January 06, 2009
What’s Wrong with Shareholder Exit?
Posted by Benjamin Means

Yesterday, I summarized my claim that courts should use the presence or absence of minority voice as an important guide to the adjudication of claims of minority shareholder oppression. My proposal runs counter to what seems to be the prevailing academic view, which is that we should simply make it easier for minority shareholders to exit the corporation. John Matheson and Kevin Maler, for example, have proposed an automatic, statutory right to exit akin to a no-fault divorce.

My principal concern with exit-focused approaches is that they undermine the significance of choosing the close corporation form and the shareholders’ interest in having a locked investment. From the ex ante perspective, it is not clear that shareholders would benefit from a rule that left their investment exposed. Also, as Stephen Bainbridge points out in his Corporation Law and Economics treatise, undermining the stability of the corporate form would require potential creditors to worry about the relationship of the equity investors and this monitoring burden and uncertainty would reduce the attractiveness of investment.

It also seems unclear whether an automatic exit right would actually reduce the cost of litigation. Given the lack of an established market for shares, creating liquidity for close corporations involves considerable valuation difficulties. Under existing doctrine, there must be a showing of harm before any remedy is available, which limits litigation and focuses those lawsuits that do go forward on liability issues which courts are better suited to address. So, even if easier exit promises some efficiency benefits, those savings may not amount to much.

We should further consider the possibility that minority shareholders could gain too much power in the governance of the close corporation. While some boost in exit could enhance voice by backing it with a credible threat, the possibility of shareholder litigation may already serve that function. If the threat of exit becomes too strong, given the need for locked investment, then minority shareholder demands may overwhelm sensible decision-making.

To make this a trilogy, I’ll post on close corporation governance again tomorrow and respond to the so-what objection – why does minority shareholder voice matter?

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