THE ONE-TIER BOARD IN THE CHANGING AND CONVERGING WORLD OF CORPORATE GOVERNANCE THE ONE-TIER BOARD IN THE CHANGING AND CONVERGING WORLD OF CORPORATE GOVERNANCE A comparative study of boards in the UK, the US and The Netherlands Willem J.L. Calkoen 2012 Kluwer – Deventer – The Netherlands This PhD thesis contained in this book was publicly defended by the author on 11 October 2011 at Erasmus University Rotterdam, The Netherlands. Omslagontwerp: H2R Vormgeving & Communicatie ISBN 978-90-13-10437-0 NUR 827-715 E-book: 978-90-13-10438-7 © 2012, Kluwer Deventer Alle rechten voorbehouden. Niets uit deze uitgave mag worden verveelvoudigd, opgeslagen in een geautomatiseerd gegevensbestand, of openbaar gemaakt, in enige vorm of op enige wijze, hetzij elektronisch, mechanisch, door fotokopieën, opnamen of enige andere manier, zonder vooraf- gaande schriftelijke toestemming van de uitgeverij. 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Preface On 11 October 2011, Willem Calkoen was awarded a PhD by Erasmus University Rotterdam (The Netherlands) for his study on the One-Tier Board in the changing and converging world of corporate governance, under the supervision of Professor Dr. L. Timmerman. It is with great pleasure that we present this book in the series of the Institute for Corporate Law. The Act of 6 June 2011 gives Dutch two-tier board companies the option to change to a one-tier board system, so well known in the UK and the US. Calkoen focuses on the best practices applied in the UK, the US and The Netherlands and what can be learned from the comparison. He gives an insight in the way boards work in practice in the three countries. This study comprises five chapters: an introduction, Chapters in the UK, US, The Netherlands and a conclusion. Each of the country chapters are composed of sections 1 − history and culture, 2 − who owns the shares, 3 − acts and informal codes, 4 − composition of boards, 5 − role of directors, 6 − duties and 7 − liability of directors. Within the Chapter on The Netherlands’ there is also a comparison between the one- and two-tier board systems. Calkoen discusses the advantages of the different systems: two-tier and one-tier and gives practical suggestions for the improvement of boardroom practice. In the context of the current economic and financial crisis, improvement in corporate governance is more relevant than ever. We are convinced that this inspiring and thorough study will contribute to a better understanding and promotion of better boardroom practices and will be welcomed by business organizations, legal professionals, academics and government representatives as a valuable resource. Maarten Kroeze Jan Berend Wezeman Institute for Corporate Law of the University of Groningen and the Erasmus University Rotterdam, The Netherlands V Table of contents Chapter 1 Introduction 1 1.1 General introduction 1 1.2 Introduction: one-tier board as alternative 2 1.3 History and culture 5 1.4 Company legislation and informal codes of best practices 6 1.5 Composition of boards 7 1.6 Role of directors 8 1.7 Duties of directors 9 1.8 Liability 9 1.9 Purpose of this study 10 Chapter 2 United Kingdom 13 2.1 History and culture 13 2.1.1 General characteristics 13 2.1.2 History of UK company governance 14 2.1.3 Aspects of British company culture 26 2.2 Who owns shares? 36 2.2.1 Sources of finance 36 2.2.2 UK banks do not use influence 36 2.2.3 Stock Exchange important for peer control 37 2.2.4 Who are the shareholders and what is their influence? 37 2.3 Formal Acts and informal Codes 42 2.4 Composition of UK boards 45 2.4.1 Introduction on composition of the board 45 2.4.2 Choice of one-tier board 46 2.4.3 NEDs before and after the Codes: from being the “cats paws” of CEOs to holding the balance of power 48 2.4.4 Types of directors on UK boards 49 2.4.5 More executives on the board and their dilemma 51 2.4.6 Important changes in composition caused by Codes 52 2.4.7 Board balance and independence 52 2.4.8 Not too large 54 2.4.9 At least half the board members to be NEDs 56 VII TABLE OF CONTENTS 2.4.10 Separate chairman and CEO 57 2.4.11 Formal documentation of roles 58 2.4.12 Summary of composition of the board in the UK 58 2.5 Role of the board members 59 2.5.1 Introduction on role of board members 59 2.5.2 Power of shareholders: freedom of constitution 60 2.5.3 Definition of the roles of the board 60 2.5.4 Dual roles of NEDs in developing strategy and monitoring 63 2.5.5 The active strategy-developing role of NEDs 64 2.5.6 Banks 73 2.5.7 Roles of chairman 74 2.5.8 Getting the best out of NEDs 81 2.5.9 Succession; formal; board as a whole 89 2.5.10 Role of shareholders: single out long-term shareholders interested in stewardship 91 2.5.11 Summary of the role of board members in the UK 93 2.6 Duties of directors 94 2.6.1 Basis of duties 94 2.6.2 To whom are duties owed? 95 2.6.3 Enlightened shareholder value 96 2.6.4 Core duties 97 2.6.5 Duty of care and distinction between executives and NEDs 97 2.6.6 Fiduciary duties 104 2.6.7 Voidability, but not against good faith third parties 108 2.6.8 Summary: duties of NEDs 109 2.7 Liability of directors 109 2.7.1 Who can sue? 109 2.7.2 General atmosphere of liability 110 2.7.3 Derivative suits in the UK 111 2.7.4 Enforcement by the company 112 2.7.5 Suits brought directly by a shareholder 113 2.7.6 Outside directors insulated: indemnification, insurance 115 2.7.7 Company insolvency matters 116 2.7.8 Regulator: criminal penalties 117 2.7.9 Other measures, including disqualification 117 2.7.10 Summary: rare cases 118 Chapter 3 United States 119 3.1 History and culture 119 3.1.1 General characteristics 119 3.1.2 History of US corporate governance 120 3.1.3 Aspects of US corporate culture 141 VIII TABLE OF CONTENTS 3.2 Who own shares? 149 3.2.1 Sources of finance 149 3.2.2 Stock exchanges important for regulations 149 3.2.3 Who are the shareholders? 150 3.3 Many formal Acts, informal codes in US by private initiative 156 3.4 Composition of US boards 157 3.4.1 Introduction on composition of boards 157 3.4.2 US one-tier board: “primacy of the board” and one-tier turning into two-tier or multiple-tier board 158 3.4.3 Evolution of US boards over the last 30 years 160 3.4.4 Types of directors on US boards 161 3.4.5 Most officers who are not on the board do attend board meetings 162 3.4.6 Counterbalance provided by independent directors 163 3.4.7 Executive sessions 164 3.4.8 Not too large 165 3.4.9 Independent directors in a strong majority on the board and as sole members of committees, plus requirements for qualifications 165 3.4.10 Term of office 168 3.4.11 Formal documentation of roles 168 3.4.12 Summary of the composition of US boards 169 3.5 Role of US board members 170 3.5.1 Introduction on role of board members 170 3.5.2 Definition of roles of the board and its members 171 3.5.3 Active role of independent directors in challenging and debating strategy 172 3.5.4 Special aspects of enterprise risk management, standards of supervision and care 181 3.5.5 What is the status of the discussion about non-CEO chairmen? What roles does a lead director have? 188 3.5.6 Elements of best practices 193 3.5.7 CEO succession 198 3.5.8 Corporate governance at banks 201 3.5.9 A summary of the role of board members in the US 201 3.6 Duties of independent directors 203 3.6.1 Introduction on duties of independent directors 203 3.6.2 Distinction between duties and liabilities, best practice codes 204 3.6.3 Developments since Enron (2002) 207 3.6.4 Basis of duties 207 3.6.5 To whom do directors owe duties? 211 3.6.6 Pressures on boards 212 3.6.7 Summary of Duties 212 IX TABLE OF CONTENTS 3.7 Liability of independent directors 212 3.7.1 Who can sue? 212 3.7.1.1 The company in a shareholder derivative lawsuit 212 3.7.1.2 Creditor’s rights 212 3.7.1.3 Shareholders directly against directors 213 3.7.1.4 Regulatory action 213 3.7.1.5 ERISA 213 3.7.2 Procedural complications 214 3.7.2.1 Derivative lawsuits 214 3.7.2.2 Creditors suits in bankruptcy 215 3.7.2.3 Direct shareholder damage and securities class action lawsuits 216 3.7.2.4 SEC enforcement 216 3.7.2.5 ERISA 216 3.7.3 Liability standards of directors in various proceedings 217 3.7.3.1 Fiduciary duty violations under corporate law, business judgment rule, duty of loyalty, duty of care 217 3.7.3.2 Enhanced business judgment rule, hostile tender offers, merger cases and deal protection measures 225 3.7.3.3 The duty of disclosure 237 3.7.3.4 Conflict-of-interest transactions 237 3.7.3.5 Securities Law duty violation 237 3.7.3.6 Insolvency, creditors rights 238 3.7.3.7 Criminal law cases 238 3.7.4 Insulation of directors from out-of-pocket payments 239 3.7.5 Summary of director liability 240 Chapter 4 The