Shareholder voting rights

 

The subject of the shareholder’s voting rights in a company is complex. It is useful as a starting point to recall some basic general principles as well as highlight the multiplicity of contexts in which such rights are exercised.

 

A first principle requires that all shareholders be given a right to vote their shares; it can be stated that the principle of a minimum of one vote per share* should be generally applicable.

 

A second principle should establish equal voting rights for shareholders who acquire and hold their stakes under similar conditions.

 

A third principle should establish the freedom of shareholders to establish a differentiation in voting rights based on “objective criteria” as described in the bylaws of the company within limits that the legislator/regulator may wish to impose to ensure transparency and fairness in the application of corporate governance principles. The acquisition of shares would imply the knowledge and acceptance of these rules by shareholders. Changes would be subject to the procedures enshrined in the bylaws.

 

With regard to the context, one should specify from the outset the scope of the framework being considered: does one wish to establish rules applicable to all shares without distinction? To shares of companies incorporated with limited liability? To shares of listed companies only?

 

The need for shareholder protection applies mainly to companies raising funds publicly, the shares of which are listed on recognized exchanges. However the rights of “minority shareholders”- especially “second generation” shareholders - in privately held companies deserve also adequate protection to avoid what could be considered “abuse of dominant voting power”.

 

Also of particular relevance in evaluating shareholder voting rights is the entitlement to the exercise of those rights: most listed shares are held by institutional investors representing beneficial owners through vehicles such as Sovereign Wealth Funds (“SWFs”), UCITS, Pension funds, Life Insurance Companies, Discretionary portfolio management etc.  This question is of particular importance because the fiduciary responsibility of

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* Reference is limited to “ordinary shares” to the exclusion of preferred shares or other quasi equity instruments which may or may not be entitled to voting rights in accordance with their terms of issue.

 

 

 

investment managers” towards their clients overrides their duty to the investee companies as shareholders. Exercising voting rights on behalf of the beneficial owners can create conflict of interest situations both between management and beneficial owners and/or between the institutions and the companies in which they invest. These considerations apply also mutatis mutandis to Sovereign Wealth Funds and their relationship to their Government owners.

 

Another important factor is the divergence of aims pursued by different categories of shareholders, in particular in listed companies:

 

-                        Entrepreneurs, be they individuals, family groups or shareholders bound by a “shareholders agreement”, will be primarily motivated by the development of the company’s activities. As promoters, they exercise a strong influence over the management. It is the success over the long term that is expected to provide their anticipated rewards. The disposal of their stakes will often be subject to contractual and/or legal requirements.

 

-                        Investors, institutional and individual, acquiring shares through market mechanisms will be motivated essentially by the anticipation of a favorable “price movement”. Though by no means indifferent to corporate policies (strategy, environment, remuneration, governance etc.) these shareholders can, in addition to expressing their views through their “voting rights”, also choose to sell their positions at any time, either because of their own needs, that price expectations have been realized, the opportunity of more attractive alternatives, unfavorable developments affecting the company or, indeed, because of disagreements with management. Their choice of remaining as shareholders will therefore be tributary to developments affecting the company and/or totally extraneous factors. This applies to SWFs and their relationship to their owners.

 

-                        Speculators (defined here as short term holders with no pejorative connotation) will become shareholders only to benefit from an anticipated imminent price movement. This can be caused by the evaluation of the market reaction to company specific news or general economic/political information or simply by rumor. For this category of shareholder their does not exist any “affectio societatis” with the company, its shares serving exclusively as vehicle for the speculative “play”. Some categories of speculators such as “arbitrageurs” can play an important role in providing liquidity to the market for the benefit of all investors; they can weigh on the outcome of corporate mergers by their “temporary” voting power through the sheer size of their positions.

 

Regulating shareholder voting rights should strike an appropriate balance between the “rights” and “obligations” of each type of constituency, and also take into account the impact such rules may have on the legitimate interests of other corporate stakeholders (employees, customers, and suppliers).

 

It is in the light of the growing divergence between the aims of different shareholder constituencies and the possibility of acute conflicts of interest between the parties that it appears appropriate to question imposing across the board a uniform “one share one vote” principle.

 

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It seems appropriate that shareholders who make a “long term commitment” to the development of a company should benefit from a greater say in company affairs. This should apply uniformly to the initial investors in a company who contribute either know-how or risk capital. In accordance with the second “principle” referred to here above, they should benefit from equal voting rights, having acquired their stakes under similar conditions. As long as the company remains privately held, their does not seem to be an overriding need to depart from the one share, on vote principle.

 

At such time as a company seeks to raise funds publicly, introducing the second category of shareholders referred to as Investors here above, the situation changes radically. The rights of the new shareholders should be fully described in the Prospectus accompanying the share offer emphasizing, if applicable, any differences in voting power between shares held by existing shareholders and new investors. Such differentiated voting rules will have been adopted by existing shareholders prior to the offer according to procedures set in the company bylaws.

 

A greater “voting power” can also be justified by necessary restrictions on the sale of shares held by original investors which reduce their “value” by limiting their marketability. These measures are designed to achieve three objectives:

 

a)         Reassure new Investors of the Entrepreneur’s long term       commitment to the development of the company.

a)                  Protection against insider trading by those closest to the company.

b)                  Avoid the “overhang” of shares held by original investors which can distort the transparency and equilibrium of the market.

 

Implementation of such a system could be inspired by the share “registration” mechanisms applied to publicly traded securities in the US market, the absence of which in European markets has lead, in the past, to numerous cases of “market abuse. However two major differences with the American system are suggested:

 

a)      First “registered” shares held by a shareholder - or group acting in concert – exercising more than say 25 %(?) of the voting rights would be to subject to “deregistration” if the shares were held for a period exceeding 12 months. This provision is aimed at shareholders with a specific corporate long term objective without impairing market mechanisms or penalizing shareholders in a failed attempt at a corporate restructuring by limiting their ability to disengage from their commitment through the same channels used to acquire their stakes. Such deregistration could be accompanied by the attribution of multiple voting rights to the extent that other non registered shares already benefit from such a provision. This provision should also apply, independently of the size of the holdings, to investors who are represented on the Board of Directors of the investee company. This provision should apply mutatis mutandis to SWFs.

b)      An element of flexibility should be introduced allowing holders of “unregistered” shares to sell their stakes. Rules limiting such sales as a percentage of the “float” (registered shares) and/or average daily trading volume together with the obligation to publicize such sales would ensure that the market would remain fully transparent. Sales not meeting these criteria should be subject to a full registration statement (i.e. Prospectus) which could also be “piggy backed” on offerings aimed at raising capital for the company.

 

Limitations on the ability to confer multiple voting rights could be imposed by the legislator/regulator i.e. a maximum of 5(?) votes per share, and/or in the form of specific decisions requiring separate votes by category of shareholder (change in bylaws, mergers, remuneration of management, corporate governance rules).

 

Ordinary investors should also be able to acquire multiple voting rights defined in the bylaws. These rights, acquired only after a minimum “holding” period of say 3 to 5 years, should be subject to a lower maximum limit (3?) and should not entail any restriction on the ability to resell in the market, provided that the initial acquisition had been in the form of “registered shares”.

 

Speculators, as defined, should be satisfied with one share one vote.

 

Nothing should prevent companies to choose a one share one vote system which could also be made the legal “default clause” in cases where the bylaws failed to specify other arrangements.

 

Dissemination of the relevant information concerning differentiated voting rights in listed companies should be regulated by the Exchange’s “listing requirements”. For instance, transaction confirmations should flag the existence of multiple voting rights, and their terms should be available on relevant Exchange Webb sites.

 

 

 

 

Conclusion

 

Though no one system can ensure an absolute fairness and a guarantee against manipulation, it would appear that the dangers of a legally enforced “one share one vote” system across the board can, in the present investment context, lead to consequences that are counterproductive in particular by facilitating the realization purely short term objectives by giving excessive weight to sheer financial muscle easily mobilized by speculators and institutional investors and totally ignorant of the interests of other stakeholders. These measures, without being discriminatory, should also alleviate fears of the misuse by SWFs of their voting power.

 

A balanced approach leaving a great amount of freedom to shareholders in the design of their own governance, and within limits of a regulated framework seems the most appropriate approach to this delicate and important subject.

 

Paul N. Goldschmidt                                                  Brussels, January 12 2007

Director, European Commission (ret.)