Nonprofit Organizations as Investor Protection: Economic Theory, and Evidence from East Asia

55 Pages Posted: 1 Apr 2003

See all articles by Curtis J. Milhaupt

Curtis J. Milhaupt

Stanford Law School; European Corporate Governance Institute


Enforcement problems plague shareholder activism and investor protection in many parts of the world. The importance of solving this problem has led scholars to consider a range of partial alternatives to weak domestic corporate law enforcement regimes, ranging from writing "self enforcing" corporate laws to using cross listings on foreign stock exchanges as a means of bonding firms to higher quality enforcement.

The recent experience of the three largest capitalist market economies of East Asia suggests that there is another partial solution to the problem of weak investor protection and corporate law enforcement, one that has received no theoretical or empirical attention - the nonprofit organization. This partial solution emerges from a puzzle at the center of contemporary East Asian corporate governance. With the possible exception of the government itself, nonprofit organizations (NPOs) have emerged as the most important corporate law enforcement agents in Korea, Japan and Taiwan. In each system, an NPO holding a portfolio of shares is engaged directly in the exercise of shareholders' rights to combat corporate fraud and mismanagement, and to improve the investor protection climate. In numerous instances, these organizations have won significant court victories or settlements against management. This development is puzzling because the defining characteristic of an NPO is the nondistribution constraint. That is, while nonprofits are not prohibited from making profits, they are prohibited from distributing them to their owners. Why are three organizations operating within the nondistribution constraint - rather than institutional investors or individual shareholders represented by plaintiffs' attorneys - the principal shareholder activists cum corporate law enforcement agents in this region?

This paper analyzes the role of NPOs in East Asian corporate governance, and applies economic theory on the existence of nonprofits as suppliers of public goods (along with several complementary theories) to explain the rise of NPOs as suppliers of investor protection in the region. The paper also examines the academic and policy implications of the East Asian experience. Academically, the NPO as a corporate law enforcement mechanism is a highly distinctive illustration of functional convergence in corporate governance: several societies have spontaneously generated substitutes for the attorney-oriented incentive mechanisms relied upon in the United States to enhance investor protection. Yet each NPO displays its own unique structure and strategy, differences that can be tied directly to the distinct domestic legal and political structures in which they operate. At the level of law reform, for transition economies the NPO has several advantages as a corporate law enforcement device, particularly in societies reluctant or unable to transplant the U.S. "attorney as bounty hunter" model of law enforcement. First, the nondistribution constraint inherent in the NPO form provides a built-in check on frivolous litigation. Second, shareholder activist NPOs seek to use and improve local law enforcement institutions, while most of the alternatives discussed in the literature involve abandoning weak local enforcement regimes.

Suggested Citation

Milhaupt, Curtis J., Nonprofit Organizations as Investor Protection: Economic Theory, and Evidence from East Asia. Available at SSRN: or

Curtis J. Milhaupt (Contact Author)

Stanford Law School ( email )

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Stanford, CA 94305-8610
United States

European Corporate Governance Institute ( email )

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