The Convergence of Blockchain Technology and Corporate Governance: Values, Paths and Legal Responses
The path of “technological rationality”, represented by blockchain technology, is to approach the problem from the perspective of legal enforcement and effectiveness, and to improve corporate governance by enhancing corporate transparency and reducing agency costs.
Author: Wu Weijiao, Ph.D. Candidate, School of Law, Renmin University of China
Abstract: The agency cost problem in corporate governance is rooted in information asymmetry. Traditional solutions follow “institutional rationality” but have limited effect. With the help of technology, the “technological rationality” path, represented by blockchain technology, can address the problem from the perspective of legal enforcement and effectiveness, and improve corporate governance by enhancing corporate transparency and reducing agency costs. The field of corporate governance, where trust is scarce, is the natural target of blockchain technology as a trust-making machine. In the construction of the specific path of integrating blockchain technology into corporate governance, private chain should be used as the basic chain type, market as the main body of chain supply, company stakeholders as the nodes of chain participation, and equity transaction data, company asset transaction data and company voting data as the bookkeeping object. The integration of blockchain technology into corporate governance may also give rise to risks from four aspects: blockchain information product providers, participating nodes, private chain central institutions and hackers. The legal system can respond to these four types of risks from the perspectives of both private law remedies and regulatory responses.
Keywords: technological rationality; institutional rationality; blockchain; corporate governance; agency costs
Blockchain is a distributed ledger in which blocks of data are combined in a sequentially linked manner into a chained data structure in chronological order and guaranteed by cryptography to be tamper-evident and unforgeable. The concept of blockchain can be traced back to cryptography and distributed computing (Huawei Blockchain Technology Development Team, 2019), but it really started to attract widespread attention in 2008 with Satoshi Nakamoto’s article “Bitcoin: A Peer-to-Peer Electronic Cash System”. Since the rise of Bitcoin, blockchain technology, which is the underlying foundation technology of Bitcoin, has gradually become independent and has been applied to a variety of social scenarios.
Replacing institutional trust with technical trust is considered to be the greatest value of blockchain (Chao Shi, 2020). Based on this theoretical foundation, the domestic legal academy has paid great attention to the legal causation of blockchain technology. Due to the existence of the principal-agent problem, the field of corporate governance, where the element of trust is scarce, should be a natural and ideal object of application of blockchain technology, but it has not received due attention. Considering the importance of the company as a form of organization in modern society, the impact of blockchain technology on corporate governance needs to be urgently explored. In this paper, we will explore the value, path, risk and legal response of integrating blockchain technology into corporate governance from the perspective of agency costs in corporate law.
II. The value of integrating blockchain technology into corporate governance
(I) Agency cost problem, traditional response and limitation
The principal-agent problem in corporate law has a long history, dating back at least to Adam Smith’s (2015) book “The Wealth of Nations” published in 1776, and in 1932, Burleigh and Means (2005) put forward the theory of “separation of ownership and control” in their book “The Modern Corporation and Private Property”. The separation of ownership and control is thought to give rise to agency costs. The root cause of agency costs is information asymmetry, i.e., the principal cannot monitor the agent’s behavior due to information asymmetry, so that the agent will act to maximize his own interests rather than the principal’s interests (Mankun, 2015).
To cope with the agency cost problem, corporate law has set up numerous mechanisms. These mechanisms can be summarized as both internal and external governance structures, the former including the board of directors, shareholder voting and exercise of voice, and executive compensation, and the latter including corporate finance and the market for corporate control (Roberta Romano, 2013). These responses take an institutional rational path, i.e., reducing agency costs within the firm through the construction and improvement of institutions. The problem with this path is that as well constructed as the institutional level is, if it is not effectively enforced, the institutional provisions remain mere texts. In reality, the implementation of the system has a cost, and if the implementation cost of the system is not taken into account, the system itself may not play the expected role. The implementation costs of the system are diverse, and one of the most important categories is the cost of information. Missing, false, inaccurate and delayed information can make the enforcement of the aforementioned corporate law system unable to open or unable to obtain the support of the court or tribunal due to the lack of evidence legal claims, and the cost of obtaining accurate and timely information cannot be ignored.
(II) Blockchain’s mitigation of information asymmetry problem and technical basis
Unlike the path of institutional rationality, blockchain technology adopts a path of technical rationality in the face of corporate agency cost problem. This path extends the focus from system setting to system execution, focusing on the execution effect of the corporate law system. With the unique technical features, blockchain technology can alleviate the information asymmetry problem in the company, reduce the information cost of system implementation, enhance the effectiveness of the corporate law system, and ultimately create trust within the company. As Karen Young (2019) points out, blockchain technology and law have a “mutually reinforcing” relationship and can be “used to support and enhance the efficiency of traditional law enforcement”.
With its technical features, blockchain technology can alleviate the information asymmetry within companies and reduce the information cost of implementing corporate law system in three dimensions: information sharing, authenticity and real-time. Firstly, the sharing of information. Compared with the centralized ledger in which transaction records are monopolized by one center, each node in the blockchain has all the transaction data. The blockchain ledger records various types of “transaction data” in the form of pre and post connected blocks (Chang Tongs and Han Feng, 2016). In the corporate domain these transaction data include equity transaction data, corporate asset transaction data, and corporate voting data, etc. Each node in the blockchain has equal status and enjoys the ability to send, receive, and record information equally. A verified transaction record will be propagated to each node in the blockchain network in a short period of time until all nodes receive this transaction record (Wenjian Tang and Wen Lu, 2016). Second, the authenticity of the information. The data information recorded in the blockchain ledger is tamper-evident, and this feature ensures that the data information recorded in the blockchain is authentic and reliable. The technical basis for the tamper-evident nature of blockchain data records lies in technologies such as hash operations, consensus algorithms, Merkle trees, and timestamps. There are only two ways to tamper with the data information in the blockchain, one is to forge the transaction chain, and the other is to control more than 50% of the nodes. Both paths are extremely unrealistic from a technical point of view (Huawei Blockchain Technology Development Team, 2019). Merkle tree technology and timestamp technology further solidify the tamper-evidence of blockchain: the former helps to quickly summarize and verify the existence and integrity of block data, making tampering easy to detect and detect; the latter stamps each data block on the blockchain with a generation time equivalent to an ID card, increasing the difficulty of data tampering (Yuan Yong and Wang Feiyue, 2016). Finally, the real-time nature of information. The blockchain ledger is in a real-time update state and is able to record the latest transaction information in a timely manner. The whole process of a transaction from occurring to finally being credited to the existing blockchain does not take long. Take Linq, a blockchain technology platform adopted by the NASDAQ stock exchange in the U.S. As an example, the Linq blockchain provides a service for private companies to record the transfer of shares held by founders, early investors and employees. With no reliance on any third party to validate and approve these transactions, the standard settlement time was reduced from three days to 10 minutes (Singh et al., 2020). And as blockchain technology continues to advance, blockchain transaction confirmation time continues to decrease. The timely access to information can ensure the real-time supervision of the company and enhance the effectiveness of supervision.
(III) Practical significance of integrating blockchain technology into corporate governance
The information symmetry effect brought by the integration of blockchain technology into corporate governance can create trust within the company. This trust creation is carried out sequentially along the lines of “trust in data”, “trust in corporate law system” and “trust in company insiders”: technical features of blockchain The authenticity and real-time nature of the company blockchain data are guaranteed; the authenticity and real-time nature of the company blockchain data enable the shareholders and creditors of the company, who are the nodes of the blockchain, to observe the latest developments of the company in real time and accumulate evidential information to initiate relevant legal procedures in a timely manner. In this way, while the effectiveness of the corporate law system is enhanced, the trust of system participants in the corporate law system is naturally enhanced; because the corporate law system and the protections it provides can be trusted, small and medium-sized shareholders and creditors, as outsiders to the company, can also feel comfortable leaving their funds in the hands of company insiders. Company insiders will also become trustworthy under the regulation of effective corporate law system.
From the perspective of our corporate governance practice, the internal trust creation mechanism of blockchain is important for the protection of small and medium-sized shareholders and corporate creditors. In China’s corporate governance practice, there are numerous cases in which directors, management and major shareholders use their positions and shareholdings to harm the interests of small and medium shareholders. Through affiliated transactions, short term transactions and insider trading, directors, management and major shareholders seize unlawful benefits from the company to the detriment of the interests of vulnerable minority shareholders. Although China’s Company Law and Securities Law have set up corresponding legal liability mechanisms, the actual effect is still limited. One of the most crucial reasons is that the illegal acts of directors, management and major shareholders cannot be discovered in time so that the accountability procedure can be initiated in time, and at the same time, the legal claims of minority shareholders cannot be supported by courts or arbitration tribunals due to the unavailability of sufficient evidence. After the introduction of blockchain into corporate governance, small and medium shareholders, as nodes of the company’s blockchain network, have information such as the company’s equity transaction data, asset transaction data and voting data, and these data obtained through the blockchain itself are untamperable and timely. This can help the minority shareholders as the nodes of the participating chain to observe the wrongdoings of these specific subjects in a timely manner and accumulate evidence, as well as to deter potential wrongful damage. The introduction of blockchain technology will make the minority shareholder protection system in corporate law effective and ultimately boost the trust of minority shareholders in the corporate law system and corporate insiders.
The introduction of blockchain technology into corporate governance can also protect the company’s creditors. By becoming a blockchain node during transactions with a company, a company’s creditors are able to access past and real-time data on the company’s financial and operational status. And based on the trust in the company’s blockchain data, creditors are able to transact with the company at a lower transaction cost. Taking the company’s ultra vires guarantee as an example, in recent years, there has been more than controversy in our academic circles over the legal validity of guarantee contracts signed by companies in violation of internal procedures. After blockchaining the company’s vote, by becoming a node of the company’s blockchain, the creditor is able to obtain data information related to the company’s guarantee resolution from the company’s blockchain, and with the technical characteristics of the blockchain, this resolution has true accuracy. In this way, the problem of company’s ultra vires guarantee is eradicated at the source. In addition, if the transaction contract between the company’s creditors and the company stipulates a certain condition or behavior of the company as an event of default, then with the real-time nature of the company’s blockchain data, the creditors can also discover the company’s default early and thus initiate relevant legal procedures. In this way, the effectiveness of creditor legal protection systems is enhanced, and creditor trust in these systems and company insiders is naturally increased.
As the information asymmetry problem weakens, agency costs are reduced. However, it must be acknowledged that there are limits to the improvement of corporate governance by blockchain technology. First, blockchain technology itself has costs, such as technology risk costs, energy costs, and so on. The relative measure of these costs versus the value enhancement of blockchain technology to the company will influence the decision to introduce blockchain technology in a given company. In the early stage, blockchain technology is mainly used by public companies due to cost considerations, and limited liability companies are not suitable for introducing blockchain. However, as the technology develops, the cost of using blockchain technology will gradually decrease and the scope of application will be broader. In addition, as mentioned below, the basic chain type of company blockchain is private chain, and the energy cost of such chain type is not significant. Second, blockchain technology cannot infinitely reduce the cost of corporate agency. Mark Roy (2008) distinguishes agency costs as those of breaching the duty of diligence and those of breaching the duty of loyalty. According to this dichotomous framework, blockchain technology mainly targets the agency cost of breach of duty of loyalty, such as discovering connected transactions and insider trading through abnormal capital flow records; while for the agency cost of breach of duty of diligence, blockchain technology is of limited use.
Third, the path of integrating blockchain technology into corporate governance
(A) Chain type choice: private chain rather than public chain and alliance chain
There are three subtypes of blockchain: public chain, coalition chain and private chain, which are based on different consensus mechanisms, and the degree of openness or decentralization decreases in order from there (Zhao Lei, 2020). Among these three types of blockchains, public and alliance chains are not suitable as the basic chain type of company blockchains, and private chains are relatively more suitable chain types although they also have certain defects.
For the reasons of node scale and company trade secret protection, public chain is not suitable as the basic chain type of company blockchain. First of all, the public chain lacks a central maintenance organization, and the basis for it to run on its own without crashing is that there are so many nodes participating in the public chain that no person or organization can control more than 50% of the nodes. No person or organization can control more than 50% of the nodes, and the number of shareholders of a single company is limited, so it is easy to fall into the trap of “51% attack”. Second, anyone in the public chain can freely access the company’s blockchain and obtain information about the company’s internal transactions. Once the company’s trade secrets characterized by this information are compromised, the company will be passive (Kelly and Mescall, 2018). In addition, the regulatory challenges and unaffordable costs caused by decentralization are disadvantages of public chain corporatization applications.
Private chains and federated chains acting as a corporate blockchain foundation each have advantages and disadvantages, but in comparison, private chains have more potential. First, from the perspective of real-life applications, private chains are more compatible with corporatization scenarios. The nodes in a coalition chain are mainly organizations, and the applicable scenarios are mainly industries, such as payment settlement between banks, logistics supply chain management between enterprises, and data sharing between government departments. In contrast, private chains are mainly used within organizations, such as bill management and account auditing within enterprises, or internal government management (Huawei Blockchain Technology Development Team, 2019). Second, in terms of the compensability of defects, the compensability of private chain drawbacks is much higher. The disadvantage of a private chain is that a centralized organization may abuse its control power to tamper with the company’s blockchain ledger records, while its advantage is that the existence of a power center facilitates supervision and enables timely and effective resolution of disagreements in the blockchain to reach consensus. On the contrary, the consensus mechanism is based on the unanimous agreement of pre-selected nodes, so it has the advantage that no one person or organization can control the operation of the blockchain. At the same time, the unanimous agreement of preselected nodes means that there must be a high degree of trust among preselected nodes. Once the coalition chain fails to reach consensus and falls into “consensus deadlock”, the blockchain will not function properly. Therefore, federated chains are suitable for organizations with high trust and limited membership size. However, the trust relationship is not constant, which directly leads to the limited scope of the application of coalition chain corporatization. The lifeblood of private chains lies in centralized institutions, and the scope of corporate application of private chains is extremely wide under the premise that centralized institutions are effectively regulated by law.
(B) Choice of the main body of the supply chain: the market rather than the government
The choice of the main body of chain supply involves two issues: first, is the market or the government to provide blockchain information products? Secondly, if blockchain information products are provided by the market, does the chain provider need to meet certain regulatory requirements?
Blockchain information products should obviously be provided by market entities. In the mainstream economic theory, the government only provides one kind of product, “public goods”. This is because public goods are not exclusive and competitive, and the problem of free-riding is serious, but public goods can really improve social welfare, so the government should provide such products to society (Mankun, 2015). Based on the technical means that can isolate non-payers from blockchain information products, blockchain information products are exclusive and do not belong to public goods.
Of course, not any market entity can provide corporate blockchain information products, and it is necessary to impose some external regulation on the supplying entity. Blockchain information products are highly technical, which makes the information asymmetry between providers and consumers of blockchain information products worsen, and the moral risk of providers also rises. The market for blockchain information products has the characteristics of a “lemon market”, and external intervention can enhance social welfare (Akerlof, 1970). As for how to construct the regulatory mechanism and the corresponding private law rules, it will be discussed later.
(iii) Choice of nodes in the chain of participation: stakeholder-oriented
The third issue at the path level is which subjects can access the company blockchain network as nodes. Is only the shareholder group suitable for accessing the company’s blockchain? Can other company stakeholders access it? In addition, can public authorities such as governments and courts require access?
Whether stakeholders (including shareholders) can access the company’s blockchain network involves the measurement of both the protection of company’s trade secrets and the benefits brought by the stakeholders’ access to the company. On the one hand, allowing stakeholders to access a company’s blockchain can bring gains to the company in terms of trading terms. With increased transparency and access to company information, the agency costs of the company will be reduced: the company will be able to obtain financing from shareholders and creditors at a lower cost, as well as more room for benefits in employment contracts with company employees; and consumers will be willing to buy company products or services at a higher price. On the other hand, with the expansion of the scale of access nodes, the number of individuals who have access to the company’s internal information increases, and the risk of leakage of the company’s trade secrets gradually rises. However, it must be pointed out that the risk of trade secret leakage is limited because the company information recorded in the company blockchain is only data about the company’s equity transactions, company asset transactions and company voting, and there are no other specific matters, so the trade secret nature of the company blockchain ledger is limited. Even if a node decodes the company’s trade secret with the limited information in the blockchain ledger, the company can still defend its rights according to the legal system of trade secret protection in China. In conclusion, whether the stakeholders can access the company blockchain is a commercial decision issue, which should be rationally weighed by the company as a commercial subject and its transaction objects.
In principle, public authorities are not allowed to access the company blockchain, but only in the case of public functions and protection of public interests are public authorities allowed to access the company blockchain system. At the same time, the law should give the company certain remedial rights. For example, in order to investigate the illegal acts related to the company blockchain and to obtain evidence, the supervisory department can request access to the company blockchain according to the law in order to implement administrative investigation. At the same time, in order to protect the company as an administrative counterpart, the regulatory department should follow the principle of statutory authority and statutory procedure, identify itself to the company and fulfill its obligation to inform and explain. In the investigation process, the company has the right to state and defend and request the investigation department to be recorded, and can be defended through administrative reconsideration, administrative litigation and administrative compensation and other post-facto ways.
(D) bookkeeping object choice: equity transaction data, corporate asset transaction data and voting data
After determining the chain type, the main body of the supply chain and the participating nodes, the last issue of blockchain corporatization application is which types of company information can be chained to become the object of the company blockchain ledger record. Blockchain is essentially a distributed ledger to record all kinds of “transactions”, and the transactions in the company scenario include shareholder-level equity transactions and company-level asset transactions. In addition, since company voting also involves “interactive relationship”, with the help of blockchain technology to simulate the voting behavior by coin voting, the company voting information can be transformed into “transaction-like” data and recorded in the company blockchain. Therefore, there are three types of data that can be recorded by the company blockchain: equity transaction data, company asset transaction data and company voting data.
- Equity transaction data as a record object
By blockchaining the issuance and trading of company shares, i.e., requiring all shareholders to become company blockchain nodes and subscribe and trade company shares on the blockchain through tokens, the equity transaction data can become the object of company blockchain records. With the help of blockchain technology, the information of company’s equity transactions recorded on the company’s blockchain is timely and accurate. At the same time, after the blockchaining of company equity transactions including stock issuance, each subject in the company blockchain node can be informed of the current structure and changes in the company’s equity holdings, which greatly enhances the transparency and liquidity of the company’s equity holdings (Yermack, 2017).
In terms of the effectiveness of the enforcement of the corporate law system, the blockchaining of corporate equity transactions can effectively enforce Articles 44 and 53 of the Securities Law, combat short trading practices and insider trading practices, and reduce corporate agency costs. Although China’s Securities Law sets civil liability mechanism of short trading imputation right and administrative liability mechanism of warning and fine for short trading behavior, in reality short trading behavior is not effectively regulated (Jiang Peng, 2017), and the important reason is that it is difficult to discover short trading behavior in time. With the blockchain distributed ledger, each subject in the node has the incentive and ability to discover the short trading behavior of the special subject in time, and promote the civil and administrative enforcement procedures against the illegal behavior. Similarly, the blockchaining of corporate equity trading also helps to timely detect insider trading violations, thus initiating corresponding enforcement procedures and improving the effectiveness and deterrence of the insider trading legal system.
Blockchaining of corporate equity transactions can also promote the effective implementation of the large shareholding disclosure system. Controlling shareholders or other major shareholders are considered to have accurate information about the value of the company, so requiring these shareholders to disclose their shareholding movements in a timely manner can disseminate information about the true value of the company to other shareholders (Xie, Zhengshan, 2018). However, Article 63 of our Securities Law still sets aside a buffer period of several days for disclosure obligors, which certainly takes into account the preparation time required for disclosure, but also detracts from the function of the large shareholding disclosure system. The blockchaining of corporate equity transactions allows other shareholders of the company to observe in real time the shareholding movements of the controlling shareholder and other major shareholders and to adjust their perception of the value of the company in a timely manner based on this movement. As a result, the share price is much more sensitive to the company’s management and financial situation, and more responsive to the company’s agency costs. It is in recognition of the many values of blockchaining equity transactions that extraterritorial legislatures (Song, 2017), stock exchanges (Avdzha, 2017), and private companies (Ryan and Donohue, 2017) have started the practice early.
In the specific design of blockchaining of equity transactions, the issue of node anonymity needs to be addressed, i.e., whether anonymization of shareholders on the blockchain is required as it relates to the protection of personal property privacy. With anonymization, the company blockchain nodes can only observe the current status and changes of each account’s shareholding, and cannot see through to the true identity of the account holder. In the context of China’s corporate law, anonymization is not necessary. On the one hand, with the use of the national enterprise credit information disclosure system, the identity of shareholders has been made public, and anyone can use this platform to inquire about the true identity of shareholders of a particular company; on the other hand, the anonymization process will detract from the advantages of blockchaining equity transactions, for example, Article 44 and Article 53 of the Securities Law regulate subjects with special identities, and the anonymization of the identity of these subjects will lead to Even with the help of blockchain, the relevant illegal acts cannot be identified.
- Corporate asset transaction data as a record object
As early as 2015, some commentators discussed the possibility of companies trading assets through blockchain and recording the corresponding data in the blockchain ledger. This is technically feasible, i.e., it only requires companies and their counterparties to conduct asset transfer activities on the blockchain via tokens.
Blockchaining corporate asset transactions can reduce corporate agency costs in four ways. First, blockchaining corporate asset transactions can reduce management agency costs. With blockchain technologies such as hashing, consensus algorithms, Merkle trees, and timestamps, company managers cannot manipulate accounting reports using strategies such as backdating sales contracts to the previous reporting period or amortizing operating expenses that should be expensed immediately and pushing them to future periods (Yermack, 2017). Second, the blockchaining of corporate asset transactions can mitigate agency costs stemming from connected transactions and facilitate the enforcement of Article 20 of the Company Law. For subjects such as controlling shareholders, actual controllers, directors, supervisors, and senior managers of a company who take advantage of their shareholdings or positions to conduct unfair connected transactions with the company, Article 20 of the current Company Law in China mainly regulates them by giving the company the right to claim damages as a civil liability mechanism. However, the key to the implementation of this article is how to timely detect unfair connected transactions and obtain corresponding evidence to support them. Blockchaining the company’s asset transactions can help the participating nodes to observe the transactions between the company and these specific subjects in a timely manner, so as to accumulate evidence for the exercise of the company’s right to claim damages, and also to deter potential unfair connected transactions. Again, the blockchaining of company asset transactions can reduce the agency costs originating from accountants and auditors. While accountants and auditors can help reduce management agency costs, they can themselves lead to agency costs. The private interests of accountants and auditors are not always aligned with the interests of those to whom accounting and auditing reports are used. As Coffey (2011) suggests, imperfect market competition, reduced reputational capital value, and low risk of legal action can lead to a dysfunctional gatekeeper mechanism. With blockchaining of corporate asset transactions, users of corporate accounting and audit reports can rely on blockchain records rather than just “gatekeepers” to determine the financial and operational status of a company. Finally, blockchaining corporate asset transactions can reduce or even eventually eliminate accounting and auditing costs. With the advantages of blockchain technology’s immutability and traceability, blockchaining corporate asset transactions can guarantee the authenticity and accuracy of corporate accounting documents, which may make traditional accountants and auditors replaceable and ultimately worthless, thus saving traditional accounting and auditing expenses (Piazza, 2017).
The main theoretical challenge of blockchaining corporate asset transactions is how to prevent the disclosure of corporate trade secrets (Avdzha, 2017), thus alleviating the inherent tension between the problem of corporate information asymmetry and the protection of corporate trade secrets. In this regard, two perspectives, technical and legal, can be approached separately. The technical response is mainly limited anonymization, i.e., the anonymization of the company’s counterparties and transaction matters. In this way, the participating chain nodes can only observe the amount and time of the transaction, but cannot know the real identity of the transaction matter and the counterparty. However, the subjects such as controlling shareholders, actual controllers, directors, supervisors and senior managers of the company as stipulated in Article 20 of the Company Law must be anonymized when trading assets with the company through the blockchain, because the anonymization of these subjects brings limited risk of leakage of the company’s trade secrets, but can effectively deter unfair connected trading practices. The main legal reliance is on the legal protection system for trade secrets, which is discussed in detail below.
- Company voting data as a record object
Although corporate voting is not a purely transactional act, through technical transformation, corporate voting can be changed into a “transaction-like” act to be recorded in the corporate blockchain ledger, i.e., tokens are allocated according to the size of voting rights owned by voting subjects, and these subjects who own voting tokens vote by transferring voting tokens to blockchain addresses. The company blockchain ledger will record these “transactions” and form the final voting result (Yermack, 2017). The practical community has also begun to explore and implement this idea. The existing focus of blockchaining corporate voting is mainly on the shareholder voting scenario, but in addition to the shareholder voting scenario, the applicability of blockchaining corporate voting can also be extended to the board of directors and supervisory board voting scenarios.
Blockchaining of corporate voting data can optimize traditional voting procedures and reduce the problem of corporate proxy costs. First of all, it can improve the accuracy of vote counting and prevent unlawful acts. Whether the traditional paper-based voting method or electronic voting system, there are problems with the accuracy of vote counting. Intentional or negligent vote counting personnel will lead to inaccurate vote counting, especially in the case of close voting results, and related disputes will lead to shareholders’ loss of confidence in the voting results. Blockchaining corporate voting can improve the accuracy and credibility of corporate voting results, and promote shareholder activism while preventing management and major shareholders from manipulating voting results and reducing proxy costs (Piazza, 2017) (Daniels, 2018). Second, to prevent empty voting (empty voting) behavior. Easterbrook and Fisher (2014) point out that the separation of voting and earnings rights from each other under empty voting behavior triggers agency costs. Under corporate voting blockchaining, voting rights are tokenized and both parties to the voting transaction must transfer voting tokens through the corporate blockchain, and once the transfer occurs, it is inevitably recorded by the corporate blockchain and draws the attention of other participating nodes. Opponents can take timely action to stop the empty voting practices, and regulators may also react. Finally, the prevention of agency costs stemming from the risk of corporate guarantees has been detailed in the previous section and will not be repeated here.
IV. Risks and legal responses to the integration of blockchain technology into corporate governance
(A) Identification of the type of risk of company blockchain technology
According to the source of risk, the risk of company blockchain technology can be divided into four categories: the risk from the provider of blockchain information products, the risk from the participating nodes, the risk from the central institution and the risk from hackers (see Figure 1). The risk from blockchain information product providers mainly refers to the property loss caused by the defective or faulty blockchain information product quality, such as the blockchain system crash and data loss caused by the defective or faulty product, and the hacker taking advantage of the defective or faulty blockchain system to disrupt the normal operation of the blockchain system (such as cracking the private key of the participating node and stealing the equity tokens and voting tokens of the participating node), etc. The “DAO attack” that shocked the blockchain community in 2016 is one of these risks. The risk from participating nodes is the risk of company trade secrets leakage, i.e., participating nodes use the company information in the blockchain ledger to obtain and use the company trade secrets to harm the company’s interests. The risk of money laundering also falls under this category. The risk originated from the central institution mainly refers to the risk that the central institution of the private chain, which is the basic chain type of the company’s blockchain, abuses the technical power and disrupts the normal operation order of the company’s blockchain. For example, the central organization uses technical power to tamper with the company blockchain ledger records. Risk originating from hackers i.e. the risk arising from hackers attacking the company’s blockchain system. This type of risk does not include the risk of hacking due to defects or flaws in the company’s blockchain system itself, as this type of risk falls under the first category of risks originating from the provider of blockchain information products.
(2) Private law remedies for company blockchain technology risks
- Risks originating from the providers of blockchain information products
The risks originating from the providers of blockchain information products are often related to the quality problems of blockchain information products. Once the risk becomes real, companies and participating chain nodes often become direct victims. When the damage occurs, depending on the specific nature of the quality problem, the relevant damaged subjects can claim the liability for breach of contract or tort liability according to the mechanism of contract law or the mechanism of tort liability law.
First of all, if the quality of blockchain information products is “defective”, the company as a buyer can demand the seller to bear the liability for breach of contract according to the contract jurisprudence. According to Article 617 of the Civil Code, if the blockchain information products delivered by the seller of the blockchain information products do not meet the quality requirements (i.e. there are defects), the company as the buyer can request the seller to bear the liability for breach of contract according to the provisions of Articles 582 to 584 of the Civil Code. The specific determination of defects is provided for in Articles 615 and 616 of the Civil Code, respectively, in cases where there is an agreement in the contract and cases where there is no agreement or an unclear agreement. Of course, the company as the buyer according to Article 620 of the Civil Code also has a certain obligation to inspect, but this obligation is very limited. Since blockchain information products are different from general products in terms of information, intangibility and high-technology, the buyer’s obligation to inspect is only limited to the defects in the “appearance” of blockchain information products according to Article 622 of the Civil Code. After the provider of blockchain information products assumes the liability of breach of contract to the company, the damaged participating nodes can request the company to assume the liability of breach of contract based on the legal relationship of the participation contract with the company.
Secondly, if the quality of the blockchain information product is “defective”, the tortfeasor, including the company and the participating nodes, can request the provider of the blockchain information product to bear the tort liability according to the tort liability jurisprudence. According to paragraph 1 of Article 1203 of the Civil Code, if a blockchain information product is defective and causes damage to others, the tortfeasor can request compensation from the producer or seller of the blockchain information product; Article 1205 of the same law gives the tortfeasor the right to request the producer or seller to assume tort liability such as stopping infringement, removing obstruction and eliminating danger. For the identification of defects of blockchain information products, we can refer to the provisions of Article 46 of the Product Quality Law, which specifically includes three types of design defects, manufacturing defects and warning defects (Cheng Xiao, 2011). the DAO attack was obviously due to the defects in the design of the DAO platform.
When the blockchain information product constitutes both defects and defects, the company enjoys the right to claim breach of contract liability and tort liability against the product provider at the same time, but these two constitute competing claims, and if the company exercises one of them, the remaining one will be eliminated at the same time. Similarly, the damaged chain node’s claim for breach of contract and tort liability against the company and the product provider also constitute competing claims.
- Risk from the Participating Node
The company’s blockchain node may use the company’s information recorded in the company’s blockchain ledger to obtain the company’s trade secrets and disclose, use or allow others to use these secrets, thus causing damage to the company’s interests. In this regard, the Company may seek remedy according to the civil liability mechanism for trade secrets set by the Anti-Unfair Competition Law. Since the chain node and the company signed the chain agreement necessarily involves the confidentiality obligation of the chain node, the act of the chain node obtaining and disclosing, using or allowing others to use the company’s trade secrets with the help of the company’s blockchain ledger belongs to the act of infringement of trade secrets stipulated in Article 9, paragraph 1, item 3 of the Anti-Unfair Competition Law. Moreover, the second paragraph of Article 9 of the Anti-Unfair Competition Law has extended the subject of infringement of trade secrets from operators to non-operators such as natural persons, legal persons and unincorporated organizations, so there is no doubt about the subject matter. According to paragraph 1 of Article 17 of the Anti-Unfair Competition Law, the company may request the nodes of the chain of participation to bear civil liability, and the amount of specific damages may be determined according to paragraphs 2 and 3 of the same article.
- Risks from the central institution
The chain type suitable for company blockchain is private chain, but there is a central organization in the private chain, which has great power, and if it is not regulated, the normal operation of company blockchain will be damaged. The private regulation of the central institution can be carried out at two levels: contract mechanism and fiduciary obligation mechanism. First of all, the company can set the code of conduct of the central institution in the agreement with the central institution, including specific provisions and underwriting provisions. In case of misconduct of the central institution, which violates the specific terms of the agreement or does not comply with the spirit of the underwriting clause, the company can require the central institution to bear the liability for breach of contract according to the terms of the agreement. Second, the company may direct a specific director or officer to hold a position at the center. In this way, the director’s or senior management’s behavior is included in the scope of regulation of Article 147(1) of the Company Law of China, which requires a fiduciary obligation to the company. This fiduciary duty is a statutory obligation and does not require a specific contractual provision. In the event that a director or officer of a central institution abuses his or her technical authority and causes damage to the company, the company may request that the director or officer be held liable for damages pursuant to Articles 147(1) and 149 of the Company Law.
- Risk from hackers
Hacking of the company blockchain can cause damage to the company and the participating nodes. In this case, the company and the participating nodes can claim private law remedies under Article 127 of the Civil Code. Among them, the company claims that the data rights are damaged, i.e. the hacker attack causes the loss or leakage of the company data information recorded in the company’s blockchain ledger; the participating nodes claim that the network virtual property rights are damaged, i.e. the hacker attack causes the theft or loss of the equity tokens and voting tokens of the participating nodes. However, in the near future, the relief effect of Article 127 of the Civil Code is limited. On the one hand, the hacker’s identity is highly concealed, and the real identity of the hacker is difficult to be discovered under the existing technical means; on the other hand, the supporting provisions of Article 127 of the Civil Code are not sound, and the academic and practical circles do not have a uniform understanding of the relevant issues. For example, the legal nature of the right to network virtual property and the setting of supporting legal rules are widely divergent in the academic community (Yang Lixin, 2017). In addition to the relief of Article 127 of the Civil Code, the insurance mechanism can also be an alternative remedy, but this requires finding an insurer in advance and signing a property insurance contract, as well as agreeing the hacking attack as an insurance accident.
(C) Regulatory response to the risk of corporate blockchain technology
- Need for regulation: correcting market failure and preventing technical power abuse
Is it necessary to respond to the risk of corporate blockchain technology through government regulation? From the perspectives of correcting market failure and preventing abuse of technological power, government regulation is necessary.
The regulation of corporate blockchain technology is consistent with the theory of market failure. Private autonomy should be the basic principle in the field of private relations, and government intervention should be the exception. However, the government is not inactive, and “market failure” constitutes a legitimate reason for government intervention, including imperfect competition, imperfect information, externalities and public goods (Stiglitz and Walsh, 2010). Blockchain technology is characterized by information, complexity and technology, and the problem of information asymmetry between buyers and sellers is more serious. As a seller, the provider of blockchain information products has sufficient information about the performance of the products, while the company as a buyer has limited expertise and ignorance of the specific performance of the products, and holds a natural distrust of the quality of the products, so the market of blockchain information products is actually a “lemon market”. Government regulation can eliminate the mistrust between buyers and sellers, eliminate the lemon market effect, and correct the market failure.
Moreover, government regulation can curb the abuse of technical power and protect the vulnerable participating nodes. Under the corporate blockchain network, the central institution has technical power over the general participating nodes and can decide the participation authority and read access to the corporate blockchain. As Montesquieu pointed out, it is an unchanging law that any person with power is prone to power abuse. The only way to prevent power abuse is to restrain power with power, and this holds true for corporate blockchains as well. “Even if the blockchain can work perfectly, its design, implementation and use are all done by people. While its manifestation is in objective code, subjective intent still has an impact on this system. Blockchains are vulnerable to selfish actions, attacks, and manipulation.” (Wolbach and Shaowei Lin, 2018). It is through the power of government regulation to restrain the power of technology in order to prevent the abuse of blockchain technology power, eliminate technology discrimination, and protect consumers of blockchain information products.
- the unfolding of the regulatory path – and evaluation of the Blockchain Information Service Management Regulations
(1) The objects of regulation include blockchain information product providers, central institutions, and participating chain nodes
Although blockchain information product providers, central institutions, and participating chain nodes are all sources of risk for the company’s blockchain technology, the need for regulation does not exist for every subject, especially when private law remedies are sufficient to prevent specific risks. Regulation also has costs, and there should be a fine-grained screening of regulatory targets.
Blockchain information product providers need to be included in the category of regulatory targets because of the serious information asymmetry between them and consumers of blockchain information products. The regulation imposed on the providers of blockchain information products can enhance consumers’ confidence in the market of the company’s blockchain information products and promote the sound development of the product market. Even if it is possible to privately regulate the providers of blockchain information products by means of breach of contract and tort liability, the high-tech nature of the products and the serious information asymmetry problem will make it difficult to identify the defects and flaws of the products, which will ultimately undermine the effect of private regulation, so regulatory intervention is necessary. The necessity of regulating private chain central institutions is to prevent them from abusing their technical power and infringing on ordinary participating nodes. Although such risk can be privately regulated through breach of contract and fiduciary duty, the same information gap and evidence collection problems will make it difficult to support private law claims. There are also certain regulatory requirements for the participating nodes, because while private law regulation can prevent the risk of commercial leakage of companies, it cannot do anything about the risk of money laundering.
According to Article 2 of the “Blockchain Information Service Management Regulations” (hereinafter referred to as “Blockchain Regulations”), the targets of regulation are “blockchain information service providers” and “blockchain information service users”. Blockchain information service providers include subject-based, node-based and technical support providers, and blockchain information service users refer to organizations or individuals who use blockchain information services. Here, the company blockchain information product provider belongs to the main type provider, while the central organization belongs to the node type provider, and the company and the general participating nodes belong to the blockchain information service users. In this way, blockchain information product providers, private chain central institutions, general participating nodes and even companies belong to the regulatory objects of the Blockchain Regulations.
(2) Constructing a comprehensive regulatory system of public regulation, self-regulation, private regulation and social regulation
From the Blockchain Provisions, China has established a comprehensive regulatory system from public regulation, self-regulation, private regulation to social regulation. First, public regulation. According to Article 3 of the Blockchain Provisions, China has established two levels of regulatory bodies, namely the State Internet Information Office and the Internet Information Offices of provinces, autonomous regions and municipalities directly under the Central Government, and the two levels of public regulatory bodies are responsible for the supervision, management and enforcement of blockchain information services nationwide and within their own administrative regions according to their duties. To facilitate the performance of duties, the Blockchain Provisions also grant the public regulators the necessary regulatory powers, including the right to regularly check relevant information (Article 14), to require cooperation with supervision and inspection according to law (Article 18) and to impose administrative penalties. Second, self-regulation. According to Article 4 of the Blockchain Provisions, China encourages blockchain industry organizations to strengthen industry self-regulation and establish a sound industry self-regulatory system and industry guidelines. Again, private regulation. China’s private regulation of blockchain information services can be divided into two types: intermediary regulation and regulation of blockchain information service providers. The former mainly refers to the “construction of industry credit evaluation system” in Article 4 of the Blockchain Provisions, such as the development of some rating agencies to rate the performance of blockchain information products of companies; the latter mainly refers to the regulation of blockchain information service providers on the performance of blockchain information products. The latter mainly refers to the regulation of blockchain information service providers on blockchain information service users, such as real identity registration (Article 8), special handling measures (Article 16) and content records (Article 17). Finally, social regulation. Article 4 of the Blockchain Provisions specifies the status of social supervision, while paragraph 2 of Article 18 stipulates the path to achieve social supervision, i.e., the public can complain and report through the complaint reporting portal set by the blockchain information service provider.
It should be said that the regulatory system of China’s blockchain information services has been relatively complete, but there are three aspects that need to be improved. First, the internal coordination and articulation of the regulatory system. The improvement of the regulatory system is not only in the comprehensiveness of the coverage of the regulatory body, but also in how to clarify and avoid regulatory overlap and regulatory offloading, clarify the regulatory boundary between different regulatory bodies, reduce regulatory costs and maximize regulatory benefits. The Blockchain Regulations do not pay enough attention to the problem of regulatory conflicts between different regulatory bodies. Second, the improvement of the supporting rules of the regulatory system. For example, should the “industry credit evaluation system construction” rely on the market or the government? How to stimulate public participation and supervision? Finally, the standard should be upgraded to a higher level, and regulated by law rather than just departmental regulations.
(3) Regulatory Approach
①Adopt classification regulation instead of integrated regulation
According to whether the differentiated regulation is carried out according to the difference of regulatory objects, the regulation is divided into two types: one regulation and categorized regulation. The Blockchain Regulations adopt the path of categorical regulation for the regulatory objects, i.e., different regulatory paths are adopted for blockchain information service providers and blockchain information service users. First, from the perspective of the regulatory system, blockchain information service providers are mainly regulated by two levels of Internet information offices, while blockchain information service users are mainly regulated by blockchain information service providers. Secondly, in terms of regulatory basis, the two levels of Internet information offices regulate the blockchain information service providers mainly based on the administrative regulations of the Blockchain Provisions; and based on Article 7 of the Blockchain Provisions, the blockchain information service providers regulate the blockchain information service users based on service agreements and platform conventions.
The classification regulation based on the criteria of provider and user is reasonable. On the one hand, it is cheaper for providers rather than public institutions to supervise users. Compared with public regulators, providers enjoy the advantages of information and platform because they are directly connected with users, so it is less costly to identify and effectively respond to the risks originating from users in a timely manner. On the other hand, the full use of private regulatory resources can save public regulatory resources, so that the limited public regulatory resources can be focused on the supervision of providers and enhance regulatory effectiveness.
② Adopt a mixed access regulation system of subject access filing and product access approval
Access regulation involves both subject access and product access, and there are roughly two attitudes of approval system and filing system. Under the approval system, providers of blockchain information services must be approved by the regulator to obtain a “license” before providing blockchain information services; at the same time, new products and services must also be approved by the regulator to enter the market. The approval system is represented by New York State’s Bitcoin licensing system. In New York State, organizations or individuals involved in virtual currency business activities must obtain a license issued by a superintendent, and violators will be prohibited from operating in New York State or serving New York State residents. Similarly, new products or services entering the market must also be approved by the Superintendent. The original intent of the approval system was to safeguard the quality of blockchain information products and services through access control. Regardless of whether this original intent can be achieved, in New York State, the drawbacks of the approval system are already evident (Abualy, 2020). The development of the blockchain information product market has been hampered by strict regulation and the limited number of entities willing and able to obtain a license. Between June 2015 and June 2018, only six licenses were issued in New York State.
Our Blockchain Regulations adopt a hybrid system of subject access filing and product access approval. According to Article 11 of the Blockchain Provisions, a blockchain information service provider entering the blockchain information service market only needs to fill in the name of the service provider, service category, service form, application area, server address and other information through the blockchain information service filing management system of the State Internet Information Office within 10 working days from the date of service provision and fulfill the filing procedures, without the need to obtain any institutional approval. At the same time, the filed blockchain information service provider shall prominently mark its filing number (Article 13) on its Internet websites and applications that provide services to the public. However, according to Article 9 of the Blockchain Provisions, blockchain information service providers developing new products, applications and functions on line shall report to the Internet Information Office at the appropriate level for security assessment in accordance with relevant regulations, and failure to participate in security assessment will incur corresponding administrative liability (including suspension) and criminal liability (Article 19). This actually constitutes a kind of product access approval system.
It should be said that China’s market access system for blockchain information products is relatively reasonable. On the one hand, the subject access filing system, while recording the identity and address of the subject, reduces the difficulty and cost for the subject to enter the blockchain information product market, reduces the barriers to market entry, improves market competition, and is conducive to the improvement of blockchain information product quality and market prosperity; on the other hand, the legal liability system for security assessment and non-safety assessment of blockchain information products can effectively prevent the risk caused by blockchain information On the other hand, the legal liability system of security assessment and non-safety assessment of blockchain information products can effectively prevent the risks caused by defects and flaws of blockchain information products.
③Adopting principle-oriented rather than rule-oriented regulation
According to the regulation based on rules or principles, the regulation of the behavior of the regulatory object can be divided into two types of regulation by rules and regulation by principles. China’s “Blockchain Regulations” adopts the principle-based regulation for the behavior regulation of regulatory objects, and this approach has two advantages. First, the principle regulation does not set a uniform code of conduct for the regulatory target, but only requires the regulatory target to meet the regulatory standards according to its own situation. For example, Article 5 of the Blockchain Regulations requires blockchain information service providers to implement the responsibility of information content security management and establish a sound management system for user registration, information audit, emergency disposal and security protection. However, this article does not limit the specific content of the relevant management system, but can be designed by specific blockchain information service providers according to their own specific conditions. Article 6 of the Blockchain Regulations more clearly proposes that blockchain information service providers should have the technical conditions “appropriate to their services”. Second, the principle of regulation involving a wider scope can avoid the avoidance of law caused by too narrowly defined rules and better achieve the regulatory objectives. Article 10 of the Blockchain Regulations stipulates the lawful conduct obligations of blockchain information service providers and users, in which “national security”, “social order”, “the lawful rights and interests of others “The semantic range of “activities prohibited by laws and administrative regulations” and “information content prohibited by laws and administrative regulations” is extremely wide, which can effectively regulate the endless kinds of illegal behaviors of regulatory targets and achieve the regulatory objectives. The concept of “information security risks” in Article 15 of the Blockchain Regulations also has this feature.
(4) Summary: Blockchain Regulations from the perspective of corporate governance
Since the central organization and the participating nodes under the corporate blockchain essentially correspond to the directors (or officers) and stakeholders under corporate law, this means that the Blockchain Regulation will have an impact on corporate governance. First, in terms of the regulatory regime, directors acting as central agency duties are subject to the supervision of the Internet Information Office at both levels, while stakeholders accessing the company’s blockchain are subject to the supervision of directors acting as central agency duties. Secondly, in terms of access regulation, directors acting as the central agency need to perform filing procedures with the State Internet Information Office, while stakeholders participating in the chain need to register their true identity with the central agency director. Finally, in terms of behavior rules, compared with general directors, directors of blockchain central institutions have richer obligations, such as the responsibility of information content security management, which not only extends the content of fiduciary obligations to companies and shareholders, but also points to public interests; similarly, compared with general stakeholders, stakeholders of participating chain nodes also have more obligations, such as not using blockchain information services to produce, copy, For example, they shall not use blockchain information services to produce, copy, publish or disseminate information content prohibited by laws and administrative regulations, etc.
Blockchain technology can enhance transparency in specific fields, alleviate the problem of information asymmetry, and ultimately create trust. This makes blockchain technology uniquely advantageous in the field of corporate governance where trust is scarce. Unlike the traditional “institutional rationality”, blockchain technology represents a path of “technical rationality”. This technical rationality path cuts into the agency cost problem from the perspective of improving the effectiveness of legal enforcement, and solves the information asymmetry problem in corporate governance by promoting the sharing, authenticity and timeliness of information within the company, so as to improve the level of corporate governance.
In the specific path of blockchainization of corporate governance, private chain should be used as the basic chain type, market as the main body of chain supply, company stakeholders as the nodes of chain participation, and equity transaction data, company asset transaction data and company voting data as the bookkeeping objects. The integration of blockchain technology into corporate governance also brings new risks, which can be classified into four categories based on the source: risks from the providers of blockchain information products, risks from the participating nodes, risks from the central institution of the private chain and risks from hackers. The legal system can respond to these four types of risks from the perspectives of both private law remedies and regulatory responses.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/the-convergence-of-blockchain-technology-and-corporate-governance-values-paths-and-legal-responses/
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