October 16, 2015
Business Law Policy Consultation
Consumer and Business Policy Unit
Ministry of Government and Consumer Services
Re: Ministry of Government and Consumer Services – Business Law Agenda: Priority Findings and Recommendations Report (“Business Law Agenda Report”) for reform of Ontario’s corporate and commercial legislation
Thank you for the opportunity to comment on the Ministry of Government and Consumer Services (“Ministry”) Business Law Agenda Report on priorities and recommendations for reform of Ontario’s corporate and commercial legislation, which was published for comment on July 9, 2015. We appreciate the opportunity to be a part of the Ministry’s reform process and to contribute to these important developments.
Hurt Capital Inc. is a research-driven investment and venture capital platform. Since 2008, our investment selections in the capital markets have outpaced the S&P 500. This was achieved with minimal trading, and predominantly a buy-and-hold approach to investing. We attribute this success to an investment methodology rooted in academic research, alongside the traditional value investing principles taught by Ben Graham at Columbia University in the 1930’s and espoused by Warren Buffett with much success in recent years. Hurt Capital's research in this field strives to contribute to Ontario’s economic prosperity and competitiveness as a jurisdiction of choice for entrepreneurial activity, investor engagement, and business expansion.
We applaud the Ministry for undertaking this initiative as part of its broader commitment to ensuring that Ontario’s legislative structure facilitates an efficient market and prosperous business climate. We are supportive of the intent of the Business Law Agenda Report and we recognize the volunteer panel’s significant efforts and difficult task in developing recommendations. Our comments that follow relate primarily to the panel’s recommendations for making Ontario a jurisdiction of choice for innovative business and are broad in nature with a view to informing the trajectory of legislative reform and advancing the overall policy objectives of the Ministry.
Fiduciary Duty and the Principle of Fair Treatment
“An Indeterminate Theory of Canadian Corporate Law”,[1] published in the University of British Columbia Law Review, establishes the foundation of a distinct theory for the enhanced efficiency of business corporations. In revisiting BCE v 1976 Debentureholders (“BCE”), this article uncovers novel insights and reveals new theoretical implications on otherwise challenging developments in corporate governance. In Canadian corporate law, an organizing principle of fair treatment is encompassed within the fiduciary duty. This distinctive duty reflects elements of Warren Buffett’s approach to corporate governance, both essentially rejecting central tenets of shareholder primacy and stakeholder theory. In considering Buffett’s control position in Berkshire Hathaway, which in turn holds a controlling interest in numerous other companies, this research posits that the existence of ethical dominant shareholders may enhance the economic efficiency of publicly traded firms. In militating against agency costs, companies with powerful shareholders may benefit from greater efficiencies, provided that an inversely correlated “discriminatory problem” is mitigated. Anecdotal evidence is drawn from Warren Buffett’s preference for concentrated ownership structures combined with an approach to corporate governance that reduces “discriminatory costs”, a variant of the agency costs pervasive in widely dispersed U.S. corporations.[2] We encourage the Ministry to consider this fresh perspective on the fiduciary duty and its linkage with the oppression remedy.
Innovative Business and Concentrated Share Ownership
In a study on U.S. firms, funded by the Investor Responsibility Research Center Institute and conducted by Institutional Shareholder Services Inc., researchers found that controlled companies are on the rise. In 2002, the S&P 1500 Composite had 87 controlled firms; by 2012 this number was up 31% to 114. Within these firms, 79 contained multi-class capital structures with unequal voting rights, while 35 were controlled through a single class of voting stock.[3] The technology sector is at the forefront of this trend, as represented by Google’s (U.S. $464 billion, market capitalization) multi-class share split to concentrate voting control in the hands of two shareholders, the control position of a single shareholder over Facebook ($270 billion), and the concentrated shareholdings found in Amazon ($263 billion), Netflix ($43 billion), Tesla ($29 billion) and other emerging and newly listed technology companies.
At an earlier stage of this movement towards concentrated share ownership in the U.S., prominent Harvard scholar Michael C. Jensen[4] commented:
[t]he success of these massive real time experiments in new management and governance techniques over these last two decades [referring to the rise of shareholder activism, private equity, and increased use of performance pay] is a testament to the power of aligning the interests of principals and agents… All of this takes on more importance in light of the fact that we are in the midst of an unusually powerful shift in the worldwide economy, one strong enough to be labeled the Third Industrial Revolution.[5]
This observation emphasizes the significance of corporate governance theory in the context of rapid technology-driven progress and economic expansion.
In Canada, legal mechanisms have developed over a forty-year period in response to a prevalence of controlling shareholders and dual class share structures in public markets. The theoretical underpinning of Canadian corporate law has evolved within this context, which is almost precisely obverse to the principal-agent ownership structure observed by Berle and Means[6] in 1932 – specifically, the separation of ownership and control in U.S. firms. In contrast, the Canadian regime has advanced along a trajectory that contemplates a divergence of interests between dominant and dispersed shareholders, alongside conventional agency issues. As a result of this historical experience, Ontario is strongly positioned as jurisdiction of choice for both investors in innovative business and founders intent on retaining a control position in their venture.
In the U.S., the era of the Berle-Means dispersed share ownership structure is in decline. The magnitude of this shift is underappreciated, yet seismic in its implications. Increasingly, shareholders wield the power to determine or significantly influence corporate policy in U.S. firms. In focusing upon this evolution in share ownership structure – specifically, narrowing within the separation between ownership and control – a distinct economic theory for the enhanced efficiency of business corporations is emerging.
We encourage the Ministry to consider the unique characteristics of Ontario’s capital markets, particularly with regard to concentrated share ownership patterns and the inherent efficiencies that are shifting the U.S. landscape towards greater levels of shareholder influence over corporate policy. Innovative business is both contributing to- and responding to the shifting governance landscape. In undertaking this review process – alongside the Ministry’s commitment to advancing legal frameworks that are responsive, flexible and adaptable – Ontario will be well-positioned for this next phase of economic expansion.
[1] Claudio R Rojas, “An Indeterminate Theory of Canadian Corporate Law” (2014) 47:1 UBC L Rev 59, online: SSRN <http://ssrn.com/abstract=2391775>.
[2] Ibid at 62-63 (principle of fair treatment), 82-84 (fiduciary duty), 88-89, 114-20 (discriminatory costs), 122-24 (Warren Buffett).
[3] Investor Responsibility Research Center Institute, “Controlled Companies in the Standard & Poor’s 1500: A Ten Year Performance and Risk Review” (October 2012), online: <http://irrcinstitute.org>.
[4] Michael C Jensen is the Jesse Isidor Straus Professor of Business Administration Emeritus at the Harvard Business School. His research and writing is prominent in the U.S. national debate on corporate governance.
[5] Michael C Jensen, Theory of the Firm: Governance, Residual Claims and Organizational Forms (Cambridge: Harvard University Press, 2000) at 5.
[6] Adolf Berle & Gardiner Means, The Modern Corporation and Private Property (1932), (New York: Harcourt, Brace and World, 1967).