No Derivative Shareholder Suits in Europe - A Model of Percentage Limits, Collusion and Residual Owners

We address one of the cardinal puzzles of European corporate law: the lack of derivate shareholder suits. In the vast majority of European jurisdictions, shareholders can bring a derivative action (for damages) against the management for breach of fiduciary duty. In all of these countries, a derivative lawsuit is the only remedy against managerial misconduct. In spite of corporate fraud by managers there are no such lawsuits. We explain this apparent paradox on the basis of percentage limits. The laws of percentage limits require shareholders to hold a minimum amount of typically 5% to 10% in order to bring an action against the management and they are extremely wide-spread in Europe. Since small shareholders are not entitled to sue, there is an incentive for managers to collude with large shareholders. In a four-stage-model, we show that, given the current percentage limits, managers will misappropriate corporate assets and split the proceeds with large shareholders. Contrary to current and past approaches to agency theory, we find that, in this equilibrium, (1) large shareholders do not monitor the management, (2) small shareholders do not free ride and (3) the residual ownership is not held by the shareholders on the whole but by the managers and the large shareholders. This interpretation of the current situation is consistent with empirical studies that find a more concentrated shareholder structure in Europe than in the United States