Archive for the ‘Voting Rights’ Category

Blockholders and Private Benefits

The idea that economic and political rights are granted in proportion to investments made by diffused shareholders constitutes a “central premise in modern financial theory”. Nevertheless, even in the Anglo-saxon countries, the fact that a single shareholder owns a relevant stake, (more than 10%, 15% or even 50%) is very common, so that there is a possibility that some private benefits could be extracted by them. Do these private benefits exist? Would stock prices reflect these benefits if they existed? Read more…

Should we favor long-term shareholders? How?

January 2, 2014 1 comment

The Generation Foundation teamed with Mercer and Stikeman Elliot LLP in 2013, in order to do research on what investors and issuers thought about the possibility that loyalty-driven securities could be used as a tool to favor long-term shareholders, with the final aim that society as a whole could avoid the negative effects of short-termism that we would here take as granted. (1)

This was one in five elements previously identified in their article “Sustainable Capitalism”.(2) The new study finds out that the idea is mostly understood but rejected, in favor of some other alternatives to reward patient capitalists.

Some measures that have been proposed (some of them are already applied in France or the Netherlands) include:

–         Shareholder political rights: limiting access or reduce rights of short-term investors; or increasing those of long-term ones, with multiple voting rights that vest in time, or L-shares, (warrants that vest in time and give the right to purchase at a certain price a certain number of shares).

–         Economic rights: financial rewards to long–term shareholders , (for example additional dividends, or bonus shares).

–         Tax breaks or subsidies, (although those escape from the firm`s control, so the study doesn`t focus on it). Read more…

How are board directors elected? The US/Canada and Spain cases.

October 11, 2013 1 comment

According to the Council of Institutional Investors, (CII), at most US companies, (it is also the case in Canada, although there is a trend to change that), directors are elected by a plurality of votes cast; under this procedure, the candidate that receives the most “for” votes, is elected as a director. This might seem acceptable, but what does this entail? First, a director may be elected by a minority of votes cast, which might put into question the adequacy of the candidate for the job, but this is common to the majority system; second, what happens in an uncontested election? In that case, the election turns into a “for or withhold” choice, so that the “withheld votes” could win if that bipolarity was respected; but, if not, a single “for” vote could be enough for a candidate to be elected. This is the case in Canada and the US, except where companies have adopted an alternative procedure. Majority systems require a candidate to obtain more “for” than “withhold” votes to be elected or reelected, and in many companies, those directors not reaching that target need to offer their resignation, (even if the Board does not accept it, which leads to what recent literature calls “zombie directors”). Read more…

Introducing Growth and Value Creation in a Corporate Governance model

Although early investors and founders in Facebook are necessarily happy with their investment, it is not the case of those investors having joined the company at the occasion of the IPO.

Corporate Governance advocates had somehow predicted the result, as they had argued its governance structure (multiple voting shares allocated to founders and a few others so that they controlled much more than their investment stipulated) did not guarantee shareholder value creation would be a priority. The Corporate Governance model they advocate for focuses in managerial control mechanisms, as the agency problem between investors and stakeholders, versus founders and early investors, needs to be tackled.

Nevertheless, others justify this governance structure: the autocratic system helps founders of high potential growth companies to focus on long-term sustainable growth, while rejecting short-term pressure by equity markets.

Regulation after the late 2000s crisis tried to fight short-termism, introducing shareholder engagement, (thus the two dimension model, managerial control and long-term commitment). But engagement is somehow still limited to voting the shares, and the rational behavior is following proxy advisors, that are not enough to help long-term behavior. Trading differentiated taxes, voting right allocation rules in favor of long-term investors and so on, are nowadays in the political agenda.

But, how can those opposite strengths –short and long-term perspectives- be more efficiently reconciled?

A new Corporate Governance model with a focus on growth and value creation, (the third dimension), is proposed by McCahery, Vermeulen, and Hisatake, in their article “The Present and Future of Corporate Governance: Re-Examining the Role of the Board of Directors and Investor Relations in Listed Companies”.

How does the model work in practice, what is the dynamics?

The point is: shareholder value and stakeholder satisfaction comes from growth and innovation potential, (instead of coming from oversight or long-term investor commitment).

Board dynamics and composition. There are several steps followed by successful companies:

–         First funds come from family, friends, and fools, that do not generally have access to the board.

–         Secondly, angel investors and venture capital funds appear, and they typically have access to the board. They are usually beneficial for growth, for their industry experience, and their strategic involvement, and understanding of value drivers.

–         Third, after an IPO, the model accepts the dual-class share governance structure, as something connected to innovation and value creation in that kind of company, and thinks of the board as not only responsible for oversight functions, but more relevantly for experienced advice for strategy, value creation and growth. That leaves room for boards full of industry experts, familiar to the Ceo or not, but deeply involved in the company`s growth strategy. On the other hand, this model is not confronted to independence, diversity, Chairman-Ceo separation, and other standard composition rules.

The relevance of Investor relations.

The authors advocate for a strong communication and investor relations strategy, so that investors and other stakeholders clearly understand the competitive advantage their corporate governance structure provides, and why it separates from certain general “one-fits-all” recommendations. Investors need to understand how this structure promotes revenue generation and stakeholder satisfaction.

Above all, these companies need to be transparent and engage in information sharing regarding their innovation and growth prospects.

One Share, one Vote.

March 5, 2013 2 comments

According to Professor Colleen Dunlavy of the University of Wisconsin-Madison, corporations were not governed by this principle during the first 19th century decades, so that big shareholders did not hold as much power as they did afterwards. Shareholders were more equally treated than their investments would have suggested. By the middle of the century, democratic norms were pushed and the huge power concentration so  normal at the end of the century started. The change was presumably led by wealthy lobbies, which were able to make legislation passed through.

Anthony Kammer thus argues it is not so rare to propose a different system.

Some realities in the capital markets today lead to rethink the principle. Firstly, decoupling, that is, the split of voting and economic rights, (through derivative markets, share lending activities, and so on), forces to reconsider the principle as “empty voters” have a different interest than “full owners”, the last ones still holding an economic interest and risk, so that the two groups would vote differently. Secondly, a difference might be done between long-term shareholders and short-term ones, so as to avoid the kind of bad behaviors and performance deeply responsible for part of the damages generated by the 2008 financial crisis. Regulation is being pushed in that sense, in the EU and beyond.

In fact several endogenous mechanisms allow some shareholders to hold higher voting rights that those corresponding to their investment and risk exposure: dual-class share systems, pyramidal structures, cross-holdings and so on.

Since the 1990`s, the principle has been dominant, and separation from it has been narrowed, even in those countries where a dual class share system was possible, (Sweden in 2004). But their presence gives room to some empirical studies.

First, what are the reasons for that separation from the principle? Some ideas follow:

–         Shares with higher voting rights usually extract a higher premium in acquisitions.

–         Founders launching an IPO usually want  higher proportion of voting rights than cash-flow risk, having cashed-in for the free-float.

–         Some control of private benefits for controlling shareholders might be guaranteed.

–         The cost of capital tends to be higher in dual-class firms, so a reduced need of funds might be present.

A critical point in assessing this kind of proposal, concerns the effects of the disproportionate allocation of voting rights to some shares. Does it affect shareholder value? Although not empirically irrefutable, it is widely accepted that outside equity loses value, because there is a tendency towards private benefits being extracted by controlling shareholders, and because of a higher cost of capital in these economies/firms.

In terms of social welfare, disproportionate control seems to have certain effects, basically connected to the underdevelopment of the financial markets, (the current political trend is probably populist, or led by recent financial events, so that this fact will probably be disregarded). We also refered to the increase in the cost of capital, so these economies would eventually face a certain underinvestment.

A factor worth being considered is the extent to which the level of disproportion in the allocation of voting rights affects the results, and it appears to be relevant, so that a reduced disproportion could have little shareholder value and welfare effects, and so allow for the current regulatory proposals to have some acceptance.

Consequently, the case for extraordinary allocation of voting rights to long-term shareholders can be made. The aim of enhancing long-term shareholding and behavior is laudable, and the effects could to some extent be disregarded. It exists in some countries and companies, (in Sweden, France, Germany), with a degree of success, (as in the case of LVMH, Volkswagen, L`Oreal, and so on). Some unwanted effects can follow if also extraordinary dividend rights are granted, -as proposed in the EU-, (think of the difficulty to calculate the dividend cost and adequate policy).

But the main discussion concerns whether the measure is the best to guarantee the desired result: a cost and benefit analysis should be done to compare it versus other tools to that purpose.

This post follows several articles or comments in HBR, FT, Anthony Kammer, Adams and Ferreira, and others.

Shareholder Activism: acting persons, aims, themes, targets, and behavior

December 29, 2012 Leave a comment

Shareholder activism is the effort by owners of equity capital to use their shares’ voting power to change the behavior of corporate management. They use to act through Shareholder Proposals.

  1. Shareholder proposals, (which -in the US- any owner of shares valued at $2,000 or more, and held for one year, can introduce at the annual meeting of a publicly held corporation, -one per shareholder and company-); investors vote in person or by proxy. In 2012, at the USA, proposals were submitted by:
    1. Labor or union pension funds, (36%). Most of these cases, proposals have nothing to do with performance, but with union`s agenda. In the USA, though, they are forced to pursue the best for the value of the investment, so they shouldn`t and are not so free, to follow different objectives.
    2. Socially responsible investors, 22%. Religious, or public policy, or political involvement agenda, …the base being the idea that directors have fiduciary duties not only to shareholders, but to other stakeholders.
    3. Institutional unaffiliated investors, (1%). Hedge funds, mutual funds and the like, with guiding stars such as Ackman, Icahn, and others. They are well-known since the 80`s, (Nabisco, and so on), and look for improving shareholder value, to the benefit of all shareholders.
    4. Other normal individual investors, (10%).
    5. Four “gadflies”: Evelyn Davies, John Chevedden, William Steiner, and the Rossi family. 31%.
  1. There is interaction between social activism, the kind that forces companies to enhance corporate governance, (majority voting, declassified boards,…), and activism pursuing shareholder returns. The first one, has enabled the second activists, because their costs and efforts have been reduced. Also, by SEC and NYSE regulation, brokers cannot vote on uncontested elections by their beneficial owners`shares.
  1. The objectives are more or less by thirds, these ones:
    1. Executive compensation: proposals pursue to enhance shareholder control on theses matters. The number is going down, as disclosure has been enforced by regulation.
    2. Social objectives: environmental, social, labor relations, animals and human rights, ….independently of the shareholders interests. Both a and b, are substance-based proposals: a specific theme to be dealt and changed.
    3. Corporate governance: they pursue to differently allocate power among Board, management and shareholders. The number of these process-based proposals is going down, because of a certain success in previous years. Usual topics are:

                                                          i.      Shareholding voting rules: majority vs. plurality and super-majorities; cumulative voting; declassified boards.

                                                             ii.      Independent chairman

iii.      Rules allowing shareholders to act out of General Meeting: special meetings or written consent,

  1. Targets of shareholder activists:
    1. Larger companies.
    2. Company industry: financial services and energy.
    3. Where organized labor is interested, (unions). Retail, telecom and finance, mainly.
  1. How do proposals fare: they normally fail, when substance-based, and succeed when process-based.
  1. Among institutional investors, we can find Hedge Funds. They can be classified for type and style:
    1. Types of Hedge Funds: among equity focused hedge funds, we may distinguish: hedge equity, (hold long and short positions, normally keeping a net long position), market neutral, (try to produce results not correlated with any market), event-driven or macro funds. There are also fixed income funds, etc.
    2. Style: equity hedge, short selling, event-driven, and long-short.
  1. How do hedge funds usually act? Their behavior is determined by certain factors:
    1. Their investor base: the more they rely on super-rich wealth, the more they accept volatility. But more than two-thirds of their funds come from pension funds, endowments, and the kind, too risk-averse for the 80`s hedge fund industry`s behavior.
    2. Leverage: it is at its low in these times.
    3. Rigidity: funds owners require stickiness to the known manager`s strategy, not accepting changes.
    4. Funds allocated to hedge funds have soared from $ 0.5 trillion in 2000 to 2.2 trillion in 2012, so that many second-rate bets are accepted; thus, profitability is not expected to be so high now.
    5. Hedge funds normally charge a 2% management fee plus a 20% on profits. With the current low-level in interest rates, this seems high, so they need to compete with mutual funds, exchange-traded funds and so on.
    6. As for activist funds, $ 57 billion are said to be dedicated to activist strategies.It is interesting to follow some of the main hedge fund managers`strategies, so as to be aware of their acting pattern, for instance Carl Icahn, Bill Ackman, and others.
  1. How do equity hedge funds usually act? It is interesting to follow some of the main hedge fund managers`strategies, so as to be aware of their acting pattern, for instance Carl Icahn, Bill Ackman, and others. The following steps can be identified:
    1. Fund starts purchasing a stake in the company, normally under 10%, for profit disclosure reasons. Share is normally undervalued.
    2. Fund then discloses its stake and agitates for change: strategy, M&A options, and so on. Usually at this moment, fund is already in the money.
    3. It the target company resists to adopt suggested change, the fund manager usually proposes a minority slate of directors, (that with shareholder approval will replace current ones and agitate adopt changes).
    4. Failure is usually followed by new election campaigns, (normally with a full slate of directors now).
    5. Finally, fund manager may decide to cash-out, or to make a bid for the company stock.
    6. If the bid succeeds, funds need to be prepared to manage the company.
    7. A different approach involves using derivatives, (short positions), when discovering a negative feature in a company, (Ackman`s case in Herbalife, when he made the case the company had accounting wrongdoing to cover a Ponzi-kind performance).

The power of shareholders. Ballots, and the option for staggered or declassified boards

December 1, 2012 Leave a comment

The shareholder franchise, (right to vote), is the ideological support for directorial power in a company with dispersed ownership, so that whenever shareholders think directors do not deserve their trust anymore, they can use democratic tools to oust them. But, are director elections really available and adequate for this? We are going to follow the debate between Bebchuk and Lipton on this matter, as in other previous posts, (noting that they mainly refer to the US).


Why is the shareholder franchise relevant?


Boards have a role in correcting the agency problem between shareholders and managers. Given their functions, their selection is a critical decision, and compensating them so that they stay aligned with shareholders, is a must. The power to replace directors by shareholders has a role in both points, (in particular Courts do not judge directors` decisions, but shareholders need to do that). Some corporate decisions are reserved to the Board, precisely on the ground that directors can be replaced, and even director independence is not enough to provide incentives to work in favour of shareholders` interests.


When analysing Contest Solicitations, the number of directors challenged to be replaced by others still seeking to manage the company independently but differently,  is very small, (mainly in middle-sized or small companies), and a majority of them fail. When those numbers are compared to the number of public companies, the number is low. Mr Lipton considers this a fact, not a proof of difficulties to ballots. But…


The more outstanding obstacles to elections are the following, according to Mr. Bebchuk:


  1. The costs are high: sending the proxy to shareholders, and receiving it back; filing the proxy statement with the SEC, and communicating the proposed strategy, through costly proxy solicitors. But only a fraction of the eventual benefits would flow to the challenger, (according to his ownership percentage).
  2. The uncertainties under the challenger`s flag: the strategy, the Ceo that will be hired, etc.
  3. Staggered boards, where only a fraction, (usually a third) of directors comes for re-election each year. Controlling that board means winning two elections, which is more expensive, reduces the challenger`s chance, and makes shareholders reluctant to vote for, so as to avoid one year of unrest and uncertainty.


Bebchuk`s reform proposal


Consequently Mr Bebchuk proposes elections should be allowed to take place annually for all directors:


  1. The frequency would not necessarily be annual, (because of costs, short-termism being imposed on directors, etc).
  2. Access to the ballot should be opened to shareholders trespassing some ownership thresholds, and committed to keep its position for a certain time, (after the proposed director is elected).
  3. Reimbursement of funds spent in the contest, would be granted to those gaining sufficient support.
  4. Shareholders should be able to replace all directors, although unless a shareholder revolt takes place, elections could be consistent with a staggered board.
  5. Some arrangements for all elections:
    1. Directors should not remain when more votes are against than in favour. First, shareholders need to be able to cast “against” votes, and not only “withhold” ones; second, majority voting needs to be implemented, against the plurality system, because most elections are uncontested.
    2. The vote should be confidential
  6. Legislators should facilitate shareholders to initiate certain bylaws changes for introducing the proposed reform, and prevent directors from doing the same when the objective is making their ousting more difficult.


Staggered boards defendants (and Mr Lipton) concerns follow:


  1. The associated costs of annual contests,
  2. Certain major shareholders could happen to launch elections in order to pursue their own agendas,
  3. Directors would be invited to abandon their long-term focus, and the board in general would be disrupted by internal dissent and “electoral” attitudes,
  4. Director recruitment problems could arise from the permanent election forecast.
  5. Independence of Independent Directors and their stability and experience could be undermined.


The activism for the Power of Shareholders has been developed by Harvard`s Professor Bebchuk through Harvard`s “Shareholder Rights Project”, which advises some institutional investors, and in particular helps them submit proposals for declassification.


The main argument in favour of declassified boards, and against staggered or classified boards, is an empirical one, and the debate should mainly be kept in this area. There are some empirical studies which help link staggered boards with a lower firm valuation, lower returns in case of a hostile takeover bid, less pay and managers` turnover correlation with performance, and so on.


Those favoring staggered boards, attack this empirical evidence. But they also validly argue the concerns included above, and the loss of value captured by shareholders in the case of a hostile takeover bid. This last point is clear when a staggered board is combined with a poison pill. We will deal with that part of the debate in a forthcoming post, because it is critical: in fact, Professor Bebchuk`s ballot proposal is compatible with staggered boards, but not with its combination with poison pills as a hostile takeover bid defense.