European Private Law: Corporations, Stakeholders, Corporate Governance and Moral Hazard

A comparative analysis on the relationship between Corporations, stakeholders and the problem of moral hazard. The analysis will be from an Australian, United States, France and broader European perspective.

By Daniel Ezekiel


Corporations exist as separate legal entities from their owners and have multiple stakeholders who are all affected in different ways by moral hazard. The central thesis of this essay is that a causal link exists between the artificial legal structure of the corporation and the creation of moral hazards, thus having a negative impact on all stakeholders, most notably, shareholders, creditors and governments. Section one will define what moral hazards are and presents an overview of the structure of the modern corporation. Section two will provide a discussion of the Australian corporate law system. Section three will discuss the corporate law system of what can be described as the epicentre of the 2008 financial crisis: the United States of America. This section will incorporate a discussion on the collapse of Lehman Brothers, which was the largest corporate bankruptcy in U.S history. Section four will analyse the French Commercial Code and section five will discuss certain harmonization instruments of European company law. A comparative analysis between the different countries and a broader discussion on European private law will be conducted in section six, which ultimately concludes that increased European harmonization is essential due to the interconnected nature of the corporate and financial systems and their impact on various stakeholders.

Section One: Moral Hazards and the Separation of Ownership and Control

Kevin Dowd defines moral hazard as a situation where “one party is responsible for the interests of another but has an incentive to put his or her own interests first.”[1] Dowd argues that moral hazards develop because there is a lack of corporate accountability and governance, both within and external to the corporation.  As a result, individuals within the corporation will take significant risks without being exposed to potential losses. This inevitably creates a system of “privatized gains and socialized losses,”[2] an analogy that will be explored further in section six.

The modern corporation exists as an entity where the owners of the firm are distinct from the individuals that control it. This separation between ownership and control in the corporation was demonstrated by Berle and Means in The Modern Corporation and Private Property (1932).[3] The essential premise of their argument is that managers, directors and ultimately the chief executive officer, are running the day-to-day operations of the firm and making the fundamental decisions; while the owners, being the shareholders, have minimal input in the way the company is operated.[4]  The problem of moral hazard thus comes to fruition. Managers charged with running the company enjoy the benefits of a successful business, but do not share in the losses.  Additionally, their interests are not aligned with those of the shareholders.

Karl Okamoto develops this argument and presents a scathing attack on the existence of moral hazard and the consequences associated with it. Similar to Dowd above, Okamoto asserts that “[m]oral hazard arises when an actor does not bear all of the consequences of his actions. It is particularly acute when he can profit by taking risks he does not fully bear.”[5] Okamoto thus describes the central thesis of this paper: moral hazard is allowed to exist due to the structure of the modern corporation, which, in conjunction with poor regulatory measures, negatively affects the stakeholders. Okamoto’s most potent and relevant statement is: “the root cause of the [f]inancial [c]risis was systemic moral hazard.”[6]

Section Two: Australia

The Corporations Act 2001 (Cth), a complicated piece of legislation that has been both amended and subject to litigation on multiple occasions, governs Australian corporations. The Australian Securities and Investment Commission (ASIC) has the primary responsibility of enforcing the provisions and ensuring that Australian companies are adhering to their obligations under the Act.[7]

The separate legal entity conception of the corporation has its origins as a common law doctrine in Salomon v. Salomon,[8] and was subsequently codified many years later.[9] This section will discuss the statutory provisions that aim to protect shareholders and creditors.  Additionally, the statutory duties of directors will be analysed, and the common law doctrine of ‘piercing the corporate veil’ will be presented as another form of protection afforded to stakeholders.

Protections and rights under the Corporations Act

The rights guaranteed to shareholders under the Act include: approving financial benefits,[10] approving retirement[11] and remuneration benefits,[12] removing[13] and appointing directors,[14] inspecting company accounts[15] and the ability to bring proceedings on behalf of a company.[16] All these rights are statutory provisions that are available to the shareholder and are exercised at the general meeting.  However, all residual powers go to directors.

An important aspect of this paper is to analyse the effects of the corporate legal structure on several stakeholders, not just shareholders. Therefore, the powers creditors have under the Act are essential for a well-functioning economy. These include: the power to apply to the court to have an insolvent company wound up[17] and to serve a statutory demand,[18] which involves a court ordered demand to pay a sum of money owed to the creditor. Secured creditors are first in line to recoup any funds in the event of the collapse of a debtor corporation. However, a failed corporation often does not have the necessary funds to meet these demands. This was evidenced in the recent collapse of Air Australia, which had debt commitments in excess of $90 million (AUD) and only approximately $400,000 (AUD) cash at the time of collapse. It was reported that the major creditor, ANZ, could expect to suffer an estimated $20 million (AUD) loss.[19] This exemplifies the disastrous consequences of corporate collapses resulting from poor management and corporate governance, which inevitably create the moral hazards that negatively affect stakeholders.

Duties of Directors

The ultimate power and responsibility in Australian companies resides with the board of directors.[20]  The all-encompassing provisions under Chapter 2D of the Act incorporate the duties of directors to act with care, skill, and diligence in the interests of the company.[21] These very broad provisions attempt to legally restrain the actions of directors to those that are in the best interest of the company.

The Corporate Veil

The corporate veil epitomizes the separation between ownership and control within a corporation. It has evolved as a common law doctrine that emphasises the limited liability status of the corporate form. Directors and managers are not personally liable for the affairs of the company, should the corporation collapse. However, common law courts have developed a doctrine that enables the so-called corporate veil to be “pierced” or “lifted”. Case law has developed to both promote a fairer system and increase the responsibility of those in charge of a corporation. Thus, creditors or shareholders with a claim against a corporation may also be able to hold the directors and managers accountable if it can be proved, among other things, that the interests of justice require the action, that the company is used to perpetuate fraud, or that the company is used to evade an existing legal obligation.[22]

The doctrine of piercing the corporate veil has been incorporated into Australian law in an attempt to decrease the occurrence of moral hazard and improve corporate governance. The success of this doctrine will be analysed in conjunction with its European and United States counterparts in section six. The demise of the large insurance company, HIH Insurance, and the litigation that followed, will be presented as an example of the extremely positive features of the common law system.

Section Three: United States of America

It is important to incorporate a discussion of the United States system, because, as U.S. President Barack Obama eloquently stated, “a financial crisis that began on Wall Street infected nearly every continent.”[23]

The collapse of the investment bank Lehman Brothers in 2008 was the largest corporate bankruptcy in U.S. history, and serves as an example of a situation where those who bear the risks are not the decision-makers within the firm. Lehman Brothers had total debts amounting to more than USD $600 billion at the time it collapsed.[24]

Johnson and Kwak stated that moral hazards were a major driver in the excessive risk taken by Lehman executives.[25] Managers within the firm were able to structure their bonuses so that they could shift losses to shareholders and creditors, thus not bearing the risk of their decision-making. Twenty-six thousand employees lost their jobs, millions of investors and creditors lost large amounts of money, and it can be argued that the collapse triggered the global financial crisis. However, Lehman executives were not held accountable for their actions or found to have acted illegally.[26]

In 2010, as a response to the financial crisis, the U.S. Congress passed the Wall Street Reform and Consumer Protection Act, also known as the Dodd-Frank Act.[27] Specifically the act contains provisions that include: Title VII, Wall Street Transparency and Accountability, and Title IX, Investor Protections and Improvements to the Regulation of Securities. Both provisions are intended to provide a more open, fair and accountable financial system. By making the corporation more transparent, the ability of moral hazards to negatively affect stakeholders can be restrained. Additionally, Title E of Title IX makes it mandatory for shareholders to approve executive compensation, thereby eliminating the problem of “golden parachutes” or excessive compensation by managers and directors. However, similar to Australia, the United States is a common law system and the courts have not yet interpreted the provisions of this act to a large extent.

It is important to acknowledge how the central theme of this paper is inextricably linked to that of the financial crisis that began in the United States. Stakeholders of all kind were affected by the actions of managers and directors from large corporations. These stakeholders ranged from: shareholders, creditors, customers, investors, governments and therefore taxpayers. For example, the bailout rescue package of the insurer AIG amounted to a price tag of $180 billion USD for the American taxpayer. The deal also meant the US Government would own 92% of the common stock of the insurer. This was definitely not a good moment for capitalism.[28] This paper presents this analogy as evidence of the disastrous consequences that can result from uncontrollable moral hazard.

Section Four: France

The French Commercial Code governs the way companies operate in France. The code specifically states that French companies will “have a legal personality,”[29] thus establishing the artificial legal structure of the corporation explained above. French company law places considerable importance on the memorandum and articles of association.[30] This section will pay particular attention to the role of managers and shareholders under the French Commercial code.

The ability of members and shareholders of a company to control or restrain managers is necessary to counter the problems of moral hazard. The code provides specific articles that give powers to shareholders. These include: the ability to have a manager dismissed by an application to the court,[31] the right to demand information from the managers,[32] and the right to approve accounts.[33] However, the most comprehensive power given to shareholders is the ability to apportion the company’s profits. Under article L232-12, “the general meeting decides on the portion to be allocated to members in the form of dividends.”[34]

Similar to Australia, according to Article L225-35, the Board of Directors is given broad powers to deal with “all questions relating to the smooth running of the company.”[35] Furthermore, and extremely relevant to this current paper, is the code restricting the actions of management and directors to the object set out in the articles of association and memorandum. Andenas and Wooldridge describe this pertinent restriction as abstaining “from acting outside the corporate purpose, as well as from taking any action which is not within the best interests of the company.”[36]

The most pertinent and consequential provision of the code concerns the liability for excess of liabilities over assets. This provision is most relevant to the current discussion, as the code specifically states that managers, of an entity that becomes insolvent, may be held joint and severally liable and personally ordered to contribute to paying off the debts owed to creditors.[37] This is in stark contrast to the American and Australian situation explained above, a contrast which will be analysed further in section six.

Under Article L225-58, the provision succinctly states that “the managing board exercises its duties under the control of a supervisory board.”[38] This is very important and is in conformity with the European Union regulation, which will be discussed below. This two-tier board system is a very effective means of controlling moral hazard.

To conclude this section, it is evident that wide-ranging powers are given to shareholders; especially the ability to apportion profits. The French system appears to try to control the power of managers and directors, to some extent, in order to indirectly counter the consequences of moral hazard. Nevertheless, there are striking differences between the common law approaches of Australia and America and that of civil law France.

Section Five: European Law Instruments, Current Harmonisation

This section will discuss specific instruments and current harmonized laws under the European Union. These include: the Council Regulation on the Statue for a European Company and two important directives on European company law.

The 2004 Council Regulation on the Statute for a European Company[39] is an important instrument that contains effective provisions for the functioning of a company. This paper attempts to present the argument that certain provisions of this Regulation can be used for a broader and wider scoped European company law. While the Regulation does leave a large portion of the governing to the national laws of Member States, it recognizes the necessity for good corporate governance.

In Article 39, implementing the two-tier system, the statute promotes the obligation of the company to have a supervisory organ within the corporation.[40] Furthermore, the independence of the supervisory board is sacrosanct as no person can be a member of both organs.[41] Additionally, shareholders appoint members of the supervisory organ, and the management organ must report to the supervisory organ once every three months.[42] These provisions provide a positive mechanism of corporate governance and for the reduction of moral hazards. However, they are only guidelines, and there is still flexibility for national companies to use a one-tier system.

European directives approved by the European Parliament have the effect of superiority over national law and are important in the development of harmonizing European private law. Specifically, the Directive on the Coordination of safeguards for the protection of member’s interests is an important directive that promotes rigorous disclosure obligations.[43] Additionally, the Directive for the exercise of certain rights of shareholders in listed companies is extremely important and relevant for the present discussions.[44]

The latter Directive imposes a number of provisions that relate to an increase in shareholder involvement in the decision-making of the company, and therefore have the effect of promoting prudent corporate governance. Article six states that shareholders have the right to put items on the agenda of general meetings, and have the right to ask questions. Furthermore, Article thirteen removes impediments that may restrict shareholders from exercising their voting rights.[45]

These measures are important because they promote prudent corporate governance in a way that increases shareholder involvement. If management is constrained by the votes of shareholders, or is forced to respond to pertinent questions about the decision-making within the firm, then this results in a more transparent and accountable company.

Section six: Comparative analysis, possibilities of reform and broader European Company law

Corporate Veil and Management Liability

Accountability and responsibility are fundamental in restricting the negative consequences of moral hazard, management risk taking and reckless behaviour. The Australian common law doctrine of ”piercing the corporate veil” is a way to counter moral hazards through judicial protection. This can be contrasted with the French Code of L651-2, which gives the Court power to impose obligations on managers to repay debts of the company. The Code specifically states that the Court has the discretion to decide; “where management fault has contributed to the excess of liabilities over assets . . . decide that the debts. . . will be borne by the managers.”[46] Indeed, improving responsibility and accountability is important. However, this provision is far too broad and gives large power to the court.

Alternatively, this paper would submit that the Australian common law system of piercing the corporate veil is more prudent from a business perspective. It is a proportional response to reckless management behaviour, while at the same time promoting management freedom to conduct their business effectively.

An example of this is the collapse of the insurance giant, HIH Insurance, in 2001, which was the largest corporate collapse in Australian history. In this case the directors were not able to rely on the separate legal entity conception of the corporation as a defence, and it was estimated that losses totalled $5.3billion (AUD) at the time of collapse.[47]

In ASIC v. Adler,[48] ASIC brought an action against the managing director of HIH, Rodney Adler, and numerous other directors and managers. The action involved contraventions of the Corporations Act, specifically, duty to act with care and diligence, and duty to act in good faith and for a proper purpose.[49] This case highlighted the strength of the Australian judicial system in holding people accountable for gross mis-management and negligence. All directors were found to have contravened their duties, and the managing director, Mr. Adler, was served with a prison sentence and a substantial fine.

Additionally, this case serves as a stark reminder of the impacts of moral hazards on stakeholders. Hundreds of shareholders lost their investments, employees of HIH lost their jobs, and the government was forced to provide a $500million (AUD) financial package “to assist those people in hardship as a result of the collapse.”[50] This situation provides an example of the “privatized gains and socialized losses” concept discussed above.

The collapse of both HIH and Lehman Brothers can be linked with Okamoto’s thesis discussed above, the idea being that poor regulatory measures and the nature of the modern corporation allow the presence of moral hazard to exist. Although the French Commercial Code, makes managers personally liable for the debts of the company, it also acts as a deterrent in attracting the most skilful people to become managers, and limits the possibility to growth and expansion through rational risk-taking. Thereby, this paper contends that the French provision, attributing personal liability to managers of the firm, is a poor business practice. From a harmonization perspective, this is a very difficult area. European private law should focus on aligning the interests of managers with those of the firm and shareholders, while refraining from attributing personal liability for their actions. Australia can serve as a positive example, as there have been no large corporate collapses since the HIH fiasco.

As stated above, it is important that shareholders have the ability to restrain managers and directors through exercising voting rights or apportioning profits. All the legal systems discussed incorporate provisions that aim to promote shareholder participation. However, with the increased dispersed ownership among corporations, Burke argues that retail investors and shareholders lack the financial knowledge to hold managers accountable and interpret financial statements.[51] This increases asymmetric information-a situation where one party possesses superior knowledge, which in turn leads to moral hazard. Furthermore, this paper agrees with the view put forward by Burke for the following two reasons.

Firstly, while the protection of shareholders and investors is important, the ongoing thesis of this paper has argued that large corporations negatively impact its multiple stakeholders. Secondly, internal mechanisms that promote accountability, transparency and alignment of manager’s interests with those of shareholders, are far more effective in achieving a sustainable and well-functioning corporation. This paper proposes two possibilities of harmonization reform. Firstly, the two-tier board system should be mandatory across Europe; and secondly, a mandatory floating based remuneration system for management and directors should be introduced.


Two-Tier Board System and Performance based remuneration

The most positive aspect of the European Company Law statute is the provision of a two-tier board system. This paper believes that a supervisory board working alongside the management board is key to a well-functioning corporation. Neither Australia nor the United States have similar provisions or board structures. In contrast, as stated previously, this structure does exist in France and is fundamental in reducing moral hazard and reckless decisions by managers and directors.

Also, it is a floating based remuneration system. This, perhaps, is the most effective tool for aligning manager’s interests with those of shareholders within the firm, and, therefore, other stakeholders who are impacted by a corporation’s actions. This proposal is not to be confused with performance based remuneration, which Okamoto articulates as a system where “the rewards of increased risk taking greatly outweigh the costs. . .  inherent moral hazard will prevail.”[52] Alternatively, this proposal ensures that managers and director’s remuneration will fluctuate according to the success of the firm. Importantly, this means that if profits are decreasing, so will the remuneration of the managers. Therefore, managers will have an incentive to make rational investment choices rather than reckless decisions.

Shareholder Activism and “Stakeholder Activism”; Shareholder’s and the interest of Stakeholders

Based on a comparative analysis across the jurisdictions, it would seem that shareholders are given large powers, such as the ability to apportion profits in France, while appointing directors and managers is done in Australia. Then, why has there been large unrest among shareholders, which have led to shareholder activism?[53] One reason is what is described above, that is, according to Burke, that retail investors lack the requisite financial and investment knowledge.[54] Nevertheless, there is a larger issue present. On the one hand, shareholders understand that as a company becomes larger, directors and managers have more scope and means to act in reckless ways that are contrary to the objectives of the company. While on the other hand, the increasing dominance and importance of corporations, and the greater level of interconnectedness in world financial markets, means that corporations now impact a broad spectrum of stakeholders. So in reality, shareholder activism could be “stakeholder activism” in disguise.



The future of expanding European private and company law is both unpredictable and doubtful. In its current form, the Statute for a European Company offers too much discretion for Member States. This paper has proposed two reform possibilities and argued that continued harmonization in this area is fundamentally important due to the growing influence of corporations, and its large impact on various stakeholders. As this paper has stipulated, stakeholders, such as shareholders, creditors, customers, society and governments, are all affected by large modern day corporations. Thus, the onus is on effective corporate governance to adapt to these changing circumstances and put in place rigorous systems that promote accountability, responsibility, prudent decision-making and that, therefore, can effectively control moral hazards.

[1] Kevin Dowd, Moral Hazard and the Financial Crisis, 29 Cato Journal 141, 142 (2009).

[2] Id. at 144.

[3] Adolf A. Berle & Gardiner C. Means, The Modern Corporation and Private Property (Revised ed. 1967)

[4] Mark S. Mizruchi, Berle and Means Revisited: The Governance and Power of Large U.S Corporations, Theory and Society 579, 581 (2004).

[5] Karl S. Okamoto, After the Bailout: Regulating Systemic Moral Hazard, 57 UCLA Law Review 183, 204 (2009).

[6] Id. at 183.

[7] Australian Securities and Investment Commission (ASIC), Our role, (last visited October 23, 2013).

[8] Salomon v. Salomon & Co. Ltd., [1897] A.C.AC 22 H.L. (U.K.).

[9] Corporations Act 2001 (Cth) s 124 (Austl.).

[10] Id. s 208.

[11] Id. s 200B.

[12] Id. s 202A.

[13] Id. ss 203C-D.

[14] Id. ss 201G-H.

[15] Id. s 247A.

[16] Id. s 236.

[17] Id. s 459A.

[18] Id. s 459E.

[19] Amy Remeikis, ANZ Takes $20M Haircut in Air Australia Collapse, The Sydney Morning Herald, (February 29, 2012), (last visited Oct. 23, 2013).

[20] Corporations Act 2001(Cth), s 198(Austl.).

[21] Id. ss 179-90.

[22] Gilford Motor Co. Ltd. v. Horne, [1933] Ch. 935(U.K.); see also Hungerfords v. Walker, [1989)] 171 CLR 125 (Austl.).

[23] BBC News, Obama’s Speech to the United Kingdom Parliament, in full, with analysis, (May 25, 2011), (last visited Oct. 23, 2013).

[24] Sam Mamudi, Lehman Folds With Record $613 billion debt, Market Watch The Wall Street Journal. (September 15, 2008),  (last visited Oct. 23, 2013).

[25] Simon Johnson & James Kwak, Lehman Brothers and the Persistence of Moral Hazard, WASHINGTON POST, OPINIONS, (Sep. 15, 2009), (last visited Oct. 20, 2013).

[26] Steve Croft, The Case Against Lehman Brothers, CBS NEWS, (April 22, 2012), (last visited October 20, 2013).

[27] Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No.111-203, 124 Stat.1376.

[28] Steve Schaefer, U.S Wraps up AIG Bailout with $7.6B Stock Sale, Touts $22.7B Return, FORBES, (Dec. 11, 2012) (last visited Oct. 20, 2013).

[29] Philip Raworth, The French Commercial Code in English [C. Com.] art. L210-6 (Fr.).

[30] Id. art. L223-2.

[31] Id. art. L223-25.

[32] Id. art. L223-30.

[33] Id. art. L225-100.

[34] Id. art. L232-12.

[35] Id. art. L225-35.


[37] Raworth, supra note 29, art. L651-2.

[38] Id. art. L225-58.

[39] European Council, Council Regulation No. 2157/2001 of 8 October 2001 on the Statute for a European Company, Eur-Lex, (Jan. 1, 2007) (last visited Oct. 23, 2013).

[40] Id. art. 39(1).

[41] Id. art 39(3).

[42] Id. art 41(1).

[43] Directive 2009/101/EC of the European Parliament and of the Council, 2009 O.J. (L 258/11). (on coordination safeguards which, for the protection of the interests of members and third parties, are required by Member States of companies within the meaning of the second paragraph of Article 48 of the Treaty, with a view to making safeguards equivalent).

[44] Directive 2007/36/EC of the European Parliament and of the Council, 2007 O.J (L 184/17). (on the exercise of certain rights of shareholders in listed companies).

[45] Id. art 13.

[46] Raworth, supra note 37, art. L651-2.

[47] David Kehl, HIH Insurance Group Collapse, Parliament of Australia, (Nov. 29, 2001), (last visited Oct. 23, 2013).

[48] ASIC v. Adler, (No 3) (2002) 20 ACLC 576.

[49] Corporations Act 2001 (Cth), ss180-82.

[50] Kehl, supra note 47.

[51] John JA Burke, Re-examining Investor Protection in Europe and the US, 16 Murdoch University Electronic Journal of law 2 (2009), (last visited Oct. 23, 2013).

[52] Okamoto, supra note 5, at 207.

[53] Andrew Cleary, Shareholder Activists Make Their Voices Heard Australian, Financial Review, (27 Dec. 2012) (last visited October 23, 2013); See also Peter Promnitz, Shareholder Activism in a Bear Market, CEO Forum Group (January 2013),–Mercer-Australia-and-New-Zealand/Shareholder-activism-in-a-bear-market (last visited Oct. 23, 2013).

[54] Burke, supraa note 51.


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