Governance by Dividends
Posted: 25 Aug 2018 Last revised: 27 Jan 2020
Date Written: September 13, 2018
The tension between corporate directors and shareholders on corporate governance issues has been expanding to the domain of business decisions made by directors. Notably, directors’ right to make pro rata dividends to shareholders has long been regarded as a business decision, protected by the deferential business judgment rule. In recent cases, however, directors utilized dividends in stock to substantially affect the company’s governance structure. In In re Google Inc. Class C Shareholder Litigation, for instance, the directors distributed a newly created non-voting Class C stock to preserve the controlling shareholders’ lock on control. By contrast, in CBS v. National Amusements, Inc., the directors tried to make a pro rata distribution of voting stock to both voting and non-voting stockholders so as to drastically dilute the controlling shareholder’s voting power. While such practices raise concerns over directors’ discretion in declaring and paying dividends, prior discussions on corporate dividends have overlooked the potential agency problems associated with dividends in stock. This paper analyzes four distinct types of dividends, with a particular focus on dividends in stock that substantially alter the governance structure. The analysis leads to several implications in law. First, as an ex-ante preventative measure, the paper examines private ordering solutions at the company level and statutory default provisions at the state level, including possible cleansing mechanisms. Second, with respect to ex-post judicial review, the paper argues that the deferential business judgment review will be unable to prevent directors’ opportunistic use of dividends as an entrenchment mechanism and that the enhanced judicial scrutiny likely becomes necessary to deal with substantial governance changes through dividends in stock.
Keywords: Stock Dividends, Business Judgment Rule, Enhanced Judicial Review, Corporate Charters, Corporate Bylaws, Shareholder Voting, Capital Structure
JEL Classification: K22
Suggested Citation: Suggested Citation