THE VALUE OF INSIDER CONTROL.

• Author: Means, Benjamin

Table of Contents Introduction 893 I. Nepotism, Inc.? 896 A. The Merit Paradigm 896 B. Kinship as Qualification 901 1. The Boss's Nephew 902 2. Access and Apprenticeship 905 II. The Controlled-Company Puzzle 908 A. The Law and Finance of Control 911 B. Entrepreneurial Vision 914 C. Stewardship 918 III. Fiduciary Obligations of Controlling Owners 924 A. The Availability of Judicial Oversight 925 B. The Duty of Care 926 C. The Duty of Loyalty 931 Conclusion 935 INTRODUCTION

Insider control has emerged as one of the hottest topics in corporate governance in the wake of public offerings by prominent technology companies such as Google, Facebook, and Snapchat involving low-vote or no-vote stock. (1) Dual-stock classification distinguishes founder stock from common stock and thereby enables founders to raise money from the capital markets without surrendering the perquisites of control. (2)

Critics charge that dual-stock classification should be restricted or disallowed because it shackles controlled companies to the vision of their founders even when there is no longer good reason to defer to that vision. (3) For example, Sumner Redstone remained in control of Viacom and CBS long after it had become apparent that he lacked the capacity to make business decisions. (4) The fact that family businesses pioneered the use of dual-class stock in order to perpetuate family control only exacerbates the critique of controlled companies. (5)

This Article contends, to the contrary, that family businesses illustrate why controlled companies can be attractive to investors and other stakeholders. In particular, family values can motivate responsible business practices. For example, acting as stewards for future generations, family owners often prioritize sustainability over more immediate payouts. (6) A focus on long-term viability benefits nonfamily groups as well, including value investors, employees, customers, and communities. (7)

Although reconciling family and business interests can be challenging, (8) "[f]amily businesses are ubiquitous in the United States and are often described as 'the backbone' of the American economy." (9) In fact, studies suggest that family businesses may outperform nonfamily businesses in the marketplace. (10) Notably, many of the most successful U.S. businesses are family controlled--for example, Ford Motor Company, (11) Wal-Mart Stores, Incorporated, (12) Mars, Incorporated, (13) Cargill, Incorporated, (14) and Hobby Lobby Stores, Incorporated. (15) According to one estimate, about a third of Fortune 500 companies are family controlled. (16) In sum, far from serving as a cautionary tale regarding the dangers of insider control, family businesses offer a useful model.

The Article proceeds as follows. Part I contends that the perpetuation of insider control should not be equated with the nepotistic hiring and promotion of unqualified individuals. (17) More commonly, the next generation of owners are carefully groomed for managerial responsibilities and must demonstrate their capacity to lead. (18)

Parts II and III respond to a different type of concern: that controlling owners will abuse their position to expropriate value without sharing it with minority investors. Part II argues that stewardship provides a plausible alternative explanation for insiderfavoring models of control. Part III contends that the fiduciary duties of care and loyalty suffice to protect the minority from mistreatment. The Article concludes that legislative or regulatory restrictions--for example, mandatory time limits on insider control--could have the unintended consequence of deterring stewardship. The benefits of family ownership and other forms of insider control need not be taken on faith, but neither should they be rejected as a matter of principle.

1. NEPOTISM, INC.?

   If insider control is to continue past a company's founding stage, there must be a strategy to perpetuate it. (19) Notably, most family businesses use kinship as an important criterion for the selection of key personnel. (20) "Family heirs benefit not only from inherited wealth but also from access to employment opportunities reserved for them." (21) The inheritance of managerial responsibilities may seem to fit the classic definition of nepotism: unfair preferences based on kinship. (22) This Part argues, however, that insider-favoring models of control need not conflict with appropriate standards of merit.

   1. The Merit Paradigm

      If we are to avoid the reductio ad absurdum of concluding that all kinship preferences are nepotism, even the care and affection that parents provide for children within the family, we must find some means of distinguishing nepotistic and non-nepotistic kinship preferences. Nepotism refers not just to the existence of a kinship preference, but to the context in which it arises. (23) Some social goods are properly assigned using kinship as a criterion; others are not. (24)

      The philosopher Michael Walzer has argued that "there has never been a single criterion ... for all distributions." (25) Instead, each kind of social good should be handled according to the procedures appropriate for it. (26) Intimate relationships, political choices, and impersonal market transactions take place in separate spheres and are governed by different rules. (27) For instance, because some goods involve matters of intimacy, people are not supposed to exchange them for money. (28) In other circumstances, where market conventions apply, money is all that is expected to matter. (29) When we seek to ascertain whether a kinship preference should be considered nepotism, the particular context is crucial. (30) We must ask, specifically, whether kinship preferences are permissible in that sphere. (31)

      Yet, Walzer's proposed mode of analysis does not tell us whether kinship preferences in family-owned business are improper because the spheres of family and business overlap. (32) An intention to pass control from generation to generation is a constitutive element of family businesses. (33) The appropriateness of kinship preferences is, therefore, inseparable from broader questions about the role of family businesses in society. (34)

      Perhaps family ownership does not make a difference and kinship preferences should be considered improper in any business context. Even if participants have preexisting relationships that affect their goals and their mutual expectations, (35) they are still joined in a forprofit venture. Further, by selecting a corporate, limited liability company, or partnership form, a family business could be said to have accepted the market principles applicable to that form of business. (36) There is no separate, family-business entity form available. (37) Across all forms of business associations, merit is the accepted principle for the distribution of opportunities in the workplace. (38)

      Kinship preferences in family businesses may be problematic because they appear to violate the principle of distribution according to merit. That is, family businesses involve the preferential transmission of direct economic advantage to insiders as to employment matters--such as hiring and promotion--that would ordinarily depend on formally neutral criteria. (39) The fact that a family owns a business does not prove that kinship preferences in the workplace are inevitable or appropriate. If the family wished to do so, it could hire professional managers to run the business.

      On the other hand, we might ask who has grounds to complain about kinship preferences. (40) If a business does not sell its stock to the general public but the stock is instead held by a single family, the business is, effectively, the family's property. (41) In this regard, one scholar suggests that public affirmative action policies elicit greater concern because they involve the allocation of resources that are open to all members of society, whereas, "in the case of a family-owned business in which nepotistic hiring is a stage in a process that will end with intergenerational transfer of the business itself, we see nepotism as completely legitimate.' (42) Why, after all, should a family have an obligation to distribute its assets to strangers?

      Perhaps employment in a family business is no less a family asset than any other kind of wealth. (43) Consider three approaches to transferring wealth across generations:

      Version One. An entrepreneur builds a successful business. Rather than giving the business to her children, she sells it before her death and leaves her children the proceeds of the sale in equal shares. Version Two. An entrepreneur builds a successful business. She leaves control of the business to her children in equal shares. The children sell the business and split the proceeds. Version Three. An entrepreneur builds a successful business. She employs her children in the business, and, ultimately, transfers control of the business to them. They continue to operate the business. In each case, setting aside any tax considerations that might pertain, the parent bequeaths substantially identical economic resources to her children. The children benefit from the morally arbitrary fact that they have a wealthy parent, whether or not they receive the money directly or access it through the business organization. If the financial consequences are identical, and if there is no public policy reason to prefer that the parent use one form of estate plan instead of another, then it is unclear what purpose is served by drawing normative distinctions. (44)

      As long as families are permitted to raise children, it is unrealistic to insist that families will convey certain benefits while withholding others. Indeed, family members are expected, and in some respects legally obligated, to care for one another. (45) One commentator argues that "[w]e have a duty to be nepotistic, and if we fail to put our families first we may destroy the very sources of altruism on which society...