List of Tables Chapter 2 Institutional Design Chapter 3 ...

List of Tables .............................................................................................................

Introduction ..............................................................................................................

Chapter 1

The Grounds of State Entrepreneurship ................................................................

1.1. Nationalistic Impetus ...........................................................................

1.2. Economic Pragmatism .........................................................................

Chapter 2

Institutional Design .................................................................................................

2.1. Oil Allocation Models ..........................................................................

2.2. Oil Exploitation Models ......................................................................

2.3. The Public Financing Strategy ...........................................................

Chapter 3

The Challenges of Investors’ Protection ................................................................

3.1. Direct Investors ....................................................................................

3.2. Portfolio Investors ...............................................................................

Conclusion …............................................................................................................

References .................................................................................................................

iii

1

4

7

15

23

24

29

39

46

48

56

75

77

1.1. Features of Latin American first wave of nationalization ..............................

2.1. Roots of Latin American domanial regimes ....................................................

2.2. Latin American shifts ........................................................................................

2.3. Risk and rewards of exploitation models ........................................................

2.4. NOCS public financing ......................................................................................

3.1. Corporate law protective measures for minority shareholders in Latin American ..

12

29

35

38

45

64

Ever since the first oil boom of mid-late 19th century in Pennsylvania and the

enshrinement as one of the most important primary commodities to start the

engine of modern societies, oil industries of resource rich-countries have been

subject to a number of schemes whereby states and private individuals interact to a

greater or lesser extent. Recent years have seen a number of contradictory events in

Latin America concerning the top five oil producers of the region, whose National

Oil Companies (NOCs) frequently fill the international news headlines.1

Consider on one end of the spectrum Petróleo Brasileiro S.A. (PETROBRAS)

and Empresa Colombiana de Petróleos (ECOPETROL). Equity and debt securities

issued by both companies are traded not only in domestic capital markets but also

in international platforms, such as NYSE, TSX, BME LATIBEX, Luxemburg, among

others. This fact itself is well seen by experts from a macro perspective, despite

drawbacks that have lately affected their stock prices.2 After all, the respective

administrations appear to put aside the classical debate according to which private

and public cash flows should be kept isolated from each other and they even make

such discussion sound impractical and out-of-date. PETROBRAS, particularly, saw

years of international splendor. In 2000, the company raised US$ 4 billion which

was deemed at that time the second largest offering ever made by an emerging

economy behind China Unicom.3 After the seasoned public offering of 2010, the

“Brazilian largest” was even considered by Bloomberg among the top four biggest

companies in the world alongside with ExxonMobil, Apple, and PetroChina,

surpassing other giants such as Microsoft and Wal-Mart.4 In addition, over the

recent months the news concerning the de-monopolization of the Mexican oil

industry spread throughout the globe. By the end of 2013 a remarkable

constitutional amendment was approved, putting an end to a 75-year-formal-

monopoly of Petróleos Mexicanos (PEMEX) over the oil and hydrocarbons sector.5

1 Mexico, Brazil, Venezuela, Colombia and Argentina are in that order the most important oil producers within

the region. See U.S. Energy Information Administration (EIA), International Energy Statistics: Petroleum

Production (2014), available at

http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=5&pid=53&aid=1&cid=AR,BL,BR,CI,CO,EC,M

X,PE,UY,VE,&syid=2000&eyid=2013&unit=TBPD 2 “The company’s market cap is currently $75.6 billion, a billion dollars less than it was when the FT did its

review. By comparison, ExxonMobil’s market cap is $407 billion. PetroChina has a market cap of $188

billion. Colombia’s Ecopetrol is now larger than Petrobras, with a market cap of $76.7 billion as of market

close today”. See Petrobras Now Smaller than Colombia's Ecopetrol, FORBES, MAR, 21, 2014, available at

http://www.forbes.com/. See also Ecopetrol Overtakes Petrobras by Market Cap, FINANCIAL TIMES, JAN,

27, 2013, available at http://www.ft.com/. 3 See William L. Megginson, The Financial Economics of Privatization (OUP 2005).

4 See Petrobras Raises $70 Billion in World's Largest Share Sale, BLOOMBERG, SEP, 24, 2010, available at

http://www.bloomberg.com/. 5See Oil’s well that ends well, THE ECONOMIST, DEC 14 2013, available at

http://www.economist.com/news/americas/21591579-bumpy-year-ends-high-note-oils-well-ends-well.

2 Introduction

On the other side, the negative perception towards Petróleos de Venezuela S.A.

(PDVSA) and Yacimientos Petrolíferos Fiscales (YPF) is the outcome of recent events

whereby the incumbent heads of government boosted the role of the state in their

industries. In 2007, Venezuela compelled companies such as BP, Chevron, Statoil

and Total to accept the terms of a new exploitation regulatory scheme of

mandatory joint ventures by which PDVSA preserved a majority interest of 60% in

all upstream and downstream carried out within the country; in contrast to the

above-mentioned companies, ConocoPhillips and ExxonMobil simply decided to

dump activities.6 In 2012, the Argentinean administration re-nationalized YPF

expropriating 51% out of 62.9% outstanding shares owned by Repsol, meaning that

such company lost control and turned into a minority shareholder.

Going deeper, however, the five scenarios look more alike to what they do

at first glance. The first homogenous feature is quite straightforward; today

Argentina, Brazil, Colombia, Mexico and Venezuela are characterized by the

existence of state entrepreneurship in the matter of oil; five resource-rich

countries, five state crown jewels. Secondly, the five industries are tending to

converge in regards to allocation of oil property and exploitation rights. Therefore

the regulatory schemes of their industries have similar features. As if this were not

enough, domestic and foreign private investors have join these states as “business

partners” not only within classical concessions, taxes and royalties systems or non-

corporate joint ventures, but also within a corporate context: at the very heart of

developed capital markets are the five NOCs resorting to public financing.

Precisely, not only PETROBRAS, ECOPETROL, and YPF play in the big leagues. Even

PEMEX and PDVSA issue public debt in worldwide capital markets, offering only

debt securities perhaps as a way to keep their public statuses intact. Regardless of

the status of partially-owned or wholly-owned, these state-run companies are all

linked to a diverse array of public investors, including institutional and retail as

well as domestic and foreign investors.

The importance and significance of this technocratic way of conceiving the

oil industry is that, despite the relative hegemony of private entrepreneurship, an

alternative model is openly challenging the purist versions of neoliberal thoughts.

On that basis, mass media has termed this phenomenon as “state capitalism”7, a

refurbished concept which describes the deployment by states of a wide array of

corporate and securities law advantages to enhance the overall performance of

See also Expertos ven Fin de Monopolio de Pemex, CNN. DEC 8 2013, available at

http://www.cnnexpansion.com/economia/2013/12/08/expertos-ven-fin-de-monopolio-de-pemex 6 See Exxon Mobil and ConocoPhillips Reject Venezuela Deal, THE NEW YORK TIMES, JUN, 26, 2007,

available at http://www.nytimes.com/. 7 See The Visible Hand, THE ECONOMIST, JAN 19 2012, available at

http://www.economist.com/node/21542931.

Introduction 3

their enterprises. This is how states have achieved to talk the same language as

private firms; in other words, new state-run enterprises acknowledge the

importance of key factors such as profitability, long-term sustainability,

reputational benefits, competitive management performance, operational

efficiency, innovation, and corporate culture, among others. Under this so-called

state capitalism, in broad outline, NOCs have entered the world of securities

offerings.

To this end, daunting challenges arise concerning the protection of this

two type of investors within the Latin American oil industry, on the one hand

foreign direct investors in the form of IOCs, and on the other domestic and foreign

portfolio investors in the form of minority shareholders and bondholders of NOCs.

Sovereign expropriation and no compensation is perhaps the worst case scenario

the former might face; hence, a first agency conflict arises between host countries

and foreign direct investors. In turn, public external financing gives room to a

second type of conflict between self-interest insiders and outside investors, which

is even aggravated by the inherent characteristics of NOCs; they might be used as

public welfare maximization devices, clientelistic vehicles, and piggy-banks, all at

the expense of non-state-shareholders’ wealth.

This master thesis suggests that the current set of regulatory protective

measures for direct and portfolio investors within the top five Latin American oil

producers does not provide sufficient shielding. Moreover, it aims to show how

market-based remedies bridges gaps left by the absence of law. In this sense, the

central research question is no other than how direct and portfolio investments in

the Latin American oil industry are protected. For such purpose, three side

questions are put forward and methodically addressed: Why are NOCs prominent

in Latin America? How does law shape private investment in oil? Which are the

conflicts and remedies? The development goes as follows. By analyzing the

nationalistic and economic forces pushing in one or other direction of the

privatization-monopolization cycle, Chapter 1 serves as departure point to

contextualize the reader about how complex the surrounding of state

entrepreneurship within the region has been. Through a comparative perspective,

Chapter 2 illustrates the big picture of institutional design and it assess how every

legal regime is the result of the selection of a precise set of alternatives in the

matter of ownership and exploitation. Finally, Chapter 3 critically address the wide

array of conflicts that may occur within the current institutional designs embraced

by Argentina, Brazil, Colombia, Mexico and Venezuela to develop their oil

industries. Findings close.

In a world where the dominant trend struggles to maintain economic freedom and

private initiative as main axes of modern economy, state entrepreneurship and

state intervention on a permanent basis are regarded as abnormal phenomena,

even quixotic, that without further ado, distort the functioning and performance of

conventional capitalist markets. In accordance to this economic line of thought,

the level of state interventionism in the market must be reduced to the mere

implementation of macroeconomic policies, or at most, exceptional regulation in

regards to pricing or monopolies whenever it is necessary to ensure efficient

allocation of resources in non-efficient markets.8 Latin America, however, whose

political and economic history has proved dictated by sharp contrasts, has not

always waved the free market flags. In fact, it was not until the period of the

Washington Consensus that most Latin American states adopted their own

versions of laissez-faire, because to this day the majority is but vastly removed from

such postulate including countries that historically have leant towards the right

side of the political scale.

By 2012, the existence of State Owned Enterprises (SOEs) is widely accepted

in Latin America. This fact itself is quite eccentric into the eyes of the purest

version of neoliberalism.9 Brazil is the country with the highest number of SOEs,

147 in total, followed by Argentina with 112, Mexico with 110, and Colombia with

105.10 Moreover, the oil and hydrocarbons industry is by far dominated by regional

giants such as Petróleo Brasileiro S.A. (PETROBRAS), Petróleos Mexicanos (PEMEX),

Petróleos de Venezuela S.A. (PDVSA), Empresa Colombiana de Petróleos

(ECOPETROL), Yacimientos Petrolíferos Fiscales (YPF), and Yacimientos Petrolíferos

Fiscales Bolivarianos (YPFB). And this phenomenon is not only common in Latin

8 David Harvey, A Brief History of Neoliberalism (OUP 2005).

9 Nowadays the US is facing a similar phenomenon in which the Federal Government became controlling

shareholder of important companies as a result of the bailouts granted after the last financial crisis. This has

been subject to great controversy and the role of the state has said to be mainly transitory. See Marcel Kahan

and Edward B. Rock, When the Government Is the Controlling Shareholder (2011) TEXAS LAW REVIEW

Vol. 89, pp 1293-1364. 10

See OECD, Trends and Factors Impacting on Latin American Equity Market Development (2013) available

at http://www.oecd.org/daf/ca/2013LatinAmericaCGRoundtableEquityMarketReport.pdf.

Chapter 1 The Grounds of State Entrepreneurship 5

America. To give an example, 204 out of the 2000 largest companies are SOEs.11

Within the oil industry prominent companies such as Saudi Aramco, National

Iranian Oil, Kuwait Petroleum, PetroChina, Gazprom, Sinopec, China National

Offshore Oil, Rosneft, Abu Dhabi National Oil, Qatar Petroleum, Statoil, and

others, are well spread among resource-rich countries including Saudi Arabia, Iran,

China, Russia, Kuwait, United Arab Emirates, Qatar, Norway, and India.

In Latin America, as many other regions, the development of the oil

industry has gone through several phases. Open exploitation, concessions, taxes

and royalties systems, joint ventures, monopolies, and even partially-owned or

state-run companies; meaning that private investors have seen enough room to

engage in oil activities alongside with the state. In fact, the current set up displayed

by the top five oil producers entails a high degree of involvement of private

capital. 12 However, since two different approaches have been taken by the

incumbent administrations to regulate the industry and run their NOCs, working

alongside with some specific states may also become a great concern for private

investors, particularly because inward international cash flows can turn into

permanent sunken investments. At one pole, privatization of NOCs has been used

by some administrations as the main means of setting up a friendly investor

environment; at the other, in contrast, extreme hostility has come in the form of

selective expropriation to foreign investors. Whereas Brazil, Colombia and Mexico

opened the core of their NOCs and welcome portfolio investors; Argentina, Bolivia,

Ecuador and Venezuela tend to take over the oil industry as in the old days. These

opposite approaches are essentially due to disparities in public policies concerning

the level of state interventionism. Interestingly, both Latin American current

visions of NOCs have been considered as part of an economic cycle rather than a

continuous line with no return point, which has proved to take place particularly

in emerging economies and resource-rich countries.13 The first question that arises

is what the rationale behind the cycle liberalization-monopolization is. The

literature has developed an array of hypotheses in an attempt to explain the

determinants behind the Latin American opening and state interventionism

policies in the oil and hydrocarbons industry. The traditional theory posits that

leftist ideologies deeply influenced public policies in Latin America.14 Under this

11

See Przemyslaw Kowalski et al., State-Owned Enterprises: Trade Effects and Policy Implications (OECD

Trade Policy Papers, No. 147, 2013), available at http://dx.doi.org/10.1787/5k4869ckqk7l-en. 12

See infra sections 2.2 and 2.3. 13

See Roberto Chang, Constantino Hevia, and Norman Loaysa, Privatization and Nationalization Cycles,

(World Bank Policy Research Working Paper No. 5029, 2009), available at http://elibrary.worldbank.org 14

See, e.g., Stephen J. Kobrin, Diffusion as an Explanation of Oil Nationalization (1985) JOURNAL OF

CONFLICT RESOLUTION Vol. 29, No. 1, pp. 3-32; Amy L. Chua, The Privatization-Nationalization Cycle:

The Link Between Markets and Ethnicity in Developing Countries (1995) COLUMBIA LAW REVIEW Vol. 95,

No. 2, pp. 223-303; Jorge G. Castañeda, Latin America's Left Turn (2006) FOREIGN AFFAIRS Vol. 85, No. 3;

6 Why are NOCs Prominent in Latin America?

perspective the so-called “redistributive movements”, stimulated by nationalistic

impetus and collective sense of inequality, triggered a “domino effect” of

nationalizing retaliations of IOCs on a region whose historicity makes it more

responsive to reformist movements encouraging egalitarianism and strong

presence of state institutions. Economists, conversely to political scientists, have

suggested privatization and state ownership in the oil sector are nothing but

strategies relying upon economic rather than ideological factors.15 They posit, for

instance, one of the main drivers of nationalization is the rise of international

crude oil price as well as low returns from taxes and royalties.16 As scholarship in

general tend to classify and stereotype privatization-nationalization patterns as

“good” (e.g. right-wing, center and moderate left) and “bad” (e.g. radical left), other

academics aim to remove from literature such labels based on more objective

comparisons among NOCs. Either case, analysts in general coincide that Latin

American countries have intervened certain markets through entrepreneurial

activity aiming either the implementation of public policies on social welfare or the

generation of wealth and subsequent redistribution for the very group of citizens.

Interestingly, historic reviews show that state entrepreneurship does not usually

entails built-from-scratch state companies; in fact, nationalization of mature

companies has been the method of choice in the region well above other forms of

intervention, particularly in the upstream segment of the oil industry. At the end of

the day, however, the other side of this phenomenon is embodied by foreign

investors, who might be even pushed out in the face of any shift in the respective

public policy. Nationalization in the form of unilateral non-compensated

expropriation is perhaps the most severe risk that private capital may encounter in

developing countries whose political and economic situation proves prone to

volatility. Thus, if this behavior is part of a vicious cycle, investors need to know

Robert Kaufman, Political Economy and the ‘New Left’ in Cynthia J. Arnson with José Raúl Perales (eds),

THE NEW LEFT AND DEMOCRATIC GOVERNANCE IN LATIN AMERICA (Woodrow Wilson International

Center for Scholars 2007); Leslie Bethell, The Cambridge History of Latin America - VI Latin America since

1930: Economy, Society and Politics (CUP 1994). 15

See, e.g., William L. Megginson and Jeffry M. Netter, From State to Market: A Survey of Empirical Studies

on Privatization (2001) JOURNAL OF ECONOMIC LITERATURE, 39(2): 321-389; Alberto Chong and Florencio

López-de-Silanes, Privatization in Latin America: What Does the Evidence Say? (World Bank publications

2005); Sergei Guriev, Anton Kolotilin and Konstantin Sonin, Determinants of Nationalization in the Oil

Sector: A Theory and Evidence from Panel Data (2009) JOURNAL OF LAW, ECONOMICS, AND

ORGANIZATION, 27 (2): 301-323; Roderick Duncan, Price or politics? An Investigation of the Causes of

Expropriation (2006) THE AUSTRALIAN JOURNAL OF AGRICULTURAL AND RESOURCE ECONOMICS, 50, pp.

85–101; Osmel Manzano and Francisco Monaldi, The Political Economy of Oil Production in Latin America

(2008) ECONOMÍA Vol. 9, No. 1, pp. 59-103; Roberto Rigobon, Dealing with Expropriations: General

Guidelines for Oil Production Contracts in William Hogan and Federico Sturzenegger (eds), POPULISM AND

NATURAL RESOURCE (MIT Press 2008). 16

See, e.g., Guriev et al., supra note 15; Rubén Berríos, Andrae Marak and Scott Morgenstern, Explaining

Hydrocarbon Nationalization in Latin America: Economics and Political Ideology (2011) REVIEW OF

INTERNATIONAL POLITICAL ECONOMY, 18:5, 673-697.


symptoms in advance and make sure they have the optimal protective tools against

such risk. The study of investors’ protective measures featured by Latin American

legal systems, particularly IOCs, would be incomplete if it neglects to address first

the driving forces leading to such daunting conflict. Hence, this segment accounts

for the political and economic foundations upon which lies the position that

governments have assumed on privatization and state intervention.

According to political scientists and critical historians, the 20th century represented

for Latin America a constant political swinging shaped by tensions among

preexisting oligarch elites, liberal merchant forces, populist movements, military

commanders, and even spontaneous insurrection groups; the outcome differed

from country to country. In general, the existing literature emphasizes the fact that

the Latin American power struggle was featured by three ideological streams. In

the first place, conservative movements represented by landed elites, who

advocated for power centralization, ecclesiastical hegemony in legal affairs, and

trade barriers; secondly, liberal movements mainly represented by merchants and

upper middle class, arguing for a decentralized political system, secularization of

the state, and market liberalization; and thirdly, populist factions composed of

lower middle and lower classes, whose effusive and even radical speeches claimed

for nationalistic and anti-imperialist measures, including the protection of what

they termed working class, domestic industries shielding, health care and other

services broadening, among others. 17 As a result of this power struggle, the

frontline of Latin America economics witnessed the coexistence of a chaotic

divergence of concepts dispersed all around the Central, Caribbean, Andean

Region and the Southern Cone, such as neoliberalism, egalitarianism,

protectionism and interventionism. All these policy agenda contrasts made some

classical analysts to suggest that the region, taken as a whole, lacked of

homogeneous patterns or simultaneous uniformity in regards to political

ideologies.18 For instance, Argentina and Uruguay at one extreme or Colombia and

Venezuela at the other are not only contiguous countries but also share cultural

roots; this is why analysts found deep political differences quite paradoxical.19 By

mid 20th century, and as a result of the late influence of the so-called “redistributive

17

See Bethell, supra note 14; Enrique C. Ochoa, The Rapid Expansion of Voter Participation in Latin

America: Presidential Elections, 1845-1986 in James W. Wilkie and David Lorey (eds), STATISTICAL

ABSTRACT OF LATIN AMERICA (UCLA Latin American Center Publications 1987). 18

See Bethell, supra note 14. 19

ibid.


movements” of the previous century, a significant part of Latin American nations

was characterized by the dominance of leftist ideologies, among them, Argentina,

Bolivia, Brazil, Cuba, Costa Rica, Mexico, Nicaragua, Peru and Venezuela. In other

countries, the exercise of power by left-wing parties was merely a shooting

phenomenon unable to overcome the death of its leaders, as in the case of most

Caribbean countries, Chile, Colombia and to some extent Uruguay, in which right-

wing streams have dominated the political landscape by tradition.20

Put all together, these social and political elements are invoked to support

the ideological hypothesis of modern state entrepreneurship. Under such classical

theory, the political juncture, driven by egalitarian and redistributive ideologies,

transformed the (relative) aversion of Latin American public opinion in regards to

the role of the state as active entrepreneur, even in right-wing countries in which

market stability and macroeconomic policies’ orientation were driven by the

sometimes volatile perception of voters.21 The scholarship argues disproportional

wealth allocation in conventional capitalist economies, gave rise to intense social

divisions between “victors and losers” which ultimately drove to “deep

exacerbation” in the form of nationalizing behaviors against the wealthy.22 It has

been widely recognized centre-left and radical left movements put a vast pressure

when it came to defining the state’s role towards the level of interventionism in

each country’s economy. These claims largely focused on strong state presence in

order to directly address and minimize factors such as poverty, inequality,

analphabetism, and labor exploitation. More remarkably, inequality has been

deemed by sociologists and other scholars as one of the most decisive dynamics in

Central and South America’s history.23 During the 20th century, inequality evolved

from being a conflict between landowners and impoverished peasants to one

involving wealthy and high income individuals on the one hand and those lacking

of fluid sources of income on the other.24 Yet, egalitarian, protectionist and welfare

causes serve as inspiration for politicians.

That said, the most important effect brought by leftist movements, in

accordance to the ideological hypothesis, was the justification given to the state for

having a leading role in markets that (owing their own specificities) were prone to

social inequity. In welfare-economic terms, the state sought to behave as producer

or supplier of goods and services to promote the reestablishment of those markets

20

ibid. 21

See infra note 47 22

See Chua, supra note 14.

23 Inequality has such deep roots that even trace back to the colonial age when Creoles, that is European

descendents born in the New World, were excluded by the Iberian oligarchies. 24

See Evelyne Huber, François Nielsen, Jenny Pribble and John D. Stephens, Politics and Inequality in Latin

America and the Caribbean (2006) AMERICAN SOCIOLOGICAL REVIEW 71: 943.


vital for human preservation. Even since then, maximization of social welfare

through public services such as health care, education, access to drinkable water,

electricity, gas and transportation is widely accepted in Latin America like many

other regions in the world.25 From then on, SOEs were conceived as important

components of social development and NOCs were especially supported owing the

importance of state ownership over “key elements of the production structure”.26

In fact, the oil industry was particularly sensitive to nationalistic behaviors under

the idea of wealth redistribution, and the truth is that this sector had seen a

monumental growth in the international landscape feed by the continuous

industrial development and the massive use of the non-renewable commodity. In

the 19th and early 20th centuries, IOCs alongside with financial institutions were the

major worldwide corporate empires; IOCs particularly were composed by extensive

nets of subsidiaries vertically integrated, allowing them to focus on the three

segments of the oil exploitation activity. To give an example, Standard Oil, owned

by the legendary and controversial John D. Rockefeller, fueled the gears of US

economy. 27 Notwithstanding the increasing success, such companies also

experienced tremendous public rejection owing to high profile scandals concerning

labor abuses and competition, which were suffocated in their home countries

through legislative intervention. Latin American nations took longer to identify

and address those difficulties, and the response as it will be described was even

more radical. Although enrichment of foreigners was seen by some as necessary

evil to foster the development of (laggard and unexploited) national oil industries,

leftists considered a new form of dependence of Latin American countries towards

global powers, and sometimes more radically, as an offense from certain local elites

which granted the firsts sweetheart concessions for their personal gain at the

expense and without the pre-approval of common citizens.28 Some authors argue

that nationalization of IOCs was not in itself the first assault of nationalizing

governments, but instead they first used an aggressive tax strategy consisting on a

sharp increase of oil exploitation taxes; this took place in countries like Argentina,

Bolivia, Ecuador, Mexico, Peru and Venezuela.29 In this latter case, for example,

taxes were raised to 94% in 1974 after being at stable rate of approximately 50%

between 1943 and 1958.30 The truth is that Latin America, in general, replaced the

25

State ownership is in general acknowledged on non-profitable primary service markets, aiming price

reductions, increase of coverage and access for low income individuals. 26

See Samuel A. Morley, The Income Distribution Problem in Latin America and The Caribbean (United

Nations Publications 2001). 27

For anecdotic evidence see Daniel Yergin, The Prize: The Epic Quest for Oil, Money & Power (Simon &

Schuster 1991). 28

ibid. 29

See Manzano and Monaldi, supra note 15. 30

ibid.


tax strategy for a more radical one. One by one, Latin American states took over

the work carried out by IOCs; sovereignty over the subsoil resources was the

hegemonic rhetoric that eased the supremacy of the state monopolistic scheme.

Argentina was the first in the region to embrace the search of social welfare

and redistribution of wealth through state entrepreneurship. Academics coincide

certain legislative lethargy existed even after the discovery of Comodoro Rivadavia

oil field, especially in regards to tax and royalties policies since revenues for the

state were not proportional to the volume of the oil activity carried out by locals

and foreigners like Anglo-Persian and Standard Oil; on top of that, some level of

rejection towards the increasing power of foreign investors floated around

common citizens.31 The creation of YPF in 1922 was a moderate response from the

incumbent government, and even though the government attempted to establish a

de facto monopoly through the generalized rejection of new concessions based on

legislation established in 1924, the truth is this NOC coexisted with few IOCs within

the oil market due to political commitments.32 Uruguay, although being a net

crude oil importer, was the second country to do so. Administración Nacional de

Combustibles Alcohol y Portland (ANCAP) was created in 1931, and was granted with

monopoly in the refinery and distribution. In 1936, Bolivia’s military dictator gave a

first nationalization strike in the form of the expropriation of the assets owned by

Standard Oil.33 Since its foundation in the same year, YPFB was granted with

exclusive oil exploitation. In 1969, after a brief opening to private capital, military

occupation took place on the lands and refineries owned by Gulf Oil, expelled the

day after.34 The case of Mexico even surpassed Bolivia’s. In 1938, in the clear pursuit

of retaliation produced by the refusal to comply with a labor arbitration award, the

incumbent government enacted the Expropriation Law which by 17 IOCs were

outrageously pushed out, including subsidiaries of Standard Oil, Royal Dutch Shell

and Chevron; as a result PEMEX was founded to take on the respective activities.35

Nationalizations carried out in Bolivia and Mexico were emblematic and also the

starting point for the so-called “domino effect” in the remaining Latin American

countries since these two episodes are considered by academics as the real first

31

See Marcos Kaplan, La Pol tica del Pet leo del Estado entino: 1907-1957 in Marcos Kaplan, ASPECTOS

DEL ESTADO EN AMÉRICA LATINA (Universidad Nacional Autónoma de México 1981). See also Carl E.

Solberg, Oil and Nationalism in Argentina: A History (SUP 1978). 32

ibid. 33

See Brent Z. Kaup, A Neoliberal Nationalization?: The Constraints on Natural-Gas-Led Development in

Bolivia (2010) LATIN AMERICAN PERSPECTIVES 37: 123. See also Thomas D. Lumpkin, Gulf Oil’s

Experience in Bolivia (1971) HOUS. L. REV Vol. 8:457, 472-8. 34

ibid. 35

See Jaime Cárdenas, En Defensa del Petróleo (Universidad Nacional Autónoma de México 2009). See also

José J. Gonzales, The Scope and Limitations of the Principle of National Property of Hydrocarbons in

Mexico in Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES

(OUP 2010).


expropriation acts within the region in the matter of oil and hydrocarbons.36 Even

though Argentina and Uruguay were the first countries to claim state presence in

such industry, these institutional reforms did not have that impact and

reverberation due to several reasons; firstly because Argentina did not have a

relevant portion of crude oil exportation worldwide, secondly Argentina did not

banned IOCS until 1949, thirdly Uruguay was a net importer country with virtually

no upstream activity, and fourthly because both nationalization processes were

indirectly achieved and barely controversial. Empresa Nacional del Petróleo (ENAP),

in Chile —also net importer—, was granted with monopolistic activities in

downstream activities since its creation in 1950. The turn of Colombia took place in

1951, when the head of government decided not to renovate the voluminous Mares’

Concession which enabled Tropical Oil to exploit major oil national fields; the state

founded ECOPETROL to carry on upstream activities; however, it is important to

note that the then-regulation did not impose full monopoly since private activity

was still allowed.37 Brazil did not truly nationalize its industry until the second mid

of the 20th century. Been characterized by its virtual lack of interest concerning

IOCs, Brazil reversed the traditional public policy in 1946 and claimed monopoly

over the oil industry under the campaign “the oil is ours” which led to the creation

of PETROBRAS seven years later; the then-President described such decision as “a

new milestone in our economic independence”.38 In Peru, Empresa Petrolera Fiscal

(EPF, renamed PETROPERÚ) had coexisted with foreign privately held companies

until the appropriation of La Brea and Las Pariñas oil reserves and the subsequent

expulsion of International Petroleum Company in 1968.39 At that time, local

newspapers published the effervescent speech of Peruvian dictator in the sense

that nationalization was “a recognition instance of sovereignty and dignity”.40 In

Ecuador, Corporación Estatal Petrolera Ecuatoriana (CEPE, succeeded by

PETROECUADOR) was incorporated to continue the activities left Texaco after

36

See Kobrin, supra note 14. 37

See Juan Benavides (ed), Ecopetrol 60 años: Energía Limpia para el Futuro (Villegas Editores 2011). See

also Hernán Vasquez C., La Historia del Petróleo en Colombia (1994) Revista Universidad Eafit Vol. 30

No. 93, pp. 99-109. 38

See Marilda Rosado de Sá Ribeiro, The New Oil and Gas Industry in Brazil: An Overview of the Main Legal

Aspects (2001) TEXAS INTERNATIONAL LAW JOURNAL Vol. 36, pp.141-66; Yanko Marcius de Alencar

Xavier, Legal Models of Petroleum and Natural Gas Ownership in Brazilian Law in Aileen McHarg et al.

(eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010); Laís Palazzo Almada

and Virgínia Parente, Oil & Gas Industry in Brazil: A Brief History and Legal Framework (2013)

PANORAMA OF BRAZILIAN LAW Vol 1, No 1, pp. 223-252. 39

See Expropiación de los Yacimientos Explotados por la International Petroleum en Perú, LA VANGUARDIA,

OCT 11 1968, available at http://hemeroteca.lavanguardia.com/preview/1968/10/11/pagina-

16/34313159/pdf.html 40

ibid.


hostile acts during 1972.41 Venezuela was the last country in Latin America to

nationalize the oil industry within this first extended wave. The industry in

Venezuela, the largest oil producer in the region throughout much of the 20th

century, was entirely featured by IOCs and local private companies. By the 1970s,

the incumbent administration had seriously considered not renovating concessions

which were meant to end by 1983; however, the nationalization was executed in

advance in response to what some foreign companies did in order to dismantle

their facilities. Hence, PDVSA was incorporated in 1976 to manage all 14 preexisting

IOCs as subsidiaries; yet, the statutes left the door opened for potential reentry of

foreign investors.42

In sum, conversely to common belief, this first wave of nationalization was

not achieved completely through hostile expulsions as this was only the case of

50% the analyzed countries, of course this fact does not mean processes were

exempt from controversy. Only Bolivia, Mexico, Peru and Ecuador expelled IOCs. In

turn, preexisting concessions were not renewed by Colombia and Venezuela but

IOCs remain present in various forms. Argentina and Brazil are the only exceptions

that practically developed their upstream segment from scratch; tough the former

could face more difficulties in doing so bearing in mind the combination of

41

See, e.g., Guillaume Fontaine (ed), Petróleo y desarrollo sostenible en Ecuador (Flacso 2003). See also

Ecuador: Fin del Nacionalismo Petrolero, OILWATCH, DEC 22 2013, available at

http://www.oilwatchsudamerica.org/petroleo-en-sudamerica/ecuador/3741-ecuador-fin-del-nacionalismo-

petrolero.html. 42

See PDVSA official website

http://www.pdvsa.com/index.php?tpl=interface.en/design/readmenuprinchist.tpl.html&newsid_temas=13.

Table 1.1. Features of Latin American first wave of nationalization

Year Country Political Regime

Ideology NOC Hostility Full

Monopoly

1922 Argentina Democracy CL YPF - -

1931 Uruguay Democracy CR ANCAP - X

1936 Bolivia Authoritarian L YPFB X X

1938 México Democracy CL PEMEX X X

1950 Chile Democracy CL ENAP - X

1951 Colombia Democracy CR ECOPETROL - -

1953 Brazil Democracy CL PETROBRAS - X

1968 Peru Authoritarian L PETROPERÚ X X

1969 Bolivia Authoritarian L - X X

1972 Ecuador Authoritarian L PETROECUADOR X -

1976 Venezuela Democracy CL PDVSA - -

Sources: Alencar Xavier, Benavides, Berríos et al., Bethell, Cárdenas, Coppedge, Fontaine, Gonzales,

Kaplan, Kaup, Lumpkin, Ochoa, Palazzo & Parente, Rosado de Sá Ribeiro, Solberg, Vasquez.

Complemented by the author.


circumstantial factors such as the aftermath of The Great World, The Great

Depression and technology availability. Uruguay and Chile had modest upstream

activities hence monopolizing such segment was from far traumatic for foreign

investors. Moreover, Mexico, Venezuela, Bolivia, Uruguay, and Chile established

NOCs and monopolies simultaneously; Brazil established monopoly and much later

founded its NOC; and Argentina established its NOC first and decades later

established an absolute monopoly. In general terms Brazil, Mexico, Bolivia, Peru,

Chile and Uruguay formally set full monopolistic exploitation models for the

industry; Colombia and Ecuador, in contrast, had a neutral market were NOCs

coexisted alongside with IOCs. Argentina and Venezuela did not commit to full

monopoly in their first phase of nationalization. Unlike the case of Peru, all these

processes were finally settled with compensation arrangements. 43 The most

remarkable characteristics of oil nationalizations in Latin America are synthesized

in table 1.1.

One important remark on Latin American state entrepreneurship is that

the occurrence of such oil nationalizations is spread throughout the whole 20th

century timeline. This entails that much of the wave was certainly exempt to the

influence of the world scale expropriation movement that took place during the

1960s and 1970s.44

Table 1.1 also notes the region’s circumstantial heterogeneity at the specific

time when nationalizations were executed. For example, countries such as

Argentina, Brazil, Chile, Colombia, Mexico, Uruguay and Venezuela enjoyed

relatively stable democratic institutions, helped by legal measures such as the

introduction of anonymous vote and the progression of voting rights (which

gradually enabled peasants, analphabets and women).45 Conversely, Bolivia Peru

and Ecuador were subject to military dictatorships.46 Besides the diversity of

political regimes it is clear that, at least from a formalistic standpoint,

nationalizations were not only executed by leftist parties, as the case of Colombia

and Uruguay in which right-oriented governments were responsible to promote

the state expansion towards the market. Notably, the fact that conservative and

right-wing administrations existed among nationalizing states does not account

against the ideological hypothesis of state entrepreneurship. Indeed, this theory is

43

See Berríos et al., supra note 16. 44

It has been widely acknowledged that during this period, the nationalizing attitude towards energetic

international firms was feed by the embargo of the Organization of Arab Petroleum Exporting Countries

(OAPEC) and the oil crisis, as well as the US massive increase of hydrocarbons consumption and the

subsequent equilibrium point where US supply and demand represented the end of the US oil surplus. See

Yergin, supra note 27. For the exhaustive list of nationalizing countries between 1960 and 2006 see Guriev

et al., supra note 15. 45

See, e.g., Bethell, supra note 14, Ochoa supra note 17; infra note 47. 46

ibid.


not based on the formal ideology of the incumbent governor party itself, but

properly in the historic influence that redistributive movements had upon them.

Due to this phenomenon’s complexity, and in order to illustrate comparative

analysts, an important body of literature in political science took the task of

creating a taxonomic chart and classified all Latin American political parties and

electoral trends in the classic left-right scale.47 High rate of changes in party

fragmentation and volatility throughout the evaluated periods was observed,

besides the fact that none of the parties were thoroughly static in matter of

ideology trends. Experts coincide feedback with the contemporary social context

was a significant key element of Latin American politics since definitions of “left”

and “right” “vary greatly from decade to decade”.48 Therefore, they conclude there

is no fixed manual to create right-wing or left-wing political parties; instead, each

party adopts lines of thought according to contemporary socioeconomic context.49

In light of these considerations, it is plausible to conclude —according to

the ideological theory of the rationale behind state entrepreneurship— that a

combination of collective inequality, national proud, mass movements and

populism, was the cornerstone of the nationalizing behavior; and therefore much

of the Latin American first wave was carried out not by a specific political regime

or same-ideology parties, but same-objective parties aiming the eradication of

inequality through wealth reallocation. Naturally, domestic political and

socioeconomic dynamics as well as side factors such as “diffusion” had great

importance in the sense that nationalization in one country (e.g. Bolivia and

Mexico) considerably contributed to a “domino effect” in others.50 Besides, the

nationalistic impetus was also accompanied by other exogenous factors, such as

the rise of “world superpowers”, US and UK on one side and USSR on the other.51 It

is still plausible that nationalizations worked to some extent as reprisal on the

basis of historical resentment towards global oil producers and the so-called “seven

sisters” whose worldwide domination (e.g. Achnacarry agreement) struggled with

popular sovereignty.52 Or less drastically, Latin American versions of “welfare state”

47

See, e.g., Michael Coppedge, A Classification Of Latin American Political Parties (Working Paper No. 244,

1997), available at kellogg.nd.edu/; Nina Wiesehomeier, The Meaning of Left-Right in Latin America: a

Comparative View (Working Paper No. 370, 2010), available at kellogg.nd.edu/; Manuel Alcántara and

Cristina Rivas, The Left-Right Dimensions in Latin America Party Politics (Prepared for the annual meeting

of the American Political Science Association 2006), available at http://gredos.usal.es/. 48

“For example, in Latin America during the 1960s support for political democracy was often considered

incompatible with being on the left, but in the early 1980s it was often considered incompatible with being

on the extreme right”. See Coppedge, supra note 47. 49

See Alcántara and Rivas, supra note 47. 50

See Kobrin, supra note 14. 51

See Chua, supra note 14.

52 See Roger G. Noll, Telecommunications Reform in Developing Countries in Anne O. Kreuger (ed),

ECONOMIC POLICY REFORM: THE SECOND STAGE (University of Chicago Press 2000) quoted by

Megginson and Netter, supra note 15.


in the 20th century simply implicated the expansion of the functions of the states as

means to recover control over markets full of foreign investments as well as to

ultimately promote growth maximization.53

One final remark is that interesting deviations of the nationalistic impetus

hypothesis, but still political, are pointed out by other scholarship. Firstly, some

authors suggest that the increase of crude oil price entails in itself an increase of

IOCs’ political power; hence, nationalization is used as a means to restraint such

influence. 54 And finally, other experts consider the possibility of residual

smokescreen nationalizations set forth to cover domestic troubles.55

In opposition to the classical and prominent ideological hypothesis, the economic

theory of modern state entrepreneurship finds its grounds on a series of

macroeconomic patterns that are believed to affect the decision making of

emerging economies’ administrations. As it will be assessed, not only privatizations

but more interestingly nationalizations are highly linked to economic drivers.

Latin America has not been unfamiliar to the neoliberal economic trend, in

particular during the late 20th century. The so-called Washington Consensus

marked the beginning of a new period for Latin American countries; technocrat

and pragmatic public policy choice was the critical pillar of such new perspective.

The downfall of international communism, together with deep contraction in the

economy and severe fiscal deficit, dragged the influence of leftist policies in the

region.56 In order to fight back poor economic performance of the last decades

(especially the labeled “lost decade”), Latina American countries almost in unison

gave up to the neoliberalism and neoconservatism theses and embraced most of

the points of such stabilization plan.57 The consensus suggested the convenience of

rerouting the economic systems of developing nations to the paths of deregulation

and liberalization. This included adopting free markets which by efficient

allocation of resources was eased and foreign cash flows welcomed; plus the aim of

reducing the institutional framework for state intervention in economic affairs,

53

See Dennis Rondinelli and Max Iacono. Policies and Institutions for Managing Privatization (International

Training Centre, International Labor Office 1996) quoted by Megginson and Netter, supra note 15. 54

See Raghuram Rajan and Luigi Zingales, Saving Capitalism from Capitalists (Princeton University Press

2003) quoted by Guriev et al., supra note 15. 55

See Duncan, supra note 15. 56

Gustavo A. Flores-Macías, Statist vs. Pro-Ma ket: Explainin Leftist Gove nments’ Economic Policies in

Latin America (2010) COMPARATIVE POLITICS Vol. 42, No. 4, pp. 413-433. 57

Cuba is the most prominent exception. See Bethell, supra note 14.


including trading barriers reduction, state monopolies abolition and privatization

of SOEs.58 Prior to the consensus, as a matter of fact, privatization was one of the

hottest western economic trends since neoliberal US and UK policies had spread to

a greater extent to countries such as France, Germany, Italy and Spain; all of them

carried out dismount or denationalization programs in large scale.59 The failure of

the state as an entrepreneur was a generalized idea among academics and policy

makers. On one hand, SOEs recalled governmental bureaucracy and even

corruption in some cases. On the other, SOEs were not generating enough returns

for public expenditure, and in the contrary, given the evident inefficiency when it

came to income maximization, such companies acted as non-sustainable and loss-

making black holes that used to survive by means of bailouts (demanding and

wasting collected taxes from the same society they intended to benefit). Important

compilations of empirical studies related to privatizations conclude that the critical

factors in which state entrepreneurship’s inefficiency lies, in comparison to private

companies, are basically higher operating and manufacturing costs, less

profitability, over-capitalization and over-hiring of labor force, on top of that SOEs’

management tend to be less proactive and even less committed to bargain

contracts.60 Although originally conceived as an academic suggestion, embracing

the consensus was in part the result of the tremendous pressure put by

international financial institutions such as the International Monetary Fund and

the World Bank through their bargaining power in the matter of international

lending.61 By early 1990s Chile had externalized 96% of its SOEs to private investors;

as numbers in Mexico are said to decrease from 1115 to just 80.62 Others like

Ecuador, Nicaragua and Uruguay did simply not follow the large-scale privatization

program.63 Those financial organizations lobbied and pressed in particular for the

total or partial privatization of well-recognized NOCs, which have always proved

state crown jewels evoking the power of Latin America.64 Thus, under enthusiasm

and pressure, Argentina and Bolivia gave up all the oil and hydrocarbons industry

to IOCs and their principal NOCs; YPF and YPFB respectively, were privatized.65

58

See John Williamson. The Washington Consensus as Policy Prescription for Development (lecture in the

series “Practitioners of Development” delivered at the World Bank 2004), available at http://www.iie.com. 59

See Megginson and Netter, supra note 15. 60

See, e.g., Dennis C. Mueller, Public Choice III (CUP 1989); Chong and López-de-Silanes, supra note 15;

Megginson and Netter, supra note 15. 61

As described by its own author, the consensus was an ideal prescription containing the public policy formula

with reactivating effects. See Williamson, supra note 58. 62

See Morley, supra note 26. 63

See Chong and López-de-Silanes, supra note 15. 64

See Diego Mansilla, Petroleras Estatales en América Latina: entre la Transnacionalización y la Integración

(2008) REVISTA DEL CCC [online], available at http://www.centrocultural.coop/revista/articulo/30/. 65

See supra notes 31 and 33.


Venezuela and Brazil allowed the entry of IOCs to the market.66 Mexico and

Colombia, in turn, privatized the bulk of their SOEs as established on the

stabilization plan, but they did preserve their ownership in PEMEX and

ECOPETROL.67

However, at this point in time Latin American’s landscape is quite different

to the extent that some authors have referred to a sort of “Washington

Dissensus”.68 After two decades from the start of the “modernization process” of

Latin American economic models, more than ever the region is ruled by political

parties sympathetic towards state interventionism. The victories of leftist

candidates have been repeated and emphatic in Venezuela, Brazil, Argentina,

Bolivia, Ecuador, Nicaragua, and even Uruguay and Paraguay; by 2007 this

contemporary trend peaked nearly 60% of the region’s population under leftist

governments.69 And it still accounts the vast majority. Voters in Chile and Peru

have taken mixed decisions. Colombia, Mexico, Panama and few Caribbean

countries are the ones whose heads of government account for right-wing and

centre-right political parties.

And the importance and significance of all these events is that they appear

to account for the renaissance of the left. Nonetheless, even political scientists find

key differences with the first wave of nationalization. Even when the region would

seem to be immersed into a harmonious left wave, analysts identify two types of

left but not “diametrically opposed”; the populist and the radical.70 In the matter of

macroeconomic, the former has embraced lukewarm and orthodox lines of thought

which smelt with pro-market neoliberal postulates, while the latter has gone back

to state interventionism including the same old nationalizing way. Prominent

experts acknowledge today’s moderate left diverges to a greater extent in

comparison to old days’ left; and they also estimate state ownership policies by

66

See Mansilla, supra note 64; Luisa Palacios, The Petroleum Sector in Latin America: Reforming the Crown

Jewels in Judith Burko (ed), LES ETUDES DU CERI ETUDE (CERI 2002). 67

See, for Mexico, Rafael La Porta and Florencio López-de-Silanes, The Benefits of Privatization: Evidence

from Mexico (1999) THE QUARTERLY JOURNAL OF ECONOMICS Vol. 114, Issue 4, pp. 1193-1242; for

Colombia, Carlos Pombo and Manuel Ramírez, Privatization in Colombia: A Plant Performance Analysis

(Working Paper No. 166, 2003), available at http://www.ssrn.com/. For a study of privatizations in Latin

America see, e.g., Chong and Florencio López-de-Silanes, supra note 15. For a worldwide study see, e.g.,

Megginson, supra note 3. 68

See Ramón Casilda Béjar, América Latina y el Consenso de Washington (2004) BOLETÍN ECONÓMICO DE

ICE No. 2803, pp. 19-38. 69

See Cynthia J. Arnson, The New Left and Democratic Governance in Latin America (Woodrow Wilson

International Center for Scholars 2007). 70

See, e.g., Castañeda, supra note 14; Arnson, supra note 69; Tomáš Došek, Las Dos Izquierdas en América

Latina: Determinantes del Voto a Morales y a Mujica (Working Paper, Instituto de Iberoamérica 2011-

2012), available at http://americo.usal.es/iberoame/sites/default/files/dosek_paper_seminarioInstituto.pdf.


radical left are mere strategic adjustments in the aftermath of neoliberal policies of

the 1990s since original goals could not been satisfactory achieved.71

The case of Brazil, whose macroeconomic behavior has revealed a

preference to internationalization of the country’s economy, is one of the most

influential paradigms of moderate left and technocratic policies within the region.

Through the Constitutional Amendment Nº 9 and the subsequent Law 9.478,

carried out in the mid 1990s, Brazilian policy makers gave green light to the entry

of private competitors within the oil and hydrocarbons market and from then on

PETROBRAS must bid for upstream concessions under equal terms and conditions

with the rest of privately held companies.72 This economic measure ultimately got

the traditional monopoly blurred and established a neutral industry model. Given

the huge operational deployment, PETROBRAS still maintains the largest market

share in Brazil, but such liberalization has been exploited by other IOCs like Royal

Dutch Shell. This new Brazilian strategy is not only aimed to renovate the market,

but also their NOC. In 2000, PETROBRAS finally opened their corporate cuirass to

public hands and listed into BM&F BOVESPA (São Paulo) leaving its conventional

closely-held status. Today non-state ownership accounts for 54%, also tradeable in

NYSE, BME LATIBEX and BCBA (Buenos Aires).73 In addition, the state has put

forward sophisticated techniques that are not fully well accepted by conventional

jurists, including a dual-class share structure which enables to preserve voting

control in the shareholders’ assembly meetings by holding only a 28.7% stake of

the total equity.74 Colombia followed the path of the Brazilian paradigm and

developed a mass privatization (“democratization”) plan for ECOPETROL consisting

on a gradually progressive public offering. The first step of such challenging

process was the transformation of the company’s legal status; thus, through the

Law 1118 of 2006, ECOPETROL changed from public enterprise to join stock

company. After two rounds of issuance in 2003 and 2011, the company placed 11.5%

of its outstanding capital as free float, on BVC (Colombia) as well as NYSE, TSX and

BVL (Lima) in the form of ADRs.75 Owing the friendly investor environment, the

success of policies in Brazil and Colombia has attracted not only domestic portfolio

investors but also FPI. Even Mexico, old-guard nationalizing state in the region, is

stepping out of the path of interventionism. By 1995 Mexico had allowed

midstream activities to private individuals under certain rules. In 2008 PEMEX was

71

See Kaufman, supra note 14; Kenneth Roberts, Leslie Bethell and René Antonio Mayorga, Conceptual and

Historical Perspectives in Cynthia J. Arnson with José Raúl Perales (eds), THE NEW LEFT AND

DEMOCRATIC GOVERNANCE IN LATIN AMERICA (Woodrow Wilson International Center for Scholars

2007). 72

See Mansilla, supra note 64. 73

See infra section 2.3 for further details. 74

See PETROBRAS official website www.petrobras.com. 75

See ECOPETROL official website www.ecopetrol.com.


legally enabled to “assign areas” to IOCs in order to carry out exploration and

exploitation activities under the strong guidance and surveillance of the NOC. By

the end of 2013 a remarkable constitutional amendment known as the Energetic

Reform was approved, putting an end to a 75-year-formal-monopoly over the oil

and hydrocarbons sector and allowing the potential entry of independent IOCs.76

As to the corporate aspect of PEMEX, even though Mexican authorities have not

officially allowed the entry of portfolio investors, of major importance is the

strategy of public debt issuances the company has frequently relied on (which may

be described as conservative); such debt instruments are tradable on local and

foreign exchange markets like NYSE, and therefore portfolio investors are still

present not in the form of shareholders but bondholders.

Latin American net importer countries, in turn, have also opened the

downstream and midstream segments of the oil business. For instance, in 2002

Uruguay suppressed all kind of trade barriers and de-monopolized imports, exports

and refining of crude oil. Even more remarkably, Uruguay’s new regulation also

enabled the ANCAP to partner up with private investors.

In flat opposition, radical left oriented countries have embraced pro-statist

policies, being the case of Venezuela, Bolivia, Ecuador and Argentina. After a

rowdy electoral campaign promising the reversal of neoliberal measures, the

government of Venezuela enacted in 2007 the Decree Law 5.200 or commonly

known as Hydrocarbons Law pursuant to which total control over the exploitation

of the oil industry went back to PDVSA. International oil producers were forced to

partner up with PDVSA under a mandatory joint venture system whereby the NOC

preserved a majority interest of 60% in all upstream and downstream activities

carried out within the country.77 Whereas ExxonMobil and ConocoPhillips opted

to cease activities, other major international oil companies reluctantly accepted

minority partaking and lesser autonomy. Venezuelan government’s intention to

recover state control over the economy was such that the nationalistic trend also

spread to other sectors like energy overall, telecommunications, concrete, among

others.78 The case of Bolivia is quite similar to Venezuelan’s. The recently elected

head of government, in a maneuver described as “hostile takeover” rather than

expropriation, regained control over the energy industry for the third time in

Bolivian history and for such purpose he deemed Supreme Decree 21.060

unconstitutional which allowed private exploitation as of 1985.79 Whit the help of

tax aggressive policies and further political pressure, in 2005 the government

76

See THE ECONOMIST and CNN articles, supra note 5. 77


See Flores Macías, supra note 56. 79

See supra note 33.


compelled international investors to give up the majority ownership interest in

YPFB. By that time, the Bolivian nationalizing measures had even affected political

relations with Brazil —also leftist— owing the tremendous harm suffered even by

PETROBRAS.80 As to the case of Argentina, the partial expropriation of the majority

block owned by Repsol and the subsequent renationalization of YPF took place in

2012 after a dramatic turn in the matter of incumbent government public policies.

Law 26.741 was enacted to seize Repsol 51% out of 62.9% ownership interest in YPF;

the company is still listed in BCBA AND NYSE, though.

Based on such recent events, economists have sought room to refute the

classical hypothesis in regards to the privatization-interventionism phenomenon,

and this has been possible thanks to the increasing availability of greater data. The

first thing they note is the lack of political patterns, suggesting there is no such

relation between nationalization and political trends.81 In addition, they point out

the multiplicity of behaviors that even leftist Latin American administrations have

adopted, and this gives rise to argue that neither ideologies nor populism are able

to explain by themselves the vast diversity of behaviors displayed by social-

content-policy governments like Brazil and Mexico at one pole, and Argentina,

Bolivia and Venezuela at the other. Likewise, the economic hypothesis suggests the

continuous shift in public policies is not determined by certain ideologies or

collective nationalism; instead the privatization-nationalization behavior

applicable to emergent economies is nothing but a cyclical phenomenon driven by

macroeconomic dynamics. In this respect, economists consider that both

embracing and disregarding the state entrepreneurship strategy in oil firms merely

obeys to a rational economic behavior which is shaped, above all, by global

economy, international crude oil price and governments’ returns on tax take.

Privatization of SOEs, basically considered as a mechanism to realise an

asset, is one of the most common drivers brought into play by economists in order

to explain the opening phase of the neoliberalism-interventionism cycle. This type

of transaction frees up by virtue important cash flows so that state spending is

better off without compromising the incumbent government budget. 82 Such

maneuver enables the state to overcome fiscal deficits or simply increase liquidity

with no need to increase taxes or subject the modification of any state budget

constraint to cumbersome public scrutiny. As a matter of fact, experts calculate

revenues from Latin American privatizations from 1990 to 1999 worth an aggregate

US$ 177,839 billion; and more remarkably, proceeds of privatizations carried out by

80

See Latin America ponders nationalist energy policies. OIL AND ENERGY TRENDS. JUN. 16, 2006, available

at http://onlinelibrary.wiley.com/doi/10.1111/j.1744-7992.2006.310613.x/pdf. 81

See Duncan, supra note 15. “Political language of ‘sovereignty’ and ‘revolution’ may thus just be cover for

actions motivated by more mundane considerations”. 82

See Megginson and Netter, supra note 15.


countries like Brazil, Venezuela and Mexico exceed the 5% threshold of GDP, as

sales in Paraguay, Peru, Bolivia, Panama and Argentina represented 10% of GDP,

and even more.83 Sales of SOEs are still quite controversial for welfare economists,

though.84 The classical argument lies upon the abandonment by states of stable

cash flows generated by the company (i.e. short-term profits vs. long-term losses);

nonetheless, technocrats respond with empirical literature indicating

underperformance even before being privatized.85

As to the interventionist phase, some findings have been recently achieved.

One extraordinary econometric analysis processes information about

nationalization in several regions of the world including Latin America, carried out

between 1960 and 2006. Applying the linear probability regression model, such

study estimates that although IOCs’ nationalizations are more common in

countries with weak political institutions, the likelihood of nationalization

increases when international oil crude price proves high.86 In similar vein, other

remarkable study tests two classic economic explanations of expropriation posited

in the literature. 87 According to the first explanation the state would act

opportunistically seizing industries when real price is high (i.e. “opportunistic

explanation”); the second premise conceives expropriation as a mere reaction, even

protectionist, when real price is low (i.e. “desperation explanation”). This study

focuses on different mineral industries and shows how feasible expropriations were

in almost all examined industries during price boom, ultimately supporting the

first premise.88

In the frontline of the discussion, another economic pattern has surfaced

suggesting that countries with substantial oil reserves are more prone to takeover

such industry when rents from taxes and royalties prove ineffective to capture

revenues in the same proportion as to the volume of the activity.89 A recent

analysis of the Latin American oil sector, especially net exporter countries (e.g.

Venezuela, Mexico, Ecuador, Colombia, Argentina, Brazil, Bolivia and Peru), has

proved highly influential among economists.90 Such study indicates that the

employ of non-progressive fiscal systems triggers the nationalizing behavior; and

systems can be considered inefficient in the face of design errors whereby crude oil

83


“[P]rivatizations are generally part of an ongoing, highly politicized process”. See Megginson and Netter,

supra note 15. 85


See Guriev et al., supra note 15. 87

Both explanations were posited by Cole and English. See Duncan, supra note 15; Michael Tomz & Mark

L.J. Wright, Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation (2008),

available at http://www.ssrn.com/. 88



See Manzano and Monaldi, supra note 15.


price long-term volatility is not foreseen (i.e. unexpected price contingencies), and

consequently, rents from any abrupt increase would be allocated in greater

proportion to the private exploiter rather than the state. Put differently,

disproportional revenues from tax and royalties systems would turn the state

efforts towards any other optimal instrument; and therefore interventionism

through NOCs may be stimulated by such lack of efficiency. This may be also linked

to the degree of dependence of the state in oil tax revenues. For instance,

Venezuela had stronger dependence on tax revenues by the time statist measures

were taken in comparison to other net product exporters, suggesting

nationalization by resource-rich countries is to a greater extent subject to fiscal

dependence.91

In summary, economists reduce political factors to mere basics: “the more

democratic the political institutions of the host country are, the more sensitive to

price is the decision to expropriate”.92 Likewise, unprofitable tax and royalties

strategies increase the likelihood of statist policies.93

91

In Venezuela, oil exportation accounted for 80% of total exportations and 50% of tax revenues by the time

the Expropriation Law was enacted. See Palacios, supra note 66. 92


See Chang et al., supra note 13.

Ever since oil became one of the most important primary commodities to start the

engine of modern societies, the industry has been subject to a number of schemes

by which states have allocated property rights and exploitation rights. Every regime

is the result of the selection of a precise set of alternatives in the matter of

ownership and potential exploitation, and it has ultimately shaped the composition

of every oil and hydrocarbons market. Of course law is the ultimate tool to set up

such framework and depending on the specific selection two types of investors may

be openly involved, foreign direct investors at one end of the spectrum and

domestic and foreign portfolio investors at the other. For instance, some

jurisdictions may opt to benefit from large multinational firms and allow for such

purpose the entry of foreign direct investors in the form of IOCs; this modality

ensures investors plenty management control in their business affairs and

depending on other factors of the institutional design they may have plenty control

over the oil industry itself. Other jurisdictions may for instance restrict

independent entrepreneurship in the oil sector, but allow portfolio investors in

NOCs as either shareholders or bondholders, case in which investors’ interests

would solely rely on the actions carried out by the state either as controller

shareholder or debtor, respectively. Conversely, some host countries may prefer to

develop the oil industry on their own with no non-state cash flows. Likewise, of

particular relevance in oil production and commercialization is the comparative

theoretical framework where states have relied upon to implement their own

institutional design. The regulatory scheme proves plenty functional and capable

to serve as a means to implement greater public policies as detailed in Chapter 1.

Thus, it is not by chance that a great diversity of IOCs on one hand and NOCs either

wholly or partially-owned on the other compete within the Energy 50 world

ranking in commercial oil production.94

94

See IHS, The Definitive nnual Rankin of the Wo ld’s La est Listed Ene y Fi ms (2014) available at

http://cdn.ihs.com/www/energy50/IHS-Energy50-2014.pdf.

See also PFC, The Definitive Annual Ranking of the Wo ld’s La est Listed Ene y Fi ms (2013) available

at http://www.cpzulia.org/ARCHIVOS/PFC_Energy_50_Ranking_Jan_2013.pdf

24 How Does Law Shape Private Investment in Oil?

As briefly anticipated, the first element to be determined in any regulatory

framework is the being upon which property rights over such non-renewable

commodity will be vested with; allocation models particularly serve this function.

Legal systems have basically allocated ownership either to private individuals or

the state itself; what change is the way they have access to property rights. In those

jurisdictions where oil is kept as national wealth, ownership allocation legal

measures as such do not even put societies halfway in the legal phase of achieving

competitive oil extracting rates and sustainable high profitability. Even if states are

entitled to claim ownership over crude oil, they may lack technology, human

resources, and more importantly, know-how to exploit it. Likewise, lawmakers and

authorities in general are also meant to adopt specific strategies by which real

experts see green light to develop a real life oil and hydrocarbons industry; this is

achieved through exploitation models. Jurisdictions around the globe may opt in a

number of ways to promote sustainable growth and development; including full

liberalization, concessions, licensing, taxes and royalties systems, joint ventures,

service agreements, and corporate vehicles either state-owned or state-run. As it

will be analyzed in this chapter, states may also move freely within the theoretical

framework; put it differently, change strategies for what they believe is optimal

(either in ideological or economic terms as set forth in the previous chapter). In

fact, shifting among industry exploitation strategies is what academics have

regarded as the so-called cycle.

Eventually changing models may entail daunting costs for both, the state

itself and investors, and the latter are quite sensitive especially when shifts tend to

implement state entrepreneurship. One thing to note is that much has been said

by analysts about nationalization, state monopolies and expropriation; however,

these are just components of a more extended framework, and are frequently

mixed up in literature. As will be detailed, dispossession of foreigners’ assets is in a

higher level of the interventionism scale than forcing IOCs to act under mandatory

joint ventures with the NOC. And this is a core understanding since risks and costs

vary as well depending on the shift’s range.

An important body of legal literature has developed a comparative core taxonomy

that enables to accurately classify all regulatory schemes that may be used by

jurisdictions around the world in order to allocate property over subsoil resources,

Chapter 2 Institutional Design 25

crude oil included.95 Four schemes are identified, access commons, community

commons, private property and state property.96 This framework is of a vital

importance especially when it comes to natural resources maximization; whereas

systems of major worldwide oil players such as US vest surface landowners or those

who extract oil first with property rights, systems like UK, The Netherlands, Spain,

Denmark, Poland, and the vast majority of resource-rich nations differentiate land

surface from subsoil resources; as a result these legal systems grant ownership

rights of crude oil and other subsoil resources to the state.

The first and most basic regulatory scheme is access commons which

enables all individuals to openly access the specific resource and, therefore, anyone

has the potential to become proprietor on to the extent to which the resource is

being seized. Similarly would be the case of community commons, in which access

is still open but limited to a specific group; the resource would seem as private

property into the eyes of outsiders but as access commons to insiders. Private and

state property schemes, in broad outline, represent the so-called “bundle of rights”

privates-state are vested with, and no further seizure or “capture” would be

required. From a comparative standpoint, these four regulatory schemes have

proved the legal base for the oil allocation models; namely, absolute ownership

theory, rule of capture, ownership in place theory and domanial regime.97 Legal

systems in which oil property and potential commercialization is granted to private

individuals make use of any of the first three models; the first one deems

landowner as proprietor and settle disputes from phenomena like percolation, the

second one considers proprietor the one who first extract crude oil and the third

one is a sort of a combination of the aforementioned two models. In turn, state

property is represented by the fourth model. Whereas the absolute ownership

theory and the domanial regime vest property rights with no need to extract oil

and “reduce it to possession”98, the rule of capture and the ownership in place

theory require owners to extract the resource in order to be deemed as such, and

therefore may be put on the same level as access commons. It goes without

95

A large number of classifications have been set forth in order to clarify oil’s legal nature. Nevertheless, many

domestic Latin American authors tend to accommodate such classification within the preexisting dogmas of

their own legal systems (some overlook the divergence between allocation and exploitation models; and

their exegetic and cumbersome postulates even discuss semantic issues on terms like “state property” and

“national property”). 96

See Jonnette Watson Hamilton and Nigel Bankes, Different Views of the Cathedral: The Literature on

Property Law Theory in Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL

RESOURCES (OUP 2010). 97

See Yinka Omorogbe and Peter Oniemola, Property Rights in Oil and Gas under Domanial Regimes in

Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010);

Terence Daintith, The Rule of Capture: The Least Worst Property Rule for Oil and Gas in Aileen McHarg

et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010). 98

See Omorogbe and Oniemola, ibid.


mentioning that this brief description is made in broad strokes and all these

allocation models may clearly find further and miscellaneous regulation in each

jurisdiction.

Nowadays the vast majority of crude oil worldwide producers have formally

established domanial regimes, including the top five Latin American producers.

However, one thing to note is that neither all jurisdictions claimed state property

right from the start nor all jurisdictions had expressly enacted statutes to allocate

oil property. In fact, in the years leading the acknowledgment of oil industrial

properties, setting forth an oil allocation model was not a big concern and only few

countries like Mexico and Brazil provided at some point private property over oil,

while the remaining countries remained long time with de facto allocation models

since their legal regimes had no expressly referred to the matter.

Mexico witnessed continuous adjustments. Being, the first country to be

influenced by the discoveries made in Pennsylvania, Mexico granted the firsts oil

concessions in 1864; which arguably may be understood as if oil was state property

from then on because granting concessions (and setting up concession systems)

imply sort degree of proprietorship by the state even if no formal recognition had

been made. By 1884 Mexican statutes then provided that landowners were

“exclusive proprietors” of oil and no authorization was required to exploit it; this

statute was confirmed by further legislation in 1892.99 Finally, the authorities

implemented a formal concession system through the Petroleum Law in 1901 and

officially vested ownership to the state by means of its Constitution in 1917.100

Similarly, in 1891, the then-Federal Constitution of Brazil vested landowners with

ownership rights simply because there was barely oil activity within the country.101

In the same line than Mexico, the 1934 Federal Constitution of Brazil channeled

such towards the state and this represented a formal shift from the previous private

allocation scheme to a domanial regime.102 This means that both jurisdictions

embraced at some point in time their own versions of the absolute ownership

theory, prior to consolidate the contemporary domanial regime.

Conversely, allocation of oil property in the remaining countries was

gradually achieved. Lawmakers simply lagged behind heads of government who

did not doubt following the dynamics of oil activity through concessions even

before their legal systems provided state ownership. In other words, no recognition

over oil proprietorship was expressly made by Argentina, Colombia, Venezuela,

among others. However, this does not mean that oil was private property. They, in

99

See supra note 35. 100



See supra notes 38.


fact, granted oil concessions and established early concession systems in their legal

systems by the first decades of the 20th century, and this can be interpreted as if oil

was state property from then on.103 Venezuela first granted concessions in 1865

implicitly recognizing a domanial regime; then in 1905 enacted its Mines Law

establishing a concession system, followed by official recognition of state property

in 1920 when the first Hydrocarbons Law was approved.104 Bolivia did the same

enacting Organic Oil Law in 1938. In 1958, Argentina granted property rights to the

state by means of Law 14.773; in 1907 the government had done so but limited to

the then-newly discovered Comodoro Rivadavia oil field.105 Colombia granted the

first concessions in 1905; in 1913 officially claimed rights over vacant lots’ subsoil

and finally enacted Law 20 in 1969 whereby state property over subsoil was

proclaimed.106

As it turns out Mexico was the first country (from the current top five

regional producers) to take proprietorship away from private individuals in 1901,

and the other countries followed it gradually. Interestingly, net importers also

adopted the state property model. For example, in Chile Law 4.109 was enacted in

1926 to claim state ownership over all hydrocarbons fields, and Law 8.746 in

Uruguay claimed any “existing and future oil fields”. One important remark is that

Latin American nations in general maintained preexisting private property rights

over fields owned by individuals prior the establishment of domanial regimes (i.e.

non-retroactivity). After all these years, even in the aftermath of the

aforementioned neoliberalism phase of the privatization-nationalization cycle, oil

ownership has remained within the states. All the details are summarized in table

2.1.

International level policy makers were not indifferent to such policy trend.

United Nations General Assembly approved its first resolution in 1952 by which

sovereignty of peoples to freely use the right of “exploit their natural wealth and

resources” was recognized. This text was subject to controversy by countries like

US and others in which private models of oil allocation were embraced, owing the

fact that resolution’s wording was open to ambiguous interpretations concerning

the autonomy of the states to recognize the other side of the oil allocation

phenomenon.107 In fact, some countries like Guatemala and Iran were immediately

influenced by such regulation and began the nationalization of international

103

Some local authors use early after-independence bilateral treaties between Spain and Latin American

countries in order to trace back subsoil state ownership; however, such discussion is unnecessary since oil

commercialization was insignificant prior to mid 19th

century. 104




See James N. Hyde, Permanent Sovereignty over Natural Wealth and Resources (1956) THE AMERICAN

JOURNAL OF INTERNATIONAL LAW Vol. 50, No. 4, pp. 854-867.


companies engaged in natural resources exploitation.108 On the basis of such

controversy, this international institution adopted further texts recognizing states

permanent sovereignty in determining whether onshore oil property rights are

vested in privates or the state, as well as sovereignty rights to drill, extract and

commercialize oil found offshore within the borders of their respective continental

shelves.109

For years economists have analyzed the positive and negative effects

entailed by oil allocation models. Important scholarship, for example, considered

the access commons regulatory scheme —by which private individuals are vested

with property rights at the moment they size the resource— potentially entails an

externality termed as the tragedy of the commons or common pool problem.110 This

phenomenon relies on the grounds of a combination of scarcity and high-

population density; if the resource is scarce, individuals would have higher

inventive to overexploit it on their personal gain for the sake of shortage reduction;

and therefore this situation would lead to inefficient allocation and even

termination of the resource. Arguably in the oil and hydrocarbons industry, where

a non-renewable commodity is commercialized, IOCs would serve as intermediaries

whereby efficient allocation is achieved (e.g. by means of the private property

regulatory scheme) potentially overcoming a sort of tragedy of commons.

Nevertheless, this argument is also subject to criticism as other scholars extend the

tragedy of the commons to private property. They suggest that private individuals

—even having the guarantee that oil is theirs— may pursue the maximization of

their profit margin through overexploitation. These scholars highlight the

importance of public surveillance to maintain “conservation” instead of

“extermination”.111 In light of these discussions, oil’s non-renewable nature still

incentivizes overexploitation by private individuals despite the context of supply

and demand. On the other hand, state property may simply not an ideal

alternative. As it will be described in the Chapter 3, SOEs efficiency is constantly

put under scrutiny by economists and corporate law experts due to the fact they

may be prone to inefficiency, interventionism, protectionism, populism,

bureaucracy, conflicts of interest and so on.

108

ibid. 109

United Nations General Assembly, Resolution No. 626 (VII) 21 DIC. 1952; Resolution No. 1803 (XVII) 14

DIC 1962; Resolution No. 2158 (XXI) 1966; Resolution No. 3281 (XXIX) 12 DIC 1974. 110

See Garrett Hardin, The Tragedy of the Commons (1968) SCIENCE Vol. 162 No. 3859, pp. 1243-1248. 111

See Colin W. Clark, The Economics of Overexploitation (1973) SCIENCE NEW SERIES Vol. 181, No. 4100,

pp. 630-634.


Taken together, allocation and exploitation models prove the main pillars of the

institutional design embraced by states all over the world to organize their oil and

hydrocarbons industries. Whereas the allocation models vest property rights in

either particulars or states, the oil exploitation models outline the way in which the

Table 2.1. Roots of Latin American domanial regimes

Country Allocation Model

Argentina

18xx-1907: De facto private property (no legislation)

1907-1958: Private property in general, state property over Comodoro

Rivadavia (Decree of December 14, 1907)

1958-present: State property (Law 14.773)

Brazil

1891-1934: Private property (Federal Constitution)

1934-present: State property (Federal Constitution)

Chile


Colombia

18xx-1905: De facto private property (no legislation)

1905-1913: De facto state property (concessions to Martinez, Mares and

Barco)

1913-1969: Private property over previous discovered oil fields, state

property over vacant lots (Law 75)

1969-present: State property (Law 20)

Mexico

1864-1884: De facto state property (first oil concessions granted)

1884-1901: Private property (Mines Code and Law of July 4, 1892)

1901-1917: De facto state property (concession system established through

Petroleum Law)

1917-present: State property (constitutional status)

Uruguay


Venezuela

1865-1904: De facto state property (concession to Ferrand, Pulido,

Hamilton & Phillips)

1905-1920: De facto state property (concession system established through

Mines Code)

1920-present: State property (Hydrocarbons Law)

Note: The aforementioned statutes are intended to trace back historical roots; such pieces of legislation have

been replaced over time.

Sources: Alencar Xavier, Benavides, Cárdenas, Gonzales, Kaplan, Palazzo & Parente, Rosado de Sá Ribeiro,

Vasquez. Complemented by the author.


industry is developed. The way private individuals and the state interact within the

market is, in essence, established through exploitation models. The central issue is

the extent to which the formers may freely and independently explore, drill,

extract, refine and commercialize oil by their own with no state interference

further than average fiscal treatment and compliance with special environmental

regulation. Or put another way, the extent to which the state may block private

capital and carry out the whole activity on its own. By means of certain oil

exploitation models, foreign direct investors directly engage in oil activity in the

form of IOCs.

Essentially there exist five models to exploit the oil industry’s upstream

segment which are spot from comparative appreciation of historical events and

public policies; such taxonomy is based on functional business features rather than

mere legal concerns, thus, it takes into account criteria such as the degree in which

IOCs are involved with the market, autonomy of IOCs, level of NOCs’ control over

the market and power to force other actors to comply with their policies, and in

general the level of liberalization-monopolization; as follows, private exploitation

strategy, moderate private exploitation strategy, middle way strategy, moderate

state exploitation strategy and state exploitation strategy. This classification relies

upon the level of liberalization-monopolization deployed by the respective legal

system.112

The private exploitation strategy entails open maneuverability for IOCs. In

this case contractual arrangements to carry out the exploration and exploitation

phases would be determined between IOCs and subsoil resources proprietors,

either a private individual or the state according to what the institutional design

and particularly the allocation model set. Because the oil market is seen in this case

as any other through the eyes of the state, there only would be standard

restrictions associated with the natural resource industrialization and the

entrepreneurial activity would be charged with a simple income taxation rate; that

is to say, oil would be regarded as any other product or commodity. A second type

of private exploitation is the moderate private exploitation strategy, which is a less

open variable compared to the previous one. Once being authorized by the state

for such purpose IOCs have great margin to develop the upstream segment of the

industry, regardless of the method used to grant exploration and exploitation

rights, that is, bilateral negotiation or a competitive bidding. With this model IOCs

would be entitled to carry out activities limited to fixed location and duration or

other terms of the license or contract. In exchange of the state’s prior

112

See, e.g., Michael Likosky, Contracting and regulatory issues in the oil and gas and metallic minerals

industries (2009), available at http://unctad.org/en/docs/diaeiia20097a1_en.pdf; Kirsten Bindemann,

Production-Sharing Agreements: An Economic Analysis (Oxford Institute for Energy Studies, 1999).


authorization, special income taxes or royalties are collected. 113 This strategy

encompasses all those legal regimes whereby licensing, concessions, tax and

royalties systems are implemented. With the middle way strategy the market would

have the presence of IOCs and NOCs which are given the same conditions to

auction and being awarded concessions. Interestingly, both types of firms may

even enter into joint ventures and production sharing contracts, so that joint

bidding would let them engage together in upstream activities. From the use of the

moderate state exploitation strategy IOCs lose their operational autonomy; firstly

they need to comply with NOCs policies and secondly all affairs related to oil would

be under total control and surveillance of NOCs. Service and risk service contracts

are the most common forms of this type of strategy, where IOCs simply receive a

flat fee or a short percentage of earnings, respectively. Mandatory joint ventures

may also be regarded within this moderate state exploitation model since IOCs are

compelled to enter with NOCs into production sharing contracts as unique

alternative to engage in oil activities within the national territory, and normally in

exchange of ownership interests below 50%.114 And last, the state exploitation

strategy gather up a set of the most intense interventionist features. Under legal

instruments such as exclusive exploitation, the NOC would be the only participant

in the market, and the role of IOCs would be none. Latin American states have shift

their institutional designs in multiple occasions according to what current public

policies believe the optimal model is. All the details are summarized on table 2.2.

Mexico is one of the most notorious examples of the region since it has

oscillated through the entire strategies spectrum. Owing its proximity to US, the

influence of the northern country and the subsequent rejection were projected in

the Mexican oil exploitation model. The origin of the Mexican oil institutional

design trace back to 1864, when the country adopted the moderate private

exploitation strategy when awarding its first concessions. This model turned

towards the private exploitation strategy provided on the Mines Code of 1884 and

the subsequent Law of 1892, both legislative acts allowed oil extraction and

commercialization to landowners without prior consent by the state. By 1901

Mexico went back to the previous model; the Petroleum Law established a new

concession system and royalties tariffs. This model remained until the enactment

of the emblematic Expropriation Law and the creation of PEMEX in 1938, from then

on absolute monopoly and state exploitation strategy were embraced. Between

113

See Anita Rønne, Public and Private Rights to Natural Resources and Differences in their Protection? in

Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010). 114

Remarkably, this type of maneuver does not fit within the middle way strategy due to two reasons; firstly

because IOCs do not have the aptitude to engage in oil activities autonomously; that is, they cannot compete

with the NOC; and secondly, owing the minority ownership interest, IOCs lack of control to adopt decisions

within the joint venture.


1949 and 1951 Mexico allowed risk service contracts with IOCs and this represented

a new shift towards the moderate state exploitation strategy. Until 1960 IOCs were

allowed to partake in the market; that year Mexican constitution was amended and

monopoly was brought back. The 21st century has witnessed the most drastic

changes of traditional Mexican exploitation model. In 2003 Mexico signed

multiple-service contracts opening the door for IOCs after almost half century.

Such policy represented a shift to the moderate state exploitation strategy. Finally,

the constitutional amendment in 2013 indicates, at least from a formalistic

standpoint, the end of PEMEX’s monopoly and the adoption of the middle way

strategy.

The process in Argentina has also been surrounded by complexities. The

country adopted the moderate private exploitation strategy at the time the first

concession was granted back in 1916. The creation of YPF in 1922 as such did not

indicate the adoption of absolute monopoly, because although there was a

deliberate rejection of new concessions from 1924, due to political commitments

YPF coexisted with few IOCs that already were in the industry. Likewise, the middle

way strategy is the most accurate description of the Argentinean institutional

design at that time, even if the model was set up reluctantly. Such model lasted

until 1949, from that point on YPF carried all the weight of the oil industry. In the

subsequent years Argentina witnessed continued instability concerning its oil legal

framework. The state exploitation strategy was reverted in 1958, and established

back again in 1963.115 From 1976 a global opening process that lasted for decades

was implemented gradually. First, IOCs were allowed to engage in oil activities first

by means of service contracts and then through concessions, by the 1980s the

middle strategy had been embraced. The total privatization of YPF in 1993 meant

the adoption of the moderate private exploitation strategy by Argentina. Finally,

the expropriation carried out in 2012 gave room to a new episode in the

Argentinean institutional design because the return of the state to the market does

mean nothing but a shift towards the middle way strategy.

The Brazilian institutional design accounts for fewer shifts and is perhaps

the most stable of the region in recent decades. In 1891 the Federal Constitution

embraced the private exploitation strategy. Up to 1934 the oil entrepreneurial

activity remained private, because the Decree 24642 enacted the same year

established previous authorization and concession by the Brazilian administration

for subsoil industrial exploitation. In 1946 the state exploitation strategy set forth a

monopoly which was not fully materialized until 1953 through the incorporation of

PETROBRAS. In 1977 the conventional statist strategy was moderated since IOCs were

115

See Palacios, supra note 66.


allowed to participate under risk service contracts. This shift was reversed in 1988

when this type of contract was banned again. Ever since 1995, after the adjustments

articulated by the Constitutional Amendment Nº 9 and Law 9.478, Brazil has had

the middle way strategy.

The government of Colombia granted its first concessions in 1905. This

moderate private exploitation strategy remained for many decades until the

creation of ECOPETROL in 1951 which, added with the formal coexistence of IOCs

within the legal framework, represented the adoption of the middle way strategy.

Certainly the creation of ECOPETROL itself shoo away foreign entrepreneurship —

bearing in mind regional precedents of expropriation—, but it is important to note

that the “public enterprise” label was the mere result of circumstantial elements

since the unsuccessful original intention of Law 165 of 1948 was to set up a

company from public and private foreign capital, or at least domestic private

capital.116 In 1969, as mandated by Law 20, IOCs were put under control and policies

set forth by ECOPETROL by means of risk service contracts; a shift towards the

moderate state exploitation strategy. During 1974 new legislation allowing

associations by ECOPETROL and IOCs was enacted, however, this did not

represented further change in the matter of institutional design since joint

ventures were the only alternative for the latter to engage in exploring and

extracting activities. Finally, Colombian legal system embraced in 2003 the middle

way strategy when Legislative Decree 1760 was introduced; this piece of legislation

enabled IOCs to develop the industry freely in fair competence with ECOPETROL

under a concessions system.

Even though Venezuela has experienced several shifts, changes have not

turned out that drastic from a strategic standpoint, as opposed to common belief.

Having granted the first concessions back in 1865 and enacting the Mines Code in

1905, Venezuela adopted first the moderate private exploitation strategy. Then, in

1938, the statutes formally enabled the state to engage in oil entrepreneurial

activities; that is the middle way strategy, though the truth is that no activity was

observed in this respect. The concessions system was adjusted in 1943 and royalties

were increased, nonetheless, the pre-establish model was still in force. In the early

years before the mid-1970s, Venezuela considered to create its own oil firm and

carry on the concessions already given to IOCs. However, the creation of PDVSA in

1976 was not as such a radical drift objectively speaking. In fact, the

Nationalization Organic Law kept the possibility by which IOCs could legally re-

enter the market, put it differently, a moderate state exploitation strategy.

Likewise, new risk service contracts were signed in the 1990s within the context of

116

See supra note 37.


the neoliberal opening process based on a “reinterpretation” of preexisting laws.117

More interestingly, this moderate state exploitation strategy remained even after

the renationalizing statutes enacted in 2007. In spite of the political tensions, the

decision of the incumbent government to use mandatory joint ventures for IOCs

did not represent any shift in terms of institutional design since the model is in

essence the same.118

Many factors account for the adoption of one or another strategy. And

precisely is at this point where the bulk of academic debate and empirical analyses

have relied upon; ranging from the classic ideological responses concerning the

enigmatic privatization-monopolization cycle, through market deregulation

considerations, up to the debate of the supremacy of private enterprise over public

enterprise.119 Taken as a whole, all these studies are part of a more extensive

framework, one intended to determine what the optimal institutional design is and

its advantages to achieve specific ends. In a word, the optimal model is a mere

means. As to the end, it is also subject to further debate. On the basis that oil

market is not prone to failures and thus performs proficiently with sole presence of

private capital, an end may be providing necessary incentives so that individuals by

their own create new wealth and foster economic growth and development. The

end may also respond to geopolitical grounds due to finite nature of oil, mass

consumption and indispensability of petroleum products. Other approaches aim to

reallocate wealth through infrastructure and social welfare programs once the state

has engaged in outperforming business activities. Yet, all these ends have also been

subject to scrutiny by academics trying to decipher the most appropriate role for

the state.120 Ultimately, this debate boils down to balancing benefits and costs; it is

a matter of strategies where broad elements such as efficiency, rents, stability of

revenues and agency costs should be taken into account.121

117

See PDVSA official website www.pdvsa.com; David Hults, Petróleos de Venezuela, S.A.: The Right-Hand

Man of the Government (Working Paper No. 70, 2007), available at http://iis-

db.stanford.edu/pubs/22067/Hults,_PdVSA_case_study,_WP_70.pdf. 118

“Transforming the operational agreements to ‘joint ventures’ sends the illusory message that the oil

business is reverting to ‘public patrimony’. But Horacio Medina, a former PDVSA employee, points out that

the new mixed companies constitute privatization for the state-owned oil company, because the former

operators are now partners in joint ventures. Previously, transnational companies worked at their own risk;

now, they have a stake in a joint business”. See PDVSA: Nationalization or Privatization?, ENERGY

TRIBUNE, JUN, 1, 2006, available at http://www.energytribune.com/437/pdvsa-nationalization-or-

privatization#sthash.2WaPuk2R.y4GW7ZJR.dpbs 119

See, e.g., supra notes 14 and 15. 120

ibid. 121

See Rigobon, supra note 15.


Table 2.2. Latin American shifts

Country Exploitation Model

Argentina

1916-1922: moderate state exploitation

1922-1949: moderate state exploitation (reluctant)

1949-1958: state exploitation



1976-1993: moderate state exploitation / middle way

1993-2012: moderate private exploitation

2012-present: middle way

Brazil

1891-1934: private exploitation





1995-present day: middle way

Colombia


1951-1969: middle way



Mexico


1884-1901: private exploitation







Venezuela


1938-1976: middle way

1976-present: moderate state exploitation

Note: Non-shift measures were left out.

Sources: Alencar Xavier, Benavides, Cárdenas, Gonzales, Kaplan, Palazzo & Parente, Rosado de Sá Ribeiro,

Vasquez. Complemented by the author.

When onshore drilling became important in the late 19th and early 20th

century, few foreign companies had enough equipment and technology to ensure

drilling of proper and efficient exploration wells and maximizing resources for

finding oil of. These firms had developed complex vertical integration structures

covering all phases of the oil industry, including the upstream, downstream and

midstream segments, which ultimately meant full know how on the market inner


working. As if this were not enough the oil industry as such demands risk capital

from the very beginning; the exploratory phase is considered the most risky part of

the whole entrepreneurial activity and investments may only be recouped within

the long-term —in fact most exploration investments are frequently regarded as

sunken investments—. 122 All these circumstances made states came up with

different alternatives. At that time most Latin America states did lack of enough

infrastructure and logistics to build an oil industry from scratch, resulting in a

potentially expensive and risky option. Moreover, states also lacked information

concerning the costs required for oil extraction. 123 In light of the foregoing

considerations, embracing a model that celebrates private entrepreneurship may

then be the result of technocrat decisions by which states decide to let others to

build the industry from scratch as well as avoiding risk of failure in finding new oil

reserves. In this line of thought, even expropriation may be deemed as the result of

technocracy in the way to find that optimal model; put differently, once local oil

subsidiaries are mature and stable enough, the state may turn to resume the

activity on its own, which would give explanation to any of the alternative

exploitation models in which state entrepreneurship is vastly present. Of course

this controversial strategy is subject to criticisms in the sense that it is nothing but

a behavior in conflict with loyalty and respect to private property which ultimately

deters private investment. The first rational strategy, embraced by nature and even

necessity, could be to let IOCs in. In fact, as addressed in the Chapter 1, some

countries like Bolivia, Colombia, Ecuador, Mexico, Peru and Venezuela set up their

NOCs to continue the work already carried out by foreign investors. The cases of

Argentina and (to a lesser extent) Brazil would be the only ones in which the

industry started virtually from the scratch.

States may also put in practice a model that enables them to enjoy the

benefits of commercializing such commodity with no need to expropriate private

individuals. Using concessions, licensing, or taxes and royalties systems may be an

alternative to promote friendly environments for private investors and to send a

message of little intervention. Should the state decide to boost its returns,

increasing tariffs of special income taxes and royalties is a simple static alternative

which does not entail to shift the exploitation model (generally it requires

coordination of a number of authorities). In this case states may opt to increase

taxes and royalties under the ideal of creating enough incentives for IOCs to

maintain operations and constant extraction rates because any excessive increase

would effectively discourage oil entrepreneurial activities, in fact IOCs cannot just

simply increase price to mitigate taxes since the price of crude oil fluctuates in

122

See Bindemann, supra note 112. 123



response to macroeconomic factors and is trade based on international

benchmarks which are barely influenced by local phenomena with few

international repercussion. To give an example, high percentages of royalties

hinders exploration to a greater extent, especially when such state take is

calculated on the basis of gross incomes; in this case the oil activity is less

attractive when low extraction rates are faced and the likelihood of regarding

investment as sunk increases; therefore, legal mechanism like preemptive cost

recovery agreements are quite useful in such landscape. 124 Despite the

aforementioned, the truth is that states are more incentivized to shift strategy

when (e.g. expropriate) when revenues from tax takes and royalties fail in giving a

proportional take. There remains a residual possibility for the oil industry to be

kept in private hands as a mere result of negligence and legislative lethargy. The

absence of regulation in most Latin American jurisdictions and civil law regimes in

general just enables private individuals to act with no constraints by the state.

At the other pole, the participation of both states and private individuals

also has its rationale behind. The first of these alternatives is open competition

among producers which may promote market stability in general as private

individuals would be able to make great discoveries on their own; this ultimately

allows to boost national oil reserves, hence national wealth, and maintain highly

sustainable extraction rates within the long-run. As for the states, in this case they

would bear no expenses in the exploratory phase and allocation of property rights

over oil plus fiscal takes and royalties may be enough incentive to let private

individuals in. Joint ventures, in turn, allow splitting costs and rewards

proportionally; besides the fact that private individuals and the respective state

may create synergies in order to add dynamics in the industry development,

especially when it comes to technology, for instance, in the extraction of heavy

crude oil.125 The so-called production sharing agreements allow states to retain

profits even when they do not to sink risk capital for the exploratory phase,

although private individuals bear all the risks of exploration they do not have the

pressure of finding a new oil field, recoup investments and boost gains within a

limited time framework established through other systems like concessions.126 Yet,

participation level of private individuals is subject to specific needs of the oil sector

like the pressure of increasing oil reserves or other factors concerning geography,

geological conditions and infrastructure. Still relevant, regardless of the

exploitation method, the price of oil is volatile; hence, rents are so as well.127

124


“[T]here are high geological risks involved in oil exploration, whereas in the phases of field development

and production these risks significantly decline”. See Manzano and Monaldi, supra note 15. 126

See Likosky, supra note 112. 127



In sum, going for one or another exploitation model may be regarded as

strategic dynamic for states, and therefore the adoption of any strategy depends

either on state’s capability maximization or incompetence minimization. As for

direct investors, the loose side of the institutional design spectrum and the middle

way entail major benefits than the tight side, but they also have to bear in mind the

more tight the exploitation model the less risk of expropriation (e.g. service

contracts) as will be addressed in chapter 3.128 Table 2.3 summarizes risks and

rewards of all exploitation models.

Table 2.3. Risk and rewards of exploitation models

Exploitation Model Risk and Rewards

Private

All risks and rewards on IOCs. The state collects average

income tax.

Moderate private

Licensing, concessions, tax and royalties systems: All

risks and rewards on IOCs. The state collects royalties on

gross rewards and special income taxes after allowing a

preemptive percentage on costs of recovery. State

incomes fluctuate according to the level of rewards.

Middle way

Open competition: All risks and rewards on IOCs or

NOCs, respectively. The state collects royalties and

special income taxes upon the terms of concessions or

licensing.

Joint ventures: IOCs or NOCs share risks and rewards

according to their ownership interest.

Production sharing contracts: IOCs take all exploration

risks and share exploitation and rewards with NOCs.

Moderate state

Risk service contracts: NOCs take all exploration risks

and share exploitation and rewards with IOCs.

Service contracts: All risks and rewards on NOCs. IOCs

are entitled to a flat fee.

State All risks and rewards on NOCs. The state may also

collects taxes.

Adapted from Bindemann

Sources: Bindemann, Likosky, Palacios.

128

See Duncan, supra note 15.


Empirical evidence on firm-level data shows no cash flow is becoming more

quintessential for the functioning of Latin American NOCs than portfolio

investments. Remarkably, by joining market economy not only from a regulatory

perspective but also as real life business entrepreneurs, emerging economies as

well as a great number of emerging economies appear to put aside the classical

debate between private and public cash flows and make it even sound impractical

and out-of-date. These states are on a steady path of pragmatism implementing

external financing practices for the sake of institutional leadership promotion.

Precisely, in recent years analysts have witnessed how regional top oil producers

have tended to resort to public financing strategies and corporate state-of-the-art

measures whereby large portfolio investments are received in their oil crown jewels

in exchange of both equity and debt financial instruments, and this is achieved

through worldwide capital markets. When states use corporate equity financing

the result would be a partially-owned NOC where the role of the state as controller

shareholder is methodically ensured.129 Argentina, Brazil, Chile, Colombia, Ecuador

and Peru have an average ownership interest of 66% in their SOEs.130 Similarly, due

to political or similar reasons, states may opt to use corporate debt financing by

which NOCs receive cash flows from outside investors without creating an

additional layer of shareholders, perhaps as a way to keep their public statuses

intact. Regardless of the status of partially-owned or wholly-owned, these state-run

companies are all linked to a diverse array of public investors, including

institutional and retail as well as domestic and foreign investors. Through this

scheme resource-rich countries are raising capital to develop their oil investment

plans; and the consideration is quite straightforward; that is, sharing the harvest

with outside-passive shareholders or making fixed payments to bondholders.

The first question that arises is why NOCs resort to securities offerings. And

the answer relies on a number of factors. Access to new cash flows, diversification,

banking constraints and liquidity prove the most important determinants when

receiving portfolio investments through capital markets. As expected, the

advantages of this practice are not exclusive to states; instead, raising funds from

outside investors is more than a widely known strategy for entrepreneurs trying to

129

“Indeed, at the end of 2000, after the largest privatization wave in history, governments retain control of

62.4% of privatized firms. In civil law countries, governments tend to retain large ownership positions,

whereas in common law countries they typically use golden shares”. See Bernardo Bortolotti and Mara

Faccio, Government Control of Privatized Firms (ECGI - Working Paper No. 40/2004; FEEM Working

Paper No. 130.04; EFA 2005 Moscow Meetings Paper; AFA 2006 Boston Meetings Paper, 2007), available

at http://www.ssrn.com/. 130

See OECD, supra note 10.


benefit from public exchanges. Firstly, the common wisdom according to the

business cycle theory is that steady and sustainable growth will necessarily require

constant and progressive capital infusions, particularly in capital-intensive

businesses.131 In the case of oil, inherent circumstances of the upstream and

downstream segments of the industry have a direct impact on costs; for instance,

offshore extraction is resource demanding, though this not even compares to the

amount of risk capital or sunken investment required during the exploration phase

which is also boosted by pressure of finding new oil reserves within a limited

timeframe; also research and development programs are one of the most important

expenses in the industry. In fact, exploration and development prove the largest

expenses in the business; between 2008 and 2012 expenditures in exploration and

development by 75 oil companies from 18 different countries totaled US$334.5

billion and US$1430 billion respectively. 132 As if this were not enough even

maintaining the same level of performance and extraction rates progressively

becomes more capital demanding; analysts point out how operating costs (i.e.

marginal costs of producing one additional oil barrel) increase over time.133 In

absence of sufficient internally generated funds, states —as sole investors— would

be compelled to provide the entire necessary resources to cover these capital

expenses; and the issue, however, is that states may eventually either lack the

resources or find formal limitations for public expenditures. Securities offerings

through the primary market, in essence, enable NOCs to channel new resources

from outside investors so that the impact of cash flow shortfalls is cut and financial

needs met.134 Secondly, even if states have enough financial muscle to meet such

capital expenses and no budgetary constraints, they may opt to diversify their risk

by accepting outside investors. Likewise, costs of failure would be eventually

shared in accordance to the terms in which liquidation rights are articulated in

each type of security held by outside shareholders and bondholders; in practice

senior debt enjoys preference over junior to recoup the investment, bondholders

over shareholders, preferred stock over common stock and outside shareholders

over insiders.135 Even though the likelihood of rescue from bankruptcy by means of

financial aid and bailouts is high in the case of SOEs, the truth is that formally

speaking the state is externalizing part of the risk of failure to other investors, plus

131

See Stephen J. Choi and A.C. Pritchard, Securities Regulation: Cases and Analysis (Foundation Press

2008). 132

See Global Oil and Gas Reserves study 2013. EY, available at

http://www.ey.com/Publication/vwLUAssets/EY_-_Global_oil_and_gas_reserves_study_2013/$FILE/EY-

Global-oil-and-gas-reserves-study-2013.pdf 133

See, e.g., Palacios, supra note 66; Bindemann, supra note 112. 134

See Thomas Lee Hazen, The Law of Securities Regulation (Tomson Reuters 2009). 135

See Choi and Pritchard, supra note 131.


eventual bailouts are subject to political considerations. 136 Thirdly, corporate

finance functions as alternative investment platform for insiders to avoid or at least

reduce typical bank financing constraints.137 Bank financing may turn out costly

due to adverse selection measures carried out by financial institutions; over

collateralization of clients’ assets is frequently used as means to secure loans and

this eventually compromises indebtedness capability; moreover, banks also

demand costly covenants which tend to restrict the firms’ ability to operate on

their regular basis. Both equity and debt issuances are open alternatives to banking

finance and may even increase the bargaining power of firms against financial

institutions, since the latter are exposed to increasing competition of public

interested in serving as lenders.138 Fourthly, in the case of equity issuances, once

these types of securities are registered in public exchanges, preexisting

shareholders including the controller may opt to step out of the company and this

would be easily achieved through the benefits of the aftermarket.139 Besides, since

shareholder activism and proxy contests are null within concentrated ownership

models —where the board of directors is virtually appointed by the controller

shareholder—, secondary market liquidity ensures to a greater extent that minority

shareholders will remain passive in management seeking as they find less costly to

sell their stakes than attempting to gain higher board representation.140 And fifthly,

by issuing debt or any other type of security lacking of voting rights, insiders

ensure for themselves plenty corporate maneuverability as outside investors would

lack of voice in the company’s affairs; put differently, management would lie in the

former —and this is compensated through significant yields and liquidation

preferences—.

This final feature of public financing raises a much greater pitfall of major

concern to insiders: public equity offerings may eventually entail “loss of control

over management matters”.141 Corporate control is nothing but the most important

136

See Chong and López-de-Silanes, supra note 15; Mariana Pargendler, Aldo Musacchio and Sergio G.

Lazzarini, In Strange Company: The Puzzle of Private Investment in State-Controlled Firms (Working

Paper 13-071, 2013), available at http://www.ssrn.com/; Aldo Musacchio and Sérgio G.Lazzarini,

Leviathan in Business: Varieties of State Capitalism and Their Implications for Economic Performance

(Working Paper, 2012), available at http://www.ssrn.com/. 137

See Marco Pagano, Fabio Panetta and Luigi Zingales, Why Do Companies Go Public? An Empirical

Analysis (1998) THE JOURNAL OF FINANCE Vol. LIII No. 1, pp. 27-64. 138

ibid. 139


The more diversified the portfolio investor, “the less likely to join the insurgent coalition”, increasing the

likelihood to opt for the so-called “Wall Street Rule”. See Stephen Bainbridge, The Case for Limited

Shareholder Voting Rights (2006) UCLA LAW REVIEW, pp. 601-36. See also Andrei Shleifer and Robert

W. Vishny, A Survey on Corporate Governance (1997) THE JOURNAL FINANCE Vol. LII No. 2, pp. 737-83.

The authors suggest retaining larger share blocks increases the likelihood of legal protection effectiveness.

Also, minority shareholder activism legal measures generally set up a minimum threshold for proposals. 141

See supra note 134.


instrument in the inner functioning of any company since it allows plenty

command over invested cash flows. In practice, the purest version of the voting

proportionality postulate grants voting rights in proportion to the invested cash

flows, and it ensures to a greater extent that control is exercised by the investor

with the largest stake or at least a sufficient number of shares that allows to

domain the decision making process in the shareholders’ assembly.142 By issuing

common and preferred stock or any other type of equity instruments, the number

of shares in which capital divides is increased and consequently the percentage

originally held by insiders decreases as outside investors purchase issued shares.143

Loss of corporate control through public offerings is in essence explained on the

basis of this phenomenon which is labeled “percentage dilution”. In other words,

the larger the issuance the more likely to result diluted in the aftermath of the

public financing strategy. The outcome is the loss of voting power and therefore

corporate control. Likewise, insiders may will to issue a limited number of shares

that enables them to retain corporate control; however, if such “limited” offering

does not meet capital needs, the public financing strategy would remain ineffective

to access sufficient cash flows. Such dilemma may be solved through corporate law

state-of-the-art measures. Depending on the specific jurisdiction, a number of

control-enhancing mechanisms may be articulated in order to retain control after

letting outside shareholders in with considerable investments. The most common

means, and still controversial, is disproportional ownership.144 Deviating from the

aforementioned one-share-one-vote rule and setting up a dual-class shares

structure enables to structure a decision making system whereby shareholders hold

more or less voting rights than those conceived under the original investment or

cash flow rights. In other words disproportional ownership allows “detaching

voting rights from cash flow rights”.145 On that basis, by keeping more voting power

than public outside shareholders, insiders may issue larger portions of equity

without facing the risk of relinquishing control. Such practice has been termed by

academics as “leveraged control”.146 This type of control-enhancing mechanism

142

The expression “the purest version of the voting proportionality postulate” encompasses both sticking to the

so-called one-share-one-vote rule on one hand and precluding the use of dual-class structures on the other. 143

See Michael Woronoff and Jonathan Rosen, Understanding Anti-dilution Provisions in Convertible

Securities (2005) FORDHAM LAW REVIEW Vol. 74, p. 129. 144

See José Miguel Mendoza, The Challenge of Disproportional Ownership in Boris Kozolchyk and Francisco

Reyes (eds), LATIN AMERICAN COMPANY LAW: A COMPARATIVE AND ECONOMIC DEVELOPMENT

PERSPECTIVE (Carolina Academic Press 2012). 145

ibid. 146

Insider investors would exercise control not by having the largest stake (i.e. majority controller) or a

considerable stake (i.e. controlling blockholder surrounded by widely dispersed shareholders) but through

leverage (i.e. leveraged controller). See Ronald J. Gilson and Alan Schwartz, Constraints on Private

Benefits of Control: Ex Ante Control Mechanisms versus Ex Post Transaction Review (Yale Law &

Economics Research Paper No. 455; Stanford Law and Economics Olin Working Paper No. 432; Columbia

Law and Economics Working Paper No. 430; ECGI - Law Working Paper No. 194/2012, 2012), available


comes in the form of dual-class share structures, multiple-voting shares, non-

voting shares, golden shares and even pyramidal structures.147 Intricate cross-

ownership structures (e.g. keiretsu, chaebol) and even shareholder voting

agreements serve at some point as control-enhancing mechanisms as well.148

To this end, either ideological foundations or rational economic behavior,

the truth is that the precise set of characteristics already adopted by some

resource-rich countries allows them not only to coexist with multinational firms in

one of the most profitable activities of primary commodities’ commercialization,

but also to enjoy the economic and legal benefits that public financing without

releasing corporate control entail. As it will be detailed, Brazil, Colombia and

Argentina use public equity financing on the one hand. Whereas Brazil reserves

control in its crown jewel through the use of voting power leverage, Argentina and

Colombia have a traditional majority control. Though, the Argentinean

administration has a golden share inherited from the days of total privatization. In

the other hand, public debt financing is quite prominent among these three

countries as well as Mexico and Venezuela. NOCs public financing is summarized

in table 2.4.

The public financing strategy has enabled equity investment in PETROBRAS,

YPF and ECOPETROL. By listing in BM&F BOVESPA, NYSE, BME LATIBEX and BCBA,

PETROBRAS became a public company controlled by the Federal Government. The

Brazilian administration directly owns a stake of common stock that ultimately

accounts for 28.7% of all outstanding shares and the remaining shareholdings are

widely dispersed among domestic and foreign investors, with the exception of

BNDES Participações and BNDES which have important blocks of 10.4% and 6.9%,

respectively.149 The bulk of retail shareholding consists of ADR investors with

20.6%, non-resident investors 12.9%, and free float of 17.4%.150 Even though the

Federal Government itself is not a majority shareholder —not even exercising the

voting rights of BNDES Participações and BNDES (which are also state-owned

firms)—, dividing the capital between common and preferred stock and deviating

from the one-share-one-vote rule ensures absolute control for the state. Whereas

common shares account for one vote, preferred shares are non-voting stock, and

therefore the incumbent government controls PETROBRAS through 50.3% of voting

rights in the shareholders’ meetings. In turn, the National Government of

at http://www.ssrn.com/; Sang Yop Kang, Understanding Controlling Shareholder Regimes (Doctoral

Thesis at Columbia University 2011), available at academiccommons.columbia.edu/. 147

See Lucian Aye Bebchuk, Reinier Kraakman, and George Triantis, Stock Pyramids, Cross-Ownership and

Dual Class Equity: The Mechanisms and Agency Costs of Separating Control From Cash-Flow Rights in

Randall K. Morck (ed), CONCENTRATED CORPORATE OWNERSHIP (UCP 2000). 148

See Mendoza, supra note 144. 149

See PETROBRAS official website www.petrobras.com. 150

ibid.


Colombia is the majority controller of ECOPETROL with an ownership interest of

88.5%; the remaining 11.5% is traded in BVC, NYSE, TSX and BVL. Pension funds are

among major blockholders (e.g. Porvenir 1.6%, Protección 1.3% and Colfondos

0.4%), followed by foreign institutional investors.151 An important 5.5% circulates

among retail investors, mainly regular Colombian citizens, while a small 0.9%

fraction circulates in foreign markets as ADRs. 152 In the aftermath of re-

nationalization the Argentinean state holds 51.01% of the capital in YPF, 51% in

common stock “class D” expropriated from Repsol and 0.01% in common stock

“class A” which is basically an exclusive golden share provided with veto rights in

sensitive corporate affairs. Repsol is the largest blockholder of YPFs with an

ownership interest of 11.9%; the remaining 37.09% is free float.153 YPFs’ shares are

traded in BCBA and NYSE.154

One thing to note is the great heterogeneity of these three legal systems

towards the postulate of voting proportionality. The Brazilian and Colombian

regimes mandate the one-share-one-vote rule and ban multiple voting rights, but

at the same time enable to partially deviate from such principle by allowing non-

voting stock.155 As previously detailed, Brazil has made use of non-voting shares

while Colombia remains fully proportional. Argentinean law allows both, multiple

voting (capped to five votes per share) as well as non-voting stock.156 However,

none of these measures has been applied to its NOC. As the case of the golden

share, this simply consists on absolute veto rights for decisions like statutory

151

See ECOPETROL official website www.ecopetrol.com. 152

ibid. 153

See YPF official website http://www.ypf.com. 154

The case of YPF diverges to some extent from the aforementioned cases and deserves a special

consideration. The way these investors and the Argentinean state interact as business partners is not as such

the outcome of a deliberated public offering strategy in which outsider investor adhere to state

entrepreneurship; instead it is the result of a reverse process where the state came after public investors. It is

quite plausible the incumbent government had two main considerations in mind when expropriating only

51% of YPF; in the first place this percentage was sufficient to exercise corporate control; secondly

“cheaper is better” and therefore compensating just a percentage was less costly than expropriating the

whole company. Likewise, the existence of portfolio shareholders is to some extent the result of a unilateral

decision and this would give room to argue they are non-voluntary investors (investors still have secondary

market liquidity to exit the investment). Yet, YPF maintained the status of listed company; thus, like Brazil

and Colombia, Argentina is enjoying the advantages of public financing since YPFs’ shares are still traded

in BCBA and NYSE. 155

See Francisco Reyes, Corporate Governance in Latin America A Comparative Law Perspective (Paper

prepared for the LSU Law Center Conference: “Mediating the Divide: Challenges to Hemispheric Trade

Posed by the Common Law/Civil Law Divide” 2006), available at

http://users.wfu.edu/palmitar/Courses/ComparativeLaw/CourseReadings/Corporate%20gov%20in%20LA.p

df. 156

ibid.


mergers, change of control, dissolution, relocate the company outside the national

territory, and the assignment of oil exploitation permits.157

Additionally the public financing strategy has also enabled debt investment

in all Latin American major NOCs; PETROBRAS, PDVSA, PEMEX, ECOPETROL and YPF.

In the recent decade PETROBRAS has issued senior notes in NYSE and Luxembourg

Stock Exchange (LUX) that account for approximately US$35 billion and €7 billion,

with fixed maturity dates ranging from three years to 30 years, being 11 years the

average.158 During the last two years, YPF has issued mainly domestic short-term

notes with fixed maturity periods no higher than 10 years, though recent issuances

have been made in LUX; in total US$8 billion and AR$11.5 billion have been issued.159

ECOPETROL has made few domestic and international offerings compared to the

rest; US$6 billion and COP$1.900 billion in both short-term and long-term debt.160

Interestingly, PEMEX and PDVSA have used debt issuances instead of equity as a

more conservative way to reach portfolio investors. PEMEX has placed bonds in BMV

(Mexico) and NYSE, while PDVSA in NYSE, LUX and Berlin Exchange.161

Table 2.4. NOCs public financing

NOC Equity

financing

C-E

Mechanism

Debt

financing

Domestic

Markets

Foreign

Markets

PETROBRAS X Leveraged X X X

YPF X Majority X X X

ECOPETROL X Majority X X X

PDVSA - - X - X

PEMEX - - X X X

Sources: Public available information compiled by the author.

157

YPF bylaws. See YPF official website www.ypf.com. For golden shares see, Stefan Grundmann and Florian

Möslein, Golden Shares - State Control in Privatised Companies: Comparative Law, European Law and

Policy Aspects (Working Paper, 2003), available at http://www.ssrn.com/. 158

See PETROBRAS official website http://investidorpetrobras.com.br/en/shares-and-

indebtedness/prospectus/full-view/full-view.htm. 159

See YPF official website http://www.ypf.com/enu/InversoresAccionistas/Paginas/Emisiones-de-titulo-de-

deuda.aspx. 160

See ECOPETROL official website http://www.ecopetrol.com.co/contenido.aspx?catID=555&conID=77451

and http://www.ecopetrol.com.co/contenido.aspx?catID=556&conID=80526. 161

See PEMEX official website

http://www.ri.pemex.com/index.cfm?action=content&sectionID=20&catID=12175

Taken as a whole, the previous chapters aimed to assess the wide array of

regulatory alternatives considered by resource-rich countries when developing

their oil and hydrocarbons industry, and how each selection in Latin America has

been the outcome of a privatization-monopolization cycle driven by a great

number of determinants. Chapter 1 focused on the discussions deployed by the

existing literature regarding the explanation of the drivers that led to the current

set of public policies concerning National Oil Companies (NOCs), foreign direct

investors and portfolio investors within the region. At one pole, political scientists

and critical historians posit the restart of the cycle is triggered by ideological and

political grounds such as national proud, popular sovereignty, egalitarianism,

populism, reprisal towards foreigners, foreigners’ influence restraint, and even

smokescreen for local governance issues. At the other pole, economists argue

economic and technocratic determinants like the increase of international crude

oil price, deficiencies in the taxation and royalties systems, and liberation of new

cash flows, have been decisive when moving across different phases of the cycle.

Furthermore, Chapter 2 analyzed thoroughly and from a comparative perspective

the extended regulatory framework where states may select their own institutional

design to implement choices of public policy towards oil; in broad outline, the

outcome of each institutional design depends on the allocation of ownership and

exploitation rights over such commodity. To this end, moving back and forth

through such framework and changing institutional designs has been explained as

a cyclical phenomenon. The importance and significance of such formulation lies

in the fact that each phase of the cycle or each institutional design entails either

greater or lesser participation of NOCs and private investors. Remarkably, Latin

American top oil producers are nowadays converging and adopting similar

institutional designs, no matter what the starting point is. The combination of the

middle way or moderate state entrepreneurship plus public financing entrench a

great presence of both foreign direct investors and portfolio investors in the oil

business. Brazil, Argentina, Colombia, Venezuela and recently Mexico embraced

industries in which NOCs coexist with IOCs and the former companies resort to

outside private investors’ financing, either shareholders or bondholders.

Chapter 3 The Challen es of Investo s’ P otection 47

It is difficult to imagine how this complex set up could be exempted from

costs. In fact, recent literature points out the multiple agency conflict that may

arise from such type of institutional design. 162 Two value-reducing forms of

opportunism emerge. Consider first the relation between host countries and IOCs.

Foreign direct investment is made on the basis of particular conditions subject to

legal and political certainty; however, by means of sovereignty the states may

reshape at any time the scheme which governs the relationship with foreign

investors to benefit NOCs. Even if such adjustment is “unbiased” and simply

intended to find what governments consider an optimal strategy either socially or

economically speaking, any shift towards other oil exploitation model may

considerably alter the performance of IOCs. The risk in this case is nothing but the

modification of the preexisting conditions by which the original investment was

made; as for the costs, lower revenues for IOCs and reputational harm for the host

country. Moreover, under lower level of governmental commitments, IOCs could

be left out of the landscape; expropriation and no compensation is perhaps foreign

investors’ worst case scenario. Recently, an unprecedented phenomenon in Latin

America has switched on the alarms in the matter of investor protection: being

partially expropriated turns direct investments into pseudo portfolio investments.

As it follows, this first agency conflict arises between host countries and private

individuals, mostly foreign direct investors. In turn, public external financing gives

room to a second type of principal-agent relation; and therefore an additional

conflict might be witnessed between insiders and outside investors; NOCs on one

hand, NOCs’ shareholders and bondholders on the other. The classical horizontal

agency problem involving controller and minority shareholders arises within

partially-owned NOCs, including information asymmetries, mismanagement and

appropriation of private benefits of control. In certain cases, the likelihood of

extracting private benefits of control is increased by the use of leverage; the state

ensures plenty voting power despite holding a minority stake of ownership interest

but afterwards such strategy reduces state’s dividends. In addition, owing either

reluctance or simply conservatism, some states have opted to maintain NOCs as

wholly-owned enterprises to avoid a second layer of private shareholders; as a

result outside investors are given with the label of creditors and this ultimately

boosts the level of information asymmetry. As if this were not enough, this insider-

outsider conflict is not exempt from the sovereignty power of the state, which may

use the NOC as a political vehicle for public welfare instead of wealth

maximization, bureaucracy and clientelism in detriment of both outside

shareholders and bondholders.

162

See, e.g., Rigobon, supra note 15; Pargendler et al., supra note 136; Musacchio and Lazzarini, supra note

136.

48 Which are the Conflicts and Remedies?

Accordingly, Latin American legal systems must offer sufficient protective

measures for the full spectrum of investors within the oil business in order to

prevent and mitigate any potential misbehavior that may arise from states’

controlling position and sovereignty power. At the same time, the challenge

consists in granting protection without hampering value creation. Each of the

following sections of this chapter will separately address the aforementioned

conflicts.

Market uncertainty and other macroeconomic conditions like fluctuation of

currency exchanges and loss of purchase power through inflation are only one

fraction of what international investors face when making foreign direct

investment in developing economies. In such countries, exogenous risks are also

present as institutional instability for maintaining public policies comes to play.163

In spite that a large number of elements do have effect on the level of foreign direct

investment inflows, the oil and hydrocarbons industry especially relies upon legal

and political stability —the so-called “good governance”—. Since host countries set

up the conditions by which foreign direct investors decide to invest, the latter’s

best interest depends on the former. Likewise shifting oil exploitation schemes

compromises nothing but political and legal certainty, and IOCs embody the other

side of what might be a strategic behavior in favor of the state. Put differently,

what brings benefits for the state may create daunting costs for IOCs. In fact from

private investors’ standpoint, shifting among exploitation models is a delicate issue

in itself since it unveils lower levels of commitment from the host country

involving the preexisting rules by which investments were originally made. Even

worse, institutional designs are quite sensitive even to subtle changes and any

slight adjustment in one of their components may potentially create adverse

circumstances that turn the preexisting conditions of oil exploitation unfavorable.

If exploitation models were put into a linear scale being private exploitation at the

left and state exploitation at the right, any shift towards the right side would

invariably entail externalities for IOCs, regardless of the fact such adjustment aims

163

See, e.g., Tim Buthe and Helen V. Milner, The Politics of Foreign Direct Investment into Developing

Countries: Increasing FDI through International Trade Agreements? (2008) AMERICAN JOURNAL OF

POLITICAL SCIENCE Vol. 52, No. 4, pp. 741–762; Glen Biglaiser and Karl DeRouen, Economic Reforms

and Inflows of Foreign Direct Investment in Latin America (2006) LATIN AMERICAN RESEARCH REVIEW

Vol. 41, No. 1, pp. 51-75; Kyeonghi Baek and Xingwan Qian, An Analysis on Political Risks and the Flow

of Foreign Direct Investment in Developing and Industrialized Economies , available at

http://faculty.buffalostate.edu/qianx/index_files/PoliRiskFDI_Baek&Qian.pdf..


to pursue the “optimal institutional design” within the Coase-efficiency thinking.

Certainly, these types of shift are deemed by investors as disloyal maneuvers by

which market opportunities are decreased and therefore business stability and

confidence harmed. As it turns out, the more left-sided the preexisting exploitation

model the more risk bared by IOCs. It also follows that the overall level of reliability

in such host country is affected in the face of any shift and this eventually

decreases inward foreign direct investment flows not in the specific sector but

overall.164 This, however, may not serve as deterrent for states, since losses are not

directly suffered but externalized among the population, and Latin America in

general has an extend record filled with plenty of swings within the theoretical

framework of institutional designs over time and therefore investors .165

To this end, one may argue that there is nothing wrong with shifting since

the central issue of discussion is to acknowledge the fact that the top Latin

American oil producer countries are tending to converge into related scenarios.

And in part this is true. No matter the starting point they come from, there is a

generalized tendency to adopt similar institutional designs from the whole

framework and this may be observed by just glancing factual, historical conditions

of each country and market-level data. This phenomenon can be interpreted as a

final convergence.166 Accordingly, movements towards the left or the right side of

the scheme award the respective host countries with the “good” and “bad” labels.

For example, the progressive adjustments that allowed the entry of private

investors to compete with PETROBRAS, ECOPETROL and PEMEX led to the “good state”

label. Conversely, recent measures in PDVSA, YPF and YPFB whereby control over

the industry was regained rewarded the incumbent heads of government with the

“bad” label, even when significant compensations were involved. Whether the

starting point requires some states to go towards interventionism for achieving a

neutral oil industry, reputation may get harmed. Meanwhile if the starting point

requires other states to adopt partial privatizations, public opinion and investors in

general may be delighted. Depending on the starting point, Latin American nations

and investors are faced with either benefits or costs when shifting towards the

same state entrepreneurship strategy. One may suggest terms such as “left”, “right”,

“pro-statist”, and “pro-market”, among others, should be regarded as mere

technicalities due to the fact that Latin American oil producers are converging into

164

See, e.g., Jimmy Ng, The Political Economy of Democracy and FDI Inflows in Oil Countries (Master

Thesis for MA in QMSS 2010) available at http://qmss.columbia.edu/storage/qmss-pdf-files/student-

theses/The%20Political%20Economy%20of%20Democracy%20and%20FDI.pdf. Nonetheless, other

academics have challenged the veracity of such classic belief, see, e.g., Turan Subasat and Sotirios Bellos.

Governance and Foreign Direct Investment in Latin America: A Panel Gravity Model Approach (2013)

LATIN AMERICAN JOURNAL OF ECONOMICS Vol. 50, No. 1, 107-131. 165

For the other factors see supra note 163. 166

Phenomenon also labeled as “starting point”. See Berríos et al., supra note 16.


similar regulatory schemes, no matter the previous exploitation model they come

from. However, the truth is that serious costs are faced by multinational companies

already established and this is what distinguishes state entrepreneurship shifts

from private entrepreneurship shifts and what makes it sensitive to further

protection.

Either unilaterally or negotiated, friendly or hostile, directly or indirectly;

shifts may take a number of forms. Specific terms such as “interventionism”,

“nationalization”, “expropriation”, “monopolization”, “expulsion” or any other

similar type-of-taking expression are indistinctively mixed up in literature and kept

to describe worst case scenarios for investors. Even though adding definitions to

the debate surpasses the scope of this work, brief considerations are aimed to

enhance the explanation of the whole theoretical framework for the oil industry.167

First of all the aforementioned expressions represent direct shifts towards statist

exploitation models or the right side of the regulatory scheme. Secondly, they all

differ in the extent to which the adjustment is aimed. In broad strokes,

interventionism consists in unexpected readjustments of the preexisting model

towards any right sided strategy without taking into account IOCs’ consent and

best interests; nationalization entails the articulation of at least one NOC within the

inner working of the market (regardless of exclusivity exploitation rights);

monopolization implies NOC’s control in at least the upstream segment; expulsion

of IOCs gives rise to NOC’s hegemony in all oil activities; and expropriation refers to

confiscation of property rights, wealth deprivation or dispossession.168

This differentiation is essential because investors react in different ways

when exposed to different situations. As long as modern states enjoy the privilege

of shaping their legal regimes and changing the rules of the game, the risk to

regain control of the oil market generates a sort of a principal-agent relation

between the host country and foreign investors whereby the former has the

potential to worsen the latter and even to expropriate them. Likewise, externalities

from such risk may range depending on the scope of the respective adjustment or

shift. For instance, setting up an absolute NOC monopoly plus confiscation of

property rights would eventually entail more costs and strict mitigation measures

than just forcing IOCs to act under mandatory joint ventures. This would be the

case of Venezuela in 2007, where BP, Chevron, Statoil, Total and other IOCs

accepted the terms of the new exploitation scheme while ConocoPhillips and

167

For the divergence of definitions, see Kobrin, supra note 14; Duncan, supra note 15; Christopher Hajzler,

Expropriation of Foreign Direct Investments: Sectoral Patterns from 1993 to 2006 (2012) REV WORLD

ECON 148:119-149. 168

See OECD, “Indi ect Exp op iation” and the “Ri ht to Re ulate” in Inte national Investment Law (2004)

available at http://www.oecd.org/daf/inv/internationalinvestmentagreements/33776546.pdf.


ExxonMobil decided to dump activities within the country.169 To give another

example, being partially confiscated and afterwards remain in the industry with a

minority interest transforms foreign direct investments into pseudo-portfolio

investments; and such maneuver would potentially entail more costs for IOCs than

just being totally expelled due to the fact that investors are squeezed and lose

direct command over their cash flows.170 The recent Argentinean expropriation

case of 2012 is the perfect illustration for such level of problem; the administration

expropriated 51% out of 62.9% outstanding shares from Repsol, which not only lost

control over the company but also turned into a minority shareholder as their

stake was reduced to 11.9%.

Under an ideal landscape, it would be difficult to imagine how IOCs would

not be able to apply different mechanisms in order to fend against the specific set

of problems brought through an unexpectedly-adjusted exploitation model,

including formal, informal, ex ante and ex post measures. The truth, however, is

that the postulate of state sovereignty is one of the key elements of modern

societies and therefore few protective mechanisms exists against it for such cases.

As anticipated earlier, international law recognizes state sovereignty to openly

determine how property and exploitation rights over subsoil resources within the

respective national territories up to continental shelves are allocated.171 Moreover,

international investment postulates also recognize state sovereignty to withdraw

property rights by means of formal expropriation and establish few protective

mechanisms such as fair compensation as well as miscellaneous rights concerning

equitable treatment like non-discriminatory expropriation, foreigners’ right to fend

in local courts, among others.172 However, there are several reasons to conclude

such principles do not offer effective protection. Firstly, states may —virtually—

take property at will; public interest and foreigners’ non-discrimination are

“necessary conditions” that may remain inapplicable in practice. Secondly,

protection of property rights as such may be ambiguous and even toothless in the

oil business whenever the adjustment of the exploitation model does not entail

confiscation of foreigners’ assets. This would be again the case of Venezuela, where

plenty of IOCs were simply put under pressure to adapt to a new scheme of joint

ventures with PDVSA articulated through the Hydrocarbons Law. 173 Thirdly,

compensation is arguably a protective mechanism; instead it is regarded as natural

consequence of withdrawal. Fourthly, it is still subject to debate how

169

See THE NEW YORK TIMES article, supra note 6. 170

See Baek and Qian, supra note 163. 171


See Catherine Redgwell, Property Law Sources and Analogies in International Law in Aileen McHarg et al.

(eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010). 173

See Hults, supra note 117.


compensations should be calculated, the institution who resolves disputes, and

more importantly, who the compensated individuals should be. As for the first

segment of this debate, much has been argued about the applicable standard to

measure compensation. After Mexican dispossessions took place in 1938, the so-

called Hull Formula was set forth proposing “prompt, adequate and effective”

compensation ruled under international justice; however through Resolution Nº

3281 (XXIX) of 12 December 1974 the United Nations General Assembly accepted

the Calvo doctrine whereby states may pay “appropriate compensation” “settled

under domestic law”.174 Moreover, the conventional wisdom is that the reimbursed

price should be proportional enough to cover losses at the time expropriation took

place. However, measurement faces serious challenges different than the classical

discussion between market value and book value as benchmarks; that is, price

fluctuation. This is the case of registered securities tradable in public exchange

markets whose value instantaneously reflects publicly available information. In the

recent case of YPF, for instance, analysts reported stock price plummeted nearly

40% in BCBA and 56.9% in NYSE within a timeframe of less than one year from the

day the first rumors of expropriation were liked by the press to day expropriation

was announced by the Argentinean government; the very same day of the official

announcement the price went down 11% in BCBA 11.16% and in NYSE. 175

Consequently, the stock price was greatly depressed at the time Law 26.741 was

enacted one month later, ultimately adding further debate to the measurement

discussion; in a word, whether compensation should rely on the price when

expropriations become publicly known. In addition, Repsol stock also fell 28.4%

after news spread overseas and 6% the day of announcement176; the question that

immediately arises is whether this indirect loss should be compensated as well,

bearing in mind the direct loss is represented in the seized 51% stake itself and not

the market value of Repsol stock as such. As for who the compensated individuals

should, there are certain cases in which compensation fails to reimburse, especially

adjacent losses within a corporate context. YPF minority shareholders were not

directly expropriated; however, since almost all shareholders had the same type of

security held by Repsol (i.e. common stock “class D”), news about expropriation

ineludibly affected their stock. More interestingly, adjacent losses also become

visible in partial expropriations of corporate control blocks whereby the majority

174

See OECD, supra note 168. 175

See, e.g., Las Acciones de YPF caen con Fuerza Tras su Vuelta a la Bolsa de Argentina , EL PAÍS, APR. 17,

2012, available at http://economia.elpais.com/economia/2012/04/17/actualidad/1334645833_467867.html;

Pablo Fernández, Valoation of an Expropriated Company: The Case of YPF and Repsol in Argentina

(Working Paper 1055E, 2012), available at http://www.iese.edu/research/pdfs/WP-1055-E.pdf; Joaquín

Melgarejo Moreno, María Inmaculada López Ortiz and Borja Montaño Sanz, From Privatisation to

Nationalisation: Repsol- YPF, 1999–2012 (2013) UTILITIES POLICY Vol. 26, pp. 45-55. 176

ibid.


controller is expropriated and the remaining minority shareholders are put under

the control of the state as new decision maker. The fact that portfolio investors

may opt to buy shares in outperforming firms which are controlled (and even run)

by insiders with specific qualities suggests to a greater extent that losing the

controller shareholder as business partner may be a great loss of added value.177 As

if this were not enough, the combination of sovereignty and expropriation breaks

by virtue any existing corporate mechanism set forth to limit transferability or to

ensure co-sale rights (e.g. tag along for minority shareholders whenever the

controller seeks to exit, dissenter remedies, etc) and therefore minority

shareholders have nothing left to do from a corporate law perspective. To give an

example, YPF’s bylaws had introduced mandatory tender offer protection in case

the Argentinean administration targeted to acquire stock under certain

circumstances, as an attempt to protect shareholders with no bargaining power;

and such provision was virtually irrelevant at the time expropriation took place.

The discussion of compensating minority shareholders for the loss of their original

principal is seen by some academics as a trade-off between the Pareto-efficiency

and Kaldor-Hicks efficiency. Whereas the former entails full compensation to all

loses, the latter only demands compensation to those who suffer the direct loss.178

Determining the extent to which compensation should be granted is quite

important and significant as, for instance, the case of YPF, because an important

minority block was left subject to the will of the Argentinean administration as

new controller. Even though non-expropriated shareholders still have exit

mechanisms ensured mainly by secondary market liquidity, the decision to sell

may also be costly owing depressed stock prices caused by the host country.

Fifthly, compensation also fails to mitigate “creeping”, “de facto” or simply indirect

expropriations such as excessive increases in special oil income taxes, fines,

penalties or any other regulation that objectively affects the price of the

investment. 179 Yet, this precise set of international law postulates turns out

inefficient in addressing such daunting problems.

Bilateral Investment Treaties (BITs) as well as free trade agreements are

more useful and tailor-made mechanisms to protect IOCs than customary

international principles.180 Precisely, after suits brought under the North American

Free Trade Agreement, modern legal designs account for functional provisions to

177

See Mendoza, supra note 144. 178

See Redgwell, supra note 172. 179

See supra notes 167 and 168; Suzy H. Nikièma, Best Practices Indirect Expropriation (The International

Institute for Sustainable Development 2012), available at http://www.iisd.org/. 180

See, e.g., Jennifer Tobin and Susan Rose-Ackerman, Foreign Direct Investment and the Business

Environment in Developing Countries: The Impact of Bilateral Investment Treaties (Yale Law School

Research Paper No. 293) available at http://www.ssrn.com/.


prevent further issues like indirect expropriations and price fluctuation.181 Based on

the Hull Formula, disputes arising under these treaties are usually competence of

the World Bank’s International Center for Settlement of Investment Disputes or

the International Chamber of Commerce, which are the most common

international arbitration panels. Through BITs, international investors not only

overcome deficiencies of international law but also avoid eventual non-impartial

judicial procedures carried out by home authorities while enjoying the benefits of

specialized tribunals. However, of significant relevance is the fact that this type of

protection is only possible whenever BITs exist between the host country and the

country where foreign direct investors come from. This is a vital issue; in absence

of such legal instruments, the likelihood of misappropriation by the state increases

as the costs of expropriation are fewer.182 A prominent solution to this problem

relies on a corporate maneuver termed by some commentators as “treaty

shopping”.183 Based on a combination of widely accepted postulates of corporate

planning such as choice of law and corporate mobility, companies around the

globe may deliberately restructure their holdings offshore to fall under the scope of

any BIT. Likewise, investors form a non-treaty countries may close gaps in political

and legal uncertainty and benefit from a particular BIT by setting up a corporate

vehicle in a jurisdiction where such type of instrument is in force with respect to

the host country. Joining BITs does not prevent dispossession of property rights but

still ensures IOCs to fight the battle for compensation in front of international

tribunals. Although controversial, this strategy is quite useful within the context of

the oil business, since shifts on exploitation models may be compensated as

creeping expropriations regardless of whether assets are confiscated. It goes

without mentioning that it is still plausible the arbitral tribunal consider such

practice as abuse of the corporate form, in particular when the respective

restructuration is carried out with the sole purpose of filling the complaint.184 The

solution, in essence, is barely complex; the business vehicle is required to be

incorporated beforehand rumors about public policy change take place.185 The core

question is whether IOCs are protected in Latin America. Regional top oil

producers have entered into significant BITs (e.g. 58 by Argentina, 28 by Venezuela,

28 by Mexico, 19 by Bolivia, 14 by Brazil, 7 by Colombia), but still countries that

181

See OECD, supra note 168. 182

See Guriev et al., supra note 15. 183

See Juan C. Boué, Enforcing Pacta Sunt Servanda? Conoco-Phillips and Exxon-Mobil versus The

Bolivarian Republic of Venezuela and Petróleos de Venezuela (University of Cambridge Working Paper

Series 2 No.1, 2013) available at http://www.latin-american.cam.ac.uk/library/WP2Boue1.pdf; G. Kahale,

Is Investor-State Arbitration Broken? (2012) TRANSITIONAL DISPUTE MANAGEMENT, available at

http://www.curtis.com/siteFiles/News/Is%20Investor-State%20Arbitration%20Broken.pdf. 184

See Boué ibid. 185

ibid.


account for important outward international cash flows are in principle left outside

this type of foreign direct investors’ protection.186 As a matter of fact Central and

South America as well as the Caribbean are the regions that account for the larger

number of BIT disputes in the world; that is, an average of 30.3% of worldwide cases

registered between 2009 and the first quarter of 2014.187 Interestingly the oil, gas

and mining sectors are the principal issue of debate accounting for nearly 26.3%

within the same timeframe.188 In fact, the main reason why Latin America oil

business is subject to continued dispute is the recent wave of interventionism,

particularly in Venezuela and Argentina. In light of the foregoing considerations,

two important issues arise; the “Netherlands effect” on the one hand and

settlement bargaining dynamics on the other. Because of its extended network of

97 BITs, The Netherlands is widely used as “treaty shop” or tax “base camp” by

international companies with operations in emerging economies; accordingly the

country has witnessed an increase of “letterbox” companies, estimated in 20.000 by

2006.189 To give an example ConocoPhillips and ExxonMobil, both US companies,

had previously established corporate links with The Netherlands and were awarded

with compensation that must be paid by the Venezuelan administration under the

Netherlands-Venezuela BIT; US$ 68.8 million and US$ 907 million respectively.190

As for settlement bargaining dynamics, the combination of information asymmetry

and overestimation of losses may lead to a number of negotiation tactics. In the

first place, states may not have the same level of information in regards to the

value of IOCs’ sunken investments, operations and facilities; hence, IOCs tend to

overestimate their losses during the pre-litigation phase to reach overrated

186

See United Nations Conference on Trade and Development, Country-specific Lists of Bilateral Investment

Treaties, available at http://unctad.org/ 187

Author’s calculations based on The Caseload Statistics provided by the Institutional Centre for Settlement of

Investment Disputes, available at https://icsid.worldbank.org/ 188

ibid. 189

See Roos van Os and Roeline Knottnerus, Dutch Bilateral Investment T eaties: ateway to ‘T eaty

Shoppin ’ fo Investment P otection by Multinational Companies (2011) SOMO, available at

http://www.s2bnetwork.org/fileadmin/dateien/downloads/Dutch_Bilateral_Investment_Treaties.pdf. For

taxation see also Francis Weyzig, Tax Treaty Shopping: Structural Determinants of Foreign Direct

Investment Routed through The Netherlands (2013) INTERNATIONAL TAX AND PUBLIC FINANCE, Vol. 20,

Issue 6, pp 910-937; Michiel van Dijk, Francis Weyzig and Richard Murphy, The Netherlands: A Tax

Haven? (2006) SOMO, available at http://somo.nl/html/paginas/pdf/netherlands_tax_haven_2006_NL.pdf. 190

See ConocoPhillips Wins A Significant Victory In Ongoing Arbitration Battles With Venezuela, TREFIS,

SEP 24 2012, available at http://www.trefis.com/stock/cop/articles/144996/conocophillips-wins-a-

significant-victory-in-ongoing-arbitration-battles-with-venezuela/2012-09-24; Venezuela to Appeal World

Bank Ruling on ConocoPhillips Compensation Claim, VENEZUELAANALYSIS.COM, SEP 5 2013, available

at http://venezuelanalysis.com/news/10004; Exxon Mobil’s Dispute with Venezuela Has Global

Implications, ABA JOURNAL, APR, 1, 2011, available at

http://www.abajournal.com/magazine/article/exxon_mobils_dispute_with_venezuela_has_global_implicati

ons/; Conoco-Phillips and Exxon-Mobil v. Venezuela: Using Investment Arbitration to Rewrite a Contract ,

INVESTMENT TREATY NEWS, SEP 20 2013, available at http://www.iisd.org/itn/2013/09/20/conoco-

phillips-and-exxon-mobil-v-venezuela-using-investment-arbitration-to-rewrite-a-contract/#_edn2.


settlement amounts. ConocoPhillips, for instance, claimed first US$30 billion and

the government offered US$570.5 millions, that is, a higher offering compared to

what the tribunal finally set.191 Similarly, ExxonMobil claimed US$15 billion and the

government offered US$2 billion.192 Filing a complaint against Argentina via the

Argentina-Spain BIT, the Spanish firm Repsol estimated compensation in US$10.5

billion; this is still subject to litigation.

Although BITs are conceived as effective mechanism to protect foreign

investors, they do not prevent shifts in public policies or weaknesses in local

protection of property rights; they only mitigate effects.193 To this end, IOCs are also

prone to accept the terms of a new exploitation model in order to recover at least

part of sunken investments.194 This would be the case of BP, Chevron, Statoil, Total

and other IOCs operating in Venezuela.195

Finally, international political pressure and unilateral diplomatic sanctions,

particularly from neoliberal economies, are usually put as indirect non-legal

attempts to prevent changes towards interventionism as well. Yet, the effectiveness

of political costs varies from case to case.

In summary, the current set up does not enable IOCs to thoroughly protect

from sovereignty which has proved the most powerful instrument in the hands of

resource-rich nations.196

Much effort has been put forward by academics, policy makers and practitioners in

minimizing costs and externalities arisen from the corporate form. The unwearied

and reiterated discussion in corporate governance has essentially relied on two

core issues: the individuals under friction on the one hand, and the prevention

method of negative effects on the other. The first of these affairs has found answer

under the economic agency theory, according to which three types of conflicts of

interests among corporate actors may rationally occur.197 As for the prevention, the

191

ibid. 192

ibid. 193

See Selen Sarisoy Guerin, Law and Foreign Direct Investment (Institute for European Studies Working

Paper No. 4/2011, 2011), available at http://www.ssrn.com/. 194


See THE NEW YORK TIMES article, supra note 6. 196

See Tomz and Wright, supra note 87. 197

The first conflict, known as the vertical agency problem, finds its origin in the relationship existing between

corporate managers and shareholders; secondly, the horizontal agency problem involves controller

shareholders and minority shareholders; and the third form of agency problem refers to the conflict between

the company and its stakeholders, mainly employees and creditors. See John Armour, Henry Hansmann and


literature has posited a wide array of remedies, including ex ante, ex post, legal,

market-based, formal, functional, mandatory and reputational remedies.

Nonetheless, the outcome of such discussions does not appear to fit entirely the

phenomenon of state entrepreneurship and more specifically NOCs; and many

challenges in the matter of portfolio investors’ protection remain unaddressed.198

In the first place, much of the theorizing and empirical research under one

side of the corporate governance literature, mainly in the US, has focused in

resolving frictions between corporate managers and shareholders. Such discussion

relies upon the formulations made in the midst of global recession of early 20th

century, when academics witnessed a highly dispersed pattern of ownership

concerning companies traded on US securities exchanges.199 Ever since then, the

so-called “modern corporation” —where managerial control arises in listed

companies owing dispersion and lack of coordination among shareholders, and

where a prominent separation between ownership and control exists— has been in

the frontline of debate among corporate law experts and economists. Reluctance,

shirking, negligence, opportunism and moral hazard by directors are the most

frequent agency problems that may lead to severe agency costs such as firm

underperformance, increase of cost of capital, and private benefits, all at the

expense of spread and passive shareholders. These studies have attempted first to

explain the reasons that caused the dispersion phenomenon, which even to this

day are quite debated.200 Moreover, a wide array of measures has been proposed to

prevent and mitigate the negative impact of this principal-agent relationship. US

lawmakers and courts responded with their own set of deterrents including the

reduction of information asymmetries by means of disclosure and liability, insider

trading, directors’ fiduciary duties, ex post scrutiny of related-party transactions,

among others. Positive incentives have also been applied by practitioners; aligning

interest through reward-based compensations is a common market-based ex ante

governance remedy, for instance. The literature also coincides how market for

Reinier Kraakman, Agency Problems and Legal Strategies in Reinier Kraakman et al. (eds) THE ANATOMY

OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (OUP 2009). 198

Pursuant the key indicators displayed by the World Economic Forum in the 2013-2014 timeframe Brazil

accounted for 26, Mexico 56, Colombia 76, Argentina 129 and Venezuela 131 in the world rank of minority

investors’ protection. http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2013-14.pdf 199

A classic: Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private Property

(Transaction Publishers; Reprint edition, 1991). 200

For the common-law-supremacy-over-civil-law theory see Rafael La Porta, Florencio López-de-Silanes,

and Andrei Shleifer (LLSV), Corporate Ownership Around the World (Harvard Institute of Economic

Research Paper No. 1840, 1998), available at http://www.ssrn.com/; Henry Hansmann and Reinier

Kraakman, The End of History for Corporate Law (Yale International Center for Finance Working Paper

No. 00-09, 2000) available at http://www.ssrn.com/. For the broader theory see John C. Coffee, The Future

as History: The Prospects for Global Convergence in Corporate Governance and its Implications

(Columbia University School of Law Working Paper No. 144, 1999); Mark J. Roe, A Political Theory of

American Corporate Finance (1991) COLUMBIA LAW REVIEW 10.


corporate control is perhaps the ultimate tool to discipline managers and avoid

shirking within the dispersed ownership model, since it creates a potential threat

of hostile takeover against directors.201 Thus, managerial control may be attenuated

within dispersed structures and the gap between ownership and control may be

somewhat bridged. Whenever a blockholder manages to gain a considerable

minority ownership percentage, it could be able to exercise enough voting power

to appoint its members for the board of directors and this may serve as a call for

management efficiency.202 Yet, this practice has arisen its own costs as well; the so-

called “prisoners dilemma” within the context of control premium, greenmailing,

or certain usages of antitakeover devices by corporate directors may entail

additional problems for dispersed shareholders.203 Moreover, after recent corporate

scandals, much stricter check-box rules were introduced to enhance shareholders’

protection in US listed firms (e.g. Sarbanes-Oxley Act).

In light of the foregoing discussion, the core issue of concern that arises in

the context of NOCs relies on the fact that “dispersed remedies” may not function

properly in different environments. And the reasons are quite straightforward.

Under concentrated ownership structures —where holdings are strongly

concentrated in few individuals— there is no such thing as managerial control or

separation between ownership rights and command over cash flows; the contrary,

majority and leveraged controller shareholders enjoy plenty domain over corporate

affairs.204 Although similar, this is not the same phenomenon of controlling

minority shareholders or controlling blockholders, where certain level of

dispersion is still strategic while seeking control.205 Moreover, jurisdictions in

which concentration of ownership interest is hegemonic tend to articulate statutes

by which the shareholders’ assembly is provided with broader powers in the matter

of business decision making than in dispersed ownership structures; shareholders

are in charge of determining distribution of dividends, for instance. That said, it

can be plausible argued that the so-called “erosion theory” does not seem to have

taken place in the concentrated ownership structure as opposed to its dispersed

counterpart; in other words, shareholders’ voting power has not been constrained

201

See Henry G. Manne, Mergers and the Market for Corporate Control (1965) THE JOURNAL OF POLITICAL

ECONOMY Vol. 73, No. 2, pp. 110-120. 202

See John J. McConnell and Henri Servaes, Additional Evidence on Equity Ownership and Corporate Value

(1990) JOURNAL OF FINANCIAL ECONOMICS 27 595-612. 203

See Stephen Bainbridge. Mergers & Acquisitions (Foundation Press 2012). 204

Concentrated ownership structures are almost a universal pattern excepting US and UK. See LLSV, supra

note 200. 205

One can say there is a negative relation in the matter of controlling blockholders, the more dispersed the

capital, the less percentage required to exercise minority control.


to give way to the director primacy postulate.206 Through such authority, majority

and leveraged controllers are not only the ones who virtually set forth general

guidelines for corporate managers, but even more controversially, the latter might

just function as “corporate puppet” at service of the former. As a result of such

uniqueness, moral hazard by directors is not itself a major pitfall given the fact that

directors are openly monitored by controlling shareholders, and consequently

management efficiency is secured to a great extent. Unlike dispersed ownership

structures, the agency conflict in this different scenario barely exists between

directors and shareholders; instead the principal conflict arises between

controlling and minority shareholders.207 As it turns out, it can be plausible argued

that even though important externalities may be prevented through some of the

protective measures embraced in dispersed ownership structures, not all of them

can be simple borrowed and transplanted into the second type of ownership

model.208 Insider trading and self-dealing judicial ex post review could be effective

mechanisms to prevent the extraction of private benefits of control by corporate

insiders within concentrated structures; but the central issues of concern are

different: minimizing disproportionate returns for controlling shareholders at the

expense of their minority counterparts and deterring the autocratic use of voting

power as legitimizing device to ultimately seize the company’s assets.209 Market for

corporate control, for example, is simply not feasible in concentrated ownership

structures because any attempt to replace the principal —controlling

shareholder— needs to be directly negotiated and this is owed to the combination

of large holdings and underdeveloped capital markets. To this end, it is worrying

therefore that a great number of Latin American states —characterized by high

concentration of corporate ownership interest in few individuals— have

implemented the ex post standard of fiduciary duties for directors but not its

concentrated-structure counterpart; that is, abuse of voting rights, fiduciary duties

for shareholders or any other similar instrument. And this is of a great importance

since controlling shareholders may easily circumvent liability in absence of such

206

Pursuant the “erosion theory”, certain corporate functions that were originally vested in the shareholders

were gradually passed to directors. See Stephen Bainbridge, The New Corporate Governance in Theory and

Practice (OUP 2008). 207

“What is a problem in one system may not be a problem (or perceived as one) in another. The very act of

deciding what is a problem involves a value judgment. Thus, for example, the separation of ownership and

control is perceived as a central problem in American corporate law and is therefore assumed often to be a

central problem in other jurisdictions”. See Donald C. Clarke, “Nothin but Wind”? The Past and Futu e of

Comparative Corporate Governance (2010) AMERICAN JOURNAL OF COMPARATIVE LAW Vol. 59, pp. 75-

110. 208

See Reyes, supra note 155. 209

“Shareholders meetings are reduced to a formality”. See Donald C. Clarke, Corporate governance in China:

An Overview (2003) CHINA ECONOMIC REVIEW 14, pp. 494-507. This aim of corporate governance is

subject to debate, see, e.g., Gilson and Alan Schwartz, supra note 146.


legal remedy. Whereas Argentina, Brazil, Chile, Colombia, Mexico, Panama and

Peru implemented fiduciary duties for directors, only Brazil and Colombia have

specific statutory provisions providing actions against abuse of corporate voting

rights.210 Therefore, unlike minority shareholders of PETROBRAS and ECOPETROL,

minority shareholders of YPF lack of this legal protective measure. Evidently, such

type of remedy is of a great importance in the matter of Latin American partially-

owned NOCs where states have kept their controlling position after public equity

financing, as detailed in Chapter 2. One additional thing to note is that empirical

evidence shows how extraction of private benefits of control is intensified in the

case of leveraged shareholders because —despite the benefits of accessing fresh

cash flows and sharing risk of failure— the great effort put forward in the

management of the company is somewhat not thoroughly rewarded through

conventional means (i.e. dividends) hence expropriation of minority shareholders

occurs.211 This would be the case of PETROBRAS whose control is leveraged via dual-

class structures. For all these reasons, abuse of voting rights or shareholders’

fiduciary duties have been “visible absences” in the Latin American regulatory

schemes despite the fact they turn out crucial to properly address the conflict

between self-interested controlling shareholders and minority shareholders.

The second challenge faced by corporate governance in the matter of state

entrepreneurship and minority shareholders’ protection is the effectiveness and

efficiency of rules and standards that Latin American jurisdictions do implement in

order to close the gaps left by incomplete contracts and to alleviate particular

problems that may arise in NOCs. As anticipated above, the classical agency

problem of the concentrated ownership structure appears when self-interested

controlling shareholders extract private benefits of control and expropriate

210

See Francisco Reyes, A New Policy Agenda for Latin American Company Law: Reshaping the Closely-Held

Entity Landscape (Tilburg University 2011). See also Joseph A. McCahery and Erick P.M. Vermeulen,

Corporate Governance of Non-Listed Companies (OUP 2008). The authors show how some of the most

innovative jurisdictions in corporate law have articulated duties for controlling shareholders; for US and

UK, fiduciary duties brought by case law; for France, abus de majorité; for Germany, duty of loyalty; and

for The Netherlands, dictates of reasonableness and fairness.

Moreover, two important remarks need to be made. Firstly, this type of protections differs to a greater

extent from responsibility of holding companies during subsidiaries’ bankruptcy. Abuse of voting rights is

not limited to corporate groups or bankruptcy; it can be applied in a more day-to-day basis including

situations such as tunneling, percentage and economic dilution, exclusion through freeze out mergers, etc.

Secondly, a more generalized institution of abuse of rights does exist in Latin American jurisdictions owing

its French tradition; however, the lack of a specific statutory provision creates a gap in corporate law since

judges are barely specialized in such branch of law and usually find difficult to spot and such generalized

remedy. 211

See, e.g., Gilson and Alan Schwartz, supra note 146; Jan Bena and Jan Hanousek, Rent Extraction by Large

Shareholders: Evidence Using Dividend Policy in the Czech Republic (Discussion Paper 556 Financial

Markets Group, London School of Economics and Political Science, 2006) available at

http://eprints.lse.ac.uk/24510/1/dp556.pdf; Mara Faccio, Larry H.P. Lang and Leslie Young, Dividends and

Expropriation (2000) AFA 2001 New Orleans; EFMA Athens 2000, available at http://www.ssrn.com/.


minority shareholders’ wealth, and this can be achieved through tunneling, major

corporate transactions, insider trading and even more subtle and unnoticeable

practices like dilution.212 However, additional specific problems originated from the

role of the state as controller shareholder are also present: NOCs might be used as

public welfare maximization devices, or even worse “clientelistic vehicles” and

“piggy-banks”, all at the expense of non-state-shareholders’ wealth.213 But before an

evaluation of the existing remedies can be assessed it is indispensable to outline

some key features of Latin America corporate law. One essential aspect is the

intrinsic tightness and rigidity of Latin American legal systems in general, in which

the rule of law lies primarily in statutes rather than judicial discretion. As many

other branches, corporate law and basic housekeeping rules that serve as corporate

governance devices were originally transplanted from Napoleonic Codes; and

because of such tight nature, corporate law regimes have been described by

literature as “confined to the letter of law”. 214 As if this were not enough, Latin

America is also characterized by highly-politicized legislative procedures and

cumbersome filters that make it difficult to modernize law and to pass new

innovative bills; thus, legal modernization is hampered to a greater extent and

corporate law remains attached to preexisting statutes ultimately leading to an

indefinite status quo.215 Yet, previous successful legislative efforts have been late

responses to world trends more than any other thing.216 As a result of all these

drawbacks and considering the nature of civil law in which judges carefully follow

the dictates of the statutes, the lack of specific corporate governance laws makes

experts coincide that Latin America, as many other civil law jurisdictions, lags

behind expectations in terms of innovative functional protection.217 To give an

212

Though, this aim of corporate governance is subject to debate. See Ronald J. Gilson and Jeffrey N. Gordon ,

Controlling Controlling Shareholders (Columbia Law and Economics Working Paper No. 228; Stanford

Law and Economics Olin Working Paper No. 262, 2003), available at http://www.ssrn.com/. “[W]e have

argued that Delaware doctrine restricts the extent to which controlling shareholders can extract private

benefits of control to a level at which it is plausible that the benefits to minority shareholders from

reduction in managerial agency costs as a result of concentrated monitoring by a controlling shareholder

exceeds the costs of the controlling shareholder’s private benefits of control”. 213

See, e.g., Manzano and Monaldi, supra note 15; Pargendler et al., supra note 136. 214

“Civil law countries subjected corporations to a strict legislated regime, whereas common law countries

allowed substantially more flexibility and by implication a reallocation of control rights from shareholders

to managers”. See Katharina Pistor, Yoram Keinan, Jan Kleinheisterkamp and Mark D. West, The

Evolution of Corporate Law a Cross-Country Comparison (Working Paper No. 232, 2003) available at

http://www.ssrn.com/. 215

For instance, public scandals are widely used by politicians as a means to achieve popularity. Statutes might

be opportunistically enacted for the sake of citizen perception towards the politic parties which promoted

the respective legislation. 216

The regulation enacted in Latin America after the Sarbanes-Oxley Act is quite illustrative. See in Argentina,

Decree 677 of 2001; in Brazil, Law 10.303 of 2001; and in Colombian, Law 964 of 2005. 217

See Francisco Reyes and Erik P. M. Vermeulen, Company Law, Lawye s and ‘Le al’ Innovation: Common

Law versus Civil Law (Lex Research Topics in Corporate Law & Economics Working Paper No. 2011-3,

2011), available at http://www.ssrn.com/.


illustration, most Latin American systems resort to the traditional array of

theoretical strategies designed under the roots of civil law when it comes to fight

back against unlawful misuses of the corporate form and the principle of limited

liability against third parties. Public deeds, fixed lifetime, minimum capital

requirements, capital maintenance and ultra vires theories have been the main

corporate governance measures that offer shielding for non-shareholder

constituencies. And after all, wrongdoing is not thoroughly prevented by means of

those mechanisms since the statutes themselves may not contain explicit solutions

for every single case; on the contrary, they ultimately become formalistic barriers

or “entry prices” to carry on business activities due to the increase of transaction

costs.218 Few jurisdictions like Argentina, Colombia and Uruguay have formally

established specific rules for veil piercing by means of corporate law itself; but the

truth is that owing the primacy of statutes over judicial opinions, such regulation

finds limited applicability as judges are granted with higher discretion than what

they are accustomed to.219

Protection of shareholders’ faces the same kind of challenges in Latin

America. So far, the bulk of minority shareholders’ regulatory protection against

self-interested controlling shareholders has consisted basically in mandatory

corporate law rules regarding the shareholders’ assembly meetings. Supermajority

is the first type of these protective measures; one the one hand it provides minority

shareholders’ with plenty protection in particular circumstances in which they

might be eventually expropriated; on the other hand, supermajority is quite

relevant for gaining potential investors’ confidence as minority shareholders’

decision rights are enhanced. In general, Argentina, Brazil, Colombia and

Venezuela articulate supermajorities in a number of sensitive corporate affairs like

218

Since the company’s equity is theoretically aimed to serve a dual function (i.e. start-up financial muscle and

common pledge for stakeholders), capital requirements are jealously guarded in Latin America. However

they could be simply fulfilled through shareholders’ initial investment subtle overpricing; thus, creditors

could not be completely satisfied at once under any enforcement procedure simply because of infra

capitalization of entity’s equity covered under overpricing and leverage aid. Due to such inefficiency,

minimum capital requirements have been publicly replaced by different means such as covenant

agreements. This is exemplified by bondholders who are attracted not only through considerable interest

rates but also through the voluntary use of covenants in all corporate debt instruments which by the

company promise not to materially alter certain assets via asset-equity or asset-debt ratios. In similar vein,

ultra vires theory and fixed duration terms are innocuous rules that could end up creating uncertainty to

creditors whenever the company executes agreements outside its corporate purpose or after its dissolution

term. For capital requirements criticism see John Armour, Legal Capital: An Outdated Concept? (2006)

EUROPEAN BUSINESS ORGANIZATION LAW REVIEW Forthcoming, available at http://www.ssrn.com/. 219

“By and large, civil law countries have taken the approach that the legislature should make the allocation,

leaving little room for shareholder to reallocate rights the legislature had vested with them”. See Pistor et

al., supra note 214. See for Argentina Law 22,903; for Uruguay Law 16.060; for Colombia Law 1564 of

2012 (however its application for other joint stock corporation is still uncertain). In absence of statutes,

other countries had developed jurisprudence in this regard.


mergers, spin-off, dissolution, removal of preemption rights, among others.220

Nonetheless, it also has a downside. The excessive recognition of supermajority

may give way to permanent veto power that can lead to serious deadlocks,

eventually hindering the day-to-day development of the business. A second form of

protection comes in the form of box-ticking and housekeeping rules for the

functioning of the shareholders’ assembly meetings, which are not only aimed to

organize the functioning and developing of the assembly but also serve an

important role in corporate governance. Calling in advance for the shareholders’

meeting, entitling minority shareholders to initiate extraordinary meetings and

granting access to corporate books and records are the most outstanding checks-

and-balances. They, however, prove ineffective since “shareholders meetings are

reduced to a formality”.221 Other important forms of protection are preemption

rights, cumulative voting and dissenter remedies.222 Dilution through the issuance

of new stock is a common means of expropriating minority shareholders; and

preemptive rights prevent to some extent this practice. Such protection, however,

fails whenever controller shareholders deliberately make repeated issuances

without legitimate business purposes, knowing beforehand that minority

shareholders lack sufficient financial muscle to purchase the newly issued stock. In

turn, the cumulative voting system deployed in most Latin American legal systems

ensures board representation for minority shareholders, but even more

importantly, access to firsthand information. Therefore, even though cumulative

voting might not be sufficient to exert effective influence over management, it still

reduces information asymmetries. As for dissenter remedies, this allows minority

shareholders to step out of the company in exchange of fair compensation under

certain circumstances, mostly when their economic interests may result harmed

(e.g. major corporate transactions). Notwithstanding the fact that the entire region

is strongly attached to the heritage left by the Napoleonic Codes, there is a

tremendous lack of harmonization in one of the most controversial corporate law

postulates; that is, voting proportionality.223 Academics point out how voting

proportionality finds different regulation from country to country.224 The region, in

general, does not strictly adhere to voting proportionality since Argentina, Brazil,

Chile, Colombia, Ecuador, Mexico and Venezuela allow the issuance of non-voting

stock and the establishment of dual-class share structures. Brazil and Colombia

220

See table 3.1. 221

See Clarke, supra note 209. 222

ibid. 223

Widely known as one-share-one-vote rule. However this expression only represents one part of the voting

proportionality principle, since legal systems may adopt dual-class structures and at the same time stick to

the one-share-one-vote rule. 224

See Reyes, supra note 155.


have a cap for non-voting stock, which must not exceed 50%.225 Whereas Brazil,

Chile, Colombia, Ecuador and Mexico compel companies to stick to the one-share-

one-vote rule, Argentina and Venezuela allow multiple-voting shares; the former

set a cap of five votes per share, tough.226 Notwithstanding the above divergence,

the discussion whether voting proportionality effectively protects shareholders has

been recently challenged by some scholars.227 Dual-class shares structures are

justified in average listed companies as long as outside investors acknowledge the

fact that the founders or insiders in general turn out the core element of the high

sustainable growth of the business.228 Similarly, considering the institutional

background of NOCs and their significance as “national champions”, dual-class

share structures simply ease the process of fundraising without releasing corporate

control. Therefore such corporate practice should not be banned per se.

In summary, much of the traditional set of remedies provided by Latin

American legal systems is innocuous in mitigating conflicts (e.g. shareholders’

assembly check-and-balances), other remedies are double-edged (e.g.

supermajority) and some are increasingly deemed as business development

barriers (e.g. dual-class share structures and one-share-one-vote rule). 229

Preemptive and dissenter rights still serve a decisive role within the regulatory

scheme. A summarize of remedies is presented in table 3.1.

Table 3.1. Corporate law protective measures for minority shareholders in Latin American

Country

Abuse

of

V.R.

Pure

voting

proport.

Superma-

jority

Preemptive

rights

Dissenter

remedies

Cumulative

voting

Books

direct

access

Brazil X - X X X X X

Argentina - - X X X X -

Colombia X - X X X X X

Venezuela - - X - X X X

Mexico - - X X X X X

Chile - - X - X X X

Ecuador - - X X X X X

Source: Reyes; complemented by the author.

225

Prior to the enactment of Law 10.303, Brazil allowed issuing no more than 2/3 in non-voting shares. 226

See Reyes, supra note 155; and complemented by the author from statutes. 227

“[W]hat do the corporate governance experts generally think of Google’s [dual class] ownership structure?

The one dimensional thinkers, who tend to look at it in principal-agent extremes, criticize investors’ lack of

control, which is a fundamental weakness in their view. Apparently, they have issues with the issuance of

non-voting stock which makes it easier for the founders to maintain perpetual control”. See Joseph A.

McCahery, Erik P. M. Vermeulen and Masato Hisatake, The Present and Future of Corporate Governance:

Re-Examining the Role of the Board of Directors and Investor Relations in Listed Companies (ECGI

Working Paper No. 2011, 2013) available at http://www.ssrn.com/. 228

ibid. 229

ibid.


Furthermore, owing the fact that PETROBRAS, YPF and ECOPETROL are listed

SOEs in local capital markets, important domestic securities law rules reinforce

minority shareholders’ protection, particularly concerning disclosure. As a matter

of fact, the three countries have implemented stricter rules driven by the

prominent influence of the US Sarbanes-Oxley Act.230 Such regulations address

matters such as duties and personal liability of directors, board composition (e.g.

independence, separation between chairman and chief executive manager) and

board committees.231 In the aftermath of such enactments, by 2014 Latin American

listed NOCs’ boards of directors prove widely standardized. PETROBRAS has 2

independent directors out of 9, YPF has 8 out of 17 and ECOPETROL has 4 out of 7.

This regulatory trend, however, gives room to an additional concern: much of the

respective regulation focuses too much on board practices and monitoring

management; that is, the director-shareholder agency conflict within the dispersed

ownership structure. Three questions that remain in this regard are: whether or

not Latin American policy makers intend to establish US market standards without

taking into account the proper agency conflict in NOCs, whether or not Latin

American policy makers intend to isolate controlling shareholder from

management, and if not —as one may rationally believe— whether such regulatory

implementation is an effective deterrent for preventing controlling shareholders

value-reducing opportunism. This is a delicate issue because companies directly

bear expenses of implementing such mandatory legal measures, meaning that the

implementation of ineffective remedies may create direct and unnecessary costs. If

the case is achieving sustainable high profitability, appointing prepared and

experienced board members and top managers is sufficient itself, regardless of the

“independent” or “non-executive” statuses; appointing independent and non-

executive directors neither adds value per se nor protects minority shareholders

per se, and it needs to be determined from case to case.232 All in all, prominent

specialized scholarship emphasizes how complementarity between the

transplanted measure and the host legal regime is essential for achieving an

230

See for Argentina, Decree 677 of 2001; for Brazil, Law 10.303 of 2001; for Colombian, Law 964 of 2005. 231

See OECD Roundtable Latin American Roundtable on Corporate Governance, Achieving Effective Boards. A

comparative study of corporate governance frameworks and board practices in Argentina, Brazil, Chile,

Colombia, Mexico, Panama and Peru (2011), available at http://www.oecd.org/brazil/48510039.pdf. 232

“However, it is far from clear whether other typically crisis-driven corporate governance considerations,

such as independent directors, the separation of chairman and CEO, board diversity, active minority

shareholder engagement, the disclosure of quarterly reports and, more recently in Europe, transparency

regarding company group structures, are in fact truly material to a company’s sustainable growth and value

creation… In this sense, it can be argued that the mechanisms are often perceived as ‘nice-to-have’ instead

of ‘must-have’”. See Joseph A. McCahery and Erik P.M. Vermeulen, Six Components of Corporate

Governance That Cannot Be Ignored (Tilburg Law School Legal Studies Research Paper Series No. 8,

2014) available at http://www.ssrn.com/.


efficient reform; and yet, the problem within concentrated ownership structures

appears not to be properly addressed through such type of measures.233

On the other hand, domestic securities laws do provide related-party

transactions’ disclosure and insider trading which are decisive remedies in

preventing the classical extraction of private benefits of control. Firstly, disclosure

on related-party transactions (e.g. public officials, politicians, employees of the

administration, relatives), has by virtue the potential to switch on the alarms of

public investors and eventually discourage self-dealing or tunneling.234 In general,

all Latin American jurisdictions establish mandatory disclosure and endogenous

scrutiny to determine if the transaction is made on legitimate business purposes

and under market-value basis or arm’s length principle; besides this class and

derivative actions are eventually permitted.235 This entails that Latin American

countries have followed the global trend by restricting self-dealing on an ex post

basis rather than just prohibiting it.236 Some experts suggest the likelihood of this

type of misbehavior is increased during the days leading to privatization.237 And

secondly, there are protective measures against insider trading. As a conduct that

is said to affect public confidence in capital markets, it has found stronger set of

rules over time in developed economies.238 The truth is that the use of corporate

non-public information for making profits on capital markets is a powerful reason

in itself to ban such practice. In general terms, insider trading reduces welfare

overall. Since it produces mistrust in capital markets, the cost of capital increases

directly affecting the issuer. Liquidity in the aftermarket is reduced as well. And

more importantly, whenever insider trading takes place, individuals who execute

such transactions are taking wealth away (e.g. sell at inaccurate inflated prices) or

233

“The foregoing point about the ubiquity of patterns of concentrated share ownership in much of the world

leads to a much general observation: what is efficient in one context may not be efficient in another… In

short, having an “independent” board when other firms are using their boards to knit together a closely-

linked web of interlocking alliances may be a counterproductive innovation. Innovations, even if copied

from a well recognized model, must be able to adapt to local conditions if they are to survive”. See Coffee,

supra note 200. 234

See Lucas Enriques, Gerard Hertig and Hideki Kanda, Related-Party Transactions in Reinier Kraakman et

al. (eds) THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (OUP

2009). See also Pierre-Henri Conac, Luca Enriques and Martin Gelter, Constraining Dominant

Sha eholde s’ Self-Dealing: The Legal Framework in France, Germany, and Italy (2007) EUROPEAN

COMPANY AND FINANCIAL LAW REVIEW Vol. 4, No. 4. 235

See OECD Roundtable Latin American Roundtable on Corporate Governance, Latin American Corporate

Governance Roundtable Task Force Report on Related Party Transactions (2012), available at

http://www.oecd.org/daf/ca/LatinAmericanReportonRelatedPartyTransactions.pdf. 236

See Simeon Djankova et al., The Law and Economics of Self-dealing (2008) JOURNAL OF FINANCIAL

ECONOMICS 88 430-465; Gilson and Schwartz, supra note 146. 237

“Government restructuring of state-owned enterprises prior to their sale is an issue that is likely to be

fraught with political difficulties given that this is probably the last chance for government officials to

extract benefits”. See Chong and López-de-Silanes, supra note 15. See also Michał Kałdonski and Jacek

Mizerka, Politicians and Private Benefits of Control (2007) available at http:www.ssrn.com/. 238

See Choi and Pritchard, supra note 131.


the potential to increase wealth (e.g. buy at inaccurate depressed prices) from

others who lack information under the misbelieve of market’s efficiency when it

comes to unveil new material information; and this may affect public investors

ranging from professional giant investors to common citizens. Following the global

trend, such practice has been addressed from the criminal law standpoint in many

countries of Latin America.239

Moreover, as anticipated earlier, extraction of private benefits is not the

only agency problem faced by minority shareholders in NOCs, where a tremendous

political risk is involved. 240 A great body of empirical evidence shows the

underperformance and inefficiency of SOEs compared to privately companies relies

on higher operating and manufacturing costs, less profitability, over-capitalization

and over-hiring of labor force.241 In fact, those are the primary reasons why the

mass privatization wave of the 1990s occurred. The question that arises is whether

governments may again in the aftermath of the Washington Consensus prefer to

promote social efficiency rather than economic efficiency. Increasing employment

can be directly achieved through public enterprises.242 Similarly, given the high

dependence on oil, selling such non-renewable commodity under market price

may also be feasible under social and protectionist goals.243 In other words, state-

run enterprises in general are prone to pursue public welfare instead of

shareholders’ return maximization. 244 And this struggles with the economic

expectations of outside investors themselves particularly when social welfare leads

to losses for the company. In addition, SOEs in general are prone to a great

governmental interference, and they might be used by politicians as “clientelistic

vehicles” to enhance political relations or to increase the popularity of certain

political party.245 In this respect, appointing unprepared and inexperienced public

officials as board members or top managers does not add any value to the

company.246 Moreover, net exporter NOCs in particular might serve as “piggy-

239

For an important estimation of insider trading in Latin America see Juan J. Cruces and Enrique Kawamura,

Insider Trading and Corporate Governance in Latin America (IDB Working Paper No. 208, 2005)

available at http:www.ssrn.com/. 240

See Tomz and Wright, supra note 87. 241


The oil industry in Brazil accounts for “13.5% of federal SOE employment (with PETROBRAS as the most

important company)”. See OECD, Ownership Oversight and Board Practices for Latin American State-

Owned Enterprises (2012),

http://www.oecd.org/daf/ca/2011LatinAmericanCorporateGovernanceRoundtableSOEOwnership2013.pdf. 243

PETROBRAS, for instance, disclosed on Form 20-F of 2011 that the government can set prices “for crude oil

and oil products below prices prevailing in world markets”. See Pargendler et al., supra note 136. 244

See Megginson and Netter, supra note 15. 245


“Government interference in the NOC decision making processes seems to be more closely related to the

degree of economic or strategic relevance of the petroleum sector to the specific country, rather than the

percentage of independent BOD or BOD committees’ members”. See Silvana Tordo with Brandon S. Tracy

and Noora Arfaa, National Oil Companies and Value Creation (The World Bank 2011).


banks” whenever the state suffers budgetary setbacks that can be covered through

rents from oil.247 Additionally, management tend to be less proactive in achieving

high sustainable profitability and less committed to bargain contracts and this is

the result of the lower pressure which monopolistic SOEs are subject to owing the

lack of competition and permanent financial aid and bailouts.248 The truth,

however, is that no formal mechanism has been implemented in Latin America

legal systems to address such particular problems. Therefore the solution can by

now come in the form of self-given standards. Interestingly, PETROBRAS’ minority

shareholders, for instance, are entitled to appoint at least one board member in

case the cumulative voting fails to give representation; similarly preferred

shareholders are entitled to appoint one member when their ownership interest

accounts for at least 10% of the outstanding stock.249 In the opposite end is

ECOPETROL whose bylaws provide that three board seats are directly filled by the

incumbent government.250 Yet, other type of informal mechanisms can play the

role. NOCs are prone to political control and mass media attention, which can in

some way serve as deterrent.251 However, this entails high uncertainty for outside

minority shareholders.

In aggregate, poor investors’ legal protection accounts for “reputational

loss” in detriment of listed companies.252 As a result of negative perception, lack of

confidence and adverse selection avoidance, potential investors involuntarily apply

a market-based discounting strategy by which the company’s stock price is lowered

to cushion the impact of eventual private benefits of control, ultimately keeping

balance between the investment and expected returns.253 This, in essence, increases

the cost of capital since the respective company is supposed to issue a higher

number of shares to raise the same amount. Yet, by improving firm-level corporate

governance measures, listed companies are able to increase their reputation

towards investors and access capital at lower costs.254 Therefore reputation may by

virtue function as an informal non-mandatory remedy against agency conflicts. In

line with the above, of particular importance in the landscape of emerging

economies is what a prominent body of literature has labeled “functional

247


See Pargendler et al., supra note 136. 249

PETROBRAS bylaws. See PETROBRAS official website www.petrobras.com. 250

ECOPETROL bylaws. See ECOPETROL official website www.ecopetrol.com. 251

See Pargendler et al., supra note 136. 252

See José Miguel Mendoza, The Controlling Shareholder as Reputational Intermediary (Oxford Centre for

Corporate Reputation Working Paper No. 302, 2012), available at http://www.ssrn.com/. 253

ibid. 254

“The prospective variations in the firm’s cost of capital create an incentive for controlling shareholders to

invest in building up their reputation for fair dealing, which sets in motion the chain of events described in

the first two models”. See ibid.


convergence”.255 As opposed to formal convergence, in which the rule of law of

certain jurisdictions is supposed to follow the set of improvements dictated by

advanced economies, functional convergence refers to the phenomenon in which a

great number of companies unilaterally improve their corporate governance and

voluntarily undergo stricter standards in order to gain investors’ confidence.256

Evidently this is nothing but a response to “legislative inertia”.257 The segmentation

of BM&F BOVESPA in Brazil is one prominent example of this type of self-

improvement within the region, whereby listed firms can commit to higher

standards (i.e. level 1, level 2 and Novo Mercado); including pure voting

proportionality (i.e. no non-voting stock, one-share-one-vote rule), 25% of free

float, and tag-along rights, among others.258 International cross-listing is the most

widely acknowledged form of functional convergence, whereby foreign companies

trade their securities in developed markets (e.g. NYSE, NASDAQ) via depositary

receipt programs (e.g. ADRs) and undergo higher disclosure requirements so that

they can obtain positive increases in their stock price and benefit from the so-

called cross-listing premium.259 In general terms, cross-listing does not only ease

the process of reaching non-resident investors; it also proves to offer great

economic benefits due to the additional layers of investors’ protection provided by

developed capital markets (i.e. the bonding hypothesis).260 In US, for instance, a

variety of ADRs exist and each is aimed to fulfill diverse needs of both, issuers and

investors.261 PETROBRAS and YPF stock is traded as ADR level III, while ECOPETROL is

255

See Coffee, supra note 200; Gilson and Schwartz, supra note 146; Alberto Chong and Florencio López-de-

Silanes, Corporate Governance in Latin America (Inter-American Development Bank Working Paper No.

591, 2007), available at http://www.iadb.org/res/publications/pubfiles/pubWP-591.pdf. 256

“… [L]aws may not be necessary to support external financing if, for example, companies deliver on their

promises not because they are forced to do so, but because they want to build a good reputation to facilitate

their access to capital markets”. See Chong and López-de-Silanes, supra note 255. 257

See Coffee, supra note 200. 258

See John C. Coffee, Racing towards the Top?: The Impact of Cross-Listings and Stock Market Competition

(2002) INTERNATIONAL CORPORATE GOVERNANCE COLUMBIA LAW REVIEW Vol. 102, No. 7, pp. 1757-

1831. 259

Additional studies suggest the benefits of cross-listing are also subject to other market conditions, for

instance engaging in business activities within the US. See Michael R. King and Dan Segal, International

Cross-Listing and the Bonding Hypothesis (Bank of Canada Working Paper No. 2004-17, 2004), available

at http://www.ssrn.com/. 260

Cross-listing can also be observed as an interesting case of legal extraterritoriality, meaning that even non -

US-based companies have to comply with US securities and listing rules if they wish to be listed on US

stock exchanges; in this way developed jurisdictions export their regulation beyond their borders without

formal transplants. 261

Firstly, Restricted ADR (Rule 144A) offers low level of protection. No registration statements must be filled

in; no US GAAP required. Nonetheless, there is a major restriction: no private placements to retail investors;

only to Qualified Institutional Buyers (QIB). Secondly, ADR level I offers a semi-low protection. This

means that a company seeking to distribute ADRs under this type only has to fill Form F-6 (depositary

receipts and depositary agreement) since Rule 12g3-2b gives them an exemption to provide other

periodically info. No US GAAP. But companies cannot raise funds nor acquire a listed company. Thirdly,

ADR level II offers medium level of protection. Form F-6 (depositary receipts and depositary agreement)

and Form 20-F (annual results and general info) are needed. Is not compulsory to a reconciliation with US


level II. Broadly speaking this means that unlike the first two companies, the latter

cannot raise funds, but the three of them are subject to US liability rules in favor of

ADR holders under the so-called “Morrison’s transactional test”.262 For all these

reasons, insiders may find great reputational incentives to strengthen their

relationship with outside shareholders particularly when the former repeatedly

raises funds from the same players.263 In the specific case of states as controlling

shareholders, reputation may ease the process of new fundraising for their NOCs as

well as for other state-owned or state-run firms.

Protection for minority outside shareholders is only one side of the full

spectrum. Protection of NOCs’ bondholders arise special concerns as well. The first

thing to note in this regard is that bondholders in general are simply deemed

“other constituencies”, and this ultimately changes the whole picture in the matter

of protection. Owing the permanent dividing line between shareholders and

creditors set by corporate law regimes, bondholders are regarded as lenders (i.e.

contract creditors or voluntary creditors) of the company who ex ante were able to

deal with adverse selection and bargain for the conditions in which their sources

were put under the command of the firm as well as sufficient risk compensation.264

Since bondholders in general are non-shareholder constituencies, they are nothing

but “residual claimants” thus legal protection becomes a concern of conventional

civil, corporate and bankruptcy law. And the assumption that bondholders are just

lenders is to a greater extent acceptable but still arguable in specific cases. Firstly,

GAAP, but explanation of local accounting system is needed. The main restriction is basically fundraising.

Finally, ADR level III offers the higher protection level. In this sense Form F-6 (depositary receipts and

depositary agreement), Form F-1 (concerning deposited foreign shares) and Form 20-F (annual results and

general info) need to be filled in. US GAAP must be followed. Non-US companies also have to disclosure

any information disclosed on their own jurisdictions. Foreigner issuers still tend to fill in Form 10-q to

create confidence in both retail and institutional investors; these voluntary periodic disclosures are used as

means of increasing liquidity. See Choi and Pritchard, supra note 131. 262

Disclosure is just part of average statutory protection. But liability is not as simple as applying Rule 10b-5

in all cases. Speaking of ADRs, there is a thin line between national and foreign transactions and the

application of §10b of the Securities Exchange Act specifically relies on that. According to the so-called

“Morrison’s transactional test” misleading disclosure, fraud or insider trading on RADR and ADR level I

cannot be subject to enforcement under Rule 10b-5 since the underlying stock is not listed on US markets.

In this respect, those causes of action can only reach liability within the context of ADR Level II and III. See

further V.M. Chiappini, How American Are American Depositary Receipts? ADRs Rule 10B-5 Suits, and

Morrison v. National Australia Bank (2011) 52 B.C.L. Rev. 1795. 263

“Perhaps the most salient example of an informal institution at work is the mechanism known as

reputational intermediation. This institution is based on the existence of repeat players in capital markets

that can instigate trust between listed firms and potential investors. Reputational intermediaries provide

assurances to investors concerning the accuracy of a firm’s disclosure and the behavior of insiders. As these

intermediaries expect to interact with investors over a long-term horizon, they have incentives to build up a

positive reputation ‘on the basis of consistent behavior over time’. If the assurances provided to the market

turn out to be hollow, these intermediaries will suffer a ‘reputational loss’ that will impact negatively on

their ability to deal with investors at a future stage”. See Mendoza, supra note 252. 264

See John Armour, Gerard Hertig and Hideki Kanda, Transactions with Creditors in Reinier Kraakman et al.

(eds) THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (OUP 2009).

See also Stephen Bainbridge, Abolishing Veil Piercing (2000), available at http://www.ssrn.com/.


the assumption is accepted in the sense that insiders may openly pick the

fundraising mechanism to finance their business plans or mitigate cash shortfalls

depending on a variety of pros and cons, including legal factors; hence what turns

portfolio investor either in outside shareholders or bondholders is nothing but a

rational management decision based in a great number of factors. Going for

external equity means that insiders only have to share the harvest in the form of

periodical dividends, but at the same time they get diluted. Going for debt

ineludibly means fixed payments, but the ownership interests remain intact.

Precisely, economists have studied what the main determinants of going for either

external equity or debt are; and two theories have dominated such discussion. In

broad strokes, the “pecking order theory” estimates the costs of adverse selection

when raising different type of resources and predicts a “financing hierarchy” by

which companies resort first to retained earnings or bootstrapping, then debt and

finally external equity; whereas the “trade-off theory” calls for a balance of leverage

and equity.265 In this respect, bondholders voluntarily accept or reject the terms in

which the issuance is made. They bear adverse selection by analyzing whether or

not the issuance is properly valuated, and sometimes the issuer may even grant

some guarantees in the form of negative covenants in order to limit an eventual

risk shifting problem, ultimately making the debt securities look more attractive

into the eyes of public investors.266 Nonetheless, assuming that all bondholders are

“other constituencies” in the case of NOCs deserves a revision. Generally NOCs

recall the power of the nation among citizens and nationalistic rather than

economic grounds may lead them to purchase bonds issued without even telling

the difference between holding equity or debt. In other cases states might just

simply exert political and even legal pressure to get its bonds bought. Even though

it is unlikely to happen, legal regimes must be prepared beforehand and should

consider granting higher protection in such cases. Consider for instance what

occurred in Brazil in the early days of PETROBRAS when car owners were compelled

to buy bearer bonds as a result of a yearly compulsory contribution statute.267 To

this day, the return of a great number of this type of bondholders was subject to

prescription in courts because no claims were made on time by their surviving

relatives, and of course this circumstance owing the fact that they were bearer

bonds. Unlike average bondholders, regular citizens are not able to bear adverse

selection or to lessen the risk shifting problem. As it turns out, self-interest states

might just decide to issue debt instead of equity and not only to circumvent

265

See Murray Z. Frank and Vidhan K. Goyal, Trade-Off and Pecking Order Theories of Debt (2007),

available at http://www.ssrn.com/. 266

See Richard D. Macmin, The Fischel Model and Financial Markets (World Scientific Publishing, 2005). 267

See PETROBRAS website

http://www.investidorpetrobras.com.br/en/investor-s-center/shareholder-information.htm.


monitoring pressure, but also to maximize the state wealth at the expense of these

individuals by offering risky bonds with unreasonable yields. The truth, however, is

that even the more extensive approach of corporate governance does not even

appear to foreseen such daunting problems; therefore bondholders are treated as

simple contract creditors and consequently they are only left with a preferential set

of liquidation rights in the case of bankruptcy. According to the stockholder-

oriented approach of corporate governance, corporate law must concern only

about endogenous corporate relationships as different branches of law vest

stakeholders with adequate shielding.268 In other words, employees, creditors,

neighboring community, among others, would find protection basically under

labor, civil, tort and environmental law. On the other hand, the stakeholder-

oriented approach claims for the expansion of the protective scope of corporate

governance towards other constituencies and exogenous corporate relations.269

The bulk of the discussion between these two perspectives, however, mainly lies in

whether employees and involuntary creditors proved sufficiently protected, but

literature is quite absent concerning SOEs special bondholders.270 And this is a

delicate issue since the protection of such individuals is left for the latest phase of

the business life cycle. Some interesting measures that are not related with

bankruptcy were at some point of history embraced in some jurisdictions to

enhance protection of bondholders. In 1929, for instance, Chile provided that a

bondholders’ committee was entitled to demand for the replacement of directors

in case of default.271 Evidently, according to the current line of thought in which

shareholders are on one end and bondholder on the other, measures like this

might sound odd and out of proportion. Even if this was revised, granting such

degree of control over management might be counterproductive and can

eventually hinder the inner working of the company (e.g. possibility of losing

influence in the board when issuing large amounts of debt to such “unqualified

investors”, ultimately deterring public financing and reinforcing traditional

banking). But the debate is opened. In this respect, Latin American legal systems

268

See Klaus J. Hopt, Comparative Corporate Governance: The State of the Art and International Regulation

(Law Working Paper N°.170, 2011) available at http://www.ssrn.com/. See also Hansmann et al., supra

note 200. 269

ibid. 270

To give an example, an important number of employee-oriented jurisdictions articulate not only two-tier

management systems (in which one segment of the board is vested with management functions as such and

the other with monitoring functions), but also the so-called “labor codetermination model” whereby

employees are directly represented on the supervisory board —employees of PETROBRAS and PEMEX have

seats in the supervisory board; 1 and 5 members respectively—. Similarly, the discussion of ignoring the

limited liability postulate becomes greater when it comes to tort victims. This ex post judicial standard

known as corporate veil piercing has been reserved as last resort for extraordinary cases in which no other

protection results effective. 271

See Pistor et al., supra note 214.


can innovate in order to grant protection to such individuals outside the

conventional bankruptcy protection. For instance, mandatory conversion of debt

instruments held by unqualified investors (e.g. regular citizens) into equity

securities can be a straightforward and accurate remedy. Unlike the old Chilean

remedy that allowed appointing directors indirectly, mandatory conversion may

not affect control insomuch as controlling shareholders still may retain control

through dual-class shares. Such remedy would at least enable investors to switch

from the risk shifting problem between the company and creditors to the classical

agency problem between insiders and outside investors —benefiting from the

broader set of protections to shareholders and not only through bankruptcy

postulates—.

To this point, it is plausible argued that Latin American jurisdictions offer

lots of protective measures to portfolio investors in general, but only few appear to

provide effective protection. Reputation plays an essential role whenever insiders

and outside investors are repeated players, bridging the gap between law and real

life. However, the triumph of market-based remedies over legal remedies means

portfolio investors’ protection still faces plenty challenges. How committed are

Latin American policy makers to enhance their corporate legal regimes?

Considering the background of Latin American institutions, one additional

challenge in this regard consists in the formal implementation process of corporate

governance policies within the region. As previously assessed, the so-called

“functional convergence” of corporate governance is one of the most remarkable

formulations since listed companies find reputational incentives to voluntarily

embrace efficient protective measures to enhance the confidence of portfolio

investors.272 Because standardization is essential in emerging economies serving as

cost reduction instrument for investors, the question that remains, however, is

whether Latin American states can converge in a standardized set of corporate

governance measures through legislation. And the answer is somewhat

disappointing. In spite of the fact that regional efforts towards integration and

business constraints reduction have been materialized in the form of supranational

organizations such as Mercosur and Andean Community of Nations (ANC);

corporate law and corporate governance do not seem to be principal concerns in

their agendas. In fact, domestic corporate governance regimes have been barely

influenced by such entities. To give an example, the most prominent arrangement

in this regard was made by early 1990s when the ANC established the “Andean

Multinational Enterprise”; that is, a voluntary set of rules which local join stock

corporations were able to opt-in as an attempt to ease the process of external

272

See Coffee, supra note 200; Gilson and Schwartz, supra note 146; Chong and López-de-Silanes, supra note

255.


corporate expansion towards other member states.273 The truth, however, is that no

significant impact was witnessed due to the fact that such piece of legislation did

not offer further protection nor advantages than those offered by local corporate

statues. In absence of regional leadership, other international institutions have

taken the initiative. The Organization for Economic Co-operation and

Development (OECD), for instance, has enacted tailor-made recommendations for

the region in order to close such gap. The White Paper on Corporate Governance

in Latin America is one of the most notorious efforts intended to foster regulatory

renovation, and relies basically in the importance of equitable treatment of

shareholders, voting proportionality, board composition, and disclosure of

beneficial ownership and control. Of course, some of its contents have been subject

to persuasive criticism by regional academics, but still remains as an essential

guideline for regional policy makers.274 The OECD also promoted the creation of the

Latin American Roundtable on Corporate Governance, a forum where participants

from a great number of Latin American countries as well as Canada, Italy, Spain,

Turkey, UK and US discuss the latest trends in corporate governance.275 More

interestingly, the OECD has particularly promoted corporate governance for state

entrepreneurship since 2011 through the Latin American Network on Corporate

Governance of State-Owned Enterprises, which is expected to have a great impact

on formal convergence of corporate governance, at least in the matter of SOEs.276

Yet, Latin American traditional organizations have proved indebted.

273

See The Commission of The Cartagena Agreement, Uniform Code on Andean Multinational Enterprises

(1991) in INTERNATIONAL INVESTMENT INSTRUMENTS: A COMPENDIUM, available at

http://unctad.org/sections/dite/iia/docs/Compendium/en/47%20volume%202.pdf. 274

For the full critic see Reyes, supra note 155. 275

See http://www.oecd.org/corporate/ca/latinamericanroundtableoncorporategovernance.htm. 276

See

http://www.oecd.org/fr/gouvernementdentreprise/ae/gouvernancedesentreprisespubliques/latinamericannet

workoncorporategovernanceofstate-ownedenterprises.htm

Using a comparative view, this master thesis analyzed the current set of regulatory

protective measures which investors within the top five Latin American oil

producers are vested with. For this end, it aimed to illustrate how a wide array of

regulatory alternatives can be considered by resource-rich countries when

developing their oil and hydrocarbons industry, and how each selection in Latin

America has been the outcome of a privatization-monopolization cycle driven by a

great number of determinants. Moving throughout the framework and changing

institutional designs has been explained as a cyclical phenomenon driven by

ideological and political grounds (e.g. national proud, popular sovereignty,

egalitarianism, populism, reprisal towards foreigners, foreigners’ influence

restraint, smokescreen) and economic determinants (e.g. increase of international

crude oil price, deficiencies in the taxation and royalties systems, liberation of new

cash flows). Either case, each phase of the cycle entails either greater or lesser

participation of National Oil Companies (NOCs) and private investors. The

institutional design currently set up by the Latin American top oil producers,

involves high participation of direct and portfolio investors; that is, International

Oil Companies (IOCs) and outside shareholders and bondholders of NOCs.

Such complex design is not exempted from conflicts. Two value-reducing

forms of opportunism emerge. At one pole, host countries may reshape at any time

the scheme which governs the relationship with IOCs to benefit their “crown

jewels”. Even worse, under lower level of governmental commitments, IOCs could

be push out of the industry. At the other, since NOCs are resorting to public

external financing, a conflict arises between them as insiders and portfolio

investors. As if this classical agency problem were not enough, outside

shareholders and bondholders are also faced with specific political risks, namely

politicization, bureaucracy, populism, and so on.

After assessing each conflict, the analysis shows how investors’ protection

is mostly faint. Although controversial, “treaty shopping” has proved a market-

based remedy in the absence of formal effective means of protection for direct

investors. However, its success fighting back against the sovereignty postulate

(which is the most powerful instrument in the hands of resource-rich nations) is

relative because it does not prevent shifts in public policies or weaknesses in local

protection of property rights; it only mitigates the effects through the recognition

of compensation. The Netherlands has specially served as “treaty shop”. As for

portfolio investors, the existing legislation mainly lies in the classical corporate law

remedies such as supermajority, cumulative voting, preemptive rights and

dissenter remedies as well as other housekeeping rules regarding the shareholders’

76 Conclusion

assembly meetings. Owing the prominent influence exerted by developed

jurisdictions in fighting back against the latest corporate crises, Latin American

lawmakers have attempted to tight even more the existing legislation. Recent

enactments, however, provided a wide set of check-box rules that focus on

conflicts that arise from dispersed and not concentrated ownership structures,

creating direct and unnecessary costs. One prominent failure is that the most

important formal remedy of concentrated ownership structures —abuse of voting

rights or shareholders’ fiduciary duties— have been a “visible absence” in Latin

America, exempt for Brazil and Colombia. Naturally, the success of such ex post

remedy relies on institutional strengthening insomuch as civil law judges would

have higher discretion than what they are accustomed to. Remarkably, investors

have found market-based strategies to deter opportunist behavior by insiders. In

the combination of international cross-listing and ex ante discounting, NOCs have

found market incentives for growth to commit to higher disclosure standards as

well as market deterrents to not misappropriate minority shareholders’ wealth.

Finally, one daring claim is made in regards to the conventional protection

provided to certain bondholders of NOCs, meaning that an additional footnote in

the pages of the corporate governance discipline is needed.

In spite of the fact that each Latin American country is to some extent

trying to tune up according to the world trend in the matter of investors’

protection, the truth is that the region taken as a whole has proved indebted in

embracing tailor-made and value-creating protective measures. As a result of such

absence, investors have been compelled to resort to market-based remedies.

Results, however, are mixed up. Whereas some administrations strength their

reputation to generate confidence among investors, others simply use the power of

sovereignty to achieve any goal. And the reason is quite straightforward. The

former are subject to market discipline (i.e. discounting) and therefore may

potentially suffer direct losses, whereas the latter are not and losses are simply

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