The Basic Structure of the Modern Business Corporation

• Author: Christopher C. Nicholls
• Pages: 231-256

231

CHAPTER NINE

The Basic Structure of the

Modern Business Corporation

INTRODUCTION

If the importance of a subject can be judged by the number of government and industry

reports it has generated, then corporate governance is on its way to becoming the single,

most important topic in all of corporate law. An unprecedented rise in the market price of

publicly traded shares reached its apex in the first quarter of 2000. This equity price boom

was followed by a general slide in the market, a slide that was exacerbated by the turmoil

caused by the stunning terrorist attacks of September 11, 2001. Soon thereafter came a

series of high-profile US corporate scandals and failures in 2001 and 2002, and these

were popularly blamed for further depressing prices and stalling the market’s recovery.1

Angry investors and the politicians who court their votes soon catapulted the issue of

how business corporations govern themselves to the top of the political agenda. What

was once a question of limited popular interest, suddenly became a matter of apparent

urgency. Indeed, the public observed an especially poignant sign of the profile this issue

had acquired in the summer of 2002, when the president of the United States addressed a

national audience standing in front of a banner trumpeting the phrase “corporate respon-

sibility.” A subject once considered the exclusive preserve of corporate lawyers, regula-

tors, and business executives had managed to gain pride of place on the public agenda.

This chapter, and the two chapters following it, will outline many of the issues that are

conventionally discussed under the “corporate governance” rubric, and will briefly dis-

cuss a number of the specific legal, regulatory, and industry measures introduced to

address these issues.

Corporate governance is often bifurcated into two essential considerations: “share-

holder voice”2 (the principal topic of chapter 10) and “director (and officer) obligations”

1Some (including the present author) have questioned whether the link between these scandals and low

stock prices is really the simple “cause and effect” relationship that has been favoured by the press and

some legislators. That argument is, however, well beyond the scope of this book.

2The term “voice” in the organizational context is usually attributed to Albert O. Hirschman’s book, Exit,

Voice, and Loyalty (Cambridge, MA: Harvard University Press, 1970), in which he examined responses

to organizational failure as taking one of two forms: exit or voice. Hirschman did not confine the use of

exit and voice options to organization members (such as shareholders); he noted that these two options

were also broadly available to the consumers of an organization’s products or services.

Copyright © 2005 Emond Montgomery Publications. All Rights Reserved.

232 Chapter 9 The Basic Structure of the Modern Business Corporation

(the principal topic of chapter 11). More fundamentally, at the heart of all corporate

governance concerns lies the so-called agency issue, as discussed in chapter 1. Recall in

this context that “agency” is an economic term—it is quite distinct from the legal

definition of agency. Agency concerns, as an economic matter, arise when assets are

owned by one person (the economic “principal”), but are under the control of another

(the economic “agent”). This separation of ownership and control imposes costs—agency

costs—that do not exist when ownership and control rest in the same hands.3 In the

corporate context, agency costs include monitoring costs incurred by shareholders, bond-

ing costs incurred by corporate officers and directors, and the remaining residual losses

that cannot be eliminated.4 As one considers the array of corporate governance mech-

anisms that exist in Canada and elsewhere, it is useful to consider to what extent they

represent monitoring or bonding mechanisms.

The following sections consider each of the basic building blocks in the corporate

governance structure. The canvass of these basic structural features is then followed by a

discussion of a number of more specific parts of the governance equation. Chapter 10

will focus in particular on “shareholder voice,” and will provide an outline of some of the

principal methods by which that voice may be heard—whether as a whisper or a shout—

using the Canada Business Corporations Act (CBCA) provisions as a convenient exam-

ple. Discussion of corporate governance will then continue in chapter 11, where the

emphasis will be on the duties, responsibilities, and potential liabilities of the corpora-

tion’s directors and officers.

THE BUILDING BLOCKS OF CORPORATE GOVERNANCE

The basic structure of the modern business corporation in Canada, the United States, and

the United Kingdom is well established. Shareholders elect the corporation’s directors.

The directors then appoint the corporation’s officers, and the officers hire employees and

run the business. This pattern is conventional, though it is not invariably mandated by

statute. As Gower and Davies point out, referring to the English Companies Act,

contrary to popular belief, the Act requires neither that directors be elected by the share-

holders in general meeting nor that they submit themselves periodically to re-election by the

shareholders.5

Though true of the UK Companies Act, this statement is no longer an accurate

description of the law in many Canadian jurisdictions. The CBCA and many other

Canadian corporate statutes now do expressly provide that the shareholders must vote to

elect directors, and that this vote is to occur at the annual meeting of shareholders.6 (The

3Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and

Ownership Structure” (1976), 3 Journal of Financial Economics 305.

4Ibid.

5Paul L. Davies, Gower & Davies: Principles of Modern Company Law, 7th ed. (London: Sweet &

Maxwell, 2003), at 307.

6See, e.g., The Business Corporations Act (Sask.), s. 101(3); CBCA, s. 106(3); Business Corporations

Act (Alta.), s. 106(3) (but for an important exception, see text accompanying footnote 7, infra); The

Copyright © 2005 Emond Montgomery Publications. All Rights Reserved.