIT (1-tax rate) – (Capital Expenditures – Depreciation) – Change in non-cash
working capital = Free Cash Flow to the Firm. The author comments that “the difference
between capital expenditures and depreciation (net capital expenditures) and the increase in the
non-cash working capital represent the reinvestments made by the firm to generate future or
contemporaneous growth”.
22
See Ross, Westerfield and Jordan, op. cit., note 4, pp. 418 ff., referring to the weighted
average cost of capital (WACC), which is calculated on the basis of the respective weights of
equity and debt (if total value is V, the former is E/V, the latter is D/V, and V = E + D), the cost
of equity (RE) and the cost of debt (RD) after taxes (TC is the corporate tax rate). Consequently:
WACC = (E/V) x RE + (D/V) x RD x (1 – TC).
23
Ibidem, p. 419.
24
For a critical overview, see Damodaran, op. cit., note 21, arguing that the traditional
discounted cash flow model can be complex, as the number of inputs increases, and that it is
very difficult to tie management compensation systems to this model. “In this environment, new
mechanisms for measuring value that are simple to estimate and use, do not depend too heavily
on market movements, and do not require a lot of estimation, find a ready market” (pp. 30-31).
25
Another is “cash flow return on investment” (CFROI), which measures the percentage return
made by a firm on its existing investments: ibidem, p. 31.
26
Stewart, op. cit., note 8, p. 3.

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present value prescription is simply restated as follows: “accept all investment opportunities
which will produce a positive discounted EVA”28.

Shareholders and Stakeholders

An important question which has been widely discussed by economists and lawyers, in
connection with the creation of shareholder value, is whether corporate managers should
exclusively maximise shareholder return or balance the interests of all stakeholders29.
(i) The Anglo-American Model. An idea which was popular in the U.S. until the early
eighties held that corporations should be “socially responsible” institutions managed in the
public interest30. Today, the prevailing opinion is that management’s primary goal should be to
maximise value for shareholders. One reason is that managers should be held accountable to
someone: “a manager told to serve two masters (a little for the equity holders, a little for the
community) has been freed of both and is answerable to neither”31. Another reason is that
maximising profits for equity investors assists the other “constituencies” automatically. In a
market economy, successful firms provide jobs for workers, goods for consumers and
prosperity for stockholders. Wealthy firms provide better working conditions and social
wealth, including cleaner environments32.

27
Damodaran, op. cit., note 21 arguing that there is little that is new or unique in these
competing measures, and while they might be simpler than traditional discounted cash flow
valuation, the simplicity comes at a cost.
28
See Stewart, op. cit., note 8, p. 3.
29
Rappaport, op. cit., note 14, p. 5; Tirole, ‘Corporate Governance’, C.E.P.R. Discussion Paper
No. 2086, 1999, pp. 36 ff.
30
Blair, Ownership and Control. Rethinking Corporate Governance for the Twenty-First
Century, 1995, p. 202. Hansmann and Kraakman, op. cit., note 5, p. 4, refer to a “manager-
oriented model” of corporate law and argue that at the core of it “was the belief that
professional corporate managers could serve as disinterested technocratic fiduciaries who would
guide business corporations in ways that would serve the general public interest”. They find in
the corporate social responsibility literature of the 1950s (Merrick Dodd, John K. Galbraith and
Adolph Berle) “an embodiment of these views”.
31
Easterbrook and Fischel, op. cit., note 6, p. 38; Tirole, op. cit., note 29, pp. 5 ff.: shareholder
value provides more focus and sharper incentives to managers; it also prevents deadlock in
decisionmaking.
32
Easterbrook and Fischel, op. cit., note 6, p. 38.

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 Shareholders have governance rights because they are the residual claimants and have
the best incentives to reduce agency costs, being those who gain the most from efficient
production33. According to a recent American view, firms should maximise stockholder value
subject to a “good citizen” constraint, i.e. they should try to minimise social costs even in the
absence of a legal obligation to do so34. In fact, companies that establish a reputation for being
“good corporate citizens” can use it to their benefit. Ultimately, companies will become more
socially responsible if it is “in their best interests economically to not create social costs”35.
(ii) The German Model. The elements for analysis appear to be different in
Continental Europe, particularly if we consider the German governance model. This model is
characterised by co-operation and long-term relationships among stakeholders in the firm36.
The concept of the “interest of the company as a whole” is “a key concept of German
corporate culture”37. Klaus Hopt makes a sharp distinction between the German and U.S.
models by saying: “Maximisation of shareholders’ wealth has hardly ever been the objective of
German stock corporations, certainly not in companies with dispersed ownership or regarding
payment of dividends”38. The German model is more oriented to the enterprise than to the
corporation, as reflected by “the discussion on Aktiengesellschaft versus

33
Gilson and Roe, “Understanding the Japanese Keiretsu: Overlaps between Corporate
Governance and Industrial Organisation” (1993) 102 Yale L. J. 871, at 887; Blair, op. cit., p. 227
ff., arguing however that the goal of good corporate governance should be to maximise the
wealth creating potential of the corporation as a whole, rather than just to maximise value for
shareholders; these two goals differ whenever some participants in the enterprise other than
shareholders make special investments in physical assets, organisational capabilities, or skills
whose value is tied to the success of that enterprise: see pp. 275 ff.; see also Tirole, op. cit.,
note 29, p. 43, noting that shareholder value leaves scope for important externalities and some
distasteful implications.
34
For an account of this view, see Damodaran, Applied Corporate Finance, 1999, p. 29. This
view substantially reflects the A.L.I. Principles of Corporate Governance (see note 74 below).
35
Ibidem, arguing that firms that are perceived as socia lly irresponsible could lose customers
and profits, and that investors might avoid buying stock in these companies: “as an example,
many college and state pension plans in the United States have started reducing or eliminating
their holdings of tobacco stocks to reflect their concerns about the health effects of the product”.
36
For an overview, Gelauf and den Broeder, Governance of Stakeholder Relationships. The
German and Dutch Experience, SUERF Studies No. 1, 1997, pp. 26 ff.
37
Schneider-Lenné, “Corporate Control in Germany” (1992) 8 Oxford Review of Economic
Policy 11.
38
Hopt, ‘Labor Representation on Corporate Boards: Impacts and Problems for Corporate
Governance and Economic Integration in Europe’, in Buxbaum et al. (Eds.), European
Economic and Business Law, 1996, p. 269.

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Aktienunternehmen and Gesellschaftsrecht versus Unternehmensrecht”39. The two
models are also compared by saying that the Anglo-American model reflects a “shareholder
society”, whereas the German model corresponds to a “stakeholder society”, and that their
relevant features derive more from differences in national institutions than in managerial
objectives40.
In this scenario, little room seems to be left for shareholder value. However, changes
are under way also in the German governance model, as a consequence of globalisation and
the new weight of the securities markets in the financing of enterprises. According to a recent
comparative study, “perhaps the most dramatic manifestation of a changing corporate
landscape has been the sudden emergence of a distinctly Anglo-Saxon concept: the need for
senior company officers to concentrate on the creation of what most in Germany refer to
simply as ‘shareholder value’ ”41. Indeed, the use of the term has become fashionable and
corporate managers pay more than lip service to the interests of shareholders42. On the
doctrinal level, efforts have been made to host the shareholder value concept in the corporate
law structure43. This reflects a more general trend towards a greater shareholder focus in

39
Ibidem, arguing that labour co-determination has contributed to this outlook of the German
system, without being a decisive factor.
40
See Gelauf and den Broeder, op. cit., note 36, p. 36, arguing that under German institutions it
is rational for managers to take the interests of stakeholders into account and to invest in long
term relationships; see also Kay, The Business of Economics, 1996, pp. 112 ff. suggesting that
some aspects of the German “trusteeship model” of corporate governance offer advantages
with respect to the “agency model” prevailing in the U.S. and the U.K. and should be adopted
to build a new model of corporate governance.
41
André, ‘Cultural Hegemony: the Exportation of Anglo-Saxon Corporate Governance
Ideologies to Germany’ (1998) 73 Tul. L. Rev. 69, at 109 ff.
42
Several indicia of the consideration given to shareholder value are offered, such as the
establishment of investor relations departments by listed companies; corporate restructurings and
downsizing; increasing use of the services of American investment banks: ibidem, p. 110. Of
course, no cultural revolution is to be expected. On the one hand, the concept of shareholder
value is hardly self-defining and may serve different purposes; on the other, some are sceptical
of the Anglo-Saxon challenge to the German consensus mentality which is represented by the
concept at issue; see ibidem, 112-115, reporting that much of the debate in Germany has
focused on the “excesses” of a concept believed to be imported wholesale from the U.S.
43
Mülbert, ‘Shareholder Value aus rechtlicher Sicht’ (1997) ZGR 129, at 141 ff.; v. Werder,
‘Shareholder Value-Ansatz als (einzige) Richtschnur des Vorstandhandelns?’ (1998) ZGR 69, at
74 ff.

9
corporate governance and reform44, as also witnessed by the 1998 Law on the Control and
Transparency in business (KonTraGesetz)45.
(iii) Mixed Models. These models are characterised by the concurrence of the
institutional and the contractual views of the corporation, and also by a growing shift from the
former to the latter view46. In France, the corporate governance best practices are increasingly
focused on the shareholders’ interests47, even if the “corporation as a firm” conception has not
entirely been abandoned (see para. II below). A mixed view of the company appears to be
still dominant: “la société présente à la fois des caractères contractuels et des caractères
institutionnels”48, as reflected by the discussion on the intérêt social and its relationship with
the intérêt commun49. However, in the case of listed companies, it is the intérêt du marché
which prevails over the company’s interest50.
In Italy, the institutional theory of the corporation was dominant in the first half of the
last century, under the influence of the German model, and was then adhered to by the
Supreme Court51. However, this theory was vigorously opposed by the legal writers in the

44
Schmidt et al., Corporate Governance in Germany, HWWA Hamburg, 1997, pp. 235 ff.
45
Seibert, ‘Control and Transparency in Business (KonTraG). Corporate Governance Reform
in Germany’, http://www.bmj.bund.de/misc/e_kont.htm, including among the Parliament’s aims
“that the law should actively keep pace with public companies as they gear up to the
requirements and expectations of international financial markets. This also means that corporate
strategy needs to be more strongly oriented towards shareholder value”.
46
See Didier, ‘La théorie contractualiste de la société’ (2000) Rev. Sociétés 95.
47
See the study by C.O.B., ‘Creation de Valeur Actionnariale et Communication Financière,
2000, at http:// www.cob.fr, arguing that the shareholders’ role is gaining importance in terms of
remuneration and power in modern economic and social systems, and that the consideration of
the total costs of capital is also a stable acquisition of these systems. See also Pirovano, ‘La
«boussole» de la société. Intérêt commun, intérêt social, intérêt de l’entreprise’ (1997) Recueil
Dalloz 189.
48
Bissara, ‘L’intérêt social’ (1999) Rev. Sociétés 5, at 6.
49
Ibidem, 24, stating that the two concepts are identical, because the shareholders have made a
contract to form the corporation and only the continual prosperity of the common enterprise, to
which their company is dedicated, can generate the expected profits and increase the shares’
value. See also Cozian and Viandier, Droit des sociétés, 11th ed. 1998, p. 175 f.
50
Ibidem, 29 ff.
51
See e.g. Cass., 20 June 1958, No. 2148 (1959) I Giur. it., 1, c. 204; Cass., 25 October 1958,
No. 3471 (1959) I Giur. it., 1, c. 869. Both judgements define the company’s interest as a
superior interest, distinct from that of the individual members.

10
‘50s and 60s, so that a contractual view of the corporation is prevalent today52. The
company’s interest is identified with the shareholders’ common interest, which is defined as the
objective and hypothetical interest of the average member53. This interest is also correlated
with the goal of profit maximisation, representing the ultimate corporate aim54. However, not
all the theories elaborated under the contractual view of the corporation are alike and some
reach results similar to those obtainable under the institutional approach to the corporation55.

II. European Best Practices

European Corporate Governance made significant progress during the 1990s; amongst
its achievements, the national codes of best practice deserve particular attention. This
paragraph will analyse the role of shareholder value in internal corporate governance, the
relationship between shareholders and stakeholders in the European Codes, and the executive
remuneration best practices in view of shareholder welfare maximisation.

Corporate Governance Codes

The publication in 1992 of the Cadbury Report in the UK was a watershed to be

followed by the Viénot and Peters Reports in France (1995) and the Netherlands (1997)56. In

52
See Ascarelli, ‘L’interesse sociale dell’art. 2441 cod. civile’ (1956) Riv. soc. 93; Mengoni,
‘Appunti per una revisione della teoria sul conflitto di interessi nelle deliberazioni di assemblea
della società per azioni’ (1956) Riv. soc. 434; Mignoli, ‘L’interesse sociale’ (1958) Riv. soc. 725;
Jaeger, L’interesse sociale, 1964. For an overview, see Jaeger and Denozza, Appunti di diritto
commerciale. I. Impresa e società, 2nd ed. 1992, pp. 215 ff.; for a different approach, Galgano,
Diritto Commerciale. Le Società, 1998/99 ed., pp. 153 ff., concluding that neither the
institutional nor the contractual theories accurately reflect the Italian law.
53
Gower’s definition of the company’s interest as that of the ‘hypothetical average member’
who presumably has no personal interest apart from those as member, is approved by Mignoli,
op. cit., note 52, p. 748 (with reference to Gower, The Principles of Modern Company Law,
2nd ed. 1957, p. 520) who defines the company’s interest as the ‘lowest common denominator’
uniting shareholders since the company formation until its dissolution.
54
See Mignoli, op. cit., note 52, p. 748.
55
See Jaeger, op. cit., note 52, pp. 116 ff., who criticises the theories which define the
company’s interest either as the interest of the legal person, or as including the interests of
workers and other stakeholders, or simply those of future shareholders.
56
These reports, and the others subsequently referred to in the text, can be found at the situs of
the European Corporate Governance Network (http://www.ecgn.ulb.ac.be/ecgn/codes.htm).

11
1998, the Cardon Report was issued in Belgium and the Olivencia Report in Spain, whilst the
Hampel Report led to the London Stock Exchange’ s Combined Code. In 1999, a new
Viénot Report was issued in France and a report (including a best practice code) was
published in Italy under the auspices of Borsa Italiana (Preda Report)57. The widely-held view
that companies’ self-regulation is a distinctive feature of common law systems needs re-
assessment: codes of best practice have an increasingly important role in the governance of
continental European listed companies58. The reasons for this are well known, and include the
role played by institutional investors in modern equity markets and competition between
national financial systems 59.
The Hampel Report (1998) emphasised the role of shareholder value, stating that “the
importance of corporate governance lies in its contribution both to business prosperity and
accountability. In the UK the latter has preoccupied much public debate over the past few
years. We would wish to see the balance corrected”60. In a similar vein, Ira Millstein argued
that boardroom behaviour is critical, as the “professional board” is an active monitoring
organisation that participates with management in formulating corporate strategy in the
interests of shareholders, develops appropriate incentives for management and other
employees and judges the performance of management against the strategic plan61. This is
reflected by the definitions of the board’s responsibilities and key functions offered by the
O.E.C.D. Principles of Corporate Governance, para. V, and some Continental Codes62.
However, proof of the link between board governance and performance is difficult to
pin down. Some empirical studies have tried to link one or at most a few elements of board

57
On the Preda Report see, from a comparative perspective, Ferrarini, ‘Corporate Governance
Codes: A Path to Uniformity?’ (1999) Euredia 475.
58
See, however, for a critical view, the chapter by Rossi, in this volume, p. ....
59
For an evaluation of self-regulation in the U.K., see Cheffins, Company Law. Theory,
Structure and Operation, 1997, pp. 364 ff.; for an assessment of the U.K. best practices, see the
chapter by Rickford, in this volume, p. ..., and the comments by Pettet, p. ...
60
Hampel Report, p. 7. In the Committee’s opinion, “public companies are now among the most
accountable organisations in society”, but the board’s first responsibility is to enhance the
prosperity of the business over time. Accountability requires appropriate rules and regulations, in
which disclosure is the most important element. However, “it is dangerous to encourage the
belief that rules and regulations about structure will deliver success”.
61
Millstein, ‘The Professional Board’ (1995) 50 Bus. Law. 1427, 1433-39.
62
Cardon Report, para. I; Olivencia Report, para. I; Preda Report, para. I.

12
structure (number of independent directors, board size, etc.) to measures of corporate
performance (such as stock price) or to a single corporate event (CEO replacement, response
to takeover bids, etc.)63. Their results have been defined as “inconclusive “ or “ambivalent”,
but do not disprove a link between board activism and increased investor returns 64. A recent
65
study has attempted to establish a correlation between board independence and corporate
performance measured on the basis of “economic value added” (EVA), i.e. the company’s
ability to create wealth for shareholders66. This study demonstrates “a substantial and
statistically significant correlation between an active, independent board and superior
corporate performance”, without proving causation67.
With respect to European corporate governance codes, it will be interesting to see
whether a similar correlation exists once the principles concerning the board’s structure and
independent directors have been implemented on a large scale. However, the differences in
ownership structure between Continental European and Anglo-American listed companies
should also be taken into account 68, as already acknowledged by recent reports69.

63
For a review, see Bhagat and Black, ‘The Uncertain Relationship Between Board
Composition and Firm performance’ (1999) 54 Bus. Law. 921.
64
Millstein and MacAvoy, ‘The Active Board of Directors and Performance of the Large
Publicly Held Corporation’ (1998) 98 Col. L. Rev. 1283, at 1296-1297.
65
Assessed on the basis of indicia for the behaviour of professional boards, such as independent
board leadership, periodic meetings of the independent directors, formal rules for the relationship
between the board and management: ibidem, 1299. A different study by Bhagat and Black, op.
cit., has considered the recent trend towards supermajority-independent boards and concluded
that there is no convincing evidence that increasing board independence will improve firm
performance.
66
See Millstein and MacAvoy, op. cit., note 64, 1303.
67
Ibidem, 1318, where the comment: “It might be inferred that managers willing to assume the
risks associated with a professional board are better able to generate higher returns to
shareholders. On the other hand, why do so? It seems to us less than likely that good corporate
governance is a luxury of firms that are performing extraordinarily well”.
68
The ownership structure of European companies is highly concentrated: see Wymeersch, ‘A
Status Report on Corporate Governance Rules and Practices in Some Continental European
States’, in Hopt et al. (Eds.), Comparative Corporate Governance. The State of the Art and
Emerging Research, 1998, pp. 1152 ff. A recent study on large shareholding in Europe shows
that in several countries the median largest voting stake in listed companies is over 50 %,
suggesting that voting control by a large blockholder is the rule rather than the exception. In Italy,
out of a number of 216 listed companies, the median largest voting block is 54.53 %, similar to
Austria (52 %), Belgium (50.6 %) and Germany (52.1 %). In the U.K., on the contrary, a
sample of 250 listed companies shows a modest median value of 9.9 %, whereas in the U.S.A.
over 50 % of companies have a largest shareholder who holds less than 5 % of the shares. See

13
Presumably, the proportion of independent directors vis-à-vis other directors will reflect a
company’s ownership structure70. It is possible, however, that the number of independent
directors will increase once the new concept has been metabolised and a sufficient number of
professional directors have established a reputation for this role 71.

Profit Maximisation and Stakeholder Protection

The corporate governance codes analyse the relationship between shareholder value,
profit maximisation and stakeholder protection. The Hampel Report follows the “in the long
run” perspective which reconciles the goal of shareholder value maximisation with a more

Becht and Röell, ‘Blockholdings in Europe: An International Comparison’ (1999) 43 Eur. Econ.
Rev. 1049, who preview the findings of research on large shareholding in Europe carried out by
the European Corporate Governance Network (ECGN); Barca and Becht (Eds.), Ownership
and Control: A European perspective, Oxford (forthcoming). For a broader perspective, see
La Porta, Lopez-de-Silanes and Shleifer, ‘Corporate Ownership around the World’ (1999) J. Fin.
471, who use data on ownership structures of large corporations in 27 wealthy economies and
find that, except in economies with very good shareholder protection, very few of these firms are
widely held. Concentration helps to solve the agency problem created by dispersed shareholders,
but gives rise to a different problem as concentrated voting and management power can be
abused to the detriment of the minority shareholders: Shleifer and Vishny, op. cit., at 740 ff.
69
See, e.g., the Preda Report, which specifies that the role of independent directors may vary
with reference to the ownership structure of corporations. In the case of concentrated
ownership, emphasis is put on the protection of minority shareholders, even though the
independent directors’ role with reference to the shareholders in general is also highlighted. As
stated in the second Viénot Report (1999), para. II, “la présence d’administrateurs réellement
indépendants en nombre suffisant dans les Conseils d’administration et dans les comitès du
Conseil est un élément essentiel de la garantie de la prise en compte de l’intèrêt de l’ensemble
des actionnaires dans les décisions de la société”.
70
If there are controlling shareholders, some of the outside directors will be connected with them
and monitor the company’s management on their behalf: see the Viénot Report (1995), para. II.
2, and the Olivencia Report, para. 2.2. If the shareholders are dispersed, an Anglo-American
type of board consisting of a majority of independent directors will result.
71
This appears to be the case in France. After noting the increasing number of independent
directors in French listed companies, the second Viénot Report recommends that the boards of
such companies include at least one third of independent directors: see Part 3, para. II, also
stating that the audit and nomination committees should comprise at least one third of
independent directors, whereas the remuneration committee should have a majority of the same.
This number is higher than that recommended by the first Report, suggesting a minimum of two
independent directors for each board: see para. II.2; see also para. III.3 on the board’s
committees, providing that at least one member of the audit committee should be an independent
director. Four years have been enough to change the French attitude towards independent
directors and move the best practice in this area towards the British model.

14
broadly defined goal of social responsibility for corporations72. The shareholders are interested
in a company’s sustained prosperity and the directors can pursue the objective of long term
shareholder value successfully by developing and sustaining stakeholder relationships73.
Similarly, the A.L.I. Principles of Corporate Governance make reference to “long-run
profitability and shareholder gain”, justifying “an orientation toward lawful, ethical , and public
spirited activity”. The long-term profitability of the corporation generally depends on meeting
the fair expectations of stakeholders and short-term profits can be properly subordinated to
this goal74. The Italian and Spanish Reports follow a similar approach75. The O.E.C.D.
Principles also adhere to a “long run” view of wealth maximisation, but emphasise the
recognition of “the rights of stakeholders as established by law” (to limit the impact of
stakeholder protection on corporate law and directors duties, considering the concurring
regulation of stakeholders relationships, such as those with workers) 76.
The Viénot Report (1995) favours an “enterprise” view of the corporation77, whilst
minimising the differences from the Anglo-Saxon shareholder value approach: “ il s’agit lá de
nuances plutót que de conceptions absolument différentes”78. Viénot defines the “intérêt
social” as the “ intérêt supérieur” of the “personne morale”, i.e. of the enterprise pursuing its
own goals, which are different from those of the shareholders, employees, creditors, suppliers
and clients. These goals reflect the common interest in the prosperity of the enterprise79. The
second Viénot Report smoothes the differences from the Anglo-Saxon approach by focusing

72
This perspective is examined by Blair, op. cit., p. 216 f., with reference to the U.S. discussion.
As to British law, see Davies, in this volume, p. …, who analyses also the Company Law
Review proposals, where the primacy of the shareholders’ interests is asserted.
73
Hampel Report, para. 1.18.
74
American Law Institute, Principles of Corporate Governance: Analysis and
Recommendations, 1994, para. 2.01.
75
Preda Report, para. 4; Olivencia Report, para.1.3; see also the board of directors’ model
regulation referred to the Spanish corporate governance code, art. 6 (shareholder value creation)
and 7 (other interests).
76
See Principle No. III (the role of stakeholders in corporate governance). The relevant
comment states, inter alia: “It is, therefore, in the long-term interest of corporations to foster
wealth-creating co-operation among stakeholders”.
77
For a critical approach, see Bissara, ‘L’intérêt social’ (1999) Rev. Soc. 5.
78
Viénot Report (1995), para. 1, specifying that the company’s interest does not mean ignoring
the market, but is a standard for the directors’ conduct which transcends their particular
interests.
79
Ibidem.

15
on shareholders’ interests and referring e.g. to a periodic self-assessment by the board of
directors and to the appointment of truly independent directors80.
Difficulty in the doctrinal debate on corporate goals is posed in Germany by the
relationship between the company law and the enterprise law perspectives. Under the former
perspective, the management and supervisory boards should pursue the goal of the company
as an association, i.e. profit maximisation81. Under the latter perspective, the interests of the
company’s enterprise should also be furthered by the management and supervisory boards,
but the nature of those interests and their relationship with profit maximisation are disputed82.
Conflicting criteria have been developed by the authors, who have often suggested that the
company should pursue not only profit maximisation in the interests of investors, but also the
welfare of other stakeholders83. These theories have been critically examined in light of the
formation and spirit of the 1965 Stock Corporation Law (Aktiengesetz) and the argument has
recently been developed that under this law the company stays in the foreground and pursues
the goal of long-term profit maximisation in the shareholders’ interests84.
Furthermore, the relationship between shareholder value and profit maximisation has
been explored with particular reference to cases in which the two concepts do not coincide85.
An example is offered by the destination of surplus cash flow when the company cannot invest
the same at a rate of return sufficient to add economic value. Whereas the profit maximisation
perspective appears to be neutral on this matter, the shareholder value approach may require

80
Viénot Report (1999), para. II; see also Bissara, op. cit., note 56.
81
See Wiedemann, Gesellschaftsrecht, I, 1980, pp. 338 ff., 626 ff.. See also German Panel on
Corporate Governance, ‘Corporate Governance Rules for Quoted German Companies’, July
2000, for references to the corporate interest (para. 1.a) and long-term corporate value creation
(para. 3.a).
82
See e.g. Kübler, Gesellschaftsrecht, 5th ed. 1998, pp. 224 ff.; K. Schmidt,
Gesellschaftsrecht, 2nd ed. 1991, pp. 675 ff.
83
For a review, see Mülbert, op. cit., note 43, 141 ff.
84
Ibidem, 142 ff. See, however, Hopt, ‘Common Principles of Corporate Governance in
Europe?’, in Markesinis (Ed.), The Coming Together of the Common Law and the Civil Law,
2000, p. 105, at p. 119, arguing that the recent discussion on shareholder value has been carried
on at a rather theoretical level and has not changed the traditional view that the corporate aims
should include the interests of shareholders, the interests of creditors and those of the
employees.
85
Mülbert, op. cit., note 43, 156 ff.

16
that free-cash-flow is distributed to shareholders86. In order to reconcile the two goals from a
company law perspective, it has been suggested that it is in a listed company’s interests to take
care of its relationship with the capital market by implementing a shareholder value approach87.
Therefore, in the absence of value adding investment projects, the directors could comply with
the profit maximisation goal simply by recommending the distribution of free-cash-flow to
shareholders.

Executive Compensation

The Greenbury Report (1995) was the first in Europe to set out best practices in the
field of directors’ remuneration. Its recommendations were substantially followed by the
Hampel Report and the Combined Code, and some of its basic principles have been
incorporated in the Continental Codes. These recommendations and principles reflect the main
international concerns relating to the level of executive pay, the procedure for its determination
and the disclosure of the same.
Firstly, “the level of remuneration should be sufficient to attract and retain the directors
needed to run the company successfully, but companies should avoid paying more than is
necessary for this purpose” (see Section 1.B.1. of the Combined Code). The optimal level of
remuneration will be largely determined by the market which is increasingly global88.
Furthermore, “a proportion of executive directors’ remuneration should be structured as to
link the rewards to corporate and individual performance” (ibidem). As recognised by the
corporate governance literature, incentive contracts with managers are a way to reduce agency
costs by aligning the managers’ interests with those of investors89.
The link to company performance can be established through annual bonuses, stock
option schemes or long-term incentive plans. From a shareholder value perspective, a truly

86
See e.g. Stewart, op. cit., note 26, pp. 137 f., 481 ff.; for some policy implications, Jensen,
‘Agency Costs of Free Cash Flow, Corporate Finance and Takeovers’ (1986) 76 Am. Ec. Rev.
323 (the problem is how to motivate managers to disgorge the cash rather than investing it below
the cost of capital or wasting it in organisational inefficiencies).
87
See Mülbert, op. cit., note 43, 161 ff.
88
Hampel Report, para. 4.3. On the managerial labour market, see Fama, ‘Agency Problems
and the Theory of the Firm’ (1980) 88 J. Pol. Ec. 288.

17
effective incentive system is one that “makes managers think like and act like owners”90.
Therefore, in judging the performance of managers, the focus should be on value added
measured by one of the usual standards, such as net return on investment or EVA91. If stock
options are granted, their value is related directly to shareholder returns, providing managers
with strong economic incentives92.
Secondly, the procedure for fixing executive remuneration should be formal and
transparent, and a remuneration committee should be set up by the board of directors to avoid
potential conflicts of interest (see Section B.2 of the Combined Code). As shown by the U.S.
experience, “the more serious problem with high powered incentive contracts is that they
create enormous opportunities for self-dealing for the managers, especially if these contracts
are negotiated with poorly motivated boards of directors rather than with large investors”93.
This explains why remuneration committees should consist exclusively of “independent”
directors (see Section B.2.2 of the Combined Code), a requirement that has not been
followed by some Continental Codes94, presumably on the (rather weak) assumption that
“strong” owners are better at controlling executive pay than professional directors.
Furthermore, shareholders should be invited specifically to approve all new long-term incentive

89
See Shleifer and Vishny, op. cit., note 3, 744.
90
Ehrbar, EVA. The Real Key to Creating Wealth, 1998, p. 95, specifying that compensation
plans typically have four objectives: (i) to align management and shareholders interests; (ii) to
provide sufficient leverage, as measured by the variability of potential rewards; (iii) to limit
retention risk, i.e. the risk that managers will leave for a better offer; (iv) to keep shareholder
costs at a reasonable level.
91
See Brealey and Myers, Principles of Corporate Finance, 6th ed. 2000, p. 326; Ehrbar, op.
cit., note 90, p. 106 (“two characteristics of EVA bonus plans …are crucial to their
effectiveness as a corporate governance mechanism: Managers know that the only way they
can make themselves better off is by creating more wealth for shareholders, and they also know
that they will share in any wealth they do create”).
92
See Rappaport, op. cit., note 14, pp. 113 ff., highlighting the shortcomings of conventional
stock option plans which do not meet the “superior performance” test.
93
Shleifer and Vishny, op. cit., 745.
94
See e.g. the Preda Report, Art. 8.1 (the majority of the committee will consist of non-
executive directors); see, however, the second Viénot Report, part III, para. II (the majority of
the committee will consist of independent directors).

18
schemes (see Section B.3.4.), and the issue has also been raised whether directors should be
generally accountable to shareholders with respect to executive remuneration95.
Thirdly, the company’s annual report should contain a statement of remuneration
policy and details of the remuneration of each director (Section B.3 of the Combined Code).
Also in Continental Europe a trend is emerging which requires disclosure of executive pay in
the annual accounts96, but there is still some resistance to full disclosure of individual
remunerations, as shown by the second Viénot Report rejecting the Anglo-Saxon requirement
of detailed information97.

Assessment

Apart from these and other divergences, which either reflect variations amongst the
national legal systems or are attributable to path-dependency, the European codes of best
practice substantially contribute to uniformity in the corporate law field, particularly from the
shareholder value perspective. First of all, the principle of shareholder value creation is
recognised and the board of directors should implement this principle in formulating the
company’s strategies and in selecting and remunerating executives. A “professional” board is
generally linked with good performance, even if proof of causation has not yet been offered.
Furthermore, the Continental codes try to reconcile shareholder value maximisation and
stakeholder protection from a “long run” perspective, similar to that followed by the Anglo-
American best practice. The German model offers an exception, but the shareholder value
approach is also receiving wide recognition in the field of public companies. Following the
Greenbury Report in the U.K., the executive remuneration model is becoming uniform as to
compensation structure and level, and the board of directors’ activity is organised so as to
minimise potential conflicts of interest.

95
See the D.T.I. Consultative Document on Directors’ Remuneration, July 1999, chapter 7,
stating inter alia that it may be appropriate for the board to discuss aspects of directors’
remuneration with investors, and that the dialogue between the board and investors is more likely
to be effective if it is underpinned by a framework which facilitates voting on resolutions relating
to directors’ remuneration at company meetings.
96
See e.g. the Italian Securities Commission (Consob) Regulation No. 11791, Encl. 3C.

19
 Some general issues deserve further comment, such as the role of self-regulation and
that of corporate law. The best practice codes provide a frame of reference to the board of
directors, who are free to adhere to the relevant principles or not, provided that adequate
disclosure is offered. The capital markets ultimately assess the board’s functioning and
performance, and the share prices incorporate information as to the quality of governance98.
Institutional investors may find in the national codes guidance as to the best practices in the
countries in which they invest, and a few of them use their own codes as a parameter for
assessment of the issuers99.
Management’s acceptance of the shareholder value principle is requested by investors
also in systems traditionally classified as stakeholder societies. It is not enough for managers to
declare the acceptance of this principle, but evidence must be given of its implementation, e.g.
through stock-option plans and other incentive agreements. On the whole, market discipline is
breaking new grounds in Continental Europe, as an essential supplement to corporate law, and
the codes of best practice play an important role with respect to directors and investors.
At the same time, corporate law assures the enforcement of fiduciary duties. The
courts specify these duties, particularly in cases of director liability100. However, the business
judgement rule in practice restricts the duty of care enforcement. In fact, the courts avoid
interfering with business decisions when the directors are thought to have exercised an honest
judgement in the good faith pursuit of corporate interests101. Also the issue of shareholder
value maximisation, albeit central in the field of fiduciary duties, tends to be covered by the
business judgement rule and is rarely addressed by the courts (except for cases relating to
takeover defences: see para. III below). This is generally approved for at least two reasons.
Firstly, judges lack the professional expertise to take business decisions in lieu of directors.

97
See the second part of the second Viénot Report, recommending detailed, but not individual
disclosure of executive pay.
98
For similar comments, see Easterbrook and Fischel, op. cit., note 13, pp. 17 ff.
99
See, e.g., the CALPERS’ Corporate Governance Principles (http://www.calpers-
governance.org/principles/default.asp).
100
The fiduciary principle is a rule for completing incomplete bargains in a contractual structure:
see Easterbrook and Fischel, op. cit., note 13, p. 92.
101
See Allen, ‘The Corporate Director’s Fiduciary Duty of Care and the Business Judgement
Rule Under U.S. Corporate Law’, in Hopt et al., Comparative Corporate Governance. The
State of the Art and Emerging Research, 1998, p. 307, at p. 322.

20
Secondly (and perhaps most importantly), the perspective of an extensive judicial review of
business decisions would discourage risk taking by the boards of directors, contrary to the
interest of investors who can easily reduce firm-specific risks through diversification102.
Furthermore, corporate law provides the executive compensation mechanisms
necessary to align the managers’ interests with those of the owners. These mechanisms have
been subject to sweeping changes in Continental Europe. Traditionally, the law was only
concerned with facilitating employee participation in company capital, as witnessed by Article
41 of the second company law directive, providing that Member States may derogate from
various provisions (including Article 29 on pre-emption rights) to the extent required “to
encourage the participation of employees, or other groups of persons defined by national law,
in the capital undertakings”. However, value creation needs are best satisfied by incentive
agreements with the firm’s executives, including stock-option plans which are obviously
different from the participation schemes offered to employees.
The national legal systems tend to follow the European directive model, but some have
removed the main barriers to the introduction of stock-option plans for managers. French
legislation, for instance, was modified in various stages to host the new compensation
mechanisms. At the beginning, managers were excluded from share offers to employees (made
possible by a 1970 law), but since 1987 stock-option plans have become generally available
to joint-stock companies103. However, directors as such are not admitted to these incentive
schemes, which require the beneficiary to be bound by a labour agreement 104. Consequently,
an executive director can benefit from a stock-option plan because of his or her position as
general manager (PDG) or simply as a manager of the company. Similar treatment is
applicable to management stock-options in Italy105. In Germany, on the contrary, the stock-
corporation law was modified in 1998 (see the new para. 192 (2) No. 3 Aktiengesetz) so as

102
Ibidem, quoting the author’s judicial opinion in Gagliardi v. TriFoods Int’l, Inc. 683 A.2d
1049, 1052 (Del. Ch. 1996).
103
See Vatinet, ‘Le clair-obscur des stock options à la française’ (1997) Rev. Soc. 31.
104
Cozian and Viandier, Droit des sociétés, 11th ed., 1998, p. 346.
105
See Acerbi, ‘Osservazioni sulle stock options e sull’azionariato dei dipendenti’ (1998) Riv.
Soc. 1193, at 1253 ff.

21
to allow new share offers not only to the employees, but also to the members of the
management committee (not of the supervisory board)106.

III. Takeover Defences

General

Takeovers create value 107. As shown by Jensen and Ruback almost twenty years ago,
shareholders of target firms realise large positive abnormal returns in completed takeovers,
whilst statistically significant but small positive returns are realised by bidders108. Takeover
defenses can contribute to the value creating process, but can also hinder the target’s
acquisition by bidders. In this paragraph, I intend to examine such defences and the main rules
applicable to them from a comparative perspective, and assess the role played by the
shareholder value concept in this area.
Shareholders in tender offers are faced with a dilemma: “acting independently each
shareholder maximises his wealth by tendering, although all target shareholders are better off if
nobody tenders until they receive a larger fraction of the takeover gains”109. Takeover
defences can help to solve this co-ordination problem by enhancing the bargaining power of
target management versus bidders. Defensive measures, however, give rise to a conflict of
interest problem, as managers might entrench themselves instead of maximising shareholder
wealth110. The core question, therefore, appears to be one of internal governance: should

106
See Kühnberger and Kessler, ‘Stock option incentives – betriebswirtschaftliche und
rechtliche Probleme eines anreizkompatiblen Vergütungssystems’ (1999) AG 453, at 459 ff.
107
For an overview of the theories explaining value maximisation in takeovers, see Romano, ‘A
Guide to Takeovers: Theory, Evidence and Regulation’, in Hopt and Wymeersch (Eds.),
European Takeovers. Law and Practice, 1992, pp. 4 ff.
108
Jensen and Ruback, ‘The Market for Corporate Control. The Scientific Evidence’ (1983) 11
J. Fin. Econ. 5, at 22; from another perspective, takeovers serve as a control mechanism that
limits managerial departures from maximisation of shareholder wealth (id., at 29). For an
updated discussion, see Weston, Chung and Siu, Takeovers, Restructuring, and Corporate
Governance, 2nd ed. 1998, pp. 124 ff.
109
Jensen and Ruback, op. cit., note 108, at 31.
110
This has lead some authors to recommend a passivity rule for management: see e. g.
Easterbrook and Fischel, ‘The Proper Role of Target’s Management in Responding to a Tender
Offer’ (1981) 94 Harv. L. Rev. 1161. For a recent contribution, see Bebchuk and Ferrell,

22
managers or shareholders take the final decision as to takeover defences? This paragraph will
try to outline the American approach to poison pills and post-bid defences and the European
trends in the same area, and to compare the two approaches, focusing on core governance
issues.

American Defences

Defensive tactics are a matter within the business discretion of the target’s directors
and officers111. As stated with reference to poison pills, they were originally intended to act as
a means of allowing the board to fulfil its responsibility of maximising value for the
shareholders112. However, “a corporation does not have unbridled discretion to defeat any
perceived threat by any Draconian means available”113. A distinction is made between
defensive tactics that benefit shareholders and those that merely protect management. In order
for the business judgement rule to apply, the board must demonstrate that the takeover
represented a threat to corporate policy and existence114. Moreover, the defensive measure
must be “reasonable in relation to the threat posed115. This is an “intermediate standard” (with
respect to the business judgement rule originally invoked by the courts) requiring a
“proportionality review” in order to decide whether a defensive response is warranted116.
The validity of poison pills has been recognised in a way consistent with this standard.
In Moran v. Household International117, the Delaware Supreme Court found that a “flip-over”
plan was a reasonable protection against a two-tier tender offer. The Court also implied that
the board’s power to redeem the plan in case of a favourable offer might be essential for the

‘Federalism and Corporate Law: the Race to Protect Managers from Takeovers’ (1999) Col. L.
Rev. 1168, spec. 1193 ff.
111
Clark, op.cit., note 3, p. 581.
112
Macey, ‘The Legality and Utility of the Shareholder Rights Bylaw’ (1998) 26 Hofstra L.
Rev. 835, at 837.
113
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
114
See Cheff v. Mathes, 41 Del. Ch. 494, 199 A.2d 548 (S. Ct. 1964).
115
Unocal Corp. v. Mesa Petroleum Co., cit.
116
See Gilson and Kraakman, ‘Delaware’s Intermediate Standard for Defensive Tactics: Is
There Substance to Proportionality Review? (1989) 44 Bus. Law. 247.
117
500 A.2d 1346 (Del. 1985).

23
validity of a poison pill. As a result, the proportionality review is deferred from the time the pill
is adopted to the time an offer is made and the board declines to redeem the pill118.
However, many argue that a board can now use the poison pill to implement a “just
say no” defence against a takeover119. The basis for this argument is represented by two
recent cases (concerning defences other than the poison pill). In Paramount Communications,
Inc. v. Time Inc.120, the Delaware Supreme Court held that a defensive measure that
precluded Time’s shareholders from accepting Paramount’s tender offer and receiving a
control premium in the immediately foreseeable future was not disproportionate. This was
because the board of directors is empowered to make “the selection of a time frame for the
achievement of corporate goals” and is “not obliged to abandon a deliberately conceived
corporate plan [such as the Time tender offer for Warner] for a short-term shareholder profit
unless there is clearly no basis to sustain the corporate strategy” 121. In Unitrin, Inc. v.
American General Corp.122, the Delaware Supreme Court accepted the target’s argument that
a stock repurchase program was justified by the risk that the target’s shareholders might
accept an inadequate offer because of “ignorance or mistaken belief” regarding the board’s
assessment of the long term value of the target’s stock123. The same Court seemed to widen
further the latitude within which the directors can act when faced with a hostile bid by stating
that, “if the board of directors’ defensive response is not draconian (preclusive or coercive)
and is within a ‘range of reasonableness’, a court must not substitute its judgement for the
board’s”124.

118
See Choper, Coffee and Gilson, Cases and Materials on Corporations, 4th ed. 1995, p.
916.
119
See Gordon, ‘Mergers and Acquisitions: “Just Say Never?” Poison Pills, and Shareholder-
Adopted Bylaws: an Essay for Warren Buffett’ (1997) 19 Cardozo L. Rev. 511, at 522 ff.,
noting that perhaps the most important unresolved question in American corporate law concerns
the ultimate power of the board of a Delaware corporation to block an unwanted takeover bid.
120
571 A2d 1140 (Del. 1989).
121
Ibidem, at 1154
122
651 A2d 1361.
123
Ibidem, at 1385.
124
Ibidem, at 1388. As a result, the “just say no” question is apt to receive a positive answer and
a bidder facing the target’s board refusal to redeem the pill is left with the possibility of starting a
proxy fight to substitute the managers: see Gordon, op. cit., at 527, quoting the first and only
post-Unitrin case directly to address the question, Moore Corp. Ltd. V. Wallace Computer
Services, 907 F. Supp. 1545 (D. Del. 1995).

24
 European Defences

Takeover defences in Europe offer two broad scenarios. In the U.K., pre-bid
defences are allowed in principle, but rarely used125; post-bid defences are more common, but
subject to shareholders’ approval under the City Code126. In Continental Europe, relatively
high barriers to takeovers exist or are created in practice127, whereas post-bid defences are
subject to different national regimes waiting to be harmonised under the 13th takeovers
directive, once adopted128. These two broad scenarios reflect the different corporate
governance systems and capital market structures in Continental Europe and the U.K. In
addition, both scenarios appear to be different from that prevailing in the U.S., as is shown by
the fact that poison pills are not used in Europe and that pre-bid defences, when adopted (as
they often are on the Continent), are designed more to create barriers to takeovers than to
increase shareholder value through a successful acquisition of the target. I will focus on post-
bid defences and their treatment under the draft 13th directive.
Post-bid defences are covered by Article 8 (1) (a) of the draft directive, which
substantially derives from the U.K. model and, despite being in draft, has already influenced
national legislations, including Italy’s129. This Article contains two rules. The first can be
defined as a “managerial” passivity rule: the target’s board of directors “should abstain from
completing any action other than seeking alternative bids which may result in the frustration of
the offer” unless authorised by the shareholders’ general meeting. This rule closely resembles

125
See Davies, ‘The Regulation of Defensive Tactics in the United Kingdom and the United
States’, in Hopt and Wymeersch (Eds.), op. cit., p.195, pp. 205 ff.; Jenkinson and Mayer,
Hostile Takeovers. Defence, Attack and Corporate Governance, 1994, pp. 18 ff.
126
See General Principle 7 and Rule 21 (‘Restrictions on Frustrating Action’) of The City Code
on Takeovers and Mergers.
127
See Chapter 8 (‘Defensive Measures: the Continental Approach’) of Hopt and Wymeersch,
op. cit., note 107, pp. 217 ff., and in particular the contributions by Schaafsma (The
Netherlands), Simont (Belgium) and Maier-Raimer (Germany).
128
See Clausen and Sørensen, ‘The Regulation of Takeover Bids in Europe: the Impact of the
Proposed 13th Company Law Directive on the Present Regulation in EU Member States’ (1999)
1 ICCLJ 169, at 206 ff.
129
See Article 104 of the Consolidated Financial Services Act, modelled upon Article 8 (a) of
the draft European directive. On the influence of the U.K. model in Continental Europe, see
Hopt, op. cit., note 84, p. 111.

25
General Principle No. 7 of the City Code, as specified by Rule 21 on “frustrating action”130.
Defensive measures are typically included in this concept131. Article 8 (1) (a) of the draft
directive refers to one in particular, identified as the “issuing of shares which may result in a
lasting impediment to the offeror to obtain control over the offeree company”. However, this
specification does not limit the scope of the rule, which is very general in character and focuses
on the key concept of “frustration” of the offer132.
For present purposes, two aspects of the European rule deserve reflection. Firstly, this
rule shifts governance powers from the directors to the shareholders, implicitly assuming that
directors are in a potential conflict of interest and that shareholders have the right incentives to
decide whether and by what means a takeover bid should be resisted. If takeovers in general
maximise shareholder value, all decisions substantially affecting the probability of a takeover
bid should be taken by the target’s shareholders133.
Secondly, the rule needs specification with respect to the moment from which it is
applicable to the target company. Article 8 (1) (a), states that the board is subject to the rule
“at the latest after receiving the information referred to in Article 6 (1)”, so that the question
arises about the type of information that should be required by the national laws in order for
the rule to be applicable 134. Is it the information foreseen by Article 6 (1) of the draft directive

130
See, for a commentary, Harvey, ‘Conduct during the Offer; Timing and Revision; and
Restrictions Following Offers’, in Button and Bolton (Eds.), A Practitioner’s Guide to the City
Code on Takeovers and Mergers, 1998 Edition, pp. 172 ff.
131
See e.g. Stedman, Takeovers, 1993, pp. 395 ff.
132
See Clausen and Sørensen, op. cit., note 128, p. 207.
133
For similar comments about the treatment of “frustrating action” under the City Code, see
Davies, op. cit., note 125, pp.199 ff., stating in particular that “the proposition embodied in
General Principle 7 is really quite a strong version of the conclusion one might draw from the
ideas that the shareholders are the ultimate beneficiaries of the corporate enterprise and that the
fiduciary duties of directors to promote the interests of the shareholders can be effectively
enforced only by prophylactic rules”.
134
In Italy, despite the adoption of a rule similar to that of the draft directive (see note 129
above), the question arose whether the passivity rule is only applicable after publication of the
offer document by the bidder. This question was considered in litigation concerning the takeover
bid of Assicurazioni Generali for INA. Consob, the Italian Securities Commission, stated that the
“passivity rule” applies as soon as the offer is communicated to the target’s board of directors,
but the Rome Administrative Tribunal (reviewing Consob’s resolution by way of a summary
decree dated 21st October 1999, No. 2964/99) and Consiglio di Stato (substantially confirming the
Tribunal’s decision with a summary decree dated 29th October 1999, No. 1984/99; both decrees
are published in (2000) II Banca, Borsa, Titoli di Credito 133, with a comment by Presti and

26
(i.e. the official notification of the bid to the target) or could any information be sufficient which
gives the board of directors “reason to believe that a bona fide offer might be imminent” (as
provided for by Rule 21 of the City Code)? In order for the rule on frustrating action to be
really effective, the latter solution should be adopted by the Member States when
implementing the directive; otherwise, the rule could be easily avoided by a board knowing of
a bid before its official notification135.
Another rule is stated by Article 8 (1) (b) of the draft directive, providing that “the
board of the offeree company shall draw up and make public a document setting out its
opinion on the bid, together with the reasons on which it is based, including its views on the
effects of implementation on all the interests of the company, including employment”. This
provision reflects existing national rules and practices (see, e.g., rule 25.1 of the City Code),
and is particularly important in light of the board’s duty to abstain from frustrating actions136.
Target management can provide information which is beneficial to shareholders at least on two
counts. Firstly, target management opposing an offer in good faith presumably is in possession
of non-public information which, if released, will determine an increase in the stock price,
showing that the pre-offer market price was incorrect and that the value exceeds the tender
offer price137. Secondly, target management may also provide information concerning the value
of the bidder’s securities in an exchange offer setting. Individual shareholders may find the cost
of evaluating the new securities too great and, even if they can bear it, may not have an
incentive to disseminate the information; “only target management has an incentive, …undiluted
by free-rider problems, to produce and disseminate this information”138.

Rescigno) held that under Italian law the “passivity rule” is correlated with the requirement for
an offer document, concluding that only after this document’s publication is the board of
directors forbidden to undertake frustrating actions, unless authorised by the shareholders’
meeting. For a critical assessment of these decrees, see Ferrarini, ‘A chi la difesa della società
bersaglio?’ (2000) 2 Mercato, Concorrenza, Regole 140.
135
See Clausen and Sørensen, op. cit., note 128, p. 207; a different interpretation is suggested by
Harvey, op. cit., note 130, p. 172, who criticises the formulation of Art. 8 of the draft directive.
136
In a contested offer the offeree’s document will seek to refute the arguments and the
commercial logic put forward by the offeror: see Peck, ‘Documents from the Offeror and
Offeree Board’, in Button and Bolton (Eds.), op. cit., p. 152.
137
See Gilson, ‘A Structural Approach to Corporations: the Case against Defensive Tactics in
Tender Offers’ (1981) 33 Stan. L. Rev. 819, 866.
138
Ibidem, at 867.

27
 To sum up, Article 8 of the draft directive is important from the shareholder value
perspective for two reasons. On the one hand, defensive measures are admitted, but must be
authorised by the target’s shareholders, thus allowing managers to negotiate the terms of the
offer and, at the same time, reducing the potential for conflict of interest. On the other hand,
target directors have to publish their views on the offer and are thus entitled to disclose
information which may either determine an increase of the target’s stock price or help the
target shareholders in evaluating the bidder’s securities in an exchange offer.

Comparison

Differences among the national markets for corporate control are a reflection of
diversified ownership structures of listed companies. Diffuse ownership is common in the U.S.
and the U.K., whereas it is an exception in Continental Europe. Structural barriers to
takeovers are frequent on the Continent of Europe, but rare across the Atlantic and in the
U.K.. Technical barriers (such as cross-shareholdings, pyramidal groups, etc.) are also rare in
the U.K. and the U.S. (with the exception of non-voting shares and other departures from the
one share – one vote idea), whilst they are still important in Continental Europe.

(a) Pre-Bid Barriers or Tactics?

The very concept of a “barrier” shows the peculiar European attitude towards pre-bid
defences, aimed at immunising companies from takeovers. The American terminology
(defensive “tactics” or “strategies” and the like) implies that defences are aimed either at
improving the bid terms or frustrate the offer, if it is not wealth maximising. Shark-repellents
and poison pills are usually justified as reducing the coercion produced by takeover bids on
target shareholders. The paradigm is offered by a two-tier bid creating a prisoner’s dilemma
for target shareholders, who fear to be frozen-out in the following merger if the tender offer is
successful. But also one-tier bids can throw the offerees into a similar dilemma, if the bid price

28
does not reflect the target’s value and the shareholders accept the offer out of fear of being left
with low-value minority shares, if the bidder gains control of the target139.
In Europe, the mandatory bid rules in force at the national level (and that contemplated
by Article 5 of the draft directive) tend to exclude coercive two-tier bids, as they either require
a bid for all the shareholdings or admit a partial bid upon the condition that it is approved by
the majority of the relevant holdings140. However, also bids for all the shares can create
pressure to tender and the mandatory bid rules do not solve this problem, as they lead “neither
to the acquisition of more shares by the bidder nor to a higher premium”141. A comparison
with the American experience, therefore, shows that despite the non-recurrence in Europe of
two-tier bids of a coercive nature142, the target shareholders may need protection against the
pressure to tender generated by all-shares offers, notwithstanding the adoption of mandatory
bid rules at the member States’ level. This is what defensive tactics can provide, by allowing
the target to bargain with the bidder about the terms of the offer.
However, a defensive arsenal of the American type is still unknown in Europe. Poison
pills are not used and would probably violate either corporate law principles and statutory
rules (such as those on capital formation, pre-emption rights and equal treatment of
shareholders) or stock exchange regulations and companies’ best practices143. Shark
repellents could be more easily accepted within the European corporate and capital market

139
See Bebchuk, ‘Toward Undistorted Choice and Equal Treatment in Corporate Takeovers’
(1985) 98 Harv. L. Rev. 1693, at 1696, 1717 ff., arguing however that “allowing obstructive
tactics…is a very costly and inadequate method of dealing with the problem of distorted choice”
(at 1743).
140
This is the partial bid’s treatment adopted by the City Code on Takeovers and Mergers, Rule
36 (requiring approval by the City Panel and the shareholders holding over 50 per cent of the
voting rights). On the pressure to tender reduction operated by this rule, see Bebchuk, op. cit.,
note 139, at 1796 ff.
141
Burkart, Gromb and Panunzi, ‘Why Higher Takeover Premia Protect Minority Shareholders’
(1998) 106 J. Pol. Ec. 172, at 187, who add: “The shortcoming of the MBR [mandatory bid rule]
is its lack of coercion. It does not require the bidder to buy all shares, but merely those shares
tendered. This obligation is vacuous since it remains still at the bidder’s discretion how many
shares will actually be tendered”. On the pressure to tender in all-shares offers, see Bebchuk,
op. cit., note 139, at 1717 ff., 1796 ff. (with reference to the British Code on Takeovers and
Mergers).
142
It should also be noted that cash-out mergers are not allowed by European law, as
harmonised under the 3rd company law directive (see Articles 3 (1) and 4 (1) allowing a cash
payment not exceeding 10 per cent of the nominal value of the shares issued for the merger).

29
law setting, and to some extent they are already used (at least as far as super-majorities are
concerned).

(b) Post-Bid Resistance: Powers and Instruments

The comparative analysis of post-bid defences highlights the diversity of internal

governance structures, which in turn reflects more basic differences in the allocation of powers
between directors and shareholders in American and European corporations 144. In the U.S.,
boards of directors have been able to adopt the poison pill under their general authority to
issue shares and to decide upon the pill’s redemption under their responsibility of maximising
value for the shareholders. The same holds for the generality of pre-bid defences. In Europe,
on the contrary, a preference has emerged (and is now included in the draft 13th directive) for
an allocation of powers to the shareholders’ meeting.
The distance between the two legal systems in the present area is shown by the
academic discussion concerning recent attempts made by shareholder activists in the U.S. to
limit the power of the board through the adoption of by-laws requiring the directors to redeem
the pill in certain circumstances145. The question has been asked, in this respect, whether
shareholders have such power of initiative and, in order to answer it positively, the need has
been felt to develop a doctrinal analysis of the allocation of powers between the board and the
shareholders, asking in particular “to what extent can shareholders give the board mandatory
instructions through the medium of by-law amendments”146. On the other hand, these actions
by American shareholders may show that even there a reallocation of powers between
directors and shareholders could take place in the not too distant future147.

143
See Davies, note 125, op. cit. pp. 205 ff.
144
The question why the US state legislatures have adopted a more pro-target management
view is considered by Davies, in this volume, p. …. .
145
See Macey, op. cit., note 112, pp. 861 ff.
146
Coffee, ‘The Bylaw Battlefield: Can Institutions Change the Outcome of Corporate Control
Contests?’ (1997) 51 U. Miami L. Rev. 605, at 606.
147
A preference for the British system is expressed by Bebchuk and Ferrel, op. cit., note 110,
1193, arguing that it is an example of “regulation that both addresses possible defects in the
takeover process and ensures that shareholders, not management, have the ultimate say on
whether a takeover proceeds”.

30
 However, also the European approach needs critical assessment, particularly from the
shareholder voting perspective. The allocation of powers to the shareholders’ meeting
generates well known collective action problems, such as widespread shareholders’ rational
apathy and free riding148. These problems may be reduced by the presence of institutional
investors in the company’s capital and also by the fact that decisions on defensive strategies
are apt to increase the shares’ value in a short time, by determining an improvement of the bid
terms. Therefore, even assuming a sceptical attitude towards institutional shareholders’
activism, an exception should be made with reference to their participation to post-bid
defences, in light of the short-term profits that such conduct might generate149.
A different problem is created by block-holders if they own a minority stake of the
share capital sufficient to participate in the control of the target. If the private benefits of
control are relatively high (as happens in countries where investor protection is not yet fully
developed150), the target block-holders might resist the takeover for reasons other than
shareholder value maximisation. The outcome (if the block-holders’ vote prevails, also as a
consequence of the other shareholders’ apathy) could be similar to that obtained in the U.S.
when managers resist a takeover mainly for entrenchment purposes.
Furthermore, the comparison between the American and the European legal systems
shows a substantial diversity as to the range of defensive tools available. This appears to be an
effect of the different characteristics of corporate law, which is more enabling in the U.S. and
less concerned about creditors’ protection than in Europe151. The 2nd European directive, for
instance, severely restricts the repurchase of the company’s own shares, thus narrowing the
scope of buy-backs as defensive measures152. The same directive provides for pre-emptive
rights in the case of an increase of the company’s capital, making it difficult for the target to

148
See Clark, op. cit., note 3, p.
149
See Macey, ‘Institutional Investors and Corporate Monitoring: A Demand Side Perspective in
a Comparative View’, in Hopt et al., op. cit., p. 903, at pp. 916 ff.: institutional investors do not
seem to be engaging in the continuous monitoring that demands active involvement; like other
investors, they appear to rely on market forces, particularly on the market for corporate control.
150
See Zingales, ‘The Value of the Voting Right: a Study of the Milan Stock Exchange’ (1994) 7
Review of Financial Studies, 125.
151
See, among others, Carney, ‘The Political Economy of Competition for Corporate Charters’
(1997) J. Leg St. 303, at 318 ff.
152
For a critical analysis of the 2nd directive, see Kübler, in this volume, p. ...

31
allot shares to a friendly party in the event of an hostile bid153. As argued for the U.K. (but the
comment could be extended to Europe in general), “it is clear that companies have relatively
few defences available in the event of a hostile bid. Target companies are typically limited to
financial announcements (such as updated dividends and profit forecasts); disposals or
revaluations of assets; appeals to various regulators, or finding a white knight”154.

IV. Financial Restructurings

General

Finance theory and practice show that “most of the time financial restructurings do
change the way corporations are run and do create new, enduring values”155. As argued by
Jensen, the evidence from LBOs and leveraged restructurings “has demonstrated dramatically
that leverage, payout policy and ownership structure … affect organisational efficiency, cash
flow, and hence value. Such organizational changes show that these effects are especially
important in low-growth or declining firms where the agency costs of free cash flow are
large”156. Share repurchases and leveraged recapitalisations can reduce these costs and
contribute to value creation157. Leveraged acquisitions also assure investors that surplus cash
flow will not be wasted158 and offer “an incentive structure for realizing value (improving
operating performance) in ‘undervalued’ companies”159.
Corporate finance rules, therefore, should facilitate the various types of financial
restructurings in order to enhance shareholder wealth creation. Existing limits to share

153
See Davies, op. cit., note 125, p. 206.
154
Jenkinson and Mayer, op. cit., note 125, p. 24.
155
Stewart, op. cit., note 8, p. 479.
156
Jensen, ‘The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems’
(1993) 48 J. Fin. 18, at 868.
157
See, for an updated discussion, Weston, Chung and Siu, Takeovers, Restructuring, and
Corporate Governance, 2nd ed. 1998, pp. 257 ff., 371 ff.; leveraged recapitalisations involve a
relatively large issue of debt that is used for the payment of a relatively large cash dividend or
for the repurchase of common shares.
158
Stewart, op. cit., note 8, p. 492.
159
Baker and Smith, The New Financial Capitalists. Kohlberg Kravis Roberts and the
Creation of Corporate Value, 1998, p. xii, pp. 44 ff. See, in particular, Kaplan, ‘The Effects of
Management Buyouts on Operating Performance and Value’ (1989) 24 J. Fin. Ec. 217.

32
repurchases and leveraged buy-outs should be carefully examined and their rationale should be
confronted with the value enhancing effects of financial restructurings. A similar study would be
clearly outside the confines of this paper, as it would require an in-depth analysis of the rules
on capital, share repurchases and financial assistance included in the second company law
directive and the national laws implementing the same160. In this paragraph, in order to illustrate
a European de-regulatory trend in this area motivated by shareholder value considerations, I
will briefly consider the French and German law reforms concerning share repurchases and a
recent proposal for the revision of the second company law directive.

Recent Reforms

Both the French and German law reforms concerning share repurchases were enacted
in 1998. In France, share buy-backs were forbidden by the 1966 law on commercial
companies. However, the company could buy its own shares for one of the following
purposes: (i) to annul the same and execute a capital reduction decided upon by the
shareholders general meeting; (ii) to transfer its shares to the employees within either a profit-
sharing or a share-option scheme; (iii) to stabilise the share price (if the company was listed).
This regime appeared to be too restrictive, as extensively shown by the Esambert Report
published in January 1998161.
The Esambert Report posited that share repurchases are motivated by shareholder
value creation and argued that the exceptions contemplated by French law were insufficient for
a dynamic financial management. On the one hand, the mechanisms of the share capital’s
reduction were too rigid and burdensome; on the other, the rules concerning share repurchases
for stabilisation purposes were inadequate from a capital restructuring perspective 162. At the
same time, comparative law shows that in the U.S. “le capital social peut fluctuer de manière
assez souple” (the legal capital may fluctuate in a rather light way) and share repurchases are
frequent and respond to multiple goals. British companies are also relatively free to purchase

160
See the chapters by Kübler and Ferran, in this volume, pp. ... and ....
161
See the Report sur le rachat par les sociétés de leurs propres actions written for C.O.B.
by Mr. Bernard Esambert, at http://www.cob.fr/frset.asp?rbrq=doc.
162
Ibidem, pp. 13 ff.

33
their own shares, albeit within the limits fixed by the second company law directive and the
Stock Exchange rules163. The Esambert Report concluded by recommending a reformulation
of the French rules on share repurchases, to the extent allowed by the European directive: the
principle should be one of liberty and the procedural requirements should be simplified.
This recommendation was brought forward by Article 41 of the law of the 2nd July
1998, liberalising share repurchases. Under the new regime, the shareholders’ general meeting
can fix the goals of share buy-backs and the company can purchase and resell its own shares,
annul the same under a simplified procedure, use the shares for stock-options, etc. Such
liberalisation is balanced by increased transparency and specific rules to be followed in order
164
to carry out the relevant transactions . The reform has been successful, according to a
recent report by the Commission des Opérations de Bourse, concluding that the new rules
have stimulated many transactions and have determined an increase of the shareholders’
benefits per share and of the share prices in the short-term165.
A similar reform was introduced in Germany by the KonTraG of 1998. Also in
Germany share repurchases were allowed in exceptional circumstances provided for by para.
71(1) AktG, such as an acquisition made to avert severe and imminent damage to the
company (No. 1), to offer shares to the employees (No. 2), to compensate shareholders in
given circumstances (No. 3) or to redeem shares in order to execute a reduction of capital
(No. 6). Only credit and financial institutions had some room for manoeuvre, being entitled to
purchase their own shares for purposes of securities trading on the basis of a resolution of the
shareholders’ meeting (No. 7, introduced in 1994 by the 2nd law for the promotion of financial
markets). In 1998, Article 1, No. 5 a) of the KonTraG modified para. 71(1) AktG by
adding a new No. 8, which liberalises, to some extent and within the limits foreseen by the
second company law directive, the share buy-backs also for companies other than credit and
financial institutions. However, the trade of own shares is forbidden (only credit and financial

163
Ibidem, pp. 16 ff.
164
See C.O.B., Rachat par les Sociétès de leurs propres actions: bilan et propositions,
January 2000, at http://www.cob.fr/frset.asp?rbrq=actu, pp. 5 ff.
165
Ibidem, pp. 11 ff.

34
institutions are allowed to practice it under para. 71 (1) No. 7). Interestingly, also the German
authors explain this liberalisation with reference to the shareholder value concept166.

European Developments

The national law reforms just mentioned were conditioned by the second directive
rules on acquisition of own shares (Art. 19), but also these rules are undergoing revision within
the Simpler Legislation for the Single Market (SLIM) initiative167. A Company Law SLIM
Working Group was created with a view to identifying where simpler legislation could replace
the existing legislation in the field of the first and second company law directives168. As to Art.
19 of the second directive, the SLIM Group found that the 18 months time-limit to the general
meeting’s authorisation for the share buy-back was too brief and proposed to extend it to 5
years. Furthermore, the SLIM Group deemed the limitation to 10 per cent of the subscribed
capital169 as restrictive and unnecessary if the company disposed of distributable assets.
Consequently, it suggested to a reformulation of the rule by limiting the acquisition of own
shares to the amount of distributable assets170. In this way, the creditors would be protected,
without unnecessarily hindering the company’s ability to adjust its capital structure according to
the needs of shareholder wealth maximisation.
The SLIM Group also reviewed Art. 23 of the second directive, which prohibits
“financial assistance” by stating at its first paragraph: “ A company may not advance funds,
nor make loans, nor provide security, with a view to the acquisition of its shares by a third
party”. The SLIM group suggested reducing this prohibition to a minimum, either limiting
financial assistance to the amount of distributable net assets or limiting the prohibition to the

166
See Martens, ‘Erwerb und Veräusserung eigener Aktien im Börsenhandel’ (1996) AG 337.
167
The purpose of the SLIM initiative is not to harmonise, but to slim regulation.
168
The Working Group was made of Member States representatives and experts in and users of
company law, and was chaired by E. Wymeersch. See the Explanatory Memorandum and the
Recommendations on the Simplification of the First and Second Company Law Directives,
October 1999, at http://www.law.rug.ac.be/fli/index.html.
169
See Art. 19 (1) (b), stating that “the nominal value or, in the abscence thereof, the
accountable par of the acquired shares, including shares previously acquired by the company and
held by it, and shares acquired by a person acting in his own name but on the company’s behalf,
may not exceed 10 per cent of the subscribed capital”.
170
See the Explanatory Memorandum, cit., note 168, at 8.

35
assistance for the subscription of newly issued shares171. The rationale for this proposal can
be found in an essay written by Eddy Wymeersch shortly before172. Article 23 of the second
directive derived from British law and “was conceived as an instrument akin to the rules on the
repurchase of own shares, and hence as an instrument designed to protect the company’s
capital”173. However, “the rule is based on a strange reasoning: while the directive does not
forbid …a company to repurchase its own shares nor to grant loans to its shareholders, the
combination of both transactions in one perspective …would result in an outright
prohibition”174. Furthermore, the financial assistance prohibition affects an area of corporate
practice which is already subject to different rules, such as those on own shares, credit to
shareholders and conflicts of interest. The outcome of all this is “hardly understandable” and
deletion of Art. 23 is suggested 175.
The field which would mostly benefit from the SLIM Group’s proposal is that of
leveraged acquisitions and, in particular, leveraged buy-outs. In the Member States the
question has frequently been considered whether the financial assistance prohibition would also
forbid either the distribution of dividends by the target or the merger of the target and the
acquirer, when they provide the means to repay the loan contracted by the acquirer in order to
finance its acquisition176. This issue is often analysed without critical consideration of the
prohibition’s rationale and adequate analysis of the LBOs’ value creating potential. Therefore,
the proposed reform would probably stimulate the growth of leveraged acquisitions in Europe
and enhance shareholder value, without affecting creditor protection.

V. Conclusions

171
Ibidem.
172
Wymeersch, ‘Article 23 of the Second Company Law Directive: the Prohibition on Financial
Assistance to Acquire Shares of the Company’, in Basedow, Hopt and Kötz (Eds.), Festschrift
für Ulrich Drobnig, 1997, p. 725.
173
Ibidem, p. 733.
174
Ibidem, p. 741.
175
Ibidem, p. 746.
176
Ibidem, pp. 736 ff. This question was recently dealt with by the Milan Tribunal, judgement 13
May 1999, in the case of Bruni Pio v. Trenno S.p.A. (2000) Le Società 75, holding that LBO
transactions are valid in principle, but may be fraudulently directed to avoid the financial
assistance prohibition.

36
 I began this paper with an analysis of the role of shareholder value in internal corporate
governance. The European codes of best practice emphasise this role. They also analyse the
relationship between shareholder value, profit maximisation and stakeholder protection,
following the “in the long run” perspective which reconciles the goal of shareholder value
maximisation with that of the social responsibility of corporations. Difficulty in the doctrinal
debate is posed in Germany by the relationship between the company law and the enterprise
law perspectives. However, according to a recent German view, the company stays in the
foreground and pursues the goal of long-term profit maximisation in the shareholders’ interests.
The European corporate governance codes also set out best practices in the field of directors’
remuneration. Their recommendations and principles reflect the main international concerns
relating to the level of executive pay, the procedure for its determination and the disclosure of
the same.
On the whole, the European codes of best practice contribute to uniformity in the
corporate law field, particularly from the shareholder value perspective. A “professional”
board is generally linked with good performance, even though proof of causation has yet to be
offered. The capital markets ultimately assess the board’s functioning and performance, and
the share prices incorporate information as to the quality of governance. Market discipline is
breaking new grounds in Continental Europe and is proving to be an essential supplement to
corporate law. The issue of shareholder value maximisation, however, tends to be covered by
the business judgement rule and is rarely addressed by the courts. Nevertheless, executive
compensation mechanisms are used to align the managers’ interests with those of the owners
and have been subject to sweeping changes as a result of legal reforms.
I moved on to examine takeover defences and the main rules applicable to them from
a comparative perspective. Target shareholders are faced with a prisoner’s dilemma.
Takeover defences can help to solve the relevant co-ordination problem by enhancing the
bargaining power of the target management. Defensive measures, however, give rise to a
conflict of interest problem, as managers might entrench themselves instead of maximising
shareholder wealth. The core question appears to be one of internal governance: should
managers or shareholders take the final decision as to takeover defences? The comparative
analysis of post-bid defences highlights the diversity of internal governance structures, which in

37
turn reflects more basic differences in the allocation of powers between directors and
shareholders in American and European corporations.
The European approach, however, needs critical assessment from the shareholder
voting perspective. The allocation of powers to the shareholders’ meeting generates well
known collective action problems. Another problem is created by block-holders if they own a
minority stake of the share capital sufficient to participate in the control of the target. If the
private benefits of control are relatively high, the target block-holders might resist the takeover
for reasons other than shareholder value maximisation. Furthermore, comparison between the
American and the European legal systems reveals a substantial diversity as to the range of
defensive tools available; a reflection of the corporate finance rules included in the second
company law directive. The modification of these rules (e.g. by liberalising share buy-backs)
will allow the European defensive arsenal to grow.
I then considered some aspects of financial restructurings. Share repurchases and
leveraged recapitalisations can reduce the “costs of free cash-flow” and contribute to value
creation. Leveraged acquisitions assure investors that surplus cash flow will not be wasted and
offer an incentive structure for improving operating performance. Consequently, corporate
finance rules should facilitate the various types of financial restructurings in order to enhance
shareholder wealth creation.
A recent French report posited that share repurchases are motivated by shareholder
value creation and argued that the exceptions contemplated by French law were insufficient to
be compatible with a dynamic financial management. A reform of the law followed. Under the
new regime, the shareholders’ general meeting can fix the goals of share buy-backs which can
be made for trading, investment, etc. Such liberalisation is balanced by increased transparency
and specific rules to be followed in order to carry out the relevant transactions. A similar
reform was introduced in Germany by the KonTraG of 1998.
These reforms were conditioned by the second directive rules on the acquisition of
own shares, which are, in turn, undergoing a revision within the Simpler Legislation for the
Single Market initiative. The SLIM Working Group deemed that the 10 per cent limit of
subscribed capital is unnecessarily restrictive and suggested limiting the acquisition of own
shares to the amount of distributable net assets. The SLIM Group also suggested reducing the

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prohibition of financial assistance to a minimum. The field which would mostly benefit from the
SLIM Group’s proposal is that of leveraged acquisitions and, in particular, LBOs.
On the whole, the shareholder value concept appears as a useful yardstick by which to
measure the responsiveness of corporate law and practice to the needs of capital markets; it
also offers a wider perspective than that provided by a pure agency costs approach. The
concept of shareholder value appears to offer the rationale for law reforms in different areas,
such as executive compensation, takeover defences and financial restructurings, which
represent a promising field for further research in European corporate governance.

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