1 See Berle, A.A. & Means, G.C., The Modern Corporation and Private Property (Commerce Clearing House, Inc., New York, 1932)Google Scholar.

2 The first problem is that of “rational apathy”, and the second is that of “free riding”. Together they are known as “collective action problems”. See Clark, R.C., Corporate Law (Little, Brown & Co., Boston, 1986) 389–394Google Scholar.

3 This idea was first proposed by Professor Conard. See Conard, A.F., “Beyond Managerialism: Investor Capitalism?”, (1988) 22 U. Mich. J. L. Reform 117Google Scholar. Other solutions to agency problems include boards, in house comptrollers, audit committees, and inter-company competition in various markets, such as the product market, the capital market, the market for corporate control, and the labor market. The literature that deals with the shortcomings of these solutions is vast. For an overview of the main arguments, see Dent, G.W., “Toward Unifying Ownership and Control in the Public Corporation”, (1989) Wisc. L. R. 881Google Scholar. It seems that there is no single panacea for agency problems, but rather the answer lies in combining all the solutions together. Apparently, institutional monitoring will also not be a perfect response to agency problems, although it will contribute to their control.

4 See Barnard, W., “Institutional Investors and the New Corporate Governance”, (1991) 69 N. C. L. R. 1135Google Scholar; Black, B.S., “Shareholder Passivity Reexamined”, (1990) 89 Mich. L. R. 520CrossRefGoogle Scholar (hereinafter: Black, Shareholder Passivity Reexamined); Black, B.S., “Agents Watching Agents: The Promise of Institutional Investor Voice”, (1992) 39 UCLA L. R. 811Google Scholar (hereinafter: Black, Agents Watching Agents); Black, B.S., “The Value of Institutional Investor Monitoring: The Empirical Evidence”, (1992) 39 UCLA L. R. 895Google Scholar (hereinafter: Black, Institutional Monitoring); Black, B.S. & Coffee, J.C., “Hail Britannia?: Institutional Investor Behavior Under Limited Regulation”, (1994) 92 Mich. L. R. 1997CrossRefGoogle Scholar; Coffee, J.C., “Liquidity Versus Control: The Institutional Investor as Corporate Monitor”, (1991) 91 Colum. L. R. 1277CrossRefGoogle Scholar (hereinafter: Coffee, Liquidity Versus Control); Coffee, J.C., “The SEC and the Institutional Investor: A Half-Time Report”, (1994) 15 Cardozo L. R. 837Google Scholar (hereinafter: Coffee, Half-Time Report); Daniels, R.J. & Waitzer, E.J., “Challenges to the Citadel: A Brief Overview of Recent Trends in Canadian Corporate Governance”, (1994) 23 Can. Bus. L. J. 23Google Scholar; Ferrara, R.C. & Zirlin, H., “The Institutional Investor and Corporate Ownership”, (1992) 19 Sec. Reg. L. J. 341Google Scholar; Fisch, J.E., “Relationship Investing: Will It Happen? Will It Work?”, (1994) 55 Ohio S. L. J. 1009Google Scholar; Garten, H., “Institutional Investors and the New Financial Order”, (1992) 44 Rutgers L. R. 585Google Scholar; Gilson, R.J. & Kraakman, R., “Reinventing the Outside Director: An Agenda for Institutional Investors”, (1991) 43 Stan. L. R. 863CrossRefGoogle Scholar; Gordon, J.N., “Institutions as Relational Investors: A New Look at Cumulative Voting”, (1994) 94 Colum. L. R. 124CrossRefGoogle Scholar; Grundfest, J.A., “Just Vote No: A Minimalist Strategy for Dealing with Barbarians at the Gates”, (1993) 45 Stan. L. R. 857CrossRefGoogle Scholar; Macintosh, J.G., “The Role of Institutional and Retail Investors in Canadian Capital Markets”, (1993) 31 Osgoode Hall L. J. 371Google Scholar; Paefgen, T.C., “Institutional Investors Ante Portas: A Comparative Analysis of an Emergent Force in Corporate America and Germany”, (1992) 26 Int'l Law. 327Google Scholar; Rock, E.B., “The Logic and (Uncertain) Significance of Institutional Shareholder Activism”, (1991) 79 Geo. L. J. 445Google Scholar; Romano, R., “Public Pension Fund Activism in Corporate Governance Reconsidered”, (1993) 93 Colum. L. R. 795CrossRefGoogle Scholar; Weiss, E.J. & Beckerman, J.S., “Let the Money Do the Monitoring: How Institutional Investors Reduce Agency Costs in Securities Class Actions”, (1995) 104 Yale L. J. 2053CrossRefGoogle Scholar.

5 See Garten, ibid., at 643-648; Rock, ibid., at 449-450, 479-492; Black & Coffee, ibid., at 2017-2024, 2028-2055; Black, Shareholder Passivity Reexamined, ibid., at 570-575.

6 See Rock, ibid., at 451, 481-489; Coffee, Half-Time Report, supra n. 4, at 843-846; Fisch, supra n. 4, at 1029.

7 Approximately 63% of Fortune 500 companies are controlled by less than half of their stock. See Daniels, R.J. & MacIntosh, J.G., “Toward a Distinctive Canadian Corporate Law Regime”, (1991) 29 Osgoode Hall L. J. 863, at 884Google Scholar. For data on a similar dispersal of shares in England, see Scott, J., Capitalist Property and Financial Power: A Comparative Study of Britain, the United States and Japan (Wheatsheaf Books, Brighton, 1986) 52–54Google Scholar.

8 See Gordon, L.A. & Pound, J., “Information, Ownership Structure, and Shareholder Voting: Evidence from Shareholder-Sponsored Corporate Governance Proposals”, (1993) 48 J. Fin. 697, at 702CrossRefGoogle Scholar; Nesbitt, S.L., “Long-Term Rewards from Shareholder Activism: A Study of the ‘CalPERS Effect’”, (Winter 1994) J. App. Corp. Fin. 75, at 76Google Scholar; Rock, supra n. 4, at 484-489. Some commentators argue that the fact that antitakeover defenses did not develop in England is the result of similar institutionalinvestor attitude. See Black & Coffee, supra n. 4, at 2036.

9 See Nesbitt, ibid.; Wingerson, M.R. & Dorn, C.H., “Institutional Investors in the U.S. and the Repeal of Poison Pills: A Practitioner's Perspective”, (1992) 2 Colum. Bus. L. R. 223, at 233–235Google Scholar. Such areas include, among others, securing the independence of boards and executive compensation committees, forming shareholder advisory committees, reducing executive compensation and linking it to company performance, preventing overexpansion of company business, reforming dividend policy, and replacing underperforming management. See Grundfest, supra n. 4, at 931-934; Garten, supra n. 4, at 643-648.

10 See Black & Coffee, supra n. 4, at 2053.

11 For the convergence of the interests of controlling shareholders with the interests of shareholders as a whole, as controlling-shareholder holdings increase, see Jensen, M.C. & Meckling, W.H., “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure”, (1976) 3 J. Fin. Econ. 305, at 312–313CrossRefGoogle Scholar. For a compilation of empirical evidence demonstrating the relationship of company effectiveness to the size of its controlling block, see Black, Institutional Monitoring, supra n. 4, at 917-921.

12 This is the case both in absolute terms, because they hold a majority of the shares, as well as relatively, as they are less diversified.

13 In two-thirds of the Toronto Stock Exchange companies, the controlling block typically consists of more than half of the company shares. See Daniels & Waitzer, supra n. 4, at 26; Daniels & MacIntosh, supra n. 7, at 884. Cf. Coffee, Liquidity Versus Control, supra n. 4, at 1308-1309. For data on a similar dispersal of holdings in the Israeli stock exchange, see “Public Share Holdings and Institutional Interested Parties Part Thereof”, (1995) 167 Ha'Hodesh Ba'Bursa 5, at 10Google Scholar. See also Avramov, K. & Raz, S., “Public and Institutional-Investor Share Holdings”, (1995) 161 Ha'Hodesh Ba'Bursa 2Google Scholar; Avramov, K. & Raz, S., “Share Holdings of Interested Parties, Institutional Investors, and the Public”, (1994) 150 Ha'Hodesh Ba'Bursa 2Google Scholar; Avramov, K., “Teva is the Most Widespread and Liquid of All — Interested-Party Holdings and the Floating Quantity of Shares Listed on the Stock Exchange”, (1993) 143 Ha'Hodesh Ba'Bursa 7Google Scholar; Shalit, D., Harel, I. & Rachamim, O., “Company Groups and the Market Value of Companies Listed on the Stock Exchange”, (1993) 143 Ha'Hodesh Ba'Bursa 2Google Scholar; Avramov, K., “Controlling-Shareholder Holdings in the 30 Largest Corporations on the Stock Exchange”, (1991) 122 Ha'Hodesh Ba'Bursa 15Google Scholar.

14 See supra n. 13.

15 See Daniels & Waitzer, supra n. 4, at 35.

16 See MacIntosh, supra n. 4, at 377 n. 15, 383, 428; Daniels & MacIntosh, supra n. 7, at 897, 929-932; Ontario Stock Commission Policy Statement 9.1 — Disclosure, Valuation, Review and Approval Requirements and Recommendations for Insider Bids, Issuer Bids, Going Private Transactions and Related Party Transactions, (1991) 14 O.S.C.B. 3345, §§ 20, 30-33 (related-party transactions whose value exceeds one-quarter of the company market capitalization are subject to minority approval, and in some cases the approval of two-thirds of the minority is required). In the United States a different rule applies. Although shareholder approval is given some weight, and more substantial weight is given to minority approval, the law settles for the approval by a majority of the non-interested directors, and in any event the principal test is that of fairness. See Clark, supra n. 2, at 166-189. See also Welch, E.P. & Turezyn, A.J., Folk on the Delaware General Corporation Law: Fundamentals (Little, Brown & Co., Boston, 1993) 230–241Google Scholar; Small, M.L., “Conflicts of Interest and the ALI Corporate Governance Project — A Reporter's Perspective”, (1993) 48 Bus. Law. 1377Google Scholar; Johnston, J.F. & Alexander, F.H., “The Effect of Disinterested Director Approval of Conflicts Transactions Under the ALI Corporate Governance Project — A Practitioner's Perspective”, (1993) 48 Bus. Law. 1393Google Scholar.

17 See Pozen, R.C., “Institutional Investors: The Reluctant Activists”, (Jan.-Feb. 1994) Harv. Bus. R. 140Google Scholar. Cf. Elson, C.M., “The Duty of Care, Compensation, and Stock Ownership”, (1995) 63 U. Cin. L. R. 649, at 689Google Scholar.

18 Nonetheless, not every related-party transaction is illegitimate: the transaction may be in accordance with market terms, and may even be better than a transaction between the company and an outsider. See Clark, supra n. 2, at 184. Obviously, when the transaction sets the terms of employment of the related party in the company, it is not preventable, and the sole question is whether the terms are not too generous towards the related party. See ibid., at 148.

19 See Daniels & Waitzer, supra n. 4, at 35.

20 See ibid., at 35-36.

21 In the United States it has been argued that the great interest that institutional investors have demonstrated in fostering the market for corporate control is an exception to their general indifference. The traditional apathy that derives from legal constraints, economic considerations, and conflicts of interest, disappears the moment that the profit from selling shares in a takeover becomes clear. See Roe, M.J., “The Modern Corporation and Private Pensions”, (1993) 41 UCLA L. R. 75, at 94–95Google Scholar; Rock, supra n. 4, at 484-486; Ferrara & Zirlin, supra n. 4, at 354. On the importance of profit and loss considerations among institutional investors, see supra n. 17.

22 Cf. Black & Coffee, supra n. 4, at 2069-2070.

23 Institutional-investor lack of expertise in managing companies has been mentioned more than once as an obstacle to institutional monitoring in the United States. Whereas company management is familiar with its day to day operation, the company is just one of many for the institutional investor. Consequently, the institutional investors have no advantage over the management, and institutional interference in company affairs is liable to cause damage. For attempts to deal with this problem, see Black, Shareholder Passivity Reexamined, supra n. 4, at 580-584; Black, Agents Watching Agents, supra n. 4, at 854; Grundfest, supra n. 4, at 92G. Apparently, this problem is prominent in Israel when dealing with provident funds, who by the end of 1995 had only 11.2% of their capital invested in shares and another 9.1% in nongovernmental bonds. The reminder of their investments were not in companies. See Developments in the Capital and Finance Markets: 1995 Annual Survey (Bank of Israel, Jerusalem, 1996, in Hebrew)Google Scholar (hereinafter: 1995 Annual Survey) 120.

24 Because both mutual funds and provident funds are managed mainly by banks, who themselves hold shares and are involved in the capital market as underwriters and creditors of companies, the expertise problem in any event is reduced. In addition, the funds themselves loan money to companies by acquiring their bonds. This centralization in the Israeli capital market is perhaps a source of institutional conflicts of interest, but it also allows for specialization and professionalism of the banks as institutional investment managers. On the advantages of institutional investors who are also creditors, see Black & Coffee, supra n. 4, at 2073-2074; Gilson & Kraakman, supra n. 4, at 878. On the advantages of institutional investors who are also private investors, see Black & Coffee, ibid., at 2081.

25 It is difficult to exaggerate the power of such public opposition to suppress institutional monitoring today just as it has suppressed both institutional activism and hostile takeovers in the past. See Roe, M.J., Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (Princeton University Press, Princeton, 1994)Google Scholar.

26 See, e.g., Lowenstein, L., “More Like Whom?”, (1993) 18 J. Corp. L. 697, at 705Google Scholar.

27 See, e.g., Boyer, A.D., “Activist Shareholders, Corporate Directors, and Institutional Investors: Some Lessons from the Robber Barons”, (1993) 50 Wash. & Lee L. R. 977Google Scholar. Cf. Report of the Commission of Investigation on the Manipulation of Bank Shares (Jerusalem, M. Bejski Chairman, 1986, in Hebrew)Google Scholar.

28 See section 96-36 of the Companies Ordinance (New Version), 1983 (D.M.I. 716) (hereinafter: the Companies Ordinance) which was added in the Law for Amending the Companies Ordinance (No. 4) (Officer Liability), 1991 (S.H. 132). Section 96-36(c) of the Companies Ordinance extends the rule also to the situation where a majority of the directors who hold one-quarter or more of the means of control in the company have an interest in a transaction. The term “extraordinary transaction” is defined in section 96-24 of the Companies Ordinance as “a transaction not in the company's regular course of business, or not in market terms, or a transaction that may significantly affect the company's profitability, property, or commitments”.

29 See regulation 12 of the Securities Regulations (Limitations on Conflicts of Interest Between a Listed Company and a Controlholder), 1994 (K.T. 905) (hereinafter: the Conflicts of Interest Regulations). Sections 232, 284-291 of the Companies Bill, 1995 (H.H. 2) (hereinafter: the Companies Bill) combine the provisions of the Conflicts of Interest Regulations and Part D1 of the Companies Ordinance. Section 231 of the proposed bill extends the application of this arrangement to extraordinary transactions between the company and any of its shareholders, when a majority of the members of the audit committee have an interest in the transaction. Section 233 of the proposed bill adds several problematic exemptions to the requirement for the approval of one-third of the minority shareholders, which might open up a loophole for getting around this requirement. In this paper, the existing provisions are considered.

30 The foundation for a more stringent regime was set in Clal Industries Ltd. v. Leumi Pia, Mutual Fund Management Company Ltd., (1993) 47(ii) P.D. 329 (hereinafter: the Clal Industries case). In this case, the Supreme Court held that the enrichment of one group of shareholders at the expense of another group is subject to approval by the majority of the prejudiced shareholders. Although the court set this rule in the context of the compensation of preferred shareholders within the framework of company recapitalization, it also ruled that the distinction between groups of shareholders within the company is not made according to the class of shares they hold but rather according to their adverse interests. Consequently, future case law may develop the rule set in the Clal Industries case, and apply it to additional instances of conflicts of interest between shareholders, even if they hold the same class of shares.

31 See Hauser, S. & Shohet, I., Exercise of Share Voting Rights by Institutional Investors (Securities Authority, Jerusalem, 1992, in Hebrew) 35–36Google Scholar; Stepak, Z., Guide to Mutual Funds in Israel (Meitav, Tel Aviv, 1988, in Hebrew) 48Google Scholar; Ravid, B., “Public Participation in General Meetings”, (1991) 120 Ha'Hodesh Ba'Bursa 7Google Scholar.

32 See section 77 of the Mutual Investments in Trust Law, 1994 (S.H. 308) (hereinafter: the Mutual Investments in Trust Law). According to this section, mutual fund managers are required to present a report to the Securities Authority and to the Registrar of Companies. The information to be included in this report was determined in regulation 27 of the Mutual Investments in Trust Regulations (Immediate Reports, Monthly Reports, Unit Holding Reports, and Reports on the Voting in General Meetings), 1994 (K.T. 304).

33 See section 123(4) of the Mutual Investments in Trust Law.

34 See section 43 of the Provident Funds Bill, 1996 (H.H. 360) (hereinafter: the Provident Funds Bill).

35 This directive was issued in Provident Fund Bulletin, No. 265, Oct. 10, 1994. The directive also requires provident fund managers to vote whenever the fund holds five percent of a certain security (this, however, has been left out of the Provident Funds Bill). According to the directive issued in Provident Fund Bulletin No. 274, May 2, 1996, provident fund managers are required to report to the Capital Market, Insurance, and Savings Department of the Ministry of Finance on their voting at general meetings.

36 See supra n. 6.

37 See Coffee, Liquidity Versus Control, supra n. 4, at 1314-1315; Rock, supra n. 4, at 473; Garten, supra n. 4, at 623; Black, Agents Watching Agents, supra n. 4, at 886.

38 The method is simple: a basket of shares that reflects a certain share index is acquired, according to the weight of every share in that index, and is held for a long period of time. For data on the extent of indexed investment among institutional investors in the United States, see Walker, D.M., “The Increasing Role of Pension Plans in the Capital Markets and in Corporate Governance Matters”, in Institutional Investing: The Challenges and Responsibilities of the 21st Century, Sametz, A.W. & Bicksler, J. eds., (Business One Irwin, Homewood, 1991) 34, at 36Google Scholar; Taylor, W., “Can Big Owners Make a Big Difference?”, (Sept.-Oct. 1990) Harv. Bus. R. 70, at 72Google Scholar; Clark, S., “Why Dale Hanson Won't Go Away”, (Apr. 1990) Institutional Investor 79, at 80Google Scholar.

39 See Coffee, Half-Time Report, supra n. 4, at 867.

40 See ibid.

41 See Rock, supra a. 4, at 473; Coffee, Liquidity Versus Control, supra n. 4, at 1326-1327.

42 See Coffee, Half-Time Report, supra n. 4, at 863-864; Pozen, supra n. 17, at 144. Cf. Stepak, supra n. 31, at 85-88. In the United States, this is in part the result of legal provisions that limit incentive compensation. See Coffee, Half-Time Report, ibid., at 865-866; Coffee, Liquidity Versus Control, ibid., at 1326-1327. Still, the English experience indicates that even in the absence of legal constraints, incentive compensation is a rarity as a result of market forces. See Black & Coffee, supra n. 4, at 2058.

43 See Rock, supra n. 4, at 473; Fisch, supra n. 4, at 1019-1025. For a different perspective, see Black, Agents Watching Agents, supra n. 4, at 876-881.

44 See Rock, ibid., at 474. Investment managers in Israel also compete among themselves by reducing costs. See, e.g., Gilat, M., “The Teachers Union Transfers Study Fund Money from Bank Massad to the International Bank”, (May 12, 1995) Ha'Aretz C12Google Scholar; Gavison, Y., “Ilanot Lowers Management Fees and Load Charges”, (Dec. 12, 1995) Ha'Aretz C9Google Scholar.

45 See Black & Coffee, supra n. 4, at 2070; Fisch, supra n. 4, at 1024-1025.

46 See Hauser & Shohet, supra n. 31, at 12-13. Heavier concentration also accounts for the greater involvement of institutional investors in England, in comparison to what is common in the United States. See Coffee, Half-Time Report, supra n. 4, at 845.

47 See Hauser & Shohet, ibid. For numerical data, see Avramov & Raz (1994), supra n. 13; Stepak, supra n. 31, at 45-47, 78-80.

48 See Bank of Israel: 1994 Report (Bank of Israel, Jerusalem, 1995, in Hebrew) 334, 337Google Scholar.

49 See Stepak, supra n. 31, at 75-78.

50 Indeed, recently there have been numerous examples of such institutional activity in Israel. See, e.g., Hemi, G., “‘Unless You Approve My Bonus — I will Leave the Company’”, (June 29, 1995) Ha'Aretz C6Google Scholar; Nachshon, U., “Now I am For, Now I am Against”, (July 25, 1995) Yedioth Ahronoth (Mamon) 8Google Scholar; Hemi, G., “Maritime-Jewelex Acquires 17% of Golan Shares for about 3 Million Dollars”, (Aug. 25, 1995) Ha'Aretz C7Google Scholar; Hemi, G., “MTM — Funds Foil the Bonus for Kedem and his Children”, (Sept. 28, 1995) Ha'Aretz C9Google Scholar; Gavison, Y., “The Generous Bank of Related Parties”, (Sept. 13, 1995) Ha'Aretz C8Google Scholar. These newspaper articles provide examples of instances where institutional investors opposed — usually with success — the bestowing of benefits on controlling shareholders.

51 See Coffee, Liquidity Versus Control, supra n. 4, at 1353. An additional cost considered by institutional investors is the loss of access to soft information about a company as a result of confrontation with controlling shareholders. See Conard, supra n. 3, at 146, 149-150; Coffee, Liquidity Versus Control, ibid., at 1323-1324; Black, Shareholder Passivity Reexamined, supra n. 4, at 602.

52 See Brickley, J.A., Lease, R.C. & Smith, C.W., “Ownership Structure and Voting on Antitakeover Amendments”, (1988) 20 J. Fin. Econ. 267, at 276–279CrossRefGoogle Scholar. See also Rock, supra n. 4, at 479-481; Coffee, Half-Time Report, supra n. 4, at 869.

53 See Coffee, Liquidity Versus Control, supra n. 4, at 1353; Rock, ibid., at 476-478. For a more positive tone, see Black, Shareholder Passivity Reexamined, supra n. 4, at 597-598. The source of this directive is a letter from 1988 known as “the Avon Letter”. See Grundfest, supra n. 4, at 921. The directive was updated in greater detail by the American Department of Labor in 1994. See Interpretive Bulletin Relating to Written Statements of Investment Policy, Including Proxy Voting Policy or Guidelines, 29 C.F.R. § 2509.94-2 (1994).

54 See, e.g., the Clal Industries case, supra n. 30; Arlozorov, M., “Institutional Opposition Prevents Compensation to Discount Bank for Capital Consolidation in the Development and Mortgage Bank”, (March 16, 1994) Globes 21Google Scholar; Raviv, O., “Bank Leumi Funds Oppose the Proposed Compensation for Equalizing the Rights in Leumi Mortgage Bank”, (May 30, 1994) Globes 3Google Scholar; Raviv, O., “Leumi Mortgage Bank General Meeting Once Again Rejects the Proposal for Rights Equalization”, (July 11, 1994) Globes 24Google Scholar; Raviv, O., “Four Subsidiaries Approve Giving Options to Dudi Ezra — Meir Ezra Opposes”, (Dec. 30, 1993) Globes 18Google Scholar.

55 Between 1985-1994, the institutional-investor portion of the stock market, which consists mostly of mutual fund and provident fund investments, increased from 10% to 20%. See Hauser & Shohet, supra n. 31, at 4 (regarding 1985 data); Bank of Israel: 1995 Report (Bank of Israel, Jerusalem, 1996, in Hebrew)Google Scholar (hereinafter: 1995 Report) 293-294 (regarding 1994 data). The year of 1995, however, was marked by a dramatic drop in institutional share holding. By the end of 1995, provident funds held 10% of the shares on the market, and mutual funds held 6.5%. See 1995 Report, ibid. This was the result of the withdrawal of investor money in light of poor fund performance, the uncovering of several corruption scandals, and the growing importance of saving accounts and pension funds as alternative channels for investment in 1994. See 1995 Annual Survey, supra n. 23, at 67-75.

56 Cf. Black & Coffee, supra n. 4, at 2071-2072; Grundfest, supra n. 4, at 923; Dent, supra n. 3, at 918. On the tendency of institutional investment managers to follow customary strategies, see Conley, J.M. & O'Barr, W.M., “The Culture of Capital: An Anthropological Investigation of Institutional Investment”, (1992) 70 N. C. L. R. 823, at 832Google Scholar.

57 See Black, Shareholder Passivity Reexamined, supra n. 4, at 590; Grundfest, ibid., at 909. Even in Israel, where three banks command three-quarters of all institutional investments (15% of the shares overall), free riding and rational apathy may undermine monitoring.

58 See supra nn. 18-24 and the accompanying text.

59 Cf. Black, Shareholder Passivity Reexamined, supra a. 4, at 590.

60 See Procaccia, U., “On Laws, Contracts and Things: An Economic Approach to Basic Jurisprudential Concepts”, (1988) 18 Mishpatim 395, at 406–411Google Scholar.

61 Therefore, imposing a duty to vote on institutional investors is justified independent of the size of their holdings. Such detachment forces every institutional investor to monitor the company notwithstanding his chances to influence it and to benefit from this, and thus is essential for preventing rational apathy and free riding.

62 Apart from related-party transactions, the following decisions are also subject to approval at general meetings: changes in company bylaws (section 15 of the Companies Ordinance); changes in the articles of incorporation (section 25 of the Companies Ordinance); privatization of the company (section 42 of the Companies Ordinance); setting director compensation (section 85 of the Companies Ordinance); transfer of office from one director to another (section 94 of the Companies Ordinance); making director and executive liability unlimited (section 96 of the Companies Ordinance); recapitalization (sections 144, 151 of the Companies Ordinance); compromise or arrangement of a company in liquidation (section 233 of the Companies Ordinance); liquidation (sections 257, 319 of the Companies Ordinance); allocation of securities to an interested party or to a person who will become an interested party after allocation (regulations 7, 9 of the Securities Regulations (Allocation of Securities in a Registered Company that were not Offered to the Public), 1992 (K.T. 984)); appointment of directors (section 84 of the second supplement to the Companies Ordinance); making changes in the number of directors, and setting the order by which they will leave office (section 86 of the second supplement to the Companies Ordinance). Compare this with the list in section 80 of the Companies Bill (making structural changes; deciding on the distribution of profit; setting the number of directors and the terms of their employment, appointing and dismissing them; appointing and dismissing an accountant, setting the terms of accountant employment; changing company bylaws; approving transactions in which company officers have a personal interest, and substituting for the board and the chief executive officer). Section 229 of the proposed bill imposes a duty on shareholders to refrain from exploiting their power at the general meeting, and in this context details three situations which are susceptible to conflicts of interest between groups of shareholders: amendments to the bylaws, including changes in the rights that accompany shares, approval of dividend distribution, and approval of structural changes, including acquisition of the company.

63 Cf. Conard, supra n. 3, at 135-136.

64 This interpretation is also supported by the illustration given in sections 43 and 77, according to which potential harm also includes a related-party transaction.

65 The situations covered by section 96-36 and regulation 12 are prominent examples of conflicts of interest common in the Israeli corporate arena today, yet they do not exhaust the possible situations where this kind of conflicts of interest may arise and necessitate institutional monitoring today. Section 96-36 and regulation 12 apply to extraordinary transactions with certain related parties. They do not apply to ordinar transactions nor to other related parties. The analogous provisions in the Companies Bill apply to all shareholders, but are limited to extraordinary transactions only, and in addition introduce a number of new exemptions (see supra n. 29). Apart from these provisions, the Companies Bill includes provisions that assign the decision-making power to the majority of the non-controlling shareholders in the following situations: changes in company bylaws that prejudice a certain class of shareholders (section 25) (a similar rule can already be derived from the Clal Industries case, supra n. 30); a merger with a company that holds shares in the targeted company (sections 367-369, 390); and an acquisition by such a company (sections 380, 391). In these scenarios, the potential for abuse of corporate control to the detriment of non-controlling shareholders is great, and therefore the requirement for approval by one-third of the non-controlling shareholders has been supplanted by a requirement for approval by a majority of the non-controlling shareholders.

66 A proposal to set up a comprehensive proxy voting mechanism can be found in subchapter IX of chapter B of the Companies Bill. The explanatory notes to the proposal detail the lacuna in the existing law that the proposal is intended to fill.

67 Nevertheless, the provision that requires institutional voting whenever a proposal which can advance the interests of institutional-investor clients is brought up for a vote at the general meeting will be applicable in the future, when controlling-shareholder holdings will decrease, and non-controlling-shareholder involvement in corporate governance will increase. Only then will it be wise to require institutional investors to initiate proposals themselves.

68 See section 123(4) of the Mutual Investments in Trust Law and sections 78(b)(5), 87(2) of the Provident Funds Bill.

69 See Black, Agents Watching Agents, supra n. 4, at 826; Black, Shareholder Passivity Reexamined, supra n. 4, at 596-604; Coffee, Liquidity Versus Control, supra n. 4, at 1321-1322; Rock, supra n. 4, at 469-471; Grundfest, supra n. 4, at 919; Conard, supra n. 3, at 148-149.

70 See State Comptroller: Annual Report 45 (State Comptroller, Jerusalem, 1995, in Hebrew) 7, 12, 19Google Scholar; State Comptroller: Annual Report 46 (State Comptroller, Jerusalem, 1996, in Hebrew) 10–11Google Scholar (regarding provident funds); Stepak, supra n. 31, at 48; Levy, H., Smith, M. & Sarnat, M., The Stock Exchange and the Investment in Securities (Schocken Publishing House, Tel Aviv, 1978, in Hebrew) 428–430Google Scholar (regarding mutual funds); Report of the Commission for Examining Aspects of Bank Holdings in Non-Finance Corporations (Jerusalem, D. Brodet, Chairman, 1995, in Hebrew) 47, 55–57Google Scholar (regarding mutual funds and provident funds) (hereinafter: The Brodet Commission Report). Cf. Black & Coffee, supra n. 4, at 2059-2061 (regarding England); Coffee, Liquidity Versus Control, supra n. 4, at 1334 (regarding the United States).

71 See Coffee, Liquidity Versus Control, ibid.; Black, Agents Watching Agents, supra n. 4, at 855. For similar occurrences in Japanese banking, see Coffee, Liquidity Versus Control, ibid., at 1297, 1301.

72 For a detailed analysis of large non-controlling shareholders' conflicts of interest, see Rock, E.B., “Controlling the Dark Side of Relational Investing”, (1994) Cardozo L. R. 987Google Scholar.

73 See directive 322 of the Directives on Proper Banking Management issued by the Commissioner of Banks in accordance with his power under section 8-1(A) of the Banking Ordinance, 1941 (P.G., 1st supp., 85) (hereinafter: the Banking Ordinance).

74 See L.A. Bebchuk, L. Kaplow & J.M. Fried, “Concentration in the Israeli Economy and Bank Investment in Commercial Companies”, in The Brodet Commission Report, supra n. 70, at 19-20.

75 The argument is that in light of the dispersal of institutional investment in the United States, institutional-investor impact on companies is dependent on cooperation between institutions, and only an institution who plays by the rules will obtain such cooperation. In terms of game theory, the voting at general meetings constitutes a repeated game, in which players stigmatize cheaters, thus creating an incentive not to cheat. See Black, Agents Watching Agents, supra n. 4, at 857-859, 861, 866-867; Coffee, Half-Time Report, supra n. 4, at 872-873; Gordon, supra n. 4, at 170-171. For illustration of the fact that the success of an institutional investor in obtaining the support of his colleagues is dependent on his reputation, see Paefgen, supra n. 4, at 331-344. Cf. Kandel, E. & Lazear, E.P., “Peer Pressure and Partnerships”, (1992) 100 J. Pol. Econ. 801, at 805CrossRefGoogle Scholar.

Other responses to the concern over institutional conflicts of interest which have been proposed in the United States are less convincing. One argument is that it will be difficult for institutional investors to reap private profits for themselves. (See Black, Agents Watching Agents, ibid., at 859-861.) However, experience proves otherwise, especially in the centralized economy of Israel. Another argument is that the private profit made by institutional investors from companies may be outweighed by the benefit that the companies will derive from the institutional involvement. (See Black, Agents Watching Agents, ibid., at 861; Fisch, supra n. 4, at 1045.) However, this argument is also unsatisfactory, not only because not enough data on the desirability of institutional monitoring has accumulated (see Fisch, ibid., at 1045-1047), but also because under-the-table private gains are not limited. Cf. Clark, supra n. 2, at 154-157.

76 See Coffee, Half-Time Report, ibid., at 855, 867.

77 See supra n. 48.

78 Section 96-36 of the Companies Ordinance and regulation 12 of the Conflicts of Interest Regulations stipulate that extraordinary transactions with certain related parties, as well as the terms of employment in the company of these related parties, are subject to approval by one-third of the non-controlling shareholders. The rule in the Clal Industries case (supra n. 30), and a number of sections of the Companies Bill (supra n. 65) stipulate that certain other actions that prejudice the non-controlling shareholders are subject to approval by the majority of the non-controlling shareholders.

79 Cf. Mahoney, P.G., “Mandatory Disclosure as a Solution to Agency Problems”, (1995) 62 U. Chi. L. R. 1047CrossRefGoogle Scholar.

80 On the possibility of institutional-investor clients suing institutional investment managers for violating fiduciary duties owed to them in exercising voting rights, see O'Neill v. Davis, 721 F. Supp. 1013 (N.D. Ill. 1989); Newton v. Van Otterloo, 756 F. Supp. 1121 (N.D. Ind. 1991). Section 74 of the Mutual Investments in Trust Law, section 41-5 of the Income Tax Regulations (Rules for Approval and Management of Provident Funds), 1964 (K.T. 1302) (hereinafter: the Income Tax Regulations (Rules for Approval and Management of Provident Funds), and section 3 of the Provident Funds Bill impose on mutual fund and provident fund managers fiduciary duties to their clients. Section 83 of the Mutual Investments in Trust Law provides unit owners in a mutual fund a cause of action to sue for damages they incurred as a result of a violation of these duties. The Provident Funds Bill does not include an analogous provision, but investors in a provident fund can, in similar circumstances, file a regular damages law suit. Both the Mutual Investments in Trust Law and the Provident Funds Bill grant the authorities responsible for their implementation — the Head of the Securities Authority, and the Commissioner of the Capital Market, Insurance, and Savings of the Ministry of Finance — broad administrative and legal authority to deal with violations of this duty. However, it is not easy to prove violation of fiduciary duties and damages therefrom in court. See Conard, supra n. 3, at 150-152; Bebchuk, Kaplow & Fried, supra n. 74, at 19.

81 Such restrictions are found in abundance in the Mutual Investments in Trust Law and its regulations, in the Income Tax Regulations (Rules for Approval and Management of Provident Funds), in the Provident Funds Bill, in the Banking (Licensing) Law, 1981 (35 L.S.I. 277), in the Banking Ordinance, and in the Directives on Proper Banking Management issued by the Commissioner of Banks according to this law. The newly-enacted Banking (Licensing) Law (Amendment No. 11), 1996 (S.H. 318), is of considerable importance, in as much as it restricts bank share holding, thus attenuating potential conflicts of interest of bank-affiliated mutual or provident funds.

82 See Black & Coffee, supra n. 4.

83 In economic terms it can be stated, that institutional investment concentration in Israel, in comparison to institutional investment dispersal in the United States, intensifies risk aversion among Israeli institutional investors.

84 See Pound, J., “The Rise of the Political Model of Corporate Governance and Corporate Control”, (1993) 68 N.Y.U. L. R. 1003Google Scholar. Professor Pound demonstrates how the political model reflects Corporate America today. In fact, the English perspective described in an article by Professors Black and Coffee also parallels the political model: a quiet dialogue between company management and small ad hoc coalitions of institutional investors, which is conducted under the continuous threat of launching an overt battle for corporate control against rebellious management. See Black & Coffee, supra n. 4, at 2053-2055.

85 This is an important source of institutional-investor power in England. See Black & Coffee, ibid., at 2034-2037.

86 See Pound, supra n. 84, at 1052-1053. For an elaborate discussion of this strategy, see Grundfest, supra n. 4.

87 It should not be expected that foreign institutional investors will be pioneers in this area, both due to their more meager holdings in the Israeli stock exchange and their not being rooted in the Israeli market. Nonetheless, they may support initiatives of local institutional investors, and may even urge them to take such initiatives. Compare this to the behavior of American institutional investors in France: Fanto, J.A., “The Transformation of French Corporate Governance and United States Institutional Investors”, (1995) 21 Brook. J. Int'l L. 1Google Scholar.

88 In addition to the increased voting power in accordance with section 96-36 of the Companies Ordinance and regulation 12 of the Conflicts of Interest Regulations, increased voting power is already vested in institutional investors in accordance with the rule in the Clal Industries case, supra n. 30, and this can also act as a lever to performing wide-scoped institutional monitoring. The Companies Bill, if enacted, will provide non-controlling shareholders with increased voting power in a number of additional scenarios that give rise to concerns over transfer of wealth from the non-controlling to the controlling shareholders. See supra n. 65.

89 On the deterrent effect of targeting poorly performing companies for institutional activism, see Nesbitt, supra n. 8, at 75; Black, Agents Watching Agents, supra n. 4, at 839; Black, Shareholder Passivity Reexamined, supra n. 4, at 581-582.

90 See supra n. 23.

91 It is often argued that institutional investors seek nothing but short-term profits, and that they induce their myopia on company management. See Lipton, M. & Rosenblum, S.A., “Corporate Governance: The Quinquennial Election of Directors”, (1991) 58 U. Chi. L. R. 187, at 194, 202–215Google Scholar; Rosenbaum, R.D., “Foundations of Sand: The Weak Premises Underlying the Current Push for Proxy Rule Changes”, (1991) 17 J. Corp. L. 163, at 178–179Google Scholar; Lowenstein, L. & Millstein, I., “The American Corporation and the Institutional Investor: Are There Lessons from Abroad?”, (1988) Colum. Bus. L. R. 739, at 741Google Scholar. On the other hand, there are studies that indicate the very opposite: patience and long-term investing among institutional investors. See Hu, H.T.C., “Risk, Time, and Fiduciary Principles in Corporate Investment”, (1990) 38 UCLA L. R. (1990) 277Google Scholar; J. Jones, K. Lenn & J.H. Mulherin, “Institutional Ownership of Equity: Effects on Stock Market Liquidity and Corporate Long-Term Investments”, in Sametz & Bicksler, supra n. 38, at 115, at 123-124; Black, Agents Watching Agents, supra n. 4, at 862-864; Nesbitt, supra n. 8; Gordon & Pound, supra n. 8, at 712.

92 The smaller the block of shares held by the controlling shareholders, the more distant their interests are from the interests of the company as a whole: they pursue company growth out of greed and passion for prestige — despite any considerations of efficiency and profitability; in order to facilitate such growth without the need for external financing, they refrain from distribution of dividends to shareholders — regardless of the fact that cash retention is often wasteful; they are also willing to do just about anything to ward off takeovers — even when they are advantageous to the company. See Dent, supra n. 3, at 889-892; Black, Agents Watching Agents, ibid., at 834-839; Black, Institutional Monitoring, supra n. 4, at 903-915. In these situations it is fairly easy to point to a certain business move that is essential, and the proper institutional action is to urge the controlling shareholders to make this move. However, in companies with small controlling blocks, controlling-shareholder conflicts of interest may not necessarily be expressed in specific business decisions but rather in overall shirking. See the discussion supra, in Part II.A. In such cases, it is hard to point to a certain business move that the company needs, and therefore the proper institutional action is to urge the controlling shareholders to improve company performance.

93 The first signs of wide-scoped monitoring can also be found in Israel today. Institutional investors still do not dictate business policy to controlling shareholders, but they do take company performance into consideration when requested to approve benefits for controlling shareholders. Cf. Heard, J.E., “Executive Compensation: Perspective of the Institutional Investor” (1995) 63 U. Cin. L. R. 749Google Scholar.

94 This process has already begun. See Avramov & Raz (1994), supra n. 13, at 3.

95 See Klein, D., “The Proposed Pension Fund Arrangement in Light of the Policy of Opening Up the Financial Markets”, (1995) 33 Riv'on Le'Banka'ut 33Google Scholar.

96 After this article was sent to press, a symposium on corporate governance was published in (1995-96) 26 Can. Bus. L.J. In two articles in this volume, Daniels, R.J. and Halpern, P., “Too Close for Comfort: The Role of the Closely Held Public Corporation in the Canadian Economy and the Implications for Public Policy” on p. 11Google Scholar, and Morck, R.K., “On the Economics of Concentrated Ownership” on p. 63Google Scholar, the authors argue that large controlling blocks do not necessarily guarantee high company performance. Cf. supra n. 11. However, the argument that I make in this article is anchored on the different types of controlling-shareholder conflicts of interest dominant in different holding structures, rather than on their overall effect on company value.