Re-Envisioning the Controlling Shareholder Regime: Why Controlling Shareholders and Minority Shareholders Embrace Each Other

Abstract

In his article, Controlling Family Shareholders in Developing Countries: Anchoring Relational Exchange, Professor Ronald Gilson raises critical points against the conventional view of corporate governance in a controlling shareholder regime with poor investor protection: (1) given that equity financing is much more expensive to a corporation than debt financing due to the reinforced pecking order of corporate finance in a bad law jurisdiction, why do some controlling shareholders nonetheless have so many minority shareholders through new equity issuances? (“Gilson’s riddle”); and (2) if laws are inefficient and do not protect investors, as the conventional view explains, why do minority shareholders still invest their money in controlled corporations? (the “flipside of Gilson’s riddle”). In order to answer these conundrums, Professor Gilson himself proposes a potential — but partial — solution namely the product market-based account (PMBA). Against this backdrop, I begin with a critical review of the PMBA. Then, I propose alternative solutions to the PMBA for corporate governance conundrums. As for Gilson’s riddle, I analyze how a controlling shareholder can gain both pecuniary and non-pecuniary benefits by having more minority shareholders through equity financing (despite deep discount on equity securities). As for the flipside of Gilson’s riddle, I explain why minority shareholders tolerate a controlling shareholder’s expropriation, and how they can gain benefits through capital market transactions that can compensate for insufficient investor protection. Consequently, I show that both a controlling shareholder and minority shareholders — as a seller and purchasers in a capital market — accept market terms and conditions because their interwoven relationship creates symbiosis and a mutual hostage situation. In such cases, their cooperation is compelled and strengthened, and economic development ensues. That relationship explains why some bad-law countries have functional capital markets — an anomalous result from the standpoint of the conventional view.