Home > Shareholder Activism > Negative voting and derivative markets

Negative voting and derivative markets

This post will allow us to present a feature of derivative markets that should be a concern, given the rise in trading volume in these markets and increased activism and rights and empowerment held and granted to shareholders. We will comment a post and article by Holger Spamann, Harvard Law School, on Friday October 5, 2012. (1)

The idea can be described as follows: a share or debt holder has a stake in the company, and is interested that those assets increase their value. Nevertheless, he may also have bought a short position that more than offsets his interest, so that his total interest is short, that is, he would be favored by a decrease in the price of the assets. The concern in this case is that he could use his rights as a shareholder or debt holder to pursue that goal and against the interest of shareholders or the company.

Prof Spamann first wonders if it would be possible for an asset holder to enter in such a transaction in the derivative market, and in what circumstances. As the gains in the derivative transaction would mean a similar loss by the counterparties in the transaction, the transaction could be impossible.

The answer is found in asymmetric information and a realistic degree of investor heterogeneity. The answer is simple; if market makers cannot observe the large orders directly, because those orders are disguised to a certain extent by orders issued by liquidity traders and other participants, then the large trader and negative voter can extract some value out of his strategy, taking advantage of his private information about his trade and vote.

In any case, there are some limits to this activity, as it seems impossible to hedge an amount of shares surpassing a certain percentage of total shares issued, (for instance higher than 51%). On the other hand, in the case of shares, the trader may be limited by disclosure legal obligations, poison pills or other circumstances.

Notwithstanding this, a relatively small share or debt owner can be an influencer in certain cases, such as restructuring situations, bankruptcy procedures, mergers, and so on. In the past several years, huge amounts of money have poured into short selling activities, regarding many firms in tough financial situations, where eventually those small share or debt holders have had a significant power or control rights; nevertheless, how they used those rights, or the existence of  Negative Voting remains an empirical problem.

(1) https://blogs.law.harvard.edu/corpgov/2012/10/05/derivatives-trading-and-negative-voting/     and http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2144552.

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