Implications for Dutch law

This concluding chapter returns to the issue referred to in the Introduction that has generated most controversy: empty voting. Empty voting occurs when shareholders exercise the voting right without having a corresponding financial interest, for example because they have borrowed their shares. Such shareholders may vote in a way that decreases the value of the company without suffering the consequences, which is why policymakers are generally sceptical of empty voting. The Dutch Monitoring Committee Corporate Governance, for example, has stated that it considers empty voting undesirable.1 Chapter 3, however, has emphasized that empty voting may also be used for beneficial purposes. In particular, the use of share borrowing and equity derivatives may enable shareholders with superior information to obtain greater voting power, and thereby increase the probability that a majority of the shares is voted in favor of the option that maximizes shareholder value. The chapter therefore concluded that it makes sense to battle abusive empty voting through narrow ex post rules rather than broad ex ante prohibitions. This concluding Chapter explores what such a rule could look like under Dutch law. To this end, the chapter identifies the circumstances under which empty voting should be considered a breach of the statutory obligation for shareholders to act in accordance with standards of reasonableness and fairness (redelijkheid en billijkheid).

As a preliminary step, the chapter will attempt to reconcile the proposition central to Chapter 3, that the appropriate function of shareholder voting is to aggregate information dispersed among shareholders in order to identify the option that maximizes shareholder value, with the observation in the Introduction that shareholder value maximization may not always be an effective means of advancing general welfare. In fact, it is perfectly consistent to pursue efficiency of shareholder voting in the sense that a majority of the shares is voted for the option that maximizes shareholder value, and to simultaneously pursue the advancement of general welfare through a carefully chosen slightly broader corporate objective.2 We just need to delineate the powers of shareholders such that in the exceptional case where the objective of shareholder value maximization conflicts with the broader corporate objective, managers cannot be compelled by shareholders to run the business in a way that undermines such corporate objective.

Careful delineation of the powers of shareholders becomes even more important as pressures to maximize short-term shareholder value appear to be increasing.3 Among the possible causes of such short-term focus is the fact that while the beneficiaries of institutional investors often invest in pursuit of longterm goals such as building retirement funds, the performance of their portfolio managers is frequently measured over a short-term period. This creates a risk that institutional investors vote in favor of proposals that yield short-term results at the expense of long-term value.4 Thus, Jensen's theory of enlightened value maximization, referred to in the Introduction, implies that managers must be enabled to resist the temptation to maximize short-term financial performance.5 Corporate law can, and arguably should, create such a buffer against pressures to maximize short-term financial performance.

As a positive matter, Dutch law appears to do exactly this. To begin with, shareholders only get to vote on major decisions such as mergers. They do not have a right to initiate such decisions, but only to approve or reject proposals by the board. As a result, shareholders cannot, at least not as formal matter, use their voting right to single-handedly push through a merger that yields short-term results at the expense of long-term value. Also, the power to hire and fire managers rests not with shareholders but with the board, which acts as an intermediate layer between shareholders and managers that can absorb some of the pressure.6 Boards of Dutch listed companies also have the power to take defensive measures to temporarily fend off hostile takeovers, enabling them to absorb even more pressure.7 In terras of shareholders' ability to sue, while in the U.S., the business judgment rule creates a buffer by focusing on the process surrounding business decisions rather than their substance,8 suing directors in the Netherlands is at least as difficult: directors can only be held liable vis-à-vis the company if a serious reproach (ernstig verwijt) can be made, a standard that constitutes a high bar.9

A consequence of creating a buffer against pressures to maximize short-term financial performance is that a vacuum is created within which directors could use their discretionary power to advance their own interests rather than to maximize long-term value. There are several strategies to address this problem, three of which deserve to be briefly mentioned here. The first is to impose a standard of conduct. Under Dutch law, directors have a duty to act in the interests of the company, which implies a certain balancing of the interests of the various stakeholders.10 The Dutch Corporate Governance Code, which applies to listed companies, builds on this notion but puts more emphasis on the creation of long-term shareholder value.11 This emphasis is broadly consistent with Jensen's theory of enlightened value maximization and also with the position of several leading Dutch legal scholars.12 As a general matter, the effectiveness of standards of conduct is likely to depend on culture and the design of the legal system as a whole, particularly the extent to which the system builds on intrinsic motivation of directors and the extent to which it relies on incentives imposed by capital markets and by strict regulation.13

The second strategy to encourage directors to use their discretionary power to maximize long-term value is rewarding them for doing so successfully. Variable remuneration has long been used to create monetary incentives, but only with mixed success. Apart from concerns about remuneration package design,14 a more fundamental concern is that monetary incentives may have a negative effect on the performance of complex cognitive tasks. Indeed, recent advances in social science suggest that monetary incentives may create perverse incentives, may `crowd out' intrinsic motivation and may narrow cognitive focus.15 An additional problem is posed by the fact that measuring long-term value creation can be challenging. To Jensen, one of the very benefits of enlightened value maximization is that it offers a scorecard: managers' performance should be judged by whether they have instituted those strategies that are most likely to cause value to rise in the long term.16 Yet a difficulty arises when in practice, those in charge of measuring performance fail to fully appreciate the long-term value implications of managers' decisions. One solution to this may be to emphasize non-financial drivers of long-term value creation, as has been done in the Netherlands in response to the fmancial crisis.17 While this appears to be a sensible solution, it may also reduce the benefit of having a single-valued objective function. In light of these observations, getting variable remuneration right is a difficult task.

A third and novel strategy to encourage directors to use their discretionary power to maximize long-term value may be to foster a corporate culture of integrity. Erhard, Jensen and Zaffron have developed a positive theory of integrity, which posits that integrity enables superior performance.18 More intriguing stil, the theory holds that long-term value maximization requires integrity.19 Integrity, as they define it, exists in a positive realm devoid of normative content, and is thus not about right or wrong. Rather, it is about honoring one's word.20 In their model, one's word already implicitly includes compliance with applicable legal standards merely because one is expected to comply with legal standards, such as the aforementioned standard of conduct. But of course, directors could also explicitly give their word that they are committed to maximizing long-term value.

How do we encourage directors to explicitly give — and honour — their word that they will strive to maximize long-term value? Interestingly, listed companies, more than any other type of organization, already make public statements. While the scope of these statements has long been limited to financial matters, there is a movement toward broader disclosure. A driving force behind this movement is the Global Reporting Initiative, which has issued sophisticated reporting guidelines.21 The guidelines, which already require directors to make personal statements about the firm's long-term organizational strategy, offer a useful framework within which directors could give their word that they will strive to maximize long-term value — in a more detailed and more meaningful way than the obligatory language that is typically included in the CEO 's foreword to the annual report, and as a commitment not only to financial markets but also to the organization and its stakeholders.

In this integrity framework, when directors abuse their discretionary power so as to promote their own interests, it does not just mean that they have failed to comply with some unenforceable legal standard or that they will miss out on a bonus; it means that they have been lying.22 To maintain their integrity, directors will need to use their power solely to maximize long-term value. Is it naïve to believe that they will do so? Some might argue it is, and cite as evidence the first experiences with the Dutch Banking Code, which requires bank executives to sign a statement regarding proper conduct. Apparently, many executives do not take this statement seriously.23 One former executive suggested this might be due to the fact that the substance of the statement does not reflect an existing norm.24 Yet in the integrity framework, whether or not the statement itself reflects an existing norm is beside the point: the applicable norm is that one should honor one's word, a time-tested social norm.25 It is quite possible that many people will feel compelled to comply with this norm not because of fear of liability, monetary incentives or reputational concerns, but because they think they ought to do so.26

Summing up, shareholder voting can be deemed efficient when a majority of the shares is voted in favor of the option that maximizes shareholder value. At the same time, corporate law as a whole can be deemed efficient only when it maximizes general welfare. Because shareholder welfare does not necessarily equal general welfare, there is a need to carefully delineate the powers of shareholders. In particular, arguably there should be certain buffers that shield managers against pressures to maximize short-term financial performance, so as to enable them to focus on the creation of long-term value. As a matter of Dutch law, such buffers do exist. Inevitably, they create a vacuum within which managers can use their discretionary power to advance their own interests rather than to create long-term value. This section has tentatively explored three strategies to address this problem, including imposing standards of conduct, awarding variable remuneration and fostering a corporate culture of integrity.

Having taken this preliminary step, let us move to the issue of empty voting. Chapter 3 concluded that because it is not clear that the costs of abusive empty voting outweigh the potential benefits from empty voting, it generally makes sense to battle abusive empty voting through narrow ex post rules rather than through broad ex ante prohibitions of empty voting. By `narrow ex post rules', I mean that there should be a way to undo, or prevent, the negative consequences of abusive empty voting only if and when it is clear that such negative consequences have materialized or can reasonably be expected to materialize. This will generally require (1) a standard of conduct that requires shareholders to refrain from abusive empty voting; (2) a means for those affected to enforce such standard by initiating legal proceedings; (3) a standard for judicial review, and (4) the availability of appropriate remedies. The remainder of this section offers a brief analysis of the extent to which Dutch law meets these requirements, as well as suggestions as to directions in which the law should, as a normative matter, develop in order to effectively address the issue.

Under Dutch law, stakeholders in a company, including shareholders, should behave toward one another in accordance with the principle of reasonableness and fairness (section 2:8 DCC). This principle limits controlling shareholders' discretion when voting to freeze out minority shareholders or to approve related-party transactions.27 It is also widely understood that the principle limits the discretion of shareholders more generally.28 At first sight, this seems at odds with a series of three landmark cases in which the Dutch Supreme Court held that shareholders are free to vote as they please. Yet upon closer inspection, there need be no inconsistency. Here is why:

In the first case, the Court needed to respond to the far-reaching proposition that shareholders should vote in such a way as serves the interest of the company as a whole (as opposed to, for example, in a way as serves the collective interest of shareholders or as serves the exclusive interests of that particular shareholder). The Court understandably rejected this proposition, stating that instead a shareholder is free to vote in such a way as serves "his own interest" in the company.29 In the second and the third case, the Court needed to respond to the proposition that a voting agreement was invalid because it violated an alleged duty shareholders have toward one another to vote on the basis of their own insight. Again, this was a far-reaching proposition, one that also implies that a voting agreement would be invalid per se — as would be a voting proxy, a functional equivalent that the law explicitly permits. The Court understandably rejected this proposition too, holding that since shareholders are, in principle, free to vote as they please, they are also free to commit themselves to voting according to a third-party's instructions even if these instructions deviate Erom the shareholder's own insight.30

Nothing in these decisions suggests that shareholders are freed from the obligation to act in accordance with the principle of reasonableness and fairness. As a practical matter, these decisions also did not prejudice the company (or shareholders generally). On the contrary, in two of the cases, the Court observed that the voting agreement was in the interest of the company, and in the third case there was no reason to assume that it was not.31 Coupled with the Court's holding that shareholders are free to vote as they please only as a matter of principle, this suggests that, depending on the circumstances, a shareholder's voting behaviour may well breach the principle of reasonableness and fairness.32 Indeed, in the decades following these cases, courts have repeatedly held that a shareholder's voting behaviour (or the resulting shareholder resolution) constituted or threatened to constitute such breach. For example, in 2006, the Supreme Court held that the exercise of the voting right by a member of an association (vereniging) resulting in such member obtaining an advantage at the expense of the other members may violate the principle of reasonableness and fairness.33 In 2007, the Enterprise Chamber of the Amsterdam Court of Appeal disallowed a shareholder vote on the dismissal of the supervisory board of industrial conglomerate Stork, holding that given the circumstances, the exercise of the right to dismiss would be unacceptable judged against the principle of reasonableness and fairness, taking into account also an apparent conflict of interest of certain shareholders.34 And in 2011, the Supreme Court upheld a decision by the Enterprise Chamber ordering an investigation into the behaviour of the controlling shareholder of Inter Access Group, who voted against a share issuance that was needed to save the company from bankruptcy.35

Shareholders' discretion in respect of their voting rights could potentially also be limited by the law on vote buying. Yet there is no statutory rule that explicitly prohibits vote buying, nor is there, to my knowledge, any case law on the subject.36 This is different in the U.S., where two decisions by the Delaware Chancery Court offer useful insights. In IXC Communications, the Court held that vote buying is closely scrutinized because a shareholder who divorces property interest from voting interest "fails to serve the `community of interest' among all shareholders, since the `bought' shareholder votes may not reflect rational, economie self-interest arguably common to all shareholders."37 And in Kurz v. Holbrook, the permissibility of vote buying was judged by determining whether it caused a misalignment between the vote buyer 's interest and the general interest of the other shareholders, being the interest in shareholder value maximization.38

Against this background, I would argue, at least in respect of listed companies, that under the circumstances where:

(3) the shareholder would nevertheless vote in a way that exclusively serves his own interest (and as a result would necessarily affect the interests of all other shareholders in a negative way), and assuming no specific additional circumstances exist that warrant a different conclusion, such voting behaviour as a matter of positive Dutch law presumably would, and as a normative matter should, be considered a breach of the principle of reasonableness and fairness. Framed negatively, allowing the shareholder to exercise his right to vote as he pleases should, under those particular circumstances, be considered `unacceptable' by standards of reasonableness and fairness within the meaning of the second paragraph of section 2:8 DCC (onaanvaardbaar naar maatstaven van redelijkheid en billijkheid). Framed positively, the requirement of the first paragraph of section 2:8 DCC that shareholders behave in accordance with the principle of reasonableness and fairness (gedragen naar hetgeen door redelijkheid en billijkheid wordt gevorderd) should, under those particular circumstances, effectively require the relevant shareholder to vote in a way that he believes promotes the common interest of shareholders, generally being shareholder value maximization. This argument is broadly consistent with proposals by several other scholars,39 and also with the notion that shareholders have a duty to act in good faith toward one another, a notion that preceded the notion that shareholders have a duty to act in accordance with the principle of reasonableness and faimess.40

Let us briefly consider two elements of the proposition. First, it relates (only) to shareholders who can determine the outcome of the vote.41 This makes sense from a logical perspective, and is consistent with the prevailing notion that shareholders' responsibilities increase with their influence.42 Second, it implies that onder those particular circumstances the conflicted shareholder should let the interests of fellow shareholders prevail over his own interests, particularly — but not exclusively — if fellow shareholders' losses would otherwise be disproportional to the gains of the conflicted shareholder.43 This would be the case, for example, if (1) the board of a listed company intends to make an overpriced acquisition; (2) a shareholder of the target company obtains a stake in the acquirer and hedges this stake such that he has no financial interest in the acquirer; (3) this conflicted shareholder subsequently votes to approve the acquisition at the acquirer level; and (4) through his vote causes the acquisition to be approved by a majority of the votes cast. Under these circumstances, which resemble the much debated Perry/Mylan case, the marginal losses of the shareholders in the acquirer will exceed the marginal gains of the conflicted shareholder as long as the laffer holds less than 100% of the shares in the target company, and accordingly such losses will, as a practical matter, always be disproportional to the potential gains of the conflicted shareholder. Indeed, if such shareholder nevertheless were to let his own interests prevail over the interests of his fellow shareholders, arguably this would, and should, not only constitute a breach of the principle of reasonableness and fairness, but also qualify as `abuse of power' within the meaning of section 3:13 DCC.44 After all, abuse of power exists where, given the disproportionality between one's gains from exercising a right and the losses of those negatively affected thereby, the principle of reasonableness requires that one refrain from exercising such right.

Notably, this interpretation of the duty to behave in accordance with the principle of reasonableness and fairness toward fellow shareholders is not intended to affect the duty of shareholders to behave in accordance with the same principle toward the company (and the other stakeholders referred to in section 2:8 (1) DCC), or, for that matter, the company's ability to initiate legal proceedings in case a shareholder breaches such duty. Indeed, in the event an empty voter with a negative net economie interest votes in a way so as to decrease shareholder value, he is likely to be acting in breach of the principle towards fellow shareholders as well as towards the company. This may be the case, for example, if the board proposes an acquisition that it deems in the interest of the company and shareholders generally deem in their interest because they expect the acquisition to increase shareholder value, yet the acquisition is voted down due to an empty voter who alone stands to profit from the decrease in share price if the company fails to obtain approval for the acquisition. However, even if the interests of the company and of shareholders are aligned most of the time, this need not always be the case. After all, it is possible, at least theoretically, that the board determines an acquisition to be in the interest of the company even if the acquisition is detrimental to shareholder value. A consequence of the argument made earlier would be that even if an empty voter voting to approve such an acquisition may not be acting in breach of the principle of reasonableness and fairness towards the company, he may, depending on the circumstances, still be acting in breach of the principle towards fellow shareholders. The following section explores the ways in which shareholders could respond to this.

To ensure compliance with the principle of reasonableness and fairness as interpreted above, shareholders would need to know, first, which individual shareholders have a large enough stake to potentially determine the outcome of the meeting, and what their net economie interest is.45 In this respect, ownership disclosure mies (discussed in chapters 1 and 2) play an important role, as they are designed to reveal who controls the voting right. Although these mies reveal only the identity of shareholders with a large stake, this should not pose significant problems given that smaller stakes are unlikely to determine the outcome of the vote. To the extent there is concern that shareholders with a smaller stake may still be able to determine the outcome of the vote, a specific ad hoc disclosure obligation might be imposed, as recently proposed by the European Corporate Govemance Forum.46

Next, shareholders who are prejudiced or who expect to be prejudiced should have a means to initiate legal proceedings against the empty voter concerned. Two types of proceedings are suitable for this. First, such shareholders may initiate ordinary proceedings before the competent court, possibly preceded by summary proceedings.47 Second, they may initiate inquiry proceedings before the Enterprise Chamber. These proceedings are suitable because the scope of a court-ordered inquiry into the company's affairs may cover the conduct of the shareholders' meeting,48 including the conduct of individual shareholders.49

Before considering the scope of judicial review of shareholders' conduct, it is instructive to consider the scope of review of directors' conduct. Here, the challenge is to strike an appropriate balance between discretion and accountability. Accountability is important to ensure that directors do not abuse the powers they are entrusted with. On the other hand, directors' discretion is important to preserve the appetite for risk-taking that is inherent to entrepreneurship, i.e. to avoid directors from being overly concerned that judges will, with the benefit of hindsight, consider their business decisions as flawed. Therefore, there is broad agreement that courts should generally show deference to directors' decisions. This is different, however, when directors have a conflict of interest, and stricter scrutiny is warranted. Accordingly, under US law, such directors do not longer enjoy the protection of the business judgment rule.50 In respect of Dutch law too, it has been suggested that courts should subject the conduct of conflicted directors to stricter scrutiny.51

The same basic principles arguably apply to judicial review of shareholders' voting decisions. If one accepts the proposition that shareholder voting can fulfil a useful function by aggregating information regarding the question which option maximizes shareholder value, shareholders should be encouraged to form and express different views on which option maximizes shareholder value, and they should not need to worry about judges considering, with the benefit of hindsight, their voting decisions flawed.52 Accordingly, courts should show deference to their decisions — indeed, even greater deference than to director 's decisions, given that shareholders cannot be considered fiduciaries the way directors can be.

If, however, shareholders have a conflict of interest, stricter scrutiny is warranted. This is particularly true in respect of shareholders with a negative net economie interest, for example because they have entered into derivative contracts through which they have created a short position that exceeds the long position through the shares held. The interests of such a shareholder conflict with the interests of shareholders generally, and it cannot be safely assumed that in voting the shareholder will have acted in (subjective) good faith, i.e. that he will have made his voting decision with a view to maximizing shareholder value. Unless such shareholder were able to credibly show that his voting decision was in fact made with a view to maximizing shareholder value,53 there are clear grounds for the court to show considerably less deference to such decision, especially if such shareholder has a large enough stake to determine the outcome of the vote.

In terras of Dutch law, courts typically consider whether the shareholder could, under the prevailing circumstances, `reasonably' (in redelijkheid) have acted the way he did.54 As a result, if the interpretation of the principle of reasonableness and fairness offered earlier were to be followed, courts would consider whether an empty voter could, under the prevailing circumstances, reasonably have arrived at the judgment that voting the way he did would be conducive to maximizing shareholder value. In case the empty voter has a negative net economie interest, arguably the court should go one step further to account for the fact that the shareholder had a strong incentive not to vote with a view to maximizing shareholder value. This implies that the court may also need to assess the shareholder's (subjective) intentions, even if admittedly, this will be no easy feat.55

If a court so determines that a shareholder has acted in breach of the principle of reasonableness and fairness, what measures could it order? To answer this question, we need to distinguish between the two types of proceedings and between those situations in which proceedings are initiated prior to the vote and those in which they are initiated after the vote. Prior to the vote and in the context of short form proceedings, the court could order the provisional measure of suspending the shareholder's voting rights for the upcoming meeting.56 This measure can also be ordered by the court in inquiry proceedings. For example, in Inter Access, the court suspended the controlling shareholder's voting right to enable the adoption of any shareholder resolutions necessary for the near-bankrupt company to increase its share capital, which in turn would enable the issue of new shares.57

After the vote, the question that arises first is whether the votes cast by the relevant shareholder could be annulled. The statute prevents this: votes that have been exercised by a shareholder cannot be annulled.58 They can only be null and void onder limited circumstances such as violation of public policy.59 The focus should therefore be on the validity of the resolution adopted as a consequence of the shareholder's vote.60 In the context of standard civil proceedings, shareholders (and the company) may claim the annulment by a court of a resolution on the grounds that such resolution violates the principle of reasonableness and fairness.61 Or, more specifically, may argue that the resolution should be annulled because as part of the voting process leading to the adoption of the resolution, a shareholder acted in breach of the principle of reasonableness and fairness.62 In the context of inquiry proceedings, such breach may constitute mismanagement.63 This is also true when the breach is due to the conduct of shareholders voting to adopt or reject a resolution, in which case such conduct may be attributed to the company.64 Upon finding that there has been mismanagement, the Enterprise Chamber has the power to take certain measures designed to undo the adverse effects thereof, including annulling shareholder resolutions.65 Thus, shareholders who have been prejudiced by a fellow shareholder 's voting behaviour have various procedural means at their disposal to pursue the annulment of the resolution. Such annulment may also pave the way for a claim for damages (onrechtmatige daad, section 6:162 DCC).66

To be sure, the proposal outlined in this section provides but a rudimentary framework, and many procedural issues remain to be resolved before it could be implemented effectively. At its core, the proposal — which is consistent with the US Securities Exchange Commission (SEC)'s recent proposal to prohibit empty voting in situations where there is a negative economie interest67 — aims to simultaneously facilitate beneficial vote buying and discourage detrimental vote buying. If, and only if, plausible evidence of widespread detrimental vote buying emerges, should policymakers consider an outright prohibition of empty voting. Both the SEC and the European Securities and Markets Authority (ESMA) are currently conducting fact-finding exercises that may shed light on how ubiquitous empty voting actually is, and the results of these exercises will be of great interest going forward.