The Chronicles of a Capitalist Lawyer: Corporate Law

Showing posts with label Corporate Law. Show all posts

It's been a while since the last time I wrote in this blog. I admit, I have sinned. But enough with the excuses. I've just finished two papers having completely different themes. The first one is titled: "Special Purpose Vehicles in Law and Economics Perspective". You can download the paper here. The second one is titled: "Legal Positivism and Law & Economics: A Defense". You can download the second paper here.

The first paper will be published in the Journal of Indonesia Corruption Watch to be published this year. In this paper, I discuss the nature of Special Purpose Vehicles (SPV) in the form of corporation, their function and benefits, their potentials for misuse, and also the techniques to solve or prevent such issue. I believe that for a developing country like Indonesia, relying on legal doctrine such as piercing the corporate veil to chase the ultimate shareholders of SPVs who conduct illegal acts would be too costly. They are just too cunning and some countries specialized in the formation of SPVs have all the incentives to assist these crimes.

So, the other solution is to ensure that those SPVs established in Indonesia will be here to stay, namely, we need to put some of their capitals as hostages in Indonesia by way of mandating minimum capital requirement or bank guarantee/insurance requirements. I also discuss the costs and benefits of these solutions as there is no such thing as a perfect solution. The rest can be read in the paper.

The second paper will be presented in the third Indonesian national conference of legal philosophy to be held at Surabaya on 28 August 2013. I always enjoy legal philosophy, particularly Legal Positivism and I think that most Indonesian scholars misunderstand the nature of Legal Positivism by equalizing Legal Positivism with Legal Formalism or even worse, strict textual method of legal interpretation.

Of course this is wrong. Legal Philosophy is a theory of law while Legal Formalism is a theory of adjudication. But the mistake is so persistent that Legal Positivism is often blamed for many issues in Indonesian legal system! I think the conference would be a good place to present a defense on Legal Positivism so I decided to write this paper.

The paper will discuss the main thesis of Legal Positivism, i.e., the Source Thesis (that law is a social fact and can only be derived from social sources) and the Separability Thesis (that the content of the law does not have any necessary connection with its validity). People usually connect Separability Thesis with the relationship between law and morality. But I believe that the issue is wider than that, it can include religion, local custom and other type of norms.

I certainly believe that Legal Positivism (if applied correctly), is a democratic thought that will allow various legal theory to compete for domination within a legal system. I argue this by showing how Law and Economics (which is obviously not a pure theory of law) can survive in the framework of Legal Positivism but will be kicked out from the game in the framework of Natural Law (because by nature, Natural Law which supports only one absolute value will not be tolerant to other type of thoughts). As usual, the rest can be read in the paper itself.

Happy reading and hope it is useful.

After almost 3 years since the inception of this blog, I manage to write my 100th post! Whew, I must say that I am actually amazed that I can finally reach this stage, considering the fact that I am a master of procrastination. I hope that I can continue to write regularly in this blog for many years to come and increase my platforms of writing by publishing books and research papers. Stay tune for those future projects.

For now, I will write about one of the most fundamental issues on corporate law, the fiduciary duties and business judgment rule. After all, writing on law and business issues was actually my primary intention when I first established this blog before I expanded my interest to other fields of law and economics. So, it would be proper if my 100th article deals with such issue. I hope you can enjoy the article and thank you for reading my posts in this blog.

A. Establishing the Duties of Directors

One of the most fundamental issues in the realm of corporate law is how can we define the standard of good business judgment by the management? From such a simple question, various derivative questions can also be asked: when should we deem the directors liable for their business decision? Where can we set a line to separate the good managers from the bad ones? How should we regulate the relationship between shareholders and managers in a corporation? Should we let the market decides how such relationship will work or should the court intervene? If the court should intervene, to what extent?

From economics point of view, corporation can be considered as a business platform where market process (capital, production, and consumption) is integrated through a systematic decision making procedure (what we call as management). From law and economics point of view, corporation is a nexus of contract, i.e. the aggregation of people bound together by a complex web of contractual relationship.

I personally refuse to view corporation as simply an entity whose ownership lies in the shareholders and whose management lies in the board of directors, and therefore, the directors can be considered as the agent of the shareholders and must work for the best interest of the shareholders. Such simplification tends to be problematic in practice.

First of all, what kind of business model is where someone transfers his controlling power to other parties under the guise of ownership versus professional management where he knows that the interest of these so called professionals might not be in alignment with his own interest? Why making such sharp distinction? Second, it should also be noted that there are some instances where the interest of the shareholders will no longer be placed as a priority anymore, such as in bankruptcy cases where creditors will have higher priority than shareholders as the residual claimant.

Instead, I want to view the corporation as a business organization where the parties involved within it should have a good coordination (between the capital owner, the manager, the employees, etc) and should work together in the most efficient way to ensure the maximization of their overall welfare without imposing unnecessary costs to the society. The only way to align all of these interests within the corporation would be to ensure that all party must work for the best interest of the corporation as a whole. From that point we can determine further what would be the proper role of each parties within a corporation, especially the role of shareholders and board of directors.

With respect to the above idea, a specific discussion must be made with the nature of public corporations. As we may be aware, the ownership structure in these public corporations may vary in Indonesia. There are corporations where the ownership structure is pretty much diversified to the extent that it is difficult to find any controlling shareholders, and there are corporations which are being controlled by certain controlling shareholders.

In a perfect world with minimum transaction costs, shareholders and the board of directors can negotiate the terms and conditions for managing the corporation and we can assume that: (i) they will find the best way to balance their authorities and (ii) in case changes must be made, they can quickly adapt to such situation by amending the contract made between them. The problem is, this is almost impossible to happen within a public corporation.

In a public corporation where the numbers of shareholders are huge, it is easy to conclude that they will face collective action problem, preventing them from making an effective negotiation with the directors nor from conducting day to day management of the corporation. As a result of which, the board of directors will ultimately become the controlling party of the public corporation without any internal counterbalancing party. In short, the ownership structure in public corporations create a situation where there is no opposition in the corporation that can ensure a good check and balance mechanism.

The same problem can also occur when controlling shareholders exist within a corporation. Having the majority power to decide what the corporation should do, they can use their power to pursue their own interest at the expense of the corporation and other shareholders. In short, whoever controls the corporation, shareholders or directors, might abuse their power. Thus, a check and balance mechanism would be necessary. For the purpose of this post, I will focus on the directors part.

We have these kind of check and balance mechanisms in our government structure (or we think that we have) because we understand that the government consists of people and they are not angels which have no self interest. By simple logic, the same thing should also be applied to corporations which obviously are also managed by a bunch of people. In case shareholders cannot be the counterbalancing party, we need to have other external mechanisms to ensure that the board of directors will have the correct incentives in doing their job.

One of the possible solutions might be to rely on the market. Bad managers will reduce the value of the corporation that they manage and will induce other potential buyers to takeover the corporation and replace the old management. This seems good, but there is no guarantee that it will always work nor will it be be beneficial to the overall stakeholders of the corporation. Furthermore, in Indonesia, the regulators seem want to limit takeover practices by imposing certain limitations such as the requirement to conduct a mandatory takeover which increases the overall costs of a takeover.

An alternative solution would be having the assistance from the law and the court by filling the gap, creating specific duties that must be performed by directors and that will cause them to be liable either to the corporation or the shareholders (as mandated by the prevailing laws of Indonesia) in case they fail to perform those duties properly. By imposing such liability, we expect the directors will be more careful in performing their work and will always be loyal to the interest of the corporation.

It should be noted though that this is but one solution among many solutions to be used in guiding the directors performance. In corporations with small numbers of shareholders, where coordination between managers and shareholders is easy to achieved, limiting liability might be the best way. But for public corporations, that will not work. Imposing liability is necessary as a check and balance mechanism for corporate governance. It is what our law supports and what any rational men will agree anyway.

B. Best Interest and Best Effort

Even though legitimizing the existence of directors duties is not a difficult task, the real challenge is to expand those duties into a standard that would be acceptable to all stakeholders. Two issues that we need to address here: (i) defining the best interest of the corporation, and (ii) defining the standards that the directors must comply in order to satisfy the best interest of the corporation.

1. Defining The Best Interest of Corporation

On the first issue, in line with my view that corporation should be seen as a platform for business organization for various stakeholders, the best interest of the corporation should be translated into maximization of the value of the corporation which will benefit the whole stakeholders of the corporation in general.

Each managerial decision to be made by the directors must consider carefully whether there is a perceived benefit for the corporation if such decision is taken. Whether the benefits are for short term or long term should not be a major problem, the more important thing is that the directors when being asked by the stakeholders of the corporation can provide sufficient justification that they have done their best effort to ensure that their decision is made only and only for the benefit of the corporation as a whole.

2. Defining The Best Effort Standard

The next step is to define the term “best effort”. A good standard would not sacrifice the flexibility that the directors have in managing the corporation. Putting too high standard will burden the corporation as it will increase the costs of decision making by the directors. While putting too low standard will defeat the purpose of finding the correct incentives for directors as they can cover their liability even when they are reckless by ordinary standard.

A major issue related to defining the best effort standard is the fact that the court is not a business expert. Creating an ambiguous standard would eventually burden the court since when there is no certainty, we can expect that more cases will come to the court and there is no guarantee that the court can provide the best result. On the other hand, if the court creates a rigid business management standard, what would be the justification to provide such standard? The court could end up damaging the welfare of the society for making standards outside their own expertise.

In order to determine whether the directors have conducted their best effort, I would suggest that the court should not try to create an ambitious standard that will be problematic for future cases. I would instead urge the judges to think as if they are ordinary people who trust their money to certain trustees and expect that they will cooperate with them for their best interest and that they will work with the money as if the trustees own the money themselves. In such position, I will naturally focus on the decision making procedures that have been taken by the trustees before I move on to the end result of their decision.

Can they show that they have enough time to discuss the proposed action? Can they show that a proper study has been conducted by the board of directors, at least internally, that the action is beneficial to the corporation? Can they show that they have considered the risks that might occur, the probabilities of the risks occurrence, and how the corporation will mitigate such risks? I believe that all of these questions reflect the common sense standard in doing a business.

In case of doubt, all of these actions should be judged in accordance with the standard usually used by similar industries or type of business and the court can obviously rely on expert witnesses concerning such matter. If it can be proved that the directors did not meet those standards, they should be deemed violating the best effort standard, and it will open the door of liabilities.

Another solution would be to induce the directors to use the service of independent third party professionals in rendering their decision, such as lawyers, financial advisers, and appraisers. The use of these professionals has already been required by certain capital market regulations and might indicate the good faith of the directors to ensure that they don't make significant mistake in doing their job. Of course, the court can always review the independency of the professional parties to ensure that there is no conflict of interests which may taint the business decision.

C. Conclusion

Although our law has stated that directors have fiduciary duties to satisfy the best interest of the corporation, further elaboration is needed to ensure that all corporation stakeholders can have the right incentives in doing so. There are many ways to ensure that directors stay true to their duties, either bia the market or the law. If we want to use legal mechanism, the role of the court should be expanded as the guardian of the last resort in the business world. Of course, to achieve such state, the quality of the judges must also be improved.

I've just found an interesting case from the Supreme Court of the Unites States on whether corporations have the so called "personal privacy". You can review the opinion here and a brief commentary from the SCOTUS Blog here. Apparently, according to the Supreme Court, while in legal terms the word "person" may include corporations, the word "personal privacy" is not applicable for corporations since the word itself pertains to the privacy interest of individuals, it suggests a type of privacy evocative of human concerns, and this is not the sort usually associated with an entity like corporations. To put it simply, can you actually hurt the feeling of a corporation?

The case itself is about the request from a US trade organization asking the US Federal Communications Commission to disclose information related to its investigation upon AT&T on the basis of the Freedom of Information Act ("FOIA"). The request was rejected due to some exemptions under FOIA, i.e. (i) trade secrets and commercial or financial information, and (ii) records or information compiled for law enforcement purposes that could reasonably be expected to constitute an unwarranted invasion of personal privacy. The main issue came from the second exemption. While in the end no information was shared, the exemption was made by FCC on the basis that some of the information may attack the personal privacy of AT&T's employees. AT&T cannot accept that reasoning and further asked the court to protect the information on the basis that the disclosure of such information may attack the personal privacy of AT&T. Yes, this is a game of words.

As discussed above, the Supreme Court finally decided that personal privacy is not applicable for corporations. They have already received enough protection from the restriction to disclose trade secrets and commercial or financial information. So why bother asking protection for personal privacy information? However, it should be noted that the above opinion was made on the basis of a strict grammatical interpretation on the words "personal privacy". While I mostly concur with the use of grammatical interpretation when the text of the laws is clear, I think it would be better if the US Supreme Court can also provide an economic insight on their decision.

Sure, companies do not have any feeling and no board of directors are crazy enough to claim that a disclosure of certain information can hurt the feeling of their company. BUT, any company would do almost anything to maintain its reputation and disclosure of certain information can surely hurt the reputation of the company, which is bad for the business. Can we cover this issue of reputation within the context of personal privacy? Maybe, but for now, the United States Supreme Court will stick with their latest concept of personal privacy, and I will reserve that question for another time.

I would love to know what Indonesian jurists will do if a similar case is happening here. This might open an engaging discussion on the limit of imposing human attributes to legal entities.

To be honest, I've practiced as a lawyer for more than 6 years and still, I don't know exactly what's the true meaning of thinking like a lawyer. Apparently, Prof. Bainbridge thinks that to enable more lawyers to think like a lawyer, law schools require more experienced lawyers than PhDs to teach at those schools. See the article here. You can also see a nice law review article on thinking like a lawyer here.

I have to disagree with some of his premises though. My gut feeling says that the main problem with those PhDs is not that they can't teach lawyers about other fields that can enrich a lawyer's ways of thinking but simply because the quality of those PhDs are mediocre. On the other hand, I am quite certain that asking more experienced lawyers to teach at law schools seems like a good proposal, especially if you're talking about corporate laws. Like it or not, in Indonesia, the development of corporate laws lies mostly in the hand of corporate lawyers instead of theoretical lecturers. The problem is, most of these lawyers don't have the time to share their knowledge to law students, which is a pity.

Why do I say that the teaching of corporate laws needs corporate lawyers? Corporate law is not only about legal issues per se. There is an economic structure behind the corporate laws and to understand such structure, lawyers need to have sufficient experience handling various corporate transactions. These experiences will enable lawyers to gain knowledge on the commercial issues of their clients which will further help them in understanding the economic structure of the corporate laws and how to improve such laws.

Some thought provoking questions: Why there should be a limited liability concept for companies? Why directors have fiduciary duties toward the company? Why do we need commissioners for supervising the management of the company? Why we tend to limit a company to enter into affiliated party transactions? And many more.

As you may see, the above questions pose certain economic rationales. There is no simple right or wrong answer in corporate laws as in the end, it depends on the economic structure that the regulators choose to build the foundations of corporate laws. There are virtually unlimited ways to improve our corporate laws, promote efficiency and create more preferences to the society. We need to always remember that corporations are essential institutions of the market, and therefore, it is natural if the laws that govern corporations should be designed carefully and thoughtfully.

Stay tune as I will uncover some of these economic structures in my future posts.

Here is a very interesting article from Prof. Stephen M. Bainbridge on the absurdity of the new SEC's Shareholder Proposal Policy which basically gives the right to minority shareholders of a publicly listed company to force a vote in a general meeting of shareholders. The absurdity lies in the fact that according to a US court precedent, the tests for granting the validity of such proposal include matters on ethical and social significance, and not only economic matters.

Of course this would be problematic for companies as this is the same with providing the minority shareholders with the ammunition to control the company for matters which are not directly related to its financial and business performance. In this case, I fully agree with Prof. Bainbridge analysis on the importance of materiality principle in securities laws. If the shareholders want to be involved in the company's management, it should be done only for material transactions that may economically affect the investment value of the relevant shareholders in such company. If the shareholders can actively use the company for their own personal and political needs, why bother to have the concept of limited liabilities?

Luckily, Indonesia does not adopt this kind of rule, though I am surprised that the development of shareholders protection law in the United States has already reached a position where it is difficult to differentiate the role of shareholders and management.

About a year ago, I wrote a short article on whether there is any relationship between guaranteed high bonus and excessive risk taking by the management of a company. You can see the post here. Basically, such guaranteed high bonus gives a negative incentive to the board of directors to take higher risks in order to gain better benefit for the company. While higher risks might be translated into higher profits, they can also cause higher costs and losses which would trouble the company and the shareholders. In other words, big payment might actually produce worse results.

Apparently, Dan Ariely, a Professor of Psychology and Behavioral Economics at Duke University, has a similar view on this issue, though he reached the conclusion from different perspective. In his latest book, The Upside of Irrationality, he discusses his experiment which more or less shows that higher payment does not always work. The experiment was conducted in India, where several participants were asked to play some games in which they will receive financial compensation if they completed certain objectives within the games. The tests were divided randomly into 3 categories (the games were same, though), the first category gave very small payment (equal to payment for 1 working day in India), the second category gave mediocre payment (equal to payment for 1 week of work), and the third category provide the highest payment (equal to payment for 5 months of work). FYI, the average costs of one month living in India is US$11, so 5 months means US$55. That's why Dan had enough funds to conduct his research :).

What's the result of the experiment? Well, you might have guessed this: statistically, those who play the games in the third category end up as the worse players. It seems that the thought of having such a huge payment in the end of the game gave them a huge pressure, so huge that most of them fell under the mental pressure. This is interesting and yes, I can relate this to myself. As an example, when I do online shares trading, the bigger the stake is, the harder I make the final decision. It is a very stressful experience! The case is different when the stake is low, and I definitely can make a better decision in such case.

Therefore, it is quite easy for me to understand the result of the above experiment. When you know that the stake is very high (i.e. the end rewards), there is always a possibility that you will fall under the pressure which eventually will affect your overall performance. The similar thing can happen to those CEOs who are promised with guaranteed big fat bonuses. Since they need to establish a sufficient evidence that they are worthy enough to receive such payment, they take actions that might be riskier which then turn out to be a deep trouble for the company. Hence, lower performance.

I must say that Dan Ariely experiments entertain me most of the time. Like it or not, men are not always rational. There are certain conditions where our rationality might be defeated by our impulse. Only by accepting this fact that we can actually improve ourselves from such weakness. For more information, I suggest you to quickly buy the book. It's available in Times, as far as I know.

If I could only complain one thing on the process of doing an initial public offering of shares in Indonesia, that must be the requirement for a proposed listed company to obtain from its creditors a waiver of any restriction on such company's capacity to pay dividends to its shareholders or any restriction of dividends payment on the subsidiaries level, provided that the proposed listed company income depends on the payment of dividends from its subsidiaries.

You will be amazed to know that this is not based on a strict regulation, rather it came from an unwritten policy of the Indonesian Capital Market and Financial Institution Supervisory Agency ("Bapepam-LK"). According to Bapepam-LK officials, when a company is trying to raise funds from the public, such company should be able to pay dividends to its shareholders since such dividends will become the main source of income for its shareholders. Therefore, any restrictions for dividend payment should be eliminated as well.

Okay, to certain extent the argument makes sense, but such argument is too simple to be used as a reason for forcing those proposed listed companies to obtain a waiver of their dividend payment restrictions. As far as I know, from the investors perspective, there are two main ways to obtain income from the capital market: (i) payment of dividends, or (ii) capital gain, i.e. buy low, sell high. In other words, dividend is not the only source of income, and in practice, not all investors focus on getting the dividends.

Furthermore, waiving the restriction of such dividend payment may significantly affect the possibility of securing a financing from financial institutions. As you may be aware, for companies, there are three ways of raising funds, i.e. (i) debt financing, (ii) equity financing, and (iii) hybrid financing (the combination of debt and equity financing). Some financial institutions would require its debtors to limit their payment of dividends to ensure that the debtors could have sufficient funds to repay their debts to these financial institutions. From my experience, there were some cases where the proposed listed company had to repay its debts because its creditors did not agree to waive the dividend restriction. If the debt is not huge, than that wouldn't be a problem, but if the amount is huge, the company will face a serious problem as getting the creditors approval might not be easy and the financial condition of the company may also be compromised.

I always believe that capital market regulations should focus on transparency, on how disclosures about the condition of publicly listed companies should be made, not on how they should perform or doing its business activities, that is the role of the management and that is why they are being paid. Forcing proposed listed companies to waive their dividend restrictions is essentially the same with limiting their choices between debt and equity financing, and I am sure that this is not efficient!

In my opinion, the most important thing is that the proposed listed companies have disclosed in their prospectuses that they have several debts and in those debts, they are being limited to pay dividends (fully or partly). If proper disclosures have been made, it is up to the investors decision on whether to invest in such companies or not. That would be the ideal things to have in Indonesia.

Unfortunately, this Bapepam-LK unwritten policy has not been revoked until today. The only thing that we could do now is to lobby Bapepam-LK and make them understand on this issue. Protecting Indonesian investors is very important, but we should also do that in a proper way, not by limiting the options of publicly listed companies, which in some cases, is actually counterproductive.

Yes, according to Lucian Bebchuck, a law professor from Harvard Law School. A guaranteed bonus may, to certain extent, create distortion in determining the business risk of a company. By having the benefit to receive a guaranteed bonus no matter what the performance of the company, there would be a considerable pressure for the management to meet the company's business target or even exceed such target. As a result of this, the management may take unnecessary risks in doing the business just for the sake of getting better performance. We need to understand that in some cases, riskier business decisions may provide higher results, but they may also cause greater losses. When the results are losses, who would be the largest victim? The Company and also the shareholders.

Further, Prof. Bebchuk theorizes that if the bonuses of the management were distributed based on the overall performance of the company, say after reaching a minimum amount of annual profit, the management will have better consideration in doing the business, i.e. they would only take the risks if the odd of getting the intended performance are higher than the odd of getting a lower results. Why? Since the management bonuses are now tied to the performance of the company, it would be dangerous for them to take too much risks because if the results are bad, they will also lose their bonuses. As a result, they would play safer.

Again, this shows how incentives work in our life. I would love to see how this will be implemented in Indonesian regulations. While I absolutely don't agree if the regulator is trying to limit the amount of benefits that can be obtained by the management, a policy on how to structure the best benefit package should be okay, provided that companies can freely choose to adopt such policy or not (as will be determined by the shareholders and, if possible, an independent remuneration committee).

Related to my post on 18 August 2009 where I discussed how US lawyers and law professors make comments on a proposed regulation, after seeing another recommendations from several professors from Harvard Business School and Harvard Law School on the proposed amendment to an SEC Rule which would allow shareholders of publicly listed companies to have greater influence in deciding the composition of the board of directors and commissioners ("SEC Regulation"), I'm getting pretty interested with the actual content of this SEC Regulation.

You can read the 250 pages of the SEC Regulation (which include the proposed amendments and a thorough review of such regulation from the SEC team complete with list of detailed questions asking for public comments) here, and if you are also interested to read the US lawyers' comments on that SEC Regulation for some additional insights, you may read the 40 pages comments here. Be warned however, considering the total pages of those documents and the fact that they deal with complicated US securities regulation, it would be wise if you don't waste your time to read them unless you have a legal background, consider long and complicated reading materials as entertaining, and have absolutely nothing important to do :). Of course, you can simply read a quick summary of the main issues of such regulation below.

Summary of the SEC Regulation

Okay, since this SEC Regulation also deals with certain issues which might only be applicable to US Laws, the summary below will only cover the main issues which might be relevant for Indonesian corporate law, i.e.:

the main purpose of the SEC Regulation is to increase public shareholders participation in determining management candidates for the relevant publicly listed company and to increase information transparency of the candidates themselves;
to satisfy the above purpose, the SEC Regulation requires publicly listed companies to provide information on the candidates in the proxy materials for the shareholders with respect to a general meeting of shareholders; and
the SEC Regulation also tries to determine the qualification of shareholders who can propose candidates of management members, which include having a minimum percentage of shareholding and a minimum period for holding the shares in case their proposed candidates are successfully being elected as the management of the company.

With respect to the above proposed provisions, the Professors from HBS and HLS recommend the SEC to adopt such regulation with the following recommendations:

the minimum amount of shareholding percentage for proposing candidates of directors and commissioners shouldn't be too small (the SEC Regulation proposes 1% but this amount will also depend on the total capitalization of the relevant publicly listed company), as it may cause too many competing candidates for leading the company;
the main point of this SEC Regulation is to have more information on the candidates and if possible, new people on the board of management, not for the sake of making trivial contests, therefore, the threshold for proposing candidates should be increased, say around 5-10% provided that this threshold can be further reviewed in the future in accordance with the relevant situation and condition; and
there should be a minimum period for holding the shares of the relevant publicly listed company after the appointment of the relevant shareholders' proposed candidates is successful, say at least 1 year, just to make sure that the appointed directors/commissioners and the shareholders are serious with the long term development of the company.

Why am I Interested with this Particular SEC Regulation?

It's quite simple though, until today, Indonesia does not have a specific law which deals on how public shareholders of a publicly listed company can propose candidates for the directors and commissioners of such company and when the information on such candidates should be available to the public.

Under the current Indonesian Company Law, any shareholder(s) having at least 10% of the total shareholding of a company (unless the articles of association of the company provide a lower threshold) would be able to propose a general meeting of shareholders (including proposal of the agenda of such meeting). So in theory, if you satisfy the 10% threshold, you should be able to propose your own candidates. However, I haven't heard the actual application of this concept in publicly listed companies.

In addition, it is almost becoming a general practice that the information on the management candidates will only be provided on the date of the general meeting of shareholders. As a result of which, shareholders often do not have the privilege to review the candidates competency beforehand and may not have complete information in determining the best candidates for the management position.

Having said the above, I would like to analyze whether at this current stage Indonesia should be required to have a similar regulation with the above one. Of course, I don't expect that we will have a detailed and sophisticated regulation like in the US, we're talking about the principles only. The drafting of such regulation should only be discussed after we can clearly agree that the regulation itself is needed.

The Necessity of Having Better Transparency and Fairness to All Shareholders

Balancing the relationship between the management and shareholders of a company will always involve some problems, particularly because there are no perfect guidelines on how the management should maintain the relationship with the shareholders. Some legal theorists argue that the management is, to certain extent, acting as the agent of the shareholders, and therefore must act for the benefit of such shareholders. But then again, some of them also argue that the management should act to the best interest of the company, whereas, the interest of the company may differ from the interest of the shareholders.

While we can talk anything in theory, in practice we would need to understand that since the management is appointed by the shareholders (and of course they can always be replaced by the shareholders), there would always be an incentive for the management not to acting in the best interest of the company, particularly when such action might cause them to lose their position or possible remuneration. As a result of which, when a company is being massively controlled by certain controlling shareholders, the possibility of management breaching their fiduciary duty to the company would be most likely increased.

However, the case can also be turned the other way around, that is, if the shareholders of the company are too diversified and no one has majority control over the company (such as in certain publicly listed companies), the management of those companies would be in a stronger position to determine their own actions and rewards and will have less incentives for having better accountability toward the shareholders.

In both cases, the victim would mostly be the public shareholders, i.e. those who cannot be considered as the controlling shareholders. Indeed, Indonesian laws have provided some form of protections for these kind of shareholders, such as the right to request the company (or any third parties appointed by the company) to purchase their shares with a fair price in case they suffer losses due to decisions made by the general meeting of shareholders or the management of such company. For publicly listed companies, the case would be easier. If the company's shares are liquid, the shareholders who don't agree with the company's decision could simply sell their shares in the market.

While this protection mechanism can be considered as a good policy, it has one significant problem, i.e. it encourages public shareholders to leave the company instead to stay for a longer period. What happen if those shareholders actually believe that in the long term the company has a very good prospect, but because of the current condition, they are "forced" to sell their shares? And how about institutional investors who may have quite a huge amount of shares though they are not yet considered as controlling shareholders? They may face some difficulties in selling their shares in the market.

Further, the most important question is why we penalize the company to purchase the shares of the public shareholders who don't agree with the decisions made by the organ of the company? Wouldn't that be counter productive for the growth of the company itself?

I always believe that giving more choices to the public would benefit us all. Therefore, it would also be better if we can have a regulation which can increase public shareholders' participation in determining candidates of the management of the publicly listed companies, including better transparency with respect to information on the management candidates and fairness to any shareholders to propose their own candidates (provided that they satisfy the minimum threshold for shareholding). In this case, adopting a similar regulation with the SEC Regulation would be recommended by me. Further comments from the HBS and HLS professors should also be considered as those comments are very relevant in ensuring that the regulation is workable enough in

One question remain though, what would be the use of giving the opportunity to public shareholders to propose their own management candidates if in the end they will not have sufficient votes to approve the appointment of their candidates since the controlling shareholders do not agree with the candidates? This is particularly relevant in Indonesia where it is very rare to find a publicly listed company which does not have any controlling shareholders.

To solve this issue, it may be possible that the threshold of appointing candidates proposed by public shareholders shall be reduced to allow voting by minority shareholders or that the controlling shareholders shall have no votes with respect to the appointment of such candidates. (as if in a conflict of interest transaction). Further discussion on this issue would be definitely useful.

To end this article, it is important to note that while having better transparency and fairness for public shareholders in determining the management candidates might help a company to increase its performance, it wouldn't be quite effective unless there are other incentives which may directly affect the behavior of the management. In this case, I refer to the remuneration system of the management. To see my proposal on this issue, I recommend you to read my post on 17 August 2009, where I discussed the use of independent committee in determining the remuneration of the management.

Have you ever wished for immortality? Do you want to live forever and ever, having the luxury of doing whatever you want without any time constraint? I do, but I guess that the chance for achieving such immortality is too slim to be even considered by any rational being. However, other than any mythological creatures out there, there is an entity in this world that might actually have the capacity to achieve immortality. By this, I refer to corporations.

What Are Limited Liability Companies?
While the definition of corporations might slightly differ between various legal jurisdictions, it has several basic characteristics, i.e.:

corporations are legal entities established under the prevailing laws which have jurisdiction over such corporations (the domicile where such corporations were firstly originated);
corporations are able to maintain their own assets and liabilities, and to conduct various transactions with other parties;
corporations are "owned" by the shareholders, i.e. those who have contributed certain amount of capitals to the corporations and received shares from the corporations as evidence of their contribution and representing their ownership within such corporations;
there is a limitation of liabilities for the shareholders of corporations (mainly up to the respective shareholder's capital contribution in the corporation);
there is a separation of management within a corporation, i.e. the shareholders do not have direct management control of the corporation, instead it is conducted by a separate professional board of management (directors and commissioners); and
most corporations, if not all, are established for the purpose of getting profits, enabling them to maintain their existence for a very, very long time.

The legal concept of corporations is unique, because it is considered as a somewhat "living entity" having certain rights and obligations, while in reality it is a business organization made from joint stocks owned by certain party(s). But, only because of such characteristics that corporations are able to have an immortal life and becoming an integral part of the capitalist system.

When Was The First Limited Liability Company Established?
According to Gower's Principles of Modern Company Law, the early concept of corporations can be found in the 15th century, notably on the limitation of liabilities of the owner of such corporations. The oldest known corporation is no other than VOC (Verenigde Oost-Indische Compagnie), the "evil" company that made a reign of terror in Indonesia, and which is also the first company to conduct public offering in this world. Since the establishment of VOC in 1606, the history of corporation has lasted for more than 400 years, and that is quite a long time indeed.

Why People Made Limited Liability Companies?
The logic is quite simple, corporations allow people to have the protection of limited liabilities in doing their business, they can be established for an indefinite period, and their existence does not depend on the existence of their owners. This means that it would be easier for the owners to calculate their risk of liabilities (due to the limited liabilities) and the business activities may continue even after all of the original founders have crossed to the other side, i.e. died.

Prior to the existence of corporations, each man is liable up to all of his assets in doing business activities with other parties. Thus, if something goes wrong, he will be responsible with his entire assets, and he faces the risk of losing everything. In addition, since most of the businesses are being privately conducted by individuals in the form of self-company or partnership, the death of the particular individuals will cause the self-company or partnership ceases to exist. The introduction of corporations solves the above problems, and whoever firstly made this concept must be a genius.

The Role of Law on the Establishment of Limited Liability Companies
Of course, people can't simply establish an corporations and declare that they have limited liabilities to their counterparts solely by themselves, people need some legal support to do that. Without any legal basis, you can't expect people to believe that an abstract entity such as corporations exists. In order to achieve that purpose, we will need the government to step in.

Again, this is another genius concept. By having a state law acknowledging corporations as legal entities and stipulating rules on corporations characteristics, establishment procedures, and its rights and obligations, the existence of corporations has been secured by the law, and no one can argue more on that. With the help of law, corporations are no longer abstract beings. They exist in the vicinity and they can act and enter into various transactions as if they are living persons.

Unfortunately, the concept of corporations is not without any flaws. As we shall see further below, 400 years of existence has brought many issues that might not be considered yet when the corporation is firstly established.

The Chase for Profits and The Impact of Immortality
From the very beginning, a corporation was created to be a profit oriented business entity, and the management of a corporation has an obligation to ensure that such purpose can be satisfied most of the time, if not all the time. Under Indonesian laws, the management of a corporation must act to the best interest of the corporation, which can be interpreted to also include the obligation of the management to ensure that the corporation can obtain sufficient income and profits for maintaining its going concern status, i.e. the ability of the corporation to continue functioning as a business entity for certain period without any threat of stopping or being liquidated.

So, the obligation of the management of a corporation to pursue profits is not a trick made by some evil businessmen, rather it is an obligation stipulated by the law itself. This brings us to an important issue. You see, by having the ability to live an eternal life, there is no limit for corporations in obtaining profits. And since it can't aged, the shareholders would expect the corporation to survive in any kind of condition for as long as it can be. To give incentives to the management, huge salaries and bonuses were given for those who were succeed to make the corporation profitable enough for the shareholders and for those who were failed, losing their position might be the smallest consequence. With this kind of approach, it is no wonder that in some cases, the lust for profit can evolve to a dangerous lust for everything as greed controls the management of such corporation, and when that happens, all would be fair and square enough as long as their lust can be satisfied. VOC would be a pretty example, among with various famous crumbled corporations like Enron and WorldCom.

Can we blame them for that? Not entirely, because whether you like it or not, it is their legal obligation to secure those profits, even if they need to trick everybody. In addition, as I've mentioned above, they were paid by a huge salary and bonus to ensure that the corporation is always profitable for the shareholders. So, do we have some clear incentives for the management to do otherwise? My guess is not, since while some penal sanctions and fines might be a threat to the management, as long as their compensation is highly enough to cover the risks of being sanctioned due to their actions, there would always be a incentive for them to take such risk. As mentioned by Gary Becker, an American Nobel Laureate, crime only happen because it "does pay." See his paper here for more information.

Proposed Policies
Then, what should we do? What kind of policy that should be implemented to solve this problem? First of all, any kind of solution that restricts the corporations ability to obtain profit would be horrendous and will not be accepted. Or can we try the policy used by the US Government with respect to companies that receive US Government's aid, i.e. giving some limitation to the amount of the salaries and bonuses that can be obtained by the management?

My reply is no. The Government shouldn't regulate on the maximum amount that can be obtained by the management. How can they know how to calculate the performance of each member of the management? How can they know that the payment of such huge salaries and bonuses are exceeding the fair limit? A policy like that might give a negative incentive to the management for not doing their best simply because they see that their good results will not be as rewarding as it might be if such regulation does not exist.

Having said the above, my proposed policy would be as follows:

Determination of the form and amount of salaries and bonuses of the management should be conducted by an independent committee within the corporations. This has been done in several Indonesian publicly listed companies, but have not been yet stipulated in a clear regulation. There is of course some additional costs for having this committee but there is also a good ratio for having this committee, i.e.: (i) ensuring that the management can receive a fair reward for their performances based on the calculation of those who are being involved with the corporation, (ii) preventing the management from creating salary and bonus policy that contravenes with the corporation and/or shareholders interests, such as giving excessive shares options with low price to themselves as their bonuses, and (iii) helping the shareholders who are not involved in day to day business activities of the corporation in understanding the performance of the management and how they should be rewarded.
The sanction for the management who breach the laws for the sake of getting profits should be higher than or at least equal with their overall compensation (this include their salaries, bonuses and any type of incomes that they receive due to their illegal acts). This proposed policy is made based on the following assumptions: (i) if their compensation is low, there would be less incentives for them to breach the law; and (ii) if the compensation is high, they will face the risk of losing such compensation or even a bigger amount if they're breaching the law for getting good performances or else for benefiting themselves. As an example: "if the management is deemed guilty for conducting certain amount of crimes, they would need to pay an amount equal to triple times of their total annual salaries and bonuses that they received for the preceding years." Of course, this policy would be only effective if there is a high rate of legal enforcement, something that might not be achieved efficiently as of today.

While some elaborations and implementing provisions are definitely needed for the above policies, I do hope that the ideas presented here can contribute to the development of better policies in managing the balance between lust for profit and the business sustainability of corporations.