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This post first appeared on the Oxford Business Law Blog on 25 May 2020

By Prof. Maribel Sáez (Universidad Autónoma de Madrid) and Prof. Maria Gutierrez (Universidad Carlos III de Madrid)

This year, spring has arrived in the midst of a generalized lock-down. People have been—and in many places remain—confined to their homes. Most firms and industries are barely operative. In economic sectors where the provision of the corresponding service requires physical contact, nearly all activity has ceased. The Covid-19 outbreak is not only testing national health systems, but also the resilience of economic actors and national economies.

The current dire economic prospects create a serious and systemic threat for our economic and social welfare. The situation calls for reflection on how we may attempt to mitigate the negative effects of the pandemic on firms’ financing and survival. An emergency calls for rapid, systemic ways to channel funds to firms while operating in an extraordinary, highly uncertain environment. Companies’ crisis-management playbooks typically aim to reduce capital expenditures and preserve resources. In these circumstances, the role that corporate law can play in improving firms’ capacity to attract funding is perhaps modest, namely to ease transaction costs and simplify ex ante measures and corporate procedures.

In the longer term, if this crisis, not unlike previous ones, elicits from governments, legal systems and firms a protectionist response that is hostile to globalized finance, then corporate law and corporate governance in particular may undergo some fundamental changes.

The protectionist guidebook to the crisis 

In the aftermath of a large and systemic negative event such as the Covid-19 pandemic, the ensuing economic shock is of such a magnitude and kind that the instinctive reaction can easily be ‘every man for himself’ and ‘every country for itself’. In fact, governments are using war-like rhetoric at levels rarely seen in times of peace. Automobile and textile industries are manufacturing ventilators and masks instead of cars and the latest spring fashion clothes. Rapid testing equipment has been seized by health authorities in transit through international airports. As is common in times of war, the current challenge—overcoming the virus and absorbing the economic shock to firms and households—may lead to the enactment of protectionist regulations.

At the firm level, protectionist policies are likely to negatively affect corporate governance. In particular, the coalition between powerful local groups (of investors) and populist governments may lead to a crusade to preserve the ‘national character’ of a given country’s industry, and create the climate for raising barriers to foreign investment in domestic firms. The problem with the goal and tools of corporate nationalism is, of course, that, in the long term, it will come at the cost of reducing market monitoring and sources of finance for local firms.

Past experiences with such episodes of corporate nationalism allow us to predict some likely effects. The first effect is the (enhanced) empowerment of local insiders and controlling investors at the expense of market investors, with the ensuing reduction in the level of market supervision of corporate controllers. Foreign investors will remain welcome, but only if they support incumbents, ie, as long as they remain passive investors. Interestingly, this time around, the investment market prior to the pandemic was dominated by the large US index funds. Over the last decade those funds have found themselves in the uncomfortable position of receiving—and having to respond to—requests to take an active role in corporate governance, while maintaining their passive investment strategy. Even if a (forced) reduction in monitoring and clout might ultimately result in a comfortable low-cost and low-profile scenario for passive investment funds, it will aggravate the agency problem with their beneficial owners. Moreover, in the eyes of corporate nationalists investment funds will be pictured as foreign institutions acquiring large stocks of equity in key national companies, overlooking the fact that the protectionist strategy will hurt many domestic investors as well: those that are beneficial owners of the investment funds and the minority shareholders of the domestic firms ‘protected from foreign interference’.

Another likely consequence of corporate nationalism is increased state ownership. In order to save their domestic crown jewels, various European governments have announced the nationalization of, or large capital injections into, airlines and other (supposedly) strategic industries. The re-nationalization of Alitalia is a good example. The EU has adopted recently the amendments to the rules of public aid that could relax state-aid rules, and thus facilitate nationalizations of distressed companies. Brussels allows Member States to recapitalize their companies, large or small, listed or non-listed, provided that, without the intervention of the State, the company would be doomed to fail or would have ‘serious difficulties’ to keep its business afloat.

Reinforcement of an existing trend

It is interesting to note that the moves towards protectionism do not represent a sharp turn or a sudden change of direction. Protectionist policies were already underway. The crisis will only accelerate and consolidate an already-existing trend of financial de-globalization. Fear of both the present and the future, as well as economic recessions, fuel protectionist policies. These policies, however, may prove to have long-lasting harmful effects on corporate performance.

A year ago, the EU enacted a Regulation establishing a framework for the screening of foreign direct investment into the European Union (Regulation (EU) 2019/452 of 19 March 2019). Under the FDI Screening Regulation, Member States are entitled to implement appropriate screening tools to avoid the risk of acquisitions of strategic industries by non-EU and non-EFTA residents. The Regulation’s explicit purpose is to restrict potential attempts to acquire strategic firms via foreign direct investment, even if the acquisition is made through legal entities incorporated in the EU.  

Last month, immediately after the pandemic erupted in Europe, the European Commission issued a guideline calling upon Member States to make full use already now of its foreign direct investment screening mechanisms to take fully into account the risks to critical health infrastructures, supply of critical inputs, and other critical sectors as envisaged in the EU legal framework. The case of the US Administration’s move to purchase a German medical company developing vaccines for Covid-19 is paradigmatic. Notice that the EU Regulation leaves open the question of what industries can be considered strategic or critical or which acquisition would create a risk to security and public order. In the past, those terms were interpreted restrictively. The prevailing Zeitgeist would perhaps lead to the view that the Commission is now urging Member States to make full use of the screening mechanism to avoid the possibility of the current health crisis resulting in a sell-off of Europe’s businesses, including SMEs.

In March 2020, Spain introduced investment restrictions, forbidding non-EU investors from purchasing more than 10% of any Spanish company deemed to be strategic—a term defined broadly in the new rules—or any transaction that enables effective participation in the management or control of such a company.

Another example of the long-term coalition—or at least alignment—between populist politicians and corporate insiders

The appeal of corporate nationalism and protectionist attitudes in the face of a crisis or a new market development follows a well-known pattern. Because contracts are incomplete, when unexpected developments threaten the corporate governance status quo, incumbents seek protection against change. Very often populist politicians are happy to oblige and establish laws and regulations offering that protection. There have been previous experiences illustrating the courtship between insiders and regulators. One example is the growth of the US market for junk bonds during the 1980s. Junk bonds facilitated hostile takeovers of poorly managed companies, generating substantial gains for target shareholders. Given that the takeovers often resulted in lay-offs, the managers under siege found a highly supportive ally in politicians who were able to curb hostile acquisitions through regulatory intervention in the form of anti-takeover laws. A more recent example is the rise of activist investors, particularly activist hedge funds. In this case, the justification shared by incumbent managers and politicians has been the threat of short-term strategies that distract firms from focusing on long-term investment, growth and jobs. Although finding empirical evidence of short-termism caused by institutional investors has proven difficult, activist investors have already been tried and found guilty in the court of domestic public opinion and legal circles. Thus, many jurisdictions have defended the status quo by enacting rules allowing firms to create differential voting rights and tenure-voting (eg, France and Italy).

Specific developments in the EU

In connection with specific features of EU markets, the crisis is likely to aggravate agency problems in companies with controlling shareholders, (the prevalent ownership structure in Continental Europe).

Unfortunately, this happens shortly after the EU had started taking an interest in the corporate governance problems of controlled firms and the protection of market investors. In particular, the EU has encouraged the introduction of legal tools to curb minority shareholder expropriation, such as the regulation of related-party transactions. The aim is to reassure outside investors that their money is in good hands and  promises are kept and, ultimately, to promote capital market development (which, it was argued, would ultimately lead to opportunities for growth and expanded social welfare). It is important to take into consideration that these European measures have often been implemented over the resistance of national governments. Many of the Member States had argued that their domestic laws were already equipped with the right tools to protect minority investors, even in the face of evidence indicating the inadequacy of those mechanisms to protect minority shareholders.

The increase in corporate nationalism and protectionism that the crisis is likely to elicit means that these proposals for the improvement of the corporate-governance arrangements in controlled companies will be quarantined for a significant time, much longer than citizens will be confined to their houses. This will probably result in backward steps in the protection of market investors and in a growing deficit of controlling shareholders monitoring. Moreover, corporate groups and conglomerates, the legal regulation of which in various jurisdictions had recently been asserted to be ineffective for the protection of minority investors, will be off the hook for some time.

It is notable that many changes in corporate governance in European firms have been championed by foreign institutional investors. These changes have largely turned out to be beneficial for all market investors. Those foreign activists have imposed higher standards of good governance, thereby strengthening the monitoring of insiders. Mechanisms such as say-on-pay and a higher number of independent directors on boards are examples of that benign influence. Even controlled firms have strived to comply with these higher corporate governance standards to avoid being targeted by activist funds. But activists are increasingly likely to face additional opposition during and after the current crisis, if not to be prevented from acquiring significant stakes in EU companies to begin with.

It can also be expected that steps towards empowering minority investors and addressing conflicts of interest of controlling shareholders will be halted. True, European jurisdictions were already reluctant to grant minority investors the power to decide on matters involving conflicts of interest of the controlling shareholder, such as related-party transactions or the appointment of independent directors. Yet, if institutional investors lose their clout over insiders and regulators, it is even less likely that these measures will be implemented any time soon.

Further, we can expect a contraction in the global volume of M&A activity. This decline is natural in times of economic turmoil; however, at the same time, the sell-offs in equities increase the risk of unsolicited offers. This is where the new screening tools for FDI come into play. Note that, as long as national authorities have discretion in screening transactions, it is not unreasonable to suggest that unfriendly acquisitions have a lower probability of being approved than friendly ones. Additionally, these screening tools bias financing in favour of debt deals, which are not affected by FDI rules, and away from equity deals.

Finally, and probably even more worryingly, protectionist policies restricting foreign investors’ access to equity are likely to result in under-capitalized firms that will have higher leverage levels and will therefore be more vulnerable to future downturns. 


In a sense, it can be said that we are likely to move back to the good old times of Continental European corporate governance: a traditional, national, stakeholder-oriented and self-monitoring model starring local controlling shareholders and politicians. As a side effect, corporate nationalism will reinvigorate legal nationalism, tilting demand for legal services, knowledge and expertise in favor of domestic providers. The influence of legal scholars and the legal establishment more generally will make traditional national differences in corporate governance more persistent. It will likely slow the adoption of innovative arrangements for investor protection originating in other jurisdictions. In fact, many traditional legal scholars will be reassured in their deeply held notion that empowering minority investors or increasing the number and role of independent directors in cases of conflict of interest involving majority shareholders, represents an intolerable disempowerment of controllers. The prevailing perception among those scholars is that national corporate laws within Continental Europe already contain venerable institutions entrusted with effectively protecting minority shareholders. Minority-friendlier corporate governance arrangements for controlled firms are perceived by many as a dangerous, alien intrusion in the holy realm of corporate law and also as a threat to the business organization models that made Europe rich and powerful, chief among them its corporate groups.

Maribel Sáez is a Professor of Law at Universidad Autónoma de Madrid.

Maria Gutierrez is an Associate Profesor of Finance at the Department of Business Administration at Universidad Carlos III de Madrid.

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