Decision making

Author: | Published: 4 Jan 2001
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In private equity transactions in Asia and elsewhere, considerable care and attention should be given to the decision-making process after acquisition. Private equity transactions take a variety of different forms, ranging from passive investments by institutional investors, which maintain the status quo, to strategic investments by competitors which result in a change in control and the replacement of existing management. Nonetheless, certain common issues of strategic importance frequently arise. These require the parties to work closely together to develop a decision-making process which accurately reflects their expectations, and contributes to the success of the enterprise. This article reviews these common issues primarily from the perspective of the financial investor in an Asian company wishing to protect and maximize the value of its investment.

Traditional model; balancing of interests

The traditional corporate decision-making model allows the shareholders of a company primarily to exert their influence through their ability to elect the board of directors. This, in turn, selects corporate officers and supervises the normal operations of the company. As a general proposition, a company operates under the principal of majority rule, with the holders of a majority of the voting shares controlling the company through board representation, with the result that minority shareholders have minimal input in the decision-making process.

The traditional model is well suited for large companies which have numerous, dispersed shareholders providing capital, and a separate and functionally independent group of directors and officers providing management. This is especially true where there is a liquid market for the shares of the company, allowing minority shareholders to divest their investment easily. The traditional model, however, does not work well in the context of private equity transactions, particularly in Asia. Most private equity transactions involve investments in closely held, illiquid companies with a majority shareholder that controls the company through the board or otherwise. This is particularly true in Asia where most companies are family-owned and the directors and officers of the company are closely aligned with the controlling shareholder. In these circumstances, the traditional model would effectively deprive the financial investor of any meaningful input into the operations of the business. Moreover, there would always be the danger that the majority shareholder would use its considerable power to further its own interests to the detriment of the financial investor.

Consequently, in private equity transactions, it is necessary to layer on top of the traditional model an agreed decision-making process. This should balance the legitimate rights of majority shareholders against those of minority shareholders, while discouraging deadlocks and corporate paralysis, and ensuring flexibility so that the company can adapt quickly and efficiently to new challenges and opportunities. Striking the right balance requires the parties to understand one another's objectives, concerns and culture, and to strive to accommodate them in a mutually beneficial way. A shareholders' agreement, and in some jurisdictions, the articles or bye-laws of the company, should clearly set out the agreed decision-making process.

The factors influencing the structuring of this process will vary with each transaction, but typically include:

  • the number of shareholders and relative size of their interests;
  • the familiarity and corresponding level of comfort that the shareholders have with one another;
  • the expertise of the management team and the confidence that the shareholders have in them;
  • any relevant expertise possessed by representatives of the shareholders; and
  • often most importantly, the competitive environment in which the company operates and, in particular, the level of autonomy required by the board of directors and corporate officers to manage effectively the company's operations.

A too cumbersome decision-making process can have a profound effect on a company's ability to compete. Obviously then, the optimal structure in each case needs to be tailored to address the expectations of the parties and their particular circumstances and those of the relevant business.

A financial investor will usually participate in the decision-making process indirectly through representation on the board of directors, and directly as a shareholder. Participation at board level gives an investor considerable access to information and allows input into the decision-making process as it relates to the supervision of the operation of the business. Participation as a shareholder allows the investor input into the process as its relates to more strategic issues not appropriate to be dealt with at the board level. Although it would be naive to expect directors not to be significantly influenced by the shareholders that elected them, directors should recognize that in most jurisdictions, local laws will impose on them a fiduciary duty to act in the best interests of the company as a whole. Shareholders, on the other hand, are free to exercise their rights at the shareholder level in their own best interests without regard to anyone else.

Board of directors

The shareholders must determine the size of the board and identity of its members, the voting and quorum requirements and the timing and place of meetings. The optimal size of the board will depend on a number of factors, including the nature of the company's business, the expertise of management and the desirability of involving others with skills not otherwise available, the number of shareholders and their desire to participate directly in the decision-making process at the board level, and local laws and practice. The board will usually, at a minimum, consist of key management personnel and representatives of the significant shareholders, with the number of representatives of each shareholder being determined by the relative size of the shareholder's interest.

As most boards will make decisions on the basis of majority rule, a significant shareholder wishing to exercise control of a company will do so by ensuring that it has the right to appoint a majority of the directors, or having the right to appoint half of the directors, one of whom will be the chairman of the board with a casting vote in the event of a deadlock.

Where shareholders desire equal representation at the board level, they may choose not to appoint a chairman of the board or ensure that the chairman does not have a casting vote. Alternatively, the shareholders could appoint a third party as chairman for the purpose of resolving deadlocks, or the ability to appoint the chairman could be rotated between the shareholders at agreed upon intervals.

The timing and frequency of meetings should be chosen so as to give each director a reasonable opportunity to participate. It is useful to require that notice of meetings be given sufficiently in advance, failing which any director not in attendance must waive the notice requirement for any business conducted at the meeting to be valid. Meetings should be held at certain specified locations convenient to all, unless the directors agree otherwise. Allowing phone participation is also a must, especially in Asia where people travel frequently.

A quorum requirement for board meetings is often a majority of directors present in person or by phone. Occasionally, it could be that at least one nominee from each shareholder is required to participate for the quorum requirement to be met. This is often counter-productive, as it allows a shareholder nominee to frustrate the conduct of business by refusing to participate.

Committees of the board of directors

Where the board of directors is particularly large, meets infrequently or is continually occupied by a series of important matters, perhaps a smaller management or executive committee responsible for overseeing the day-to-day operations of the company or other matters would be appropriate. In Korea, for example, large companies frequently set up a committee of board members to act as an informal discussion group. Where the long-term exit strategy of a financial investor involves taking the company public, consideration should also be given to striking compensation and audit committees in preparation for the company's initial public offering as committees of this type will eventually be necessary, and may serve a useful purpose.

Typically, any board committee will operate within agreed guidelines, and be supervised by the board. Its composition will be dependant largely on its mandate. The supervisory role of the board should be taken seriously, since the delegation of duties to a committee does not necessarily relieve the board of accountability for the committee's actions.

There is an inherent risk with any committee that important decisions will be made at the committee level, not the board level. As a result, financial investors should carefully consider both the mandate and composition of any committee of the board, as the committee could significantly increase or decrease the financial investors' input into the decision-making process.

Observer rights

Occasionally it is useful to allow certain individuals to participate at the board level without actually sitting on the board. These people can be given all of the rights of board membership other than the right to vote, the effect of which is to put them in the information loop and allow them to participate in discussions. These observer rights are often granted to small passive investors and co-investors, when it is determined that full board membership is inappropriate. It may be granted to certain strategic investors where for liability, antitrust or competitive reasons they do not want to be seen as influencing the control of the company at the board level.


Under the traditional model, the board of directors will usually appoint the officers (such as the chief executive officer, president, chief financial officer, chief technology officer, treasurer or secretary) and sometimes the key employees of the company, and will determine the scope of their activities and reporting lines. In most situations involving a significant minority shareholder, however, the minority shareholder would expect to have some input into these decisions. Depending on the relative negotiating positions of the shareholders and other business considerations, one possible outcome involves giving each of the majority and the minority shareholders the right to appoint certain officers subject to a veto right of the other. For example, the majority shareholder could be given the right to appoint the president and chief executive officer, and the minority shareholder could be given the right to appoint the vice president, finance and chief financial officer, each subject to a veto right of the other. Alternatively, the minority shareholder could have merely a veto right over the appointment of certain senior corporate officers. At the very least, the majority shareholder should be required either directly or indirectly through board representation to consult with the minority shareholder when appointing senior corporate officers.

Although the appointment of officers and related matters are significantly influenced by business considerations, local laws and practice also can play a prominent role. For example, in China, the senior officer of a company is the manager, who is given certain statutory functions and powers and, in Korea, the board of directors typically picks one of its members to be the representative director to supervise the management, usually as the chief executive officer. A representative director may have implied or actual powers and liabilities beyond traditional western models.

Indemnification; directors' and officers' insurance

Although less of an issue in Asia than in certain other parts of the world, owing to the paucity of litigation generally, if representatives of financial investors sit on the board (or any board committees) or are appointed officers, consideration should be given to ensuring that they are adequately protected while acting in such capacities. To the extent allowed under local laws, consideration should be given to having the company indemnify its directors and officers for losses sustained by them when acting in such capacities. In addition, consideration should be given to allowing the company to obtain directors and officers' insurance to fill in the gaps where indemnification is unavailable, and to provide coverage where indemnification is legally possible but otherwise unavailable because the company is unwilling to indemnify and to reimburse any amounts it pays to indemnify.

Shareholder control

Statutory provisions

Under the traditional model, a minority shareholder's rights are limited to those contained in the applicable corporate legislation. Although most corporate legislation in Asia affords minority shareholders with some level of protection, there is considerable variation. Towards one end of the spectrum are the considerable rights afforded to minority shareholders of a Korean joint stock company corporation (which is the most common form of company in Korea), where one or more minority shareholders with more than one-third of the company's voting shares can block resolutions proposing to:

  • remove a director;
  • amend the articles of incorporation;
  • approve major changes to the company's business;
  • approve a merger, dissolution or winding-up;
  • approve certain acquisitions of property;
  • approve the issue of convertible debentures to non-shareholders; and
  • approve the issue of shares at below par value.

Any shareholder holding voting shares can block a resolution proposing to release directors and others from liability to the company, where they have acted negligently or in contravention with the company's articles. In addition, one or more minority shareholders with more than 5% of the company's shares are granted various rights, including to:

  • request the convening of a shareholders' meeting to discuss issues of concern;
  • inspect accounting books and records;
  • start an action to dismiss directors and others;
  • start an action to appoint an inspector where there is cause to suspect dishonesty or grave contravention of laws; and
  • start a directive action in certain circumstances.

Towards the other end of the spectrum, minority shareholders of a Chinese company are afforded few rights under applicable corporate legislation, apart from the ability to petition for an interim meeting of shareholders and the ability to bring matters to the attention of the supervisory board or supervisors.

Contractual rights

Ordinarily, an investor does not want to leave the protection of its investment up to a third party, such as the legislature of a country. Accordingly, in private equity transactions, regardless of the level of protection afforded minority shareholders under applicable corporate legislation, financial investors usually insist on provisions designed to protect their investment being put in the shareholders' agreement and, in many jurisdictions, the articles of association or bye-laws. These provisions require that certain significant matters be decided by a unanimous or super-majority vote of shareholders, ensuring that minority shareholders have input into those matters which have a fundamental impact on their investment. These provisions often include:

  • changing the company's name;
  • amending the company's articles of association or bye-laws;
  • changing the nature of the company's business;
  • issuing or purchasing the company's shares or other securities;
  • declaring and paying dividends or other distributions;
  • merging, amalgamating, reorganizing , dissolving or winding-up;
  • significant acquisitions or divestitures;
  • incurring significant amounts of debt or granting security over the company's assets;
  • taking the company public;
  • making capital calls on shareholders;
  • entering into related-party transactions; and
  • hiring or firing corporate officers or other key personnel.

The actual matters to be put before shareholders will vary considerately from one transaction to another. In each case, however, it is advisable to limit these matters to those truly important to the investor, as overly inclusive provisions will make decision making slow and cumbersome.

Where there are more than two shareholders, a decision must be made as to the appropriate threshold for shareholder votes. This will typically depend on the number of shareholders, the size of their shareholdings and the extent to which any of the shareholders' interests are aligned. In setting the appropriate threshold, the parties must balance the potential for majority shareholders to abuse their controlling interest against the ability of a minority shareholder to block certain actions in inappropriate circumstances. Depending on the circumstances, it may be appropriate to have two or more different voting thresholds for different categories of items.

Dispute resolution

Where shareholders have an equal interest in the company and neither has control of the board, disputes can arise which can deadlock the company, often to its detriment. In these circumstances, it is often useful to provide that the dispute gets escalated through the management ranks in stages, eventually reaching the most senior officers of each of the parties to the dispute before allowing either party to take advantage of any other rights it may have. The potential escalation of the dispute in this manner often motivates those involved to strive harder to resolve their differences. Moreover, as a dispute is escalated, it by necessity involves new people with different perspectives which may allow the parties to better find some middle ground.

If this is unsuccessful, it is useful to consider other forms of dispute resolution such as binding arbitration, compulsory buy/sell provisions (such the shotgun provision by which one party offers to buy or sell shares at a pre-determined price) or the compulsory dissolution or wind-up of the company. Although often frowned upon in Asia as being too draconian, the existence of these formal dispute resolution mechanisms often encourages the parties to reach a negotiated settlement and, ultimately, in the absence of a negotiated settlement, provides closure by resolving the dispute once and for all.

Majority shareholder loyalty

A financial investor will also want to protect its investment by ensuring that neither the majority shareholder, nor any related parties, compete with the company to its detriment. It should negotiate for appropriate non-competition provisions. In addition, a financial investor should ensure that the majority shareholder is locked-up, that is, that the majority shareholder cannot sell its interest without either obtaining the financial investor's consent, or as part of a transaction which allows the financial investor to sell its interest at the same time on terms and conditions no less favourable than those applicable to the majority shareholder (the drag along).

Shareholders' agreement

Shareholders' agreements contractually codify the agreed decision-making process and should address:

  • the size of the board of directors, the right to appoint and replace directors (including any chairman of the board) and company officers, voting and quorum requirements for board meetings and written resolutions and whether the chairman (if any) shall have a casting vote;
  • which decisions are to be reserved for the shareholders, and voting and quorum requirements for shareholder meetings and written resolutions;
  • the timing, place, notice requirements and other mechanics for board and shareholder meetings;
  • the information to be provided to directors and shareholders (including financial statements, business plans and periodic reporting), and the timing of its distribution; and
  • any mechanisms designed to resolve disputes.

Local legal advice is essential to ensure that the substantive and mechanical aspects of the agreed process conform with local laws and practice. Although a detailed review of applicable local laws and practice is beyond the scope of this article, a few examples of unique Asian considerations may be illustrative. In China, in addition to the traditional division of powers between shareholders, directors and officers, an additional layer of corporate governance is required for large companies in the form of a supervisory board, and for smaller companies in the form of one or two supervisors. These are drawn from representatives of the shareholders and employees, and may not be directors or the manager. Members of the supervisory board (or supervisors) may attend board meetings as non-voting members and have a mandate which includes supervising the conduct of the directors and the manager.

In Indonesia, the members of the board of directors are roughly the functional equivalent of officers who, under the traditional model, are responsible for the management of the company. The board of directors are supervised by a board of commissioners and, ultimately, the shareholders. The board of commissioners is roughly the functional equivalent of the board of directors under the traditional model. Members of the board of directors and the board of commissioners are appointed by and may be dismissed by the shareholders.

In India, although somewhat cumbersome, it is necessary to replicate the provisions setting out the applicable decision-making process in both the shareholders' agreement and the company's articles to ensure such provisions are enforceable.


In private equity transactions in Asia and elsewhere, the investment and management functions typically combine as financial investors seek to have meaningful input into certain decisions, and to protect their investment. This combination of functions requires majority and minority shareholders to work together to articulate a corporate decision-making process, which ultimately reflects their expectations and balances their objectives and legitimate concerns. Although in Asia there is often a reluctance to document agreed arrangements in a detailed way (western style), this tendency should be resisted, as formally setting up the corporate decision-making process and related lines of communication will frequently be in everyone's best interest.

Milbank, Tweed, Hadley & McCloy

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