Tilting the Balance Between Capital and Labor? The Effects of Regulatory Arbitrage in European Corporate Law on Employees
FORDHAM INTERNATIONAL LAW JOURNAL
Fordham International Law Journal
Copyright c 2009 by the authors. Fordham International Law Journal is produced by The
Berkeley Electronic Press (bepress). http://ir.lawnet.fordham.edu/ilj
This Article examines an issue of regulatory competition that seems to be of greater interest
for the corporate governance of large, publicly traded firms: the position of the employees. The
Article proceeds in three parts. Part I sets out the basic premise of the analysis by describing why
employees may be relevant to the corporate governance structure. This Part will briefly draw on
economic theory to explain why, at least under certain circumstances, it can be beneficial to create
an institutional structure that facilitates long-term commitment between firms and their employees.
Part II identifies aspects of European corporate law that are relevant to labor and corporate law
arbitrage opportunities. After delineating the scope of regulatory arbitrage, this Part describes the
three main issues that surround regulatory arbitrage. The most important of these are employee
participation systems, which give employee representatives a say in corporate governance. The
second issue relates to the controversial issue of directors’ duties, with special attention to the
extent that directors may defend against hostile takeovers. A third and often overlooked issue
is the degree to which directors are independent from shareholder intervention. Finally, Part III
presents the core of the analysis by describing the economic consequences of ex ante and ex
post regulatory choice. Regulatory arbitrage provides the advantages of increased flexibility and
possibilities to avoid some obviously inefficient regulation. On the other hand, mechanisms that
may help to foster long-term commitment of firm employees are undermined by ex post arbitrage
opportunities because of shareholders inability to permanently commit to a particular system. This
Article argues that employee participation systems are at risk, in spite of the arbitrage limitations
set by secondary EU law.
TILTING THE BALANCE BETWEEN CAPITAL AND
LABOR? THE EFFECTS OF REGULATORY
ARBITRAGE IN EUROPEAN CORPORATE LAW
Ten years after the European Court of Justice’s (“ECJ”)
seminal Centros decision,1 which ushered in a series of cases that
now allow firms to choose their country of registration regardless
of the location of their business activities, regulatory competition
in European corporate law has still not come of age. True,
Centros, Überseering,2 and Inspire Art3 have collectively transformed
European corporate law into a transnational field of research and
triggered a debate about regulatory competition. Some scholars
have optimistically argued that the ECJ has ushered in an era of a
race to the top in the European Union (“EU”), meaning that the
forces of competition will coerce member states to optimize their
laws.4 Others have, justifiably, expressed doubt as to whether
there will be much, if any, regulatory competition.5 Some have
taken mixed or skeptical positions.6 At the very least, the notion
that any member state could establish itself as a fully fledged
“European Delaware” is probably deemed unlikely by the
majority of scholars.7
So far, the academic literature has focused mostly on the
long-term consequences within the triangle between investors,
large shareholders, and managers. In practice, legal issues
relating to corporate creditors have been the main driver of
regulatory arbitrage.8 The incorporation of thousands of
newlyfounded firms in a particular jurisdiction, typically England, that
intend to be active primarily in another one, in many cases
Germany,9 is said to undermine the capital maintenance and
creditor protection systems in countries that import the
corporate law of a more liberal corporate law.10 Some recent
reforms to legal capital and other policies intended to protect
creditors have been identified as a form of “defensive” regulatory
competition—measures attempting to prevent economic entities
from incorporating elsewhere that are intended to do business in
the member state where these legislative measures are taken.11
However, these creditor protection mechanisms are usually an
impediment only to the formation of new firms, which is why
“defensive” regulatory competition primarily affects just these
This Article examines an issue of regulatory competition
that seems to be of greater interest for the corporate governance
of large, publicly traded firms: the position of employees. EU
member states offer a wide spectrum of different systems of
mandatory “employee participation,” under which a firm’s
employees enjoy representation on a corporation’s board of
directors. The two recent innovations of secondary EU law that
permit the formation of the European Company—Societas
Europaea (“SE”)—and the cross-border merger at first seem to
von Missbräuchen [Act to Modernize the GmbH Laws and Combat Abuse], Oct. 23,
2008, BGBl. I at 2026, takes various measures to facilitate the formation process for the
limited liability company, or Gesellschaft mit beschränkter Haftung (“GmbH”), and
introduces the entrepreneur corporation, or Unternehmergesellschaft, which is not subject
to the minimum capital requirement, but does require a business entitys taking this
form to use the designation “Unternehmergesellschaft (haftungsbeschränkt)” or simply “UG
(haftungsbeschränkt)” in its name. See id., § 5(a). For a detailed description of the German
reform, which does not take the final version into account, see William W. Bratton et al.,
How Does Corporate Mobility Affect Lawmaking? A Comparative Analysis, 57 AM. J. COMP. L.
347, 381–82 (2009). The protocols of the parliamentary debate clearly show, as do
previous proposals for the law, that the motivation for the enactment of this reform was
competition among jurisdictions and the influx of firms incorporated in England,
notwithstanding their high rates of failure. See Erklärung von Sabine Zimmermann
[Statement of Sabine Zimmermann], Deutscher Bundestag Drucksache [BTDrucks]
16/172, at 18196 (quoting Doctor Jürgen Gehb as stating that “we are standing in
European competition, not only regarding the production of goods and services, but
also with respect to legal systems and legal forms. We accept this competition. We want
to and have to win it.”); Entwurf eines Gesetzes zur Modernisierung des GmbH-Rechts
und zur Bekämpfung von Missbräuchen (MoMiG) [Draft Act to Modernize the GmbH
Laws and Combat Abuse (MoMiG)], BTDrucks 16/6140, at 56 (the original government
draft explicitly stating that the “GmbH should remain internationally competitive”).
Similarly spirited Dutch and Austrian projects are looming on the horizon. See, e.g.,
Bratton et al., supra, at 31, 34–36 (discussing the planned Dutch reform); REPUBLIK
ÖSTERREICH [REPUBLIC OF AUSTRIA], REGIERUNGSPROGRAMM [GOVERNMENT PROGRAM]
2008–2013, at 138–3
), at http://www.austria.gv.at/DocView.axd?CobId=32965
(declaration by the Austrian government announcing, among many other things, that
minimum capital will be reduced during the current legislative period).
12. The fact that new businesses have made use of the freedom of incorporation in
some countries far more than in others also seems to be influenced by administrative
burdens or even blatant ignorance of the European Court of Justice (“ECJ”) case law
that the authorities in some states impose on setting up a branch office. See Marco Becht
et al., Centros and the Cost of Branching, 9 J. CORP. L. STUD. 171 (2009) (reporting on
branching costs of several thousand Euros in Italy and a complete disregard of the
Centros decision in Greece).
limit the ability for corporate law arbitrage relating to this group
by requiring the merging firms to negotiate with employees
about their representation rights as a precondition to the
merger. However, this Article emphasizes that this protection is
incomplete, and that the structure imposed by these directives
subverts the basic premises, and potential economic
functionality, of employee participation systems. Specifically, the
regulatory arbitrage13 driven by controlling shareholders can
have negative effects for employees going beyond employee
participation systems in firms that have operated for decades.14
The economic function of employee participation systems, to
foster long-term commitment, is undermined by the inability of
shareholders to commit to a particular regime. An analysis of the
position of employees would not be complete if it were restricted
to participation systems. This Article therefore also addresses
other potentially relevant mechanisms affected by regulatory
arbitrage opportunities, particularly the degree to which
management is directly or indirectly influenced by shareholders.
The Article suggests that controlling shareholders, whose
presence characterizes corporate governance structures in much
of Europe, are in a good position to exploit arbitrage
opportunities to the disadvantage not only of minority investors,
but also of employees.
The Article proceeds in three parts. Part I sets out the basic
premise of the analysis by describing why employees may be
relevant to the corporate governance structure. This Part will
briefly draw on economic theory to explain why, at least under
13. This Article prefers the terms regulatory choice and regulatory arbitrage over
regulatory competition. This is because, as previously noted, the evidence for actual
regulatory competition of member states actively seeking re-incorporation remains
scarce. The most interesting national reaction to regulatory arbitrage so far is a recent
proposal by a group of German law professors to allow German companies to negotiate
with employees about the introduction of a flexible employee participation system
comparable based on the same negotiation mechanism that is required for the
formation of a European Company (Societas Europaea (“SE”)) or a cross-border merger.
See Arbeitskreis “Unternehmerische Mitbestimmung,” Entwurf einer Regelung zur
Mitbestimmungsvereinbarung sowie zur Größe des mitbestimmten Aufsichtsrats [Draft Rules on
Codetermination Agreement and the Size of the Supervisory Board Codetermination], 2009 ZEITSCHRIFT
FÜR WIRTSCHAFTSRECHT [ZIP] 885 (F.R.G.). For purposes of this Article, regulatory
arbitrage will mean that the involved parties make deliberated choices about the law.
14. See Daniel Komo & Charlotte Villiers, Are Trends in European Company Law
Threatening Industrial Democracy?, 34 EUR. L. REV. 175, 192–93 (2009) (discussing the
effects of incorporation choice of small firms on employee involvement).
certain circumstances, it can be beneficial to create an
institutional structure that facilitates long-term commitment
between firms and their employees. Part II identifies aspects of
European corporate law that are relevant to labor and corporate
law arbitrage opportunities. After delineating the scope of
regulatory arbitrage, this Part describes the three main issues that
surround regulatory arbitrage. The most important of these are
employee participation systems, which give employee
representatives a say in corporate governance. The second issue
relates to the controversial issue of directors’ duties, with special
attention to the extent that directors may defend against hostile
takeovers. A third and often overlooked issue is the degree to
which directors are independent from shareholder intervention.
Finally, Part III presents the core of the analysis by describing the
economic consequences of ex ante and ex post regulatory
choice. Regulatory arbitrage provides the advantages of increased
flexibility and possibilities to avoid some obviously inefficient
regulation. On the other hand, mechanisms that may help to
foster long-term commitment of firm employees are undermined
by ex post arbitrage opportunities because of shareholders
inability to permanently commit to a particular system. This
Article argues that employee participation systems are at risk, in
spite of the arbitrage limitations set by secondary EU law.
I. WHY BOTHER ABOUT EMPLOYEES IN CORPORATE LAW?
It is tempting to argue that employees play an insignificant
role in corporate law arbitrage. After all, the contractarian
approach, which predominates in academic analysis of corporate
law, presumes that nonshareholder constituencies of the firm
have their rights specified by contract, which is why they are said
to not bear a risk comparable to that of shareholders.15 However,
15. See FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE
OF CORPORATE LAW 11 (1991) (describing shareholders as the bearers of the greatest
risk); Lyman Johnson, Corporate Law Professors as Gatekeepers, 6 U. ST. THOMAS L.J. 447,
) (identifying shareholder wealth maximization as the goal of corporate law
according to the majority of scholars). Creditors are sometimes considered an exception
to this theory, even by those that endorse the shareholder primacy view. See, e.g., Henry
Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 GEO. L.J. 439,
443 (2001). The rationale behind this exception is that creditors suffer the downside
risk when the company approaches insolvency. See Stewart C. Myers, Determinants of
Corporate Borrowing, 5 J. FIN. ECON. 147, 164–70 (1977). Both U.K. and U.S. law has
much of the literature on the theory of the firm now considers
the assumption of complete contracts to be an oversimplification
that carries with it analytical limitations;16 other firm
constituencies may also be exposed to risk because of
firmspecific investment by these groups. Most important to this
Article, workers often make such an investment by acquiring
skills that are only useful within their current employment
relationship.17 This type of investment may initially be costly to
acquire, but it allows employees to gain quasi rents in the course
of the relationship with the firm. As a result, the productive
process of the firm may sometimes improve, thus increasing the
total corporate “pie,” either because of productivity increases or
because skilled workers can be motivated to take on the job (for
instance, due to moving costs).18
The traditional agency view of corporate law assumes
employee investment to be fully protected by contract, which is
why many describe employees as avoiding residual risk.19
However, real-life contracts are not normally “complete
therefore developed doctrines suggesting that directors have duties towards creditors in
the vicinity of insolvency. See, e.g., Geyer v. Ingersoll Publ’n Co., 621 A.2d 784 (Del. Ch.
1992); Credit Lyonnais Bank Neth., N.V. v. Pathe Commc’n Corp., Civ. A. No. 12150,
1991 WL 277613, at 34 n.55 (Del. Ch. Dec. 30, 1991); W. Mercia Safetywear Ltd. v.
Dodd,  B.C.L.C. 250 (Eng.). But see N. Am. Catholic Educ. Programming Found.,
Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007) (denying direct fiduciary claims against
directors by creditors and limiting these duties to situations where the firm is already
16. See, e.g., Margaret M. Blair & Lynn A. Stout, A Team Production Theory of
Corporate Law, 85 VA. L. REV. 247, 249–50 (1999).
17. See, e.g., HENRY HANSMANN, THE OWNERSHIP OF ENTERPRISE 26 (1996); John
Armour & Simon Deakin, Insolvency and Employment Protection: The Mixed Effects of the
Acquired Rights Directive, 22 INT’L REV. L. & ECON. 443, 445–46 (2002); Larry Fauver &
Michael E. Fuerst, Does Good Corporate Governance Include Employee Representation? Evidence
from German Corporate Boards, 82 J. FIN. ECON. 673, 679 (2006); Gavin Kelly & John
Parkinson, The Conceptual Foundations of the Company: A Pluralist Approach, in THE
POLITICAL ECONOMY OF THE COMPANY 113, 123–27 (John Parkinson et al. eds., 2000);
David Kershaw, No End in Sight for the History of Corporate Law: The Case of Employee
Participation in Corporate Governance, 2 J. CORP. L. STUD. 34, 42–46 (2002); see also James
M. Malcomson, Individual Employment Contracts, in 3B HANDBOOK OF LABOR ECONOMICS
2291, 2330–33 (Orley Aschenfelter & David Card eds., 1999) (reviewing the labor
economics literature on contractual protection of specific investment).
18. See, e.g., EIRIK G. FURUBOTN & RUDOLF RICHTER, INSTITUTIONS AND ECONOMIC
THEORY 232 (2d ed. 2005); see also ANNALEE SAXENIAN, REGIONAL ADVANTAGE: CULTURE
AND COMPETITION IN SILICON VALLEY AND ROUTE 128, at 135 (1994) (quoting a Texas
engineer as describing career mobility as the norm following the advent of Silicon
19. See, e.g., EASTERBROOK & FISCHEL, supra note 15, at 10–11.
contingent” agreements.20 The transaction cost necessary to
anticipate every improbable state of the world would exceed the
potential welfare gains from incorporating such provisions into
the contract. Being subject to bounded rationality, parties might
be unable to foresee possible contingencies and to process the
information they receive because of cognitive limitations.21 More
specifically, economic theory suggests that it is in many cases
impossible to make human capital investment a condition of an
enforceable contract, because courts will often be unable to
determine whether an employee has made the specified amount
of relationship-specific investments.22 It follows that employees
whose future gains from the continued employment relationship
are not protected against opportunism from other corporate
constituencies (particularly controlling shareholders, who
typically hold an ex post interest to maximize stock value) will
avoid making specific investment in the first place. Even in
corporate finance, the “purely financial” view of corporate
governance no longer dominates entirely. In the latest edition of
their leading textbook, Brealey, Myers, and Allen note that
“managers and employees of a firm are investors, too . . . . If you
give financial capital too much power, the human capital doesn’t
show up—or if it does show up, it won’t be properly motivated.”23
By going public, stockholders can commit “not to interfere if
managers and employees capture private benefits when the firm
is successful.”24 In other words, one economic function of the
publicly traded firm may be to serve as a nexus for specific
It is unnecessary to address the issue of what degree of
specific human capital investment is important in particular
corporate governance systems. Nevertheless, the various aspects
of corporate law discussed in Part II are likely to influence
whether employees have incentive to invest. Moreover, the
impact of regulatory arbitrage opportunities on the
shareholderemployee relationship are of interest even if one does not follow
the specific-asset theory of human capital because the utility
derived from employees may be of interest from a distributive
perspective.25 A particular corporate governance structure in any
given country is likely to be an equilibrium result of bargaining
on the political level and the outcome of historical path
dependence. As such, it may, in any given society, gain wide
acceptance as a balanced solution tolerable to the relevant
interest groups.26 Regulatory arbitrage creates possibilities to
modify this outcome without universal assent or at least an open
debate that probably most would prefer to have about such an
important issue of social and economic governance.
II. CORPORATE LAW ARBITRAGE OPPORTUNITIES
In order to analyze regulatory arbitrage opportunities, it is
necessary to delineate the extent to which corporate law affects
the relationship between a firm and its employees. Part II.A
identifies issues that are potentially subject to regulatory
arbitrage, and Part II.B will study the effects that these issues are
likely to have on employees.
Delineating the Scope of Employee-Related Regulatory Competition
The primary fields of law governing the employee-firm
relationship would seem to be employment and labor law, which
25. Cf. Luigi Zingales, Corporate Governance, in 1 THE NEW PALGRAVE DICTIONARY
OF ECONOMICS AND THE LAW, supra note 20, at 497, 498 (defining corporate governance
“as the complex set of constraints that shape the ex-post bargaining over the quasi-rents
generated by the firm”).
26. See generally Mark J. Roe, Backlash, 98 COLUM. L. REV. 217 (1998) (arguing that
economically efficient policy choices may not be sustainable because of political
backlash); MARK J. ROE, POLITICAL DETERMINANTS OF CORPORATE GOVERNANCE (2003)
(developing a theory of comparative corporate governance focusing on the role of past
political choices that may have been economically inefficient, but necessary to achieve
are not objects of regulatory competition in corporate law.
Under the new European regulation on the law applicable to
contractual obligations, colloquially known as the Rome I
Regulation, employment contracts are normally governed by the
law of the jurisdiction where the employee “habitually carries out
his work in performance of the contract,” even “if he is
temporarily employed in another country.”27 If no such country
can be identified, the contract is governed “by the law of the
country where the place of business through which the employee
was engaged is situated.”28 Other laws apply only when it can be
shown that “the contract is more closely connected with” another
country.29 While the regulation allows for choice of law,30 the
latter may not deprive the employee of mandatory protection
accorded to him under the otherwise applicable default law.31
Rights collectively held by employees, such as the right to
establish works councils, and the specification of their rights and
competences, typically depend on the location of the business
establishment.32 In fact, EU law requires large transnational firms
with a cross-border scope of activities to permit the establishment
of a European Works Council.33 A 2002 directive further requires
member states to implement information and consultation
systems for employee representatives in other firms that exceed a
minimum size, while leaving to national law the question
regarding how employees should be represented.34 Any
regulatory arbitrage regarding these rules will therefore be only
an element of competition for businesses in general—
employment law may influence the decision where to locate a
plant, but as a factor in regulatory competition it will be strongly
confounded with other aspects pertinent to its physical location,
B. Employee Participation Systems and Codetermination
While at least some of the issues outlined above are no
doubt important, in particular the requirement to consult with
works councils and other employee representatives, these rules
are not subject to corporate law regulatory arbitrage
opportunities. However, some corporate law issues are of
considerable importance to employees as well, which is discussed
below in more detail. At present, member states that favor
codetermination and other employee participation systems do
not even attempt to apply their employee participation statutes to
directive to the United Kingdom); see also CATHERINE BARNARD, EC EMPLOYMENT LAW
707–20 (3d ed. 2006) (providing a detailed discussion of this directive). Collective
bargaining agreements are governed by the law of the country where the employment
relationship is executed or the law of the employment contract. See Krebber, supra note
31, at 537.
34. Council Directive Establishing a General Framework for Informing and
Consulting Employees in the European Community, No. 2002/1
O.J. L 80/29; see
also BARNARD, supra note 33, at 732–39 (explaining the objectives of the directive).
35. On Germany, see, for example, CLEMENS JUST, DIE ENGLISCHE LIMITED IN DER
PRAXIS [THE ENGLISH LIMITED LIABILITY COMPANY IN PRACTICE] 199–202 (2d ed. 2006)
(F.R.G.), Marcus Kamp, Die unternehmerische Mitbestimmung nach „Überseering” und „Inspire
Art” [Codetermination After „Überseering” and „Inspire Art”], 59 BETRIEBS-BERATER 1496,
1498–99 (2004) (F.R.G.), Klaus J. Müller, Die englische Limited in Deutschland—für welche
Unternehmen ist sie tatsächlich geeignet? [The English Limited Liability Company in Germany—
For Which Businesses Is It Useful in Practice?], 61 BETRIEBS-BERATER 837, 840 (2006)
(F.R.G.), Bernd Gach, in 3 MÜNCHENER KOMMENTAR ZUM AKTIENGESETZ [MUNICH
COMMENTARY ON THE STOCK CORPORATION ACT] § 1 MitbestG cmt. 6 (Bruno Kropff &
Johannes Semler eds., 2d ed. 2004) (F.R.G.), Christoph Teichmann, Restructuring
Companies in Europe: A German Perspective, 2004 EUR. BUS. L. REV. 1325, 1334, and Martin
Veit & Joachim Wichert, Unternehmerische Mitbestimmung bei europäischen
Kapitalgesellschaften mit Verwaltungssitz in Deutschland nach „Überseering” und „Inspire Art”
[Codetermination in European Corporations with Headquarters in Germany After „Überseering”
The Prevalence and Significance of Employee Participation
The system of codetermination in Germany assigns half of
the seats on the supervisory board of German companies to
employees36 and is one of the issues that has received the most
attention in the comparative corporate governance literature.37
The system of codetermination occupies one end of the
regulatory spectrum, the other being no employee participation
Codetermination in the strictest sense of the word requires
the election of half of the members of the firm’s supervisory
board by employees39 in firms with more than 2000 employees.40
The applicable law specifies the precise number of directors that
and „Inspire Art”], 50 DIE AKTIENGESELLSCHAFT 14, 16–17 (2004) (F.R.G.). For possible
future “outreach” statutes applying employee participation systems to foreign firms, see
infra notes 133–37 and accompanying text.
36. See Mitbestimmungsgesetz [MitbestG] [Co-Determination Act], May 4, 1976,
BGBl. I at 1153, § 7, last amended by Gesetz, July 30, 2009, BGBl. I at 2479, 2491, § 1(1)
(F.R.G), translated in D. HOFFMAN, THE GERMAN CO-DETERMINATION ACT, 1976
(MITBESTIMMUNGSGESETZ 1976) (1976). The law is applicable to all companies outside
of the coal, mining, and steel industries. Id. § 1(2). These industries are governed by an
even stricter statute, the Montan-Mitbestimmungsgesetz [MontanMitbestG] [Montane
Co-Determination Act], May 21, 1951, BGBl. I at 347, last amended by Gesetz, October
31, 2006, BGBl. I at 2407, 2434 (F.R.G.).
37. See, e.g., Luca Enriques et al., The Basic Governance Structure: Minority Shareholders
and Non-Shareholder Constituencies, in THE ANATOMY OF CORPORATE LAW 90, 100–02
(Reinier Kraakman et al. eds., 2d. ed. 2009)
; Mark J. Roe, German Codetermination and
German Securities Markets, 1998 COLUM. BUS. L. REV. 167.
38. Slovenia, for instance, initially adopted the German version of codetermination
after gaining independence, but subsequently abandoned it after its constitutional court
declared the system unconstitutional. See THOMAS RAISER,
UNTERNEHMENSMITBESTIMMUNG VOR DEM HINTERGRUND EUROPARECHTLICHER
ENTWICKLUNGEN, GUTACHTEN B FÜR DEN 66. DEUTSCHEN JURISTENTAG [WORKER
BOARD-LEVEL PARTICIPATION AGAINST THE BACKDROP OF EUROPEAN DEVELOPMENT,
REPORT B FOR THE 66TH MEETING OF THE ASSOCIATION OF GERMAN JURISTS], B 42–B 43
(2006) (F.R.G.); Rado Bohinc & Stephan M. Bainbridge, Corporate Governance in
PostPrivatized Slovenia, 49 AM. J. COMP. L. 49, 58–60 (2001).
39. See MitbestG § 10. German law and the laws of various other countries in the
European Union (“EU”) require stock corporations to have dual board system
comprised of a management board, or Vorstand, whose members are the senior
managers of the firm, and a supervisory board, or Aufsichtsrat, whose members are
outside directors. See Aktiengesetz [AktG] [Stock Corporation Act], Sept. 6, 1965, BGBl.
I at 1089, §§ 76–116, last amended by Gesetz, July 31, 2009, BGBl. I at 2509 (F.R.G.),
translated in THE GERMAN STOCK CORPORATION ACT (Hannes Schneider & Martin
Heidenhain trans., 2d ed. Kluwer Law Int’l 2000).
40. See MitbestG §1(1), ¶2.
will comprise the supervisory board according to the size of the
firm.41 A minority among these directors are not employees of
the firm, but representatives of unions.42 In the case of a tied
vote, the vote of the president of the board, a shareholder
representative, is decisive, putting the representatives of capital at
an advantage.43 Nevertheless, codetermination strengthens the
position of labor by facilitating access to information and the
possibility to grant and withhold assent to important corporate
decisions, most of all regarding the composition of the
management board.44 A more moderate employee participation
scheme applies in firms with 500 to 2000 employees, in which
employee representatives fill only one-third of the board seats.45
The German system of codetermination is far from unique
in the European Union. Although Britain, perhaps the most
shareholder-centric European corporate jurisdiction today,
famously rejected what it touted as “industrial democracy” in the
1970s,46 employee participation systems giving one-third of the
seats on the board to employees exist in countries such as
Austria,47 Denmark,48 Finland,49 Luxemburg,50 and Sweden,51 as
well as in post-Communist states such as the Czech Republic,
Slovenia, Slovakia, and Hungary.52 Many of these states reserve
one-third of the seats on the board to employees.53 Notably,
Denmark, Finland, Luxemburg, and Sweden have one-tier board
systems with varying proportions of seats being assigned to
employees.54 Large Dutch firms are subject to the structure
regime known as structuurregime,55 in which one-third of the
shareholder-elected supervisory board is nominated by the works
council.56 Until statutory reform in 2004, Dutch board members
were appointed under a system of “controlled co-optation.”57
The overall efficiency of employee participation is
contested. While some scholars have found that it depresses
shareholder value (which may not necessarily mean that the
system is inefficient overall),58 other studies have suggested that
moderate forms have a beneficial effect on Tobin’s q59 in certain
industries60 or that its introduction is correlated with gains in
productivity.61 The conclusions of these studies are limited by
their use of a measure of shareholder wealth as a dependent
variable, while possible rents to employees—which are difficult to
quantify—should in principle figure into the efficiency calculus.62
Furthermore, it is quite possible that codetermination and other
employee participation systems contribute to the maintenance of
social peace and good employment relations.63 Consequently,
employee participation models, like the system of
codetermination, may therefore have an indirect benefit for
firms that are not captured by econometric studies. As noted
earlier, even if the potential efficiency benefits are unconvincing,
it seems clear that employee representation has important
distributive consequences, as it will at least enhance the
bargaining power of employees and thus entail a marginal
increase in rents accruing to labor.
Negotiations About Employee Representation
In order to subject a company to the law of a member state
other than the one under which it was originally founded,
shareholders in practice must avail themselves of specific
instruments of EU law that impose restrictions on ex post
changes to employee participation systems. The main instrument
for reincorporation is the cross-border merger as contemplated
by the Council Directive on Cross-Border Mergers.64 Under this
(William Fellner et al. eds., 2d ed. 1977). It is frequently used to measure how much
wealth a firm generates for its shareholders compared to other firms.
60. See Fauver & Fuerst, supra note 17, at 675. These results do not hold when the
employee representatives do not actually work in the firm, but are sent by unions. See id.
61. See generally Felix FitzRoy & Kornelius Kraft, Co-determination, Efficiency, and
Productivity, 43 BRIT. J. INDUS. REL. 233, 242–4
62. Conceivably, there could be other consequences, such as helping society to
become more egalitarian, which are even more difficult to assess from the perspective of
utility-maximization. See RAISER, supra note 38, at 49–50 (criticizing econometric studies
for leaving these aspects aside).
63. See MARK J. ROE, STRONG MANAGERS, WEAK OWNERS 214 (1994)
(“[C]odetermination affects corporate governance in the supervisory board, impeding
intermediaries from pushing for rapid organizational change that would disrupt
64. Council Directive on Cross-Border Mergers of Limited Liability Companies, No.
O.J. L 310/1.
instrument, a shell subsidiary is set up in the target member state,
followed by a merger between the original and the new entity.
Another potential path to a different member state’s law is
the creation of an SE through a merger under the SE Statute.65
While the SE is a corporation governed by EU law, the SE Statute
provides a rather shallow regulatory framework;66 gaps are filled
by special national legislation governing SEs with their registered
office in the respective member state, and failing that, by
national provisions applicable to public limited liability
companies.67 As a result, there are a number of British, Czech,
French, Swedish, and other SEs that are all to a large extent
governed by the respective national law.68 Since article 8 of the
SE Statute explicitly allows the transfer of the SE’s registered
office without initiating a winding up of the firm,69 national
obstacles to reincorporations can be overcome with relative
ease.70 However, for a previously existing purely national firm,
the route to a foreign type of SE is, again, to create a shell
company in the target member state and then merge with it, in
this case under the SE Statute.
The Directive on the Involvement of Employees in the SE71
sets up a negotiating procedure that must be followed before the
SE can be registered.72 Employees from both companies merging
into the new SE must elect or appoint a “special negotiating
body” (“SNB”) to settle employee representation rights in the
future SE with the competent bodies of the merging
companies.73 Negotiations should normally be concluded within
six months, but the parties may agree to extend this period to a
year.74 National legislatures are required to establish standard
rules in the event that negotiations break down.75 In the case of
an SE created by a cross-border merger, this provision applies by
operation of law when at least twenty-five percent of the
employees of the merging firms participated in some type of
employee representation system.76 However, they also apply when
a smaller number of employees were subject to such a system,
and when the SNB passes a resolution to that effect.77 The
standard rules must conform to a “highest level” principle,
meaning that the proportion of employees on the board must
correspond to the “most advanced” system before the merger.78
Even employees previously not covered by an employee
participation system at all must have this level of participation
rights after the conclusion of the merger.79
While the applicable law is that of the state in which the SE
is registered, all member states (including those without
mandatory employee representation rules for purely national
companies) are required to develop a default employee
participation system for SEs.80 These rules must stipulate that the
highest proportion of employee participation of any of the
participating firms applies to the SE resulting from the merger.81
Slightly modified rules apply under the Directive on
CrossBorder Mergers. As a general principle, the law applicable at the
registered office of the entity resulting from the merger governs
employee participation.82 However, there are three exceptions:
first, negotiations are mandatory when one of the merging
companies has an employee participation system and more than
500 employees; second, when national law applicable after the
merger does not provide the same level of employee
representation to employees that were previously subject to such
a regime; and third, when the postmerger law discriminates
against employees employed in another member state by not
granting equivalent representation rights.83
Regarding cases of mandatory negotiations, the
CrossBorder Mergers Directive refers to the respective provisions of
the SE Regulation and SE Employees Directive.84 However, the
threshold for automatic application of the “standard rules” in
this case is thirty-three and one-third percent.85 Furthermore,
employee representation in a one-tier board may be limited to
one third of the positions, even if the merged firm previously
applied parity codetermination on the supervisory board.86
absence of an agreement with the SNB if the member state refused to adopt the default
provisions in the formation of an SE through merger. See Paul Davies, Employee
Involvement in the European Company, in THE EUROPEAN COMPANY: DEVELOPING A
COMMUNITY LAW OF CORPORATIONS 67, 67 n.2 (Jonathan Rickford ed., 2003); Jonathan
Rickford, Inaugural Lecture—The European Company, in THE EUROPEAN COMPANY, supra,
13, 28 n.56; Ger van der Sangen, The European Company and the Involvement of Employees,
in THE EUROPEAN COMPANY: CORPORATE GOVERNANCE AND CROSS-BORDER
REORGANISATIONS FROM A LEGAL AND TAX PERSPECTIVE 169, 199 (S.H.M.A. Dumoulin et
al. eds., 2005). The United Kingdom did not elect to use this option, but instead
provides that the standard rules apply in the case of a merger. See European Public
Limited-Liability Company Regulations, 200
4, S.I. 2004
/2326, c. 6, § 33(3) (U.K.).
82. See Council Directive on Cross-Border Mergers of Limited Liability Companies,
No. 2005/56, art. 16(1), 2005 O.J. L 310/1, at 7.
83. See id. art. 16(2); see also Arianna Ugliano, The New Cross-Border Merger Directive:
Harmonisation of European Company Law and Free Movement, 2007 EUR. BUS. L. REV. 585,
The European Union has debated the introduction of a
directive on the cross-border transfer of a firm’s registered office
(the “14th Directive”) for many years, but the project has been
shelved since late 2007, at least for the time being.87 The ECJ
determined in the recently decided Cartesio case that a member
state may prohibit companies governed by its law from relocating
the firm’s real seat to another member state while retaining its
character as a company under the laws of the origin state.
However, a member state may not prevent a company from
converting into a company governed by the law of another state
as long as the latter will accept the firm.88 Without a directive,
however, a change of the national law applicable to the firm is
wrought with great difficulty.89 It is usually thought that if the
14th Directive is ever passed, it will include comparable
provisions regarding employee representation.90 Since a transfer
of seat involves only a single company, the codetermination
GESAMTE HANDELS- UND WIRTSCHAFTSRECHT 613, 626 (2007) (F.R.G.); Olaf Kisker,
Unternehmerische Mitbestimmung in der Europäischen Gesellschaft, der Europäischen
Genossenschaft und bei grenzüberschreitender Verschmelzung im Vergleich [Codetermination in
the European Company, the European Cooperative, and after Cross-Border Mergers in
Comparison]‚ 59 RECHT DER ARBEIT 206, 2
87. See Stephan Rammeloo, The 14th EC Company Law Directive on the Cross-Border
Transfer of the Registered Office of Limited Liability Companies—Now or Never?, 15
MAASTRICHT J. EUR. & COMP. L. 359, 372–73 (2008).
88. Cartesio Oktató és Szolgáltató bt, Case C-210/06,  ECR I-9641, ¶¶ 110–
13; see also Gert-Jan Vossestein, Cross-Border Transfer of Seat and Conversion of Companies
under the EC Treaty Provisions on Freedom of Establishment, 6 EUR. COMPANY L. 115, 120
(2009). In other words, member states may voluntarily take their own laws out of the
market for corporations, but must not inhibit competitive actions by other states. See
Rammeloo, supra note 87, at 368–71.
89. It is very plausible that provisions of the SE Regulation on the transfer of seat
would apply by analogy, which might require negotiations about employee participation.
See Georg Eckert, Sitzverlegung von Gesellschaften nach der Cartesio-Entscheidung des EuGH
[Transfer of a Company’s Real Seat Under the Cartesio Decision of the ECJ], 2009 DER
GESELLSCHAFTER 139, 149–53 (Austria).
90. See, e.g., Maureen Johnson, Does Europe Still Need a Fourteenth Company Law
Directive, 3 HERTFORDSHIRE L.J. 18, 38 (2005) (noting that a new company law directive,
if adopted, will provide for employee participation); see also Federico M. Mucciarelli,
Corporate ‘Emigration’ and EC Freedom of Establishment: Daily Mail Revisited, 9 EUR. BUS.
ORG. L. REV. 267, 300 (2008) (suggesting that a “corporate mobility” directive should
have similar safeguards as the cross-border mergers directive); Marco Ventoruzzo,
“CostBased” and “Rules-Based” Regulatory Competition: Markets for Corporate Charters in the U.S.
and the E.U., 3 N.Y.U. J.L. & BUS. 91, 149 (2006) (same); Eddy Wymeersch, Is a Directive
on Corporate Mobility Needed?, 8 EUR. BUS. ORG. L. REV. 161, 16
management214 The prevailing Nazi ideology of the Führerprinzip
certainly dictated strong leadership,215 but the policy of
insulation was at least in part the consequence of a longstanding
debate in German economic and legal theory during the
previous decades, in which a left-wing current in the literature
sought to restrain the influence of capital and, arguably, to
protect firms from changing majorities and coalitions in the
The German model affected other countries as well, such as
Austria and France. In Austria, the German model was clearly
followed when the Aktiengesetz was introduced in 1938.217 In
France, the position of the Président Directeur-General (“PDG”),
which combined the functions of the president of the board and
the CEO, was introduced in the hastily enacted reforms of
1940218 and 1943
219 and remained mandatory until 2001
214. Id. § 119(2). The law of course requires shareholder votes for structural
changes such as mergers, which go beyond mere management decisions, and the courts
have additionally required shareholder votes in the case of certain other transactions of
high significance. BGH, Feb. 25, 1982, 174 BGHZ 80 (requiring a vote on the
contribution of 80% of the firm’s assets to a wholly-owned subsidiary in a case popularly
known as Holzmüller). But see BGH April 26, 2004, 155 BGHZ 02 (clarifying that
Holzmüller duties only apply in exceptional cases). For a description of the development
of the case law see, Marc Löbbe, Corporate Groups: Competences of the Shareholders’ Meeting
and Minority Protection—The German Federal Court of Justice’ Recent Gelatine and Macotron
Cases Redefine the Holzmüller Doctrine, 5 GERMAN L.J. 1057 (2004).
215. See Jan von Hein, Vom Vorstandvorsitzenden zum CEO? [From Chief Executive
Officer to CEO?], 166 ZEITSCHRIFT FÜR DAS GESAMTE HANDELS- UND WIRTSCHAFTSRECHT
464, 475 (2002).
216. Important writers include: WALTHER RATHENAU, VOM AKTIENWESEN: EINE
GESCHÄFTLICHE BETRACHTUNG (1917); and Oskar Netter, Zur aktienrechtlichen Theorie des
„Unternehmens an sich”, in FESTSCHRIFT HERRN RECHTSANWALT UND NOTAR JUSTIZRAT
DR.JUR.H.C. ALBERT PINNER ZU SEINEM 75 GEBURTSTAG 507 (Deutscher Anwaltsverein et
al., eds., 1932). But see FRITZ HAUSSMANN, VOM AKTIENWESEN UND VOM AKTIENRECHT
(1928) (criticizing Rathenau’s theory of the institutional interest of the corporation).
217. The 1938 promulgation of Aktiengesetz was introduced for newly founded
corporations on April 11, 1938 by Erste Verordnung zur Einführung handelsrechtlicher
Vorschriften im Lande Österreich [First Regulation to Introduce Commercial Law
Provisions in the Land of Austria], RGBl No. 385/1938, and for existing firms as of
January 1, 1939, by Zweite Verordnung zur Einführung handelsrechtlicher Vorschriften
im Lande Österreich [Second Regulation to Introduce Commercial Law Provisions in
the Land of Austria] RGBl No. 982/1938.
218. Law of Nov. 16, 1940, Journal Officiel de la République Française [J.O.]
[Official Gazette of France], Nov. 16, 1940, p. 5828. This law replaced the prior Law of
September 18, 1940, before it could come into force. See Paul Cordonnier, Loi du 16
novembre 1940, in 1941 DALLOZ RECUEIL CRITIQUE 1, 1–2 (1941).
Contemporary writers sometimes attributed this development to
a “transposition of the German theory of the Führerprinzip” in
France (although the issue is, unsurprisingly, controversial).221
French law, however, always retained the rule that directors could
be removed by a shareholder resolution at any time, which
counteracted the independence of the PDG.222 Even the United
Kingdom, which is usually thought of as the most
proshareholder European jurisdiction, once had a statute requiring
directors to have regard to the interests of employees.2
Companies Act of 2006
has, however, changed the law to the
effect of requiring a concern to “enlightened shareholder
Concentrated ownership structures persisted in spite of
these rules, and large shareholders usually remain able to impose
their will on corporations, even in Germany.225 However, the
extent to which directors and managers are able to assert their
independence from large shareholders depends on a complex
set of factors, including personal authority and corporate culture.
But in the case of any individual firm, the applicable law is still a
major determinant of shareholder influence of major and minor
business decisions. This factor could therefore be the subject of
III. CONSEQUENCES OF REGULATORY ARBITRAGE IN THE
NEXUS BETWEEN SHAREHOLDERS AND EMPLOYEES
Having identified legal mechanisms that could potentially
serve as targets for regulatory arbitrage, this Part will now analyze
possible consequences of ex ante and ex post corporate law
choices in corporate law. As a result of the ECJ’s Centros and
Überseering cases, codetermination and other aspects of corporate
law relevant to employees are no longer mandatory at the
formation stage of the firm, at least in those member states that
do not counteract EC law by setting up further hurdles for setting
up a branch office.226 The only limitation is the necessity to select
the entire bundle of a particular law.
A. Ex Ante Choice of Law
At the formation stage, the incorporation decision is often
taken by a group of founders who will typically take on the role of
shareholders and managers concurrently; minority investors,
employees, and other stakeholders only enter the picture later.
In other cases, employee participation systems may already be
important at the beginning, for example when a joint subsidiary
comprising some existing business is set up by two firms from
different countries. Obviously, regulatory arbitrage can have a
beneficial impact: founders will be able to choose the bundle
most appropriate in light of the firm’s business environment.
This applies also to the firm’s relationship with its employees:227
If the mechanisms described in the previous section indeed
protect employees’ specific investment, firms operating in an
industry where specific investment is a competitive advantage will
226. See Überseering BV v. Nordic Constr. Co. Baumanagement GmbH (NCC),
Case C-208/00,  E.C.R. I-9919; Centros Ltd. v. Erhvervs-og Selskabsstyrelsen, Case
C-212/97,  E.C.R. I-1459. But see Becht et al., supra note 12 (describing differences
in costs among member states and even citing blatant disregard of ECJ case law in
227. Cf. Stefano Lombardo, Conflict of Law Rules in Company Law after Überseering:
An Economic and Comparative Analysis of the Allocation of Policy Competence in the European
Union, 4 EUR. BUS. ORG. L. REV. 301, 322–30 (2003) (making a similar argument
be able to choose the preferable legal system by committing to a
beneficial legal framework in the formation stage. Firms
choosing a suboptimal regime would—in the long run—be
eliminated by competition in product markets. The result would
be, more or less, efficient choice.228
In practice, however, pro-employee laws, particularly
employee participation systems, appear not to be selected
voluntarily on a regular basis. To the contrary, it currently seems
that some firms are trying to escape or mitigate German
codetermination through regulatory arbitrage.229 Of course, one
reason could be that these are simply inefficient and therefore
not chosen by firms.230 However, there are other possibilities. The
primary corporate law issue driving regulatory arbitrage at the
formation stage seems to be minimum capital and related
creditor protection doctrines, which have also been the only issue
addressed by legislative reactions to corporate law arbitrage. At
the founding stage, employee participation systems are hardly
any concern, since it is not known whether they will ever grow big
enough to support a substantial workforce. With employee
participation systems typically “bundled” with minimum capital
in one regulatory package, they simply are not important enough
to influence the incorporation decision.
Even a choice influenced by long-term prospects of the firm
may not be uniformly efficient. The most frequently cited
arguments in the literature regarding why such regimes are not
chosen voluntarily appears to be adverse selection: laws
increasing the bargaining position may reduce the wage
differential between senior management and workers, which is
why the best managers might avoid these firms; furthermore,
since the least able workers are likely to have the strongest
preference for job security, firms committing to consider
employee interests may also attract the least effective workers.231
Furthermore, for individual employees it may be irrational to
bargain for job protection as it may signal the absence of a
commitment to work hard.232
The analysis so far has assumed that employees are able to
look after their own interests by penalizing an unfavorable
corporate law regime with a discount, in a similar way as creditors
may impose higher interest rates, or simply by avoiding specific
investment and always expecting the looming possibility of a job
change in the near future. In reality, this assumption may not
always hold, with some employees being unable to adjust their
firm-specific investment to a level commensurate with the risk.
This mirrors the debate about corporate creditors, which
distinguishes between “adjusting creditors” on one side, and
“non-adjusting” or only “partially adjusting” creditors on the
other.233 Only adjusting creditors react to risk by requiring higher
interest rates, by stipulating that the entire loan will fall due in
the case of events that increase risk, or simply by not trading at
all. Analogously, non-adjusting workers might put too much trust
in their relationship with the firm and therefore overinvest
compared to what would be optimal from their individual
While it is hard to assess whether a substantial group of such
workers exists, regulatory arbitrage would then become largely a
fairness issue. If workers always specifically invest, the legal
arrangement is irrelevant for purposes of a firm’s
competitiveness. Still, the issue can be relevant for distributive
policy reasons. In order to maximize social welfare234 one would
then need to have context-specific information about the
marginal utility of wealth of workers and stockholders.
Even when workers adjust, one likely problem for the
voluntary provision of pro-employee rules is that crucial aspects
Sunstein, Human Behavior and the Law of Work, 87 VA. L. REV. 205, 225–26 (2001). But see
J. Hoult Verkerke, An Empirical Perspective on Indefinite Term Employment Contracts:
Resolving the Just Cause Debate, 1995 WIS. L. REV. 837, 902–05 (describing the adverse
selection argument and possible objections).
232. See, e.g., Sunstein, supra note 231, at 225–26; Verkerke, supra note 231, at 903.
233. See, e.g., John Armour, Legal Capital: An Outdated Concept?, 7 EUR. BUS. ORG. L.
REV. 5, 10–11 (2006); Lucian Arye Bebchuk & Jesse M. Fried, The Uneasy Case for the
Priority of Secured Claims in Bankruptcy, 105 YALE L.J. 857, 864–65 (1996).
234. See generally LOUIS KAPLOW & STEVEN SHAVELL, FAIRNESS VERSUS WELFARE
(2002) (discussing total social welfare as the maxim and of economic and legal analysis).
of corporate law favoring employees, such as codetermination,
pertain to the entire firm. Such mechanisms could then not
develop as the result of bargaining within the individual
employment relationship. In fact, one of the major mechanisms
protecting workers is collective bargaining, where either unions
or elected representatives act as the agents of workers.235
B. Ex Post Opportunism: The Clash Between Shareholder, Manager, and Employee Interests in Corporate Law Arbitrage
1. Benefits and Risks of Flexibility
Ex post choice, like ex ante choice, has important
advantages, the most obvious being flexibility. Employee
participation systems could be designed to operate efficiently and
adapted to the changing needs of the firm, for instance those
regarding the size of the supervisory board or the degree of
employee involvement, which of course might depend on the
industry and market of the firm.
The downside of employee participation systems is often
their inflexibility. German codetermination law rigidly stipulates
a mandatory size of the board depending on the size of the
firm236 and has thus long been criticized for making the
supervisory board cumbersome and ineffective.237 Comparable
provisions neither exist in some other member states with
codetermination systems, nor for SEs or firms that undergo a
cross-border merger.238 Firms might therefore avail themselves of
a less intrusive system where these disadvantages are less serious.
The downside of flexibility is always the risk of not meeting
someone’s expectations. In this case, employees might form
expectations about the stability of the work environment. If a
235. Cf. Armour & Deakin, supra note 17, at 445 (suggesting that specific collective
rights of employees may protect firm-specific human capital).
236. See supra note 41 and accompanying text.
237. See, e.g., ROE, supra note 26, at 73; Katharina Pistor, Codetermination: A
Sociopolitical Model with Governance Externalities, in EMPLOYEES AND CORPORATE
GOVERNANCE 163, 178–79 (Margaret M. Blair & Mark J. Roe eds., 1999).
238. For analysis of these rules, see Habersack, supra note 86, at 632–34. It is
disputed whether the total number of members must be agreed upon during
negotiations or whether it can be set in the corporate charter (meaning that the result
of negotiations would have to be the share of seats on the board allocated to
reincorporation coupled with a reduction in participation rights
is possible, these expectations might not be fulfilled because
employees’ formal or informal power has been reduced. As a
result, the possibility of reincorporation could therefore
marginally influence the incidence of specific investment.
2. Reasons for Mandatory Corporate Law and the Importance
of Ownership Structure
Ex post opportunism is often brought as a rationale why
corporate law should be mandatory. In the United States, Lucian
Bebchuk argues that management is able to accomplish charter
amendments that are detrimental to shareholders and
advantageous to management, given the powerful position of the
board in U.S. firms and collective action problems of
shareholders.239 Correspondingly, amendments that are
beneficial to shareholders, but detrimental to managers, will not
happen. Mandatory constraints might therefore be beneficial.240
As a first step, it is necessary to ask who decides about
reincorporations in practice, since this power ultimately
determines the ability to use arbitrage opportunities. Employees
as a driving force can be ruled out, given that they cannot induce
firms to reincorporate.241 While it is clear that the initial
incorporation decision is taken by the founders of the firm, the
question becomes more complicated when the company is up
and running, and when different interest groups and coalitions
have formed. If regulatory arbitrage is driven by shareholder
interest, employees may suffer from shareholder opportunism.
However, the situation is more complicated because managers
may also play a role. Given the triangle of possible coalitions,
regulatory competition might lead to different results depending
on which coalition’s form is able to prevail.
As previously noted, a variable that fundamentally alters the
equation in the theory of regulatory competition is the presence
of controlling shareholders in continental Europe and the
tendency to see dispersed ownership in U.S. firms.242 In the U.S.
context, Lucian Bebchuk has pointed out that it is necessary to
have both the board of directors and the majority of
shareholders agree to a reincorporation.243 Thus,
reincorporations typically will not purely favor either managers
or shareholders, but there must be something in it for both
groups for a firm to subject itself to the law of a new state. In
spite of possible pressures from the capital markets to
incorporate in a state with “optimal” corporate law, agency
problems will never be fully resolved because of the board veto.244
At the same time, regulatory competition will also not be fully
pro-managerial because of the necessity of a shareholder vote.245
In the United States, the requirement to submit a
reincorporation proposal to a shareholder vote provides at least
some degree of a check on managerial opportunism in deciding
on reincorporations according to Bebchuk’s modern “race to the
bottom” school of thought.246
However, concentrated ownership implies that the relevant
agency problem is not the one between managers and
shareholders, but between majority and minority shareholders.
Majority shareholders will typically decide on the issue of
reincorporation alone, which may allow them to capture the
regulatory competition process, or at least to use regulatory
arbitrage possibilities.247 As described in another article, large
shareholders effectively control reincorporation in continental
Europe.248 Unlike managers in the United States, who need a
shareholder vote for a reincorporation that increases agency cost,
managers in continental Europe do not need to seek the
approval of the minority for their actions. This argument applies
analogously with regard to non-shareholder constituencies. It has
already been suggested that creditors of European firms might
find themselves in a similar situation with their expectations
242. See supra note 209 and accompanying text.
243. See Lucian A. Bebchuk, Federalism and the Corporation: The Desirable Limits on
State Competition in Corporate Law, 105 HARV. L. REV. 1437, 1460–61 (1992).
244. See id. at 1470.
245. See id.
246. See id. at 1471–75. In fact, Bebchuk’s view can be classified as intermediate
because he seeks to identify criteria for which a race to the top or bottom is likely.
247. See Gelter, supra note 7, at 269–75. For a similar analysis see also Birkmose,
supra note 7, at 47–54.
248. See Gelter, supra note 7, at 269–75.
being negatively affected, because shareholders, particularly
large blockholders, control the incorporation process.249
Equivalently, if reincorporation is ex post beneficial to
shareholders, but harmful to employees, it is very likely that such
a redistributive reincorporation will take place when shareholder
benefits exceed the (possibly substantial) costs of
reincorporation. In the case of a true shareholder-stakeholder
conflict, large blockholders will even be able to typically obtain
the support of minority shareholders.
Thus, ownership structure plays an important role. However,
in individual cases it will depend on what coalitions are formed.
For example, in a dispersed ownership company, employees and
shareholders might share an interest in strong enforcement of
the directors’ duty of loyalty, while they would probably share
managers’ interests regarding hostile takeovers and the prospect
of confrontation with the board. In other words, with respect to
issues where managers and employees share similar objectives,
employees might gain by free-riding on managerial opportunism
because managers succeed in committing the firm to a legal
system not hospitable to takeovers and resisting shareholders’
attempts to change the applicable regime. In a concentrated
ownership environment, however, managers are immediately
subject to the wishes of the controlling shareholder and will be
unable to resist their advances.
True, ex ante there may be an incentive to commit to a
corporate law system favorable to employees in order to ensure
their goodwill and long-term cooperation. However, an ex ante
decision is only helpful if it is coupled with a previous
commitment. Shareholders may sometimes benefit from an ex
post change of the applicable regime to the detriment of
employees, in which case there will be little incentive for
shareholders or managers to take the interests of nonshareholder
constituencies into account in ex post reincorporation
decisions.250 If a reincorporation is easy, any ex ante choice is
simply preliminary, which is why it cannot have any desirable
249. Enriques & Gelter, supra note 8, at 617–18.
250. Cf. Bebchuk, supra note 243, at 1485.
3. Dispersed Ownership and Employees
Next, consider firms with dispersed ownership, which
predominate in Europe only among listed firms in the United
Kingdom. As suggested by the U.S. discussion, the objective
sought by self-interested managers seems to be increased
independence from shareholders.251 All three of the issues
identified earlier as relevant for employees252 may play a role
here—reducing direct possibilities by shareholders to influence
managerial conduct may widen the possibilities for managers to
obtain rents and classical private benefits of control. In other
words, it may affect agency cost. By contrast, team production
advocates emphasize that shielding managers from shareholders
allows insulated managers to avoid the exploitation of the
quasirents of nonshareholder constituencies.253
Part III.D of this Article describes the potential conflicts of
interest where managers and employees will be on one side, and
shareholders on the other. While I have argued elsewhere that
the influence of dispersed shareholders on managerial
decisionmaking is greater in the United Kingdom than in the United
States (among other things, because of a higher incidence of
hostile takeovers),254 it does not seem likely that managers might
use it as an opportunity to secure independence from
shareholders. To be sure, the issues identified above might serve
this purpose. In a dispersed ownership firm, employees on the
board might be faithful allies of management against “intrusion”
by shareholder activists or outside board members seeking to
maximize shareholder wealth. Directors’ duties using a pluralist
objective may sometimes help directors to justify their actions
when seeking re-election, as they could say that a new
management team would not be in the position to do anything
else. And, of course, it might help them to construct a shield
against the occasional liability suit. Likewise, a reduced risk of
hostile takeovers may increase managers’ freedom to act. Here, it
251. See Bebchuk, supra note 243, at 1462–68 (describing the value-decreasing rules
that managers may seek when determining whether to reincorporate).
252. See supra Part II.B–D.
253. See Blair & Stout, supra note 16; see also Coffee, supra note 202, at 70–71, 73–81
(discussing breaches of implicit agreements as a result of hostile takeovers); Shleifer &
Summers, supra note 153, at 42 (same).
254. Gelter, supra note 195, at 186–93.
is the duties of managers (or their freedom to defend against
takeovers) that may be important also for employees. The U.S.
experience provides a good example: firms all but threatened to
migrate out of Delaware when it was suggested that managers
would be forced to let hostile takeovers go through.255
Among these three options, it is probably safe to say that
employee participation systems are likely to be the least popular
among managers. Even as potential allies, employee board
representatives are difficult to keep under control and will
typically seek to promote their own agenda.256 It is sometimes
argued that German codetermination undermines the
functioning of the supervisory board because employee
representatives cannot sometimes be trusted with confidential
information.257 While this argument is usually made before the
backdrop of German concentrated ownership, it applies
irrespective of ownership structure: employee participation may
help managers when employee and managerial interests
coincide, but it may hurt them greatly when they do not.258 In
dispersed-ownership firms, managers will therefore rather seek a
coalition with shareholders against employees with regard to
codetermination. Although the European legal framework puts
255. The notorious “Wachtell Lipton Memo” was disseminated by one of the
leading U.S. corporate law firms after the Delaware Chancery Court’s decision in City
Capital Assoc. v. Interco Inc., 551 A.2d. 787 (Del. Ch. 1988), which would have greatly
reduced managers ability to defend against hostile bids. See Jeffrey N. Gordon,
Corporations, Markets, and Courts, 91 COLUM. L. REV. 1931, 1959 n.95 (1991) (quoting
Memorandum from Wachtell, Lipton, Rosen, & Katz to clients, The Interco Case (Nov.
3, 1988)). The decision was subsequently rejected by the Delaware Supreme Court. See
Paramount Communications, Inc. v. Time, Inc., 571 A.2d. 1140 (Del. 1990).
256. See, e.g., Klaus J. Hopt, The German Two-Tier Board: Experience, Theories, Reforms,
in COMPARATIVE CORPORATE GOVERNANCE: THE STATE OF THE ART AND EMERGING
RESEARCH 227, 247 (Klaus J. Hopt et al. eds., 1998) (describing how labor interests
predominate the discussion on German boards).
257. See, e.g., Jean J. Du Plessis & Otto Sandrock, The Rise and Fall of Supervisory
Board Codetermination in Germany, 16 INT’L COMPANY & COM. L. REV. 67, 74–75 (2005);
FitzRoy & Kraft, supra note 61, at 236 (citing studies revealing a deliberate restriction of
information in some firms); Roe, supra note 37, at 171–75.
258. See supra notes 198–203 (contrasting when employee and manager interests
coincide and when they do not). An example would be managerial private benefits of
control or self-dealing, which is typically not in line with employee interests. However, it
may sometimes be possible to bribe employee representatives on the board, which is not
a novel practice. The most prominent case is the Volkswagen corruption affair. See Mark
Landler, Sentences in Volkswagen Scandal, N.Y. TIMES, Feb. 23, 2008, at C3. From the
perspective of a potential managerial self-dealer it will be preferable if there is no
employee representative they would have to bribe.
some breaks on the erosion of employee participation systems,
codetermination arbitrage may be a factor to reckon with even in
continental dispersed-ownership firms, whose number has
increased during the past decade.259
Reduced exposure to takeovers and attenuated influence of
shareholders on the firm may be of broader interest for both
employees and managers. One might, for example, expect
managers to seek opportunistic movements away from member
states that implement the neutrality rule. In fact, regulatory
competition is usually considered to be the reason for the
promanager slant in U.S. takeover law.260 However, as a general
matter, it seems relatively unlikely that shareholders in European
firms that already have dispersed ownership would agree to a
reincorporation into a less takeover-friendly jurisdiction,
particularly if such a move was motivated by pro-employee
concerns. Most of all, a shareholder vote would seem to be a
particularly strong obstacle for British companies. True, U.S.
shareholders have often approved staggered boards in the past,
which is one of the elements that makes a company
takeoverproof, but this has stopped since about 1990.261 Institutional
investors in Britain are also known to be more proactive than
their U.S. counterparts; while normally acting cautiously, they are
known to take action in situations where the alarm bells in a
particular firm ring.262 A reincorporation into another member
state from Britain, and the (partial) attempt to escape from the
financial culture of the City of London would seem to be a more
significant event than a mere reincorporation from one U.S. state
to another. Arguably, the recent EU Shareholder Rights
Directive263 will strengthen the position of institutional
investors—often based in the United States or the United
Kingdom—also in other member states.264 Thus, the argument
would seem to apply by analogy also in continental dispersed
4. Concentrated Ownership and Employees
The more pressing issue seems to be whether firms with
concentrated ownership might avail themselves of corporate law
arbitrage opportunities that are relevant to employees. Here, the
triangular relationship between shareholders, managers, and
employees is transformed into one involving large shareholders,
small investors, and employees. This changes the situation
dramatically, since powerful managers are essentially eliminated
from the picture as another independent force framing issues of
corporate policy. Large blockholders, either acting
singlehandedly or in coalition, can easily initiate a reincorporation if
they can garner the required supermajority.265 Large
shareholders are also in a position to exploit holdup possibilities
with respect to employees by means of their continued control
over management; if, for some reason, they are unwilling or
unable to do so, they may voluntarily sell control to someone else
who will, and thus share part of the profits arising from
opportunistic behavior towards employees. In the issues
identified above as potential shareholder-stakeholder conflicts,
minority and large shareholders share an ex post interest in large
financial gains. While I have elsewhere argued that large
shareholders are in a position to exploit the minority by means of
regulatory arbitrage,266 they are equally well-positioned to exploit
holdup possibilities to the detriment of employees.
This argument is in line with U.S. varieties of stakeholder
theories of corporate law, particularly the team production
theory,267 which emphasizes that stakeholders will benefit from
the insulation of the board from shareholders. In the
comparative corporate governance debate, some authors seem to
share this position.268 Others have suggested that employees
could rely on the long-term position of large shareholders within
the firm, who might have a greater stake in securing the
longterm cooperation of stakeholders.269 The second view would
seem to rule out opportunistic reincorporations to the detriment
of labor and rather indicate that controlling shareholders might
seek alliances with labor against small investors. The literature
seems not yet to have made much progress towards a synthesis of
these two opposing views, which would require a closer
investigation of what factors determine the stance towards
stakeholders taken by either managers or controlling
shareholders.270 For purposes of regulatory arbitrage, it is
important to emphasize that the effects on employees may largely
depend on the identity of the controlling shareholder, as that
person may refrain from opportunism for idiosyncratic reasons.
Employees can be protected from takeovers because of
nonpecuniary benefits received by the controller of a firm.271
267. See, e.g., Blair & Stout, supra note 195, at 418–22.
268. See, e.g., Gérard Charreaux & Philippe Desbrières, Corporate Governance:
Stakeholder Value versus Shareholder Value, 5 J. MGMT. & GOVERNANCE 107, 116 (2001);
Andrei Shleifer & Robert W. Vishny, A Survey of Corporate Governance, 52 J. FIN. 737, 758
(1997); see also Michel A. Habib, Monitoring, Implicit Contracting, and the Lack of
Permanence of Leveraged Buyouts, 1 EUR. FIN. REV. 139 (1997) (mathematical model in the
LBO context); Pagano & Volpin, supra note 203, at 841 (providing a model in which
managers have an incentive to provide employees with strong protection to make the
firm unattractive as a target of takeovers; however, this incentive rests on managers
having only a small stake in equity).
269. See William W. Bratton & Joseph A. McCahery, Comparative Corporate
Governance and Barriers to Global Cross Reference, in CORPORATE GOVERNANCE REGIMES:
CONVERGENCE AND DIVERSITY 23, supra note 176, at 27; Julian Franks & Colin Mayer,
Ownership and Control in Europe, in 2 THE NEW PALGRAVE DICTIONARY OF ECONOMICS
AND THE LAW, supra note 20, at 722, 728–29; Ruth V. Aguilera & Gregory Jackson, The
Cross-National Diversity of Corporate Governance: Dimensions and Determinants, 28 ACAD.
MGMT. REV. 447, 451 (2003).
270. For an attempt to provide a formal model addressing the issue see Giulio
Ecchia, Martin Gelter & Piero Pasotti, Corporate Governance, Corporate and Employment
Law, and the Costs of Expropriation (European Corporate Governance Institute Law
Working Paper No. 128/200
), available at http//ssrn.com/abstract=1430623.
271. See Gilson, supra note 209, at 1663–64 (defining nonpecuniary benefits as
“forms of psychic and other benefits that, without more, involve no transfer of real
company resources and do not disproportionately dilute the company’s stock to a
This could be, for example, the personal satisfaction that a
member of an entrepreneurial family may derive from his or her
privileged position as a controlling shareholder,272 or political
benefits if the controlling shareholder is a government entity.
Those controlling shareholders that are in a position to initiate
reincorporations therefore have a shared interest with employees
and are unlikely to reincorporate in an environment where their
position is less secure. However, regulatory arbitrage could be a
possible road to go down once the nonpecuniary benefit has
subsided—such as when a family firm is passed on by the
founding generation. As far as aspects of corporate law actually
help to foster long-term commitment, regulatory arbitrage gains
can easily obtained by the controlling shareholder once such a
Assuming constant ownership structures, are any of the
relevant corporate law issues likely to trigger anti-employee
arbitrage, or sufficiently significant to help support a decision to
reincorporate? Board-centric takeover defenses are largely
irrelevant for firms with concentrated ownership; blockholders’
cooperation is often needed for a change of control over the
firm. The neutrality rule is irrelevant. The breakthrough rule
may be significant, given that it removes some entrenchment
possibilities of large shareholders.273 For employees, its relevance
is limited to those where the incumbent controller (such as an
entrepreneurial family) takes a friendly attitude towards them to
foster long-term investment, whereas the challenger (such as a
hedge fund), takes a different position.
In some cases, the reciprocity rule of the Takeover Directive
may create incentives to opt into board neutrality and the
breakthrough rule. Since other firms normally applying these
rules may opt out of them vis-à-vis firms that do not apply them,
the reciprocity rule facilitates taking over firms. Firms (through
their controlling shareholders) expecting to be bidders and not
targets might avail themselves of this possibility, but potential
272. See Mike Burkart et al., Family Firms, 58 J. FIN. 2167, 2168 (2003) (“A founder
may derive pleasure from having his child run the company that bears the family
name.”); cf. Gilson, supra note 209, at 1666 (describing social and political benefits that
accompany being a member of the fifteen wealthiest families in Sweden).
273. See Joseph A. McCahery et al., The Economics of the Proposed European Takeover
Directive, in REFORMING COMPANY AND TAKEOVER LAW IN EUROPE 575, 623–36 (Guido
Ferrarini et al. eds., 2004).
targets will not. Firms are more likely to be targets if there are
either inefficiencies, potential private benefits of control for the
bidder,274 or rents that can be expropriated from employees.275
Opting out of the neutrality or breakthrough rule in order
to avoid being an open target may be a potential corporate law
arbitrage strategy, and typically one that employees will
appreciate. By contrast, opting into either of these rules will not
work in their favor. However, an opt-in does not necessarily
require corporate law arbitrage because member states must
permit firms to do so in their charter.276
Thus, the one major employee-relevant issue where one
might expect significant corporate law arbitrage is employee
participation. Controlling shareholders are not likely to be in
favor of it, in substance for the same reason as powerful
managers in a Berle-Means firm. While employee directors might
sometimes turn out to be useful allies for managers,277 their
propensity to develop their own agenda, and the frequent
suspicion that they cannot be trusted with certain sensitive
information relevant for their constituencies,278 will most likely
be a deterrent against codetermination. As a result of an
increased involvement of international institutional investors
precipitated by developments such as the Shareholder Rights
Directive,279 even relatively employee-friendly controlling
shareholders might feel compelled to put greater weight on the
concerns of small shareholders with issues that are as visible as
employee participation.280 It seems safe to conjecture that
corporate law arbitrage would in most cases disfavor employee
274. See generally Lucian A. Bebchuk, Efficient and Inefficient Sales of Corporate Control,
109 Q.J. ECON. 957 (1994) (providing an analysis how various factors, including private
benefits of control of controlling shareholders, determine what kind of takeover law is
best suited for a particular corporate governance system).
275. Shleifer & Summers, supra note 153, at 34.
276. See supra note 178 and accompanying text.
277. See supra note 203 and accompanying text.
278. See supra notes 256–57 and accompanying text.
279. Council Directive on the Exercise of Certain Rights of Shareholders in Listed
Companies, No. 2007/36, 2007 O.J. L 184/17.
280. Cf. Pinto, supra 264, at 621 (postulating that the Shareholder Rights Directive
might reconfigure the power balance between various players in the corporate
Some scholars have suggested that regulatory competition
could precipitate changes in corporate governance structures.
Most of all, the U.K. takeover regime might draw continental
firms seeking a stock exchange listing, ultimately aiming for
dispersed ownership.281 In addition to the other benefits, this
could entail an increase due to gains from employees if the firm
becomes more contestable.282 However, making use of
transnational regulatory possibilities may not even be necessary.
Although member states are not required to implement the
neutrality and breakthrough rules as mandatory law, they are
required to allow firms to apply them voluntarily.283 Unless the
British Takeover Panel possesses significant institutional
advantages over its counterparts in other EU member states, a
choice within one legal system (and simply making the respective
choice in the charter) will suffice. Firms can still seek an
exchange listing in the United Kingdom, in which case they will
be subject to those aspects of U.K. takeover law that hinge on the
exchange listing. Most other issues of takeover law, besides board
duties, are not dependent on where the firm has its registered
5. Erosion of Codetermination?
The rather theoretical reflections of the preceding sections
aside, the one practical issue where we already seem to be seeing
regulatory arbitrage is employee participation. Ex post changes
of the applicable codetermination regime could be used for
opportunistic purposes by controlling shareholders, as the assent
of employees is not required. At first glance, the negotiation
mechanism regarding employee participation applicable to
crossborder mergers and the creation of an SE would seem to greatly
mitigate the effects of such a move. Even when using the less
“employee-friendly” rules of the Directive on Cross-Border
Mergers, the highest level of employee participation prevails
when a third of the merged firm’s employees were previously
subject to any participation system; and even where a single
281. See Armour, supra note 4, at 390–91; Armour & Skeel, supra note 163, at 1789–
282. See supra Part II.C.3.
283. See supra note 178 and accompanying text.
284. See Enriques & Tröger, supra note 184, at 531–32.
employee was previously subject to such a mechanism, the SNB
may decide which participation system applies.
One might therefore conclude that the SNB has a strong
bargaining position, as the default rule awards the entire prize to
their constituency.285 Some commentators have concluded that
codetermination effectively insulates employee participation
systems from regulatory competition.286 If the analysis stopped
here, the only situation where the expectations of employees in
one member state with regard to a particular level of
participation would be disappointed might be one where
shareholders and managers succeed in pitting employee groups
from different states against each other.287 Significantly, the
default rules do not apply in newly merged entities where
previously fewer than twenty-five percent (SE Directive) or
thirtythree percent (Cross-Border Merger Directive) of employers
were subject to an employee participation system.288 The
rationale for this threshold is apparently to avoid forcing
boardroom participation on reluctant employees.289
However, the impression that codetermination is completely
protected is deceptive. An SE can indeed be used to escape
codetermination by converting into a legal form of national
law.290 A conversion into a corporation governed by national law
is permitted two years after the registration of the SE, and after
that period, it will not normally be considered “misuse.”291 As
already pointed out, a merger with a legal form of national law
may even be possible before the end of the two-year period.292
Whether an employee participation system must be “transferred”
to the acquiring firm is essentially up to the member state.
285. Furthermore, it can delay the registration of an SE by six months, which is the
default maximum duration of negotiations. See supra note 74 and accompanying text.
This creates additional bargaining power for the employee side. See Rickford, supra note
81, at 27 n.50.
286. See, e.g., Johnston, supra note 91, at 109.
287. See discussion supra note Part II.B.3.
288. See supra notes 76, 85 and accompanying text.
289. See Rickford, supra note 81, at 28 n.56. For example, British unions were
historically skeptical about employee participation. See, e.g., KNUDSEN, supra note 46, at
290. See supra notes 117–22 and accompanying text.
291. Supra notes 117–18 and accompanying text; see also Kisker, surpa note 86, at
208 (suggesting that a transformation after more than two years will not be a “misuse”).
292. See supra note 119 and accompanying text.
Likewise, after a period of least three years (unless member state
law prescribes a longer period), a firm formed by a cross-border
merger can be merged with a “clean slate” firm that is not subject
to a negotiated employee participation agreement.293 In both
cases, it is largely left to the member state where the firm is
incorporated to decide how the negotiated employee
participation system is dealt with in such cases. True, some
companies may be deterred from setting up an SE or merging by
the lengthy negotiation process.294 However, companies may
elect to submit to the applicable default participation rules
voluntarily in a cross-border merger and thus avoid lengthy
negotiations.295 Whether “outreach statutes” applying national
employee participation systems to “pseudo-foreign” firms
incorporated in other member states will be politically feasible
and legally possible under EU law remains to be seen.296
While transformations into the SE form have so far not yet
become a mass phenomenon, they are growing in popularity. In
June 2008, there were 213 SEs in Europe.297 So far there is no
systematic data on the exact motivation to transform a firm into
an SE, but anecdotal evidence indicates that board structure
plays an important role. While some observers point out that the
legally mandated size of the German supervisory board is often
considered detrimental by firms,298 at least in some cases, SEs
appear to have been used to avoid the future possibility of
codetermination or of a stronger form of it once the firm
exceeds the required size threshold.299 Some observers predict
that a large proportion of large publicly traded German firms
may become SEs in the future.300 Given that only a handful of the
293. See supra note 124.
294. See Joseph McCahery & Erik Vermeulen, Does the European Company Prevent the
‘Delaware Effect’?, 11 EUR. L.J. 785, 799 (2005); Rock et al., supra note 124, at 218.
295. See supra notes 82–83.
296. See supra notes 133–37 and accompanying text.
297. Eidenmüller et al., supra note 68, at 20.
298. See id. at 25 (reporting that several German publicly traded firms reduced the
number of board members).
299. See Ingrid Herden & Reinhard Kowalewsky, Das neue Drohpotenzial: Europa-AG
[The New Potential Threat: Europe-AG], CAPITAL, Mar. 1
, at 192 (citing a
representative of Klöckner SE saying that there will never be board codetermination
after the firm has been transformed); see also supra note 108 (describing how the
creation of an SE reduced the size of the Allianz supervisory board).
300. See Herden & Kowalewsky, supra note 299, at 192 (quoting German corporate
governance experts and politicians that a large number of firms will transform into SEs).
existing SEs are truly large firms, this assessment may be
premature.301 Furthermore, the evidence compiled by
Eidenmüller et al. suggests that SEs are more popular in
countries with employee participation systems, such as Austria,
the Czech Republic, Germany, or the Netherlands, than in others
such as France, Italy Spain, or the United Kingdom, where SEs
are rare relative to population size, or do not exist at all thus
Ultimately, whatever bargaining victory the SNB achieves, it
may be a pyrrhic one since shareholders are unable to commit to
retaining the results after a subsequent merger. It seems also
unlikely that a court would consider a subsequent merger abusive
in the case of a time lag of several years. The assessment that
European corporate law legislation could result in an “erosion”
of German codetermination303 may therefore well turn out right.
The possibilities of regulatory arbitrage put employees at a
disadvantage compared to the traditional “protected” national
systems of corporate law. Previous articles have pointed out that
differences in ownership structure between Europe and the
United States are likely to result in stronger risks in the European
context due to the relatively unchecked power of controlling
shareholders on the European continent. Due to differences in
ownership structure, the results of regulatory arbitrage
opportunities are likely to be very different from the United
States, where regulatory competition seems to have largely
reinforced the pre-eminence of managers over shareholder
power. U.S. shareholders have traditionally been prevented by
political forces (that have influenced securities law and financial
regulation) from gaining an intrusive influence on firms.304 True,
301. See Eidenmüller et al., supra note 68, at 22–23 (reporting on the conversion of
only four firms with more than 10,000 employees, those being Allianz, Porsche, Strabag,
302. See id. at 20 (reporting numbers of SEs by population). This is my own
interpretation of their evidence. In fact there are many reasons why the SE form may be
chosen, including tax advantages.
303. See, e.g., Habersack, supra note 86, at 643; Teichmann, supra note 137, at 1787;
see also MILHAUPT & PISTOR, supra note 108, at 85 (“[T]he mandatory codetermination
regime can be softened considerably.”).
304. See generally ROE, supra note 26.
FORDHAM INTERNATIONAL LAW JOURNAL [Vol. 33:792
no state in the United States has implemented an employee
participation system. Still, employees have often figured
prominently in the debate on hostile takeovers, in which
managers asserted their independence and insulation. U.S.
managers’ assertion of their independence has probably shielded
employees from takeovers to some extent—where employee and
managerial interests overlap, it has most likely done so even
without employees having a formal influence on decisions
whether or not to reincorporate.
In continental Europe, by contrast, blockholders dominate
corporate governance. Controlling shareholders are not only in a
position to use their influence to the detriment of other
stakeholders, but they are also the likely beneficiaries. Their
position has been strengthened further by the regulatory
arbitrage opportunities created by EU law that can undermine
pro-employee institutions of national corporate governance
systems. Employee participation systems are the main issue that
could become a target of regulatory arbitrage. While EU law sets
certain limits to arbitrage by requiring negotiations, there are
techniques that can allow patient shareholders to erode
codetermination. The negotiation mechanism implemented by
the SE Employees Directive and the Directive on Cross-Border
Mergers does not provide complete protection, and even allows
controlling shareholders to escape employee participation
systems. Possible incentives in long-term commitment and
firmspecific investment are mitigated or eliminated because
controlling shareholders can renege on a prior commitment to a
Free choice of the corporate law regime regarding
employees implies that shareholders cannot permanently
commit. The reason why such mechanisms may sometimes be
beneficial for firm-specific investment is precisely because they
are likely to foster long-term commitment and trust. Regulatory
arbitrage rules out a permanent commitment to codetermination
or similar systems. Decisions on reincorporations are taken
exclusively by shareholders, who cannot stipulate against mergers
or the creation of an SE. The limits of “codetermination
arbitrage” under European law remain tentative. Thus, even if an
efficient ex ante choice is possible, specific investment by
employees may not occur or be adjusted in anticipation of
1. Centros Ltd . v. Erhvervs-og Selskabsstyrelsen , Case C- 212 /97,  E.C.R. I1459 .
2. Überseering BV v. Nordic Constr. Co. Baumanagement GmbH (NCC) , Case C208/00 ,  E.C.R. I- 9919 .
3. Kamer van Koophandel en Fabrieken voor Amsterdam v. Inspire Art Ltd., Case C - 167 /01,  E.C.R. I- 10155 .
4. See, e.g., STEFANO LOMBARDO , REGULATORY COMPETITION IN COMPANY LAW IN THE EUROPEAN COMMUNITY: PREREQUESITES AND LIMITS ( 2002 ) ; John Armour, Who Should Make Corporate Law? EU Legislation Versus Regulatory Competition, 58 CURRENT LEGAL PROBS . 369 ( 2005 ) ; Jens C. Dammann, Freedom of Choice in European Corporate Law, 29 YALE J . INT'L L . 477 ( 2004 ).
5. See, e.g., Luca Enriques, EC Company Law and the Fears of a European Delaware , 15 EUR. BUS. L. REV. 1259 ( 2004 ).
6. See, e.g., Martin Gelter , The Structure of Regulatory Competition in European Corporate Law , 5 J. CORP . L. STUD. 247 ( 2005 ) ; Tobias H . Tröger, Choice of Jurisdiction in European Corporate Law: Perspectives of European Corporate Governance, 6 EUR. BUS. ORG. L. REV. 3 , 6 ( 2005 ).
7. See, e.g., Enriques, supra note 5; see also, e.g., Gelter, supra note 6 , at 253-64; Tröger, supra note 6, at 5-6.
8. See, e.g., Luca Enriques & Martin Gelter, How the Old World Encountered the New One: Regulatory Competition and Cooperation in European Corporate and Bankruptcy Law , 81 TUL. L. REV. 577 , 612 - 13 ( 2007 ).
9. See Udo Kornblum , Bundesweite Rechtstatsachen zum Unternehmens- und Gesellschaftsrecht , Stand 1.1.2008 [Nationwide Facts on Business and Corporate Law, as of 1.1.2008], 100 GMBH-RUNDSCHAU [GMBHR] 25 , 31 (2009) (F.R .G.) (estimating roughly 15,000 limited liability companies in Germany as of year-end 2007 ). See generally Marco Becht et al ., Where Do Firms Incorporate? Deregulation and the Cost of Entry , 14 J. CORP . FIN. 241 ( 2008 ) (providing empirical data on the basis of the residence of directors).
10. Centros and its progeny have triggered an intense academic debate about creditor protection rules, which are thought to be more important in Europe than in the United States . See generally LEGAL CAPITAL IN EUROPE . ECFR SPECIAL NO. 1 (Marcus Lutter ed ., 2006 ); THE LAW AND ECONOMICS OF CREDITOR PROTECTION: A TRANSATLANTIC PERSPECTIVE (Horst Eidenmüller & Wolfgang Schön eds., 2008 ) (analyzing the merits of legal capital from various perspectives); Luca Enriques & Jonathan R. Macey , Creditors Versus Capital Formation: The Case Against the European Legal Capital Rules , 86 CORNELL L. REV. 1165 ( 2001 ) (criticizing legal capital as inefficient); Peter O. Mülbert & Max Birke, Legal Capital-Is There a Case Against the European Legal Capital Rules?, 3 EUR . BUS. ORG. L. REV. 695 ( 2002 ) (same).
11. A recent German reform can be clearly identified as motivated by regulatory competition. The Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung
20. A complete contingent contract would require stipulations for payoffs to all parties under every single possible state of the world, however unlikely . See, e.g., Alan Schwartz , Incomplete Contracts, in 2 THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 277, 277 (Peter K. Newman ed., 1999 ).
21. The idea of “bounded rationality” is attributed to Herbert Simon. See Herbert Simon, A Behavioral Model of Rational Choice, 69 Q .J. ECON. 99 , 104 ( 1955 ) ; see also OLIVER HART, FIRMS, CONTRACTS AND FINANCIAL STRUCTURE 81 ( 1995 ); OLIVER E. WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM 45-46 ( 1985 ); Christine Jolls, Cass R. Sunstein & Richard Thaler , A Behavioral Approach to Law and Economics, 50 STAN. L. REV. 1471 , 1477 ( 1998 ).
22. Cf . FURUBOTN & RICHTER, supra note 18, at 233 (defining the terms “verifiable” and “observable”); HART , supra note 21, at 37-38 n. 15 ( same ).
23. RICHARD A. BREALEY, STEWART C. MYERS & FRANKLIN ALLEN , PRINCIPLES OF CORPORATE FINANCE 949 (8th ed. 2006 ).
24. Id . at 949 n.36.
27. Council Regulation on the Law Applicable to Contractual Obligations (Rome I) , No. 593/ 2008 , art. 8 ( 2 ), 2008 O.J. L 177/6.
28. Id . art. 8 ( 3 ).
29. Id . art. 8 ( 4 ).
30. See id. art. 3.
31. See id. art. 8 ( 1 ). For a more detailed discussion of the equivalent predecessor provisions of these rules in the former Rome I convention, see SIR PETER NORTH & J.J. FAWCETT , CHESHIRE AND NORTH'S PRIVATE INTERNATIONAL LAW 208- 10 (13th ed. 2004 ). See also Sebastian Krebber, Conflict of Laws in Employment in Europe, 21 COMP . LAB. L. & POL'Y J . 501 , 522 - 29 ( 2000 ).
32. See Krebber, supra note 31 , at 538- 39 . For a German perspective, see Rolf Birk, in 1 MÜNCHENER HANDBUCH ZUM ARBEITSRECHT [MUNICH HANDBOOK ON EMPLOYMENT AND LABOR LAW] § 22 , cmts. 5- 6 ( Reinhard Richardi & Otfried Wlotzke eds., 2d ed. 2000 ) (F.R .G.) (explaining the principle of territoriality), and Dieter Martiny, in 10 MÜNCHENER KOMMENTAR ZUM BÜRGERLICHEN GESETZBUCH [MUNICH COMMENTARY ON THE CIVIL CODE] EBGBG art . 30 , cmts. 129 - 36 (Kurt Rebmann et al. eds., 4th ed. 2006 ) (F.R .G.) (same). For a French perspective, see PIERRE MAYER & VINCENT HEUZÉ, DROIT INTERNATIONAL PRIVÉ [PRIVATE INTERNATIONAL LAW] 553 - 54 (9th ed. 2007 ) (Fr.) (pointing out that collective rights of employees necessarily depend on territoriality and mentioning a case where an international firm had to permit a works council in its French operations ).
33. Council Directive on the Establishment of a European Works Council or a Procedure in Community-Scale Undertakings and Community-Scale Group Undertakings for the Purposes of Informing and Consulting Employees , No. 94 /45, art. 1 ( 2 ), 1994 O.J. L 254/64, amended by 1998 O.J. L 10 / 22 (extending the original
41. See id. § 7 ( 1 ).
42. See id. § 7 ( 2 ).
43. See id. § 29 .
44. Enriques et al., surpa note 37 , at 101.
45. See Drittelbeteiligungsgesetz [ One-Third Employee Representation Act], May 18 , 2004 , BGBl. I at 974, last amended by Gesetz, July 30 , 2009 , BGBl. I. at 2479, § 1 ( F.R.G.).
46. A codetermination system comparable to the German one was recommended in the “ Bullock Report.” REPORT OF THE COMMITTEE OF INQUIRY ON INDUSTRIAL DEMOCRACY , 1977 , Cmnd. 6706 ( U.K. ). For the reasons on why it was rejected, see, for example , HERMAN KNUDSEN, EMPLOYEE PARTICIPATION IN EUROPE 53 ( 1995 ), and David Marsh & Gareth Locksley, Capital in Britain: Its Structural Power and Influence over Policy, 6 WEST EUR . POL . 36 , 49 - 50 ( 1983 ).
47. See Arbeitsverfassungsgesetz [ArbVG] [Labor Constitution Act], Bundesgesetzblatt Teil I [BGB1 I] No. 22/ 1974 , § 110 (Austria).
48. RAISER, supra note 38, at B 43-B 44. Regarding the Danish system , see KNUDSEN, supra note 46 , at 81-95, and Jesper Lau Hansen, The Danish Green Paper on Company Law Reform-Modernising Company Law in the 21st Century, 10 EUR. BUS. ORG. L. REV . 73 , 89 - 90 ( 2009 ).
49. See Laki yhteistoiminnasta yrityksissä [Act on Cooperation with Undertakings] ( 1978 : 725) (Fin.). A unofficial translation by the Finnish government is electronically available at http://www.finlex.fi/pdf/saadkaan/E9780725.pdf.
50. See Law of May 6, 1974 , Mémorial du Grand-Duché de Luxembourg [Official Gazette of Luxembourg], A -No. 35 , May 10 , 1974 , at 620 (Lux.).
51. See 32 § Lag om Medbestämmande i arbetslivet [Act on Codetermination in the Workplace] (Svensk författningssamling [SFS] 1976 : 580) (Swed.), translated in FOLKE SCHMIDT, LAW AND INDUSTRIAL RELATIONS IN SWEDEN ( 1977 ).
52. See RAISER , supra note 38, at B 42. The idea likely spread to these postcommunist countries because their legal tradition has historically been influenced by Germany. See Holger Spamann, Contemporary Legal Transplants-Legal Families and the Diffusion of (Corporate) Law, 2009 B.Y.U. L. REV . 1813 , 1867 .
53. See RAISER , supra note 38, at B 42.
54. See id. at B 43-B 44.
55. See Abe de Jong & Alisa Roëll, Financing and Control in the Netherlands: A Historical Perspective, in A HISTORY OF CORPORATE GOVERNANCE AROUND THE WORLD 467, 473 (Randall K. Morck ed., 2005 ) (discussing the aim of structurregime and its drawbacks) . See generally STEVEN R. SCHUIT ET AL., CORPORATE LAW AND PRACTICE OF THE NETHERLANDS 111-14 (2d ed. 2002 ) (describing the corporate structure of “large” Dutch corporations); Edo Groenewald, Corporate Governance in the Netherlands: From the Verdam Report of 1964 to the Tabaksblat Code of 2003, 6 EUR . BUS. ORG. L. REV. 291 , 294 ( 2005 ) (providing a breakdown of the statutory two-tier regime) . To qualify as a “large” company, a firm must meet three criteria: (1) an equity capital of at least € 13 , 000 ,000; (2) the corporation or a dependent company must have established a Works Council (as required by law); and (3) a regular workforce of 100 or more persons in the Netherlands (together with dependent companies) . See Burgerlijk Wetboek [BW2] [Civil Code] bk. 2 , tit . 5, arts. 153 ( 2 ), 263 ( 2 ) (Neth.). There are several exemptions to this definition. For example, a dependent firm with a parent company that fulfills the requirements is exempt . See SCHUIT ET AL., supra, at 115-17.
56. See BW2 [Civil Code] bk. 2, tit . 5, art. 158 ( 6 ). A rejection of the nominees of the works council is only possible for a limited number of reasons . See Groenewald, supra note 55 , at 295 (describing the grounds for the shareholders to object to a nominee of the works council ).
57. Groenewald , supra note 55, at 297.
58. See , e.g., Gary Gorton & Frank A. Schmid, Capital, Labor and the Firm: A Study of German Codetermination, 2 J . EUR. ECON. ASS'N 863 , 885 - 86 ( 2004 ).
59. Tobin 's q, as it is referred, is the ratio between the firm's market value and the replacement value of its assets . See, e.g., James Tobin & William C. Brainard , Asset Markets and the Cost of Capital, in ECONOMIC PROGRESS , PRIVATE VALUES , AND PUBLIC POLICY 235
65. Council Regulation on the Statute for a European Company , No. 2157/ 2001 , arts. 17 - 31 , 2001 O.J. L 294/1, at 7- 10 . See generally Luca Enriques, Silence is Golden: The European Company as a Catalyst for Company Law Arbitrage, 4 J. CORP . L. STUD. 77 ( 2004 ) (discussing how the Societas Europaea (“SE”) can be used for company law arbitrage).
66. See Enriques, supra note 65 , at 77 ( noting that the statute is limited in scope).
67. Council Regulation on the Statute for a European Company , No. 2157/ 2001 , art. 9, 2001 O.J. L 294/1, at 6.
68. A recent study found a total of 213 of these companies . See Horst Eidenmüller et al., Incorporating Under European Law: The Societas Europaea as a Vehicle for Legal Arbitrage, 10 EUR . BUS. ORG. L. REV. 1 , 20 ( 2009 ).
69. Council Regulation on the Statute for a European Company , No. 2157/ 2001 , art. 8, 2001 O.J. L 294/1, at 5-6.
70. See Enriques, supra note 65 , at 81-82.
71. Council Directive Supplementing the Statute for a European Company with Regard to the Involvement of Employees , No. 2001 /86, 2001 O.J. L 294/22.
72. For a detailed description of this directive , see BARNARD, supra note 33 , at 723-
73. See Council Directive Supplementing the Statute for a European Company with Regard to the Involvement of Employees , No. 2001 /86, arts. 3- 4 , 2001 O.J. L 294/22, at 24- 26 . Article 4(2) sets out the issues the agreement must cover, such as the allocation of seats and the powers of the representative body . Id. art. 4 ( 2 ).
74. See id, art. 5 , 2001 O.J. L 294/22, at 27.
75. See id. annex (setting out the fundamental principles of these rules).
76. See id. annex, pt. 3(b); see also BARNARD , supra note 33 , at 730; Paul L. Davies, Workers on the Board of the European Company? 32 INDUS . L.J. 75 , 85 - 87 ( 2003 ) (explaining the “highest level” requirement).
77. See Council Directive Supplementing the Statute for a European Company with Regard to the Involvement of Employees , No. 2001 /86, art. 7 ( 2 )(b), 2001 O.J. L 294 /22, at 27.
78. See id. art. 7.
79. BARNARD, supra note 33, at 730.
80. See Council Directive Supplementing the Statute for a European Company with Regard to the Involvement of Employees , No. 2001 /86, pmbl. ¶¶ 3 - 4 , 2001 O.J. L 294/22, at 22.
81. See id. annex, pt. 3(b) . According to article 7(3), member states may provide that the default provisions do not apply if the SE is formed by merger . Id. art. 7 ( 3 ). This provision was introduced in order to secure Spain's approval of the directive . According to the predominant interpretation of the provision, an SE cannot be formed in the
84. See Council Directive on Cross-Border Mergers of Limited Liability Companies , No. 2005 /56, art. 16 ( 3 ), 2005 O.J. L 310/1, at 8.
85. See id. art. 16 ( 3 )(e).
86. See id. art. 16 ( 4 ) (c). The rationale seems to be that employee influence on a one-tier board is thought to be more significant than on a supervisory board, which is less directly involved in the firm's decision-making processes . See Mathias Habersack , Grundsatzfragen der Mitbestimmung in SE und SCE sowie bei grenzüberschreitender Verschmelzung [Fundamental Issues of Codetermination in the European Company and the European Cooperative, as well as After a Cross-border Merger], 171 ZEITSCHRIFT FÜR DAS
219. Law of Mar. 4 , 1943 , J.O. , Mar. 6 , 1943 , p. 642 ( Fr .) ; see also MICHEL GERMAIN & LOUIS VOGEL, 1:2 TRAITÉ DE DROIT COMMERCIAL 400 , 442 - 45 (G. Ripert & R. Roblot eds., 18th ed. 2001 ).
220. Law No. 2001 -420 of Mar. 15 , 2001 , J.O. , May 16 , 2001 , p. 7776 ( Fr .).
221. See , e.g., JEAN PAILLUSSEAU , LA SOCIETE ANONYME , TECHNIQUE D'ORGANISATION DE L'ENTREPRISE 154- 55 ( 1967 ) (Fr.) (providing various references).
222. See GERMAIN & VOGEL, supra note 219, at 453; Claude Ducouloux-Favard, Les déviances de la gestion dans nos grandes entreprises [The Deviations of Management in Our Largest Businesses], 1996 RECUEIL DALLOZ SIREY , chronique 190 , 191 (describing the possibility of removal at nutum as being at odds with the prevailing institutional theory of the firm); Enriques et al ., supra note 36 , at 61 (noting the nonwaivable right in French law to remove directors midterm).
223. See supra notes 142- 43 .
224. See supra note 141.
225. Supervisory board members, who decide about the removal of management board members, are typically close confidants of large shareholders, and the requirement of a 75% supermajority is not insurmountable . See, e.g., Peter Doralt , Die Unabhängigkeit des Vorstands nach österreichischem und deutschen Aktienrecht-Schein und Wirklichkeit [The Independence of the Board Under Austrian and German Company LawAppearance and Reality], in DIE GESTALTUNG DER ORGANISATIONSDYNAMIK . FESTSCHRIFT FÜR OSKAR GRÜN 31 , 47 - 48 (Werner H. Hoffmann ed., 2003 ); see also Reinhard H. Schmidt, Corporate Governance in Germany: An Economic Perspective, in THE GERMAN FINANCIAL SYSTEM 386, 393 (Jan Pieter Krahnen & Reinhard H . Schmidt eds., 2004 ) (reporting that blockholders and banks are represented on the supervisory board besides employees).
228. See , e.g., Michael C. Jensen & William H. Meckling , Rights and Production Functions : An Application to Labor-Managed Firms and Codetermination, 52 J. BUS. 469 , 472 - 75 ( 1979 ) (arguing that the burden of proof lies with the proponents of codetermination).
229. See supra notes 108-09 and accompanying text.
230. See Jensen & Meckling, supra note 228, at 472-75.
231. See Fauver & Fuerst, supra note 17, at 679. For similar arguments regarding the voluntary introduction of provisions equivalent to employment protection laws , see Armour & Deakin, supra note 17 , at 447-48; David I. Levine , Just-Cause Employment Policies in the Presence of Worker Adverse Selection, 9 J. LAB . ECON. 293 ( 1991 ) ; and Cass R.
239. See Lucian A. Bebchuk , Limiting Contractual Freedom in Corporate Law: The Desirable Limits of Constraints on Charter Amendments , 102 HARV. L. REV. 1820 , 1835 - 47 ( 1989 ).
240. See Jeffrey N. Gordon , The Mandatory Structure of Corporate Law , 89 COLUM. L. REV. 1549 , 1573 - 85 ( 1989 ).
241. See Dammann, supra note 4 , 515 - 16 .
259. See generally Julian Franks et al., The Life Cycle of Family Ownership: A Comparative Study of France, Germany, Italy and the U.K. ( Oct. 1 , 2009 ) (unpublished manuscript) , available at http://ssrn.com/abstract=1102475.
260. See e.g., Bebchuk & Ferrell, supra note 154.
261. Bebchuk et al., supra note 159 , at 900 ( describing how staggered boards were frequently approved before 1990, but not afterwards ).
262. See , e.g., G. P. STAPLEDON , INSTITUTIONAL SHAREHOLDERS AND CORPORATE GOVERNANCE 122-29 ( 1996 ); John Armour et al., Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom , 55 VAND. L. REV. 1699 , 1751 - 54 , 1752 ( 2002 ) ; Bernard S. Black & John C. Coffee , Jr., Hail Britannia?: Institutional Investor Behavior Under Limited Regulation , 92 MICH. L. REV. 1997 , 2036 - 37 , 2053 ( 1994 ).
263. Council Directive on the Exercise of Certain Rights of Shareholders in Listed Companies , No. 2007 /36, 2007 O.J. L 184/17.
264. See Arthur R. Pinto , The European Union's Shareholder Voting Rights Directive from an American Perspective: Some Comparisons and Observations, 32 FORDHAM INT'L L.J . 587 , 617 - 19 ( 2009 ).
265. Amendments to a firm's charter in European states, including the United Kingdom, typically require a supermajority . See, e.g., AktG, Sept. 6 , 1965 , BGBl. I at 1089, § 179 ( 2 ), last amended by Gesetz, July 31 , 2009 , BGBl. I at 2509 ( F.R.G. ) (requiring a majority vote of three-quarters for reincorporation); C. TRAV . art. L. 225 - 96 (Fr.) (requiring two-thirds) ; Companies Act 2006 , 2006 , c. 46 , §§ 21 ( 1 ), 283 ( 1 ) (U.K. ) (requiring three-quarters) .
266. Gelter , supra note 7, at 269-75.