The Law and Finance of Related Party Transactions: A Comparative Analysis

Topic and Objectives

The regulation of related party transactions (RPTs) that can facilitate private rent-seeking by controllers features high on the agenda of policy makers around the world. The rationale that underpins this focus refers to the negative impact that an inadequate regime for RPTs has on capital market development, ultimately curbing growth opportunities and decreasing social welfare.

Although the specifics of an efficient regulatory framework that prevents undesirable tunneling but permits value-enhancing transactions with controlling insiders are far from obvious, Germany’s consistent and recurring rejection of reform efforts that seek to tighten the direct grip on tainted transactions is remarkable. The most recent evidence of this attitude is the successful resistance, fueled also by policy-oriented contributions from academics, to the respective rule in the recast EU Shareholder Rights Directive. As a result, the restrictions originally foreseen by the European Commission were considerably watered down in the legislative process.

This chapter looks through the superficial rhetoric that identifies a neglected divergence between the internal governance structures of companies following the continental European civil law tradition on the one hand and the common law family on the other as the substantive reason for legitimate opposition. Instead, it advances an explanation that hinges on long-standing industrial organization particularities: the significant shareholdings, primarily of financial institutions, and the interlocked management functions in deeply hierarchized corporate groups typically referred to as Germany Inc. (“Deutschland AG”). These idiosyncrasies entail a normatively different and far more positive assessment of at least a subset of RPTs that better explains the proclivity of policy makers, corporate stakeholders, and also practically-oriented legal scholars to look more favorably at a system that is rather hospitable to transacting with (certain) controllers. However, this chapter also makes the point that a reorientation of banks’ business models removed a key component from the institutional setting, which destroys the basis for the suggestions to maintain an allegedly tested and proven regime.

To be sure, German corporate law does not neglect minority protection outright, and never has done so for that matter. Yet, at first sight, it relies on rather idiosyncratic institutions – a codified law of corporate groups in particular – to implement the objectives that are widely shared across jurisdictions. After all, the conflict between incumbent blockholders and outside investors is identical at the outset across jurisdictions. What is it then that explains Germany’s reluctance to regulate RPTs head on? If institutional frameworks differ in a way that influences economic results, one plausible explanation relates to a sustained divergence in the payouts that (minority) shareholders and/or stakeholders receive in various jurisdictions. Obviously, such differences influence the political diagram of forces that shapes corporate law. More specifically, if German minority shareholders and other stakeholders received compensating benefits that are larger than in other jurisdictions they might rationally accept more tunneling and endorse institutions that permit such practices to a certain degree. Under these preconditions, the consumption of private benefits of control can be understood as a reward for the creation of additional value by controllers. In that sense, the explanation identifies a real-world example of the normative recommendation put forward in the strand of literature that argues for permitting an optimal level of controller rent-seeking.