Rethinking Self-Dealing and the Fairness Standard: A Law and Economics Framework for Internal Transactions in Corporate Groups

Abstract

In the controlling shareholder ownership, tunneling (i.e., wealth transfer from a corporation to a controlling shareholder) is a prevailing business practice. In corporate groups — which are main business associations in many emerging markets — it is reported that tunneling primarily takes place in the form of internal transactions among affiliated companies. Regarding a controlling shareholder’s incentive to attain private benefits, this Article analyzes three components of a controller’s internal-transaction tunneling: ownership gap, price gap, and the quantity of goods or services. In addition, based on two leading U.S. cases on conflicted transactions, Sinclair Oil Corp. v. Levien and Weinberger v. UOP, Inc., this Article develops an analytical tool to reinterpret the fairness standard in the context of internal-transaction tunneling in corporate groups. Specifically, three conditions of the Sinclair standard — a controller’s domination on both sides of a transaction, exclusion of non-controlling shareholders from benefits available to a controller, and detriment of non-controlling shareholders — are rigorously reviewed. This Article also provides courts with law and economics logic for a fair range of price gap, and reinterprets Weinberger to examine a special issue of substantially large internal transactions without abnormal profits (i.e., with normal profits). In addition, this Article explains market-based mechanisms to mitigate tunneling such as non-controlling shareholders’ discounted purchase of stocks and diversified portfolios. In sum, this Article suggests a new, more sophisticated law and economics-based analysis of tunneling/self-dealing. In doing so, this Article will shed light on corporate governance scholarship on tunneling in corporate group settings.

Keywords: Controlling Shareholder, Corporate Group, Tunneling, Self-Dealing, Fairness Test, Internal Transaction, Three Components of a Controller’s Internal-Transaction Tunneling, Sinclair Oil Corp. v. Levien, Weinberger v. UOP, Inc., Three Conditions of the Sinclair Standard

JEL Classification: G30, G32, G34, G38, K22