Agency between Shareholders and Companies
Apr 26, 2015

Agency between Shareholders and Companies

This is more an academic thought than a practical tip.

I am reading the book “Agency, Partnership and the LLC” (2nd ed, West Nutshell Series)  by J. Dennis Hynes in particular to find support for my personal understanding of the agency relationship between shareholders/members and the companies/corporations they invest.

In China, law scholars seldom shed lights on the nature and contents of the relationship between shareholders and companies. People tend to think that is something to be answered by the concept of “shareholder right” which has been considered as a new type of ‘civil right’ parallel with property right and creditor right in civil law systems. To me, that is wrong.  There is a great degree of resemblance between the shareholder-company relationship and the typical agency relationship.

However, I didn’t find the support in this book, instead I noticed that under the sub-title “agency status of directors of a corporation”, the author said “although a board of directors is elected by the shareholders, the board is entitled to use its own business judgment in managing the affairs of the corporation, making the control by the shareholders too remote to constitute agency….. However, these duties are owed to the corporation itself rather than to the shareholders individually or collectively… An individual director has still less resemblance to an agent since he has no power on his own to act on the corporation’s behalf”.

As to the cited opinions above, I have a few questions:

(1)  “too remote a control” seems to me very arbitrary as it is almost impossible to accurately demarcate the degree of control to distinguish agency and non-agency. I am not familiar with American laws, under China Company Law, the shareholder meeting is still mandated with certain powers over the operation of the company. More or less, control does exist here. The amount of control does not seem a strong ground to deny the agency between shareholders (collectively) and the board of the directors (equally the company itself, as explained below).

In my opinion, unless the law deprives shareholders of all its powers or control over the company, predicated on shareholders’ ownership in corporate assets, shareholders are always entitled to some degree of control, for example, the shareholders may restrict the purpose of the companies, or put in place some other restrictions over the board such as merger or division etc.

(2) I apparently disagree with the statement “these duties are owed to the corporation itself”. Taking out the board of directors, a company or corporation is nothing at all.

This is about the nature of a legal person, a very abstract legal issue. Despite the mainstream view of real entity theory (opposite to the fiction theory) in China, I believe a company as a legal person is a personalized creature and in much the same way, a legal person has its own will as an individual does. The will of the legal person is nothing but the collective will of the board or in the absence of a board, the will of the executive director (as provided in China Company Law) or the will of other organ of the company that makes the highest decision of and within the company. Without such a will, a company will be mystified as something undefinable.

The key in my understanding is the “Will”. As a personalized creature by law, the personalization foundation is “will”, making the will of the decision-making organ within the company the will of the company towards the outside.

The paradox of “owed to the corporation itself” is that nobody or nothing represents the corporation itself (the principal) when taking the board of directors as something separate from the company itself. Who will be enforcing the duties on behalf of the company then?

Based on the two doubts, I would embolden myself to say the author’s view may have serious flaw.

In the meantime, if we look at the other key factor of agency “on behalf of” or “for the benefit of”, we may be more confident to find agency out between shareholders and company. The company (here actually we refer to the board of directors) runs the company for the benefits of the shareholders. There is little dispute over the point that a company shall maximize the interests of its shareholders, which reflects exactly the “on behalf of” element in the agency relationship. After all, the fact that the company shall distribute its profits to its shareholders as dividend is of the same nature of an agent transferring to its principal interests derived from its agency acts.

People who feel difficult in finding agency between shareholders and companies often get confused when the concept of limited liability is in the picture. Typically in a civil agency, principal is always fully and unlimitedly responsible for whatever consequences brought about by his or her agent. But in the case of a company or corporation, shareholders as principal (as a whole) are protected by the doctrine of limited liability. My explanation is: the change from “unlimited” to “limited” does not affect the very two fundamental elements in an agency relationship, and the change is the result of development of corporate law, a public policy aimed to promote the corporate activities in an economy. On the other hand, the rise of limited liability changes substantially the landscape of corporate law, because the corporate law has to develop more rules to strike the balance between shareholders (on one side) and creditors (on the other side), which see a substantial set of mandatory rules written into corporate law statutes. In turn, these mandatory rules make it more difficult to recognize agency between shareholders and companies. But, whatever changes in appearance, the fundamentals remain the same. Agency is still there.

I would like to have comments from law professors and other legal professionals from around the world.


  1. Jason Tian says:

    In response to a comment raised by Graham Brown on LinkedIn:

    “This is an oversimplification, and on a particular view of (non US) common law, but I hope it is useful.

    When it comes to management of a company, I think that it is fair to say that there is no agency relationship between shareholders and the company. Shareholders are the owners of the company, but (historically) gave up their right to management in return for limited liability. Their rights are limited to those set out in the law and as developed by case law, where that is relevant – they have no direct right to tell directors what to do, except by way of resolution at a properly convened general meeting.

    Shareholders elect the directors whose function it is to manage the company in the best interests of shareholders as a whole. There has been some theoretical discussion about whether directors act as agents of the company, or as the company itself , but overall I think agency theory has not prevailed.

    Aggrieved minority shareholders unhappy about the direction a company is taking can seek relief from oppressive conduct via the courts.”

    Here is my answer:

    “Again, the key point in understanding agency relationship between shareholders and companies is the answer to the question: what is a company by nature?

    People often say “shareholders own the company” in a sense that the company is just a bundle of properties or assets, not a person. Otherwise, you cannot say one person owns the other person. A company is a legal person at law, though artificial, but as a subject at law, it cannot be owned by another person or group of persons.

    Like in a typical agency relationship, principal and agent are two independent persons where the agent is kind of subject to the will of the principal to the extent that the agent agrees on, between shareholders and companies, shareholders as principal have the right to give instructions (those stipulated in articles of association or shareholder resolutions) to the company and the company shall execute them to be the best interests of the shareholders.

    Graham noted the subtle theoretical discussion about whether directors act as agents of the company or as the company itself, this is the very key issue that divides our views on the agency question. In my understanding, directors as a whole are of course representing the company itself and Will of the board of directors is the basis for personifying a legal entity into a person, a process of installing a Will for a otherwise empty shell. After all, no person has not a Will. It is in this sense that we can take the company as the board of directors itself.

    Otherwise, if people separate the board of directors from the company, then what is a company? I believe nobody can define the company as a legal person without finding its “will”.

    I basically agreed with Graham that shareholders “gave up their right to management in return for limited liability”, but shareholders don’t give up all rights to management. At least under China Company Law, shareholders are empowered with certain rights in deciding on certain affairs of the company. The limited liability is running squarely against conventional understanding of an agency in which the principal is always bearing unlimited liability for the conducts of its agent. But the way of bearing liability has no impact on creating an agency relationship or agency exists regardless of limited or unlimited liability.

    Indeed, as a recent development at law, limited liability for principal is simply a special agency where the principal gives up certain rights to control for the entitlement for limited liability with the view to promoting economic activities.

    Somehow, I feel that this special agency can explain most confusions surrounding corporate legal theories in China. “