“One-share, one-vote,” a bedrock principle of Anglo-Saxon corporate governance, is back in the spotlight. Except this time the aim is to diminish its application rather than to extend its global footprint. Rising short-termism among investors — which threatens to destabilize both companies and the wider economy — is prompting a reconsideration of the principle that all shareholders should have equal say.

Prominent commentators such as former U.S. Vice President Al Gore, McKinsey Managing Director Dominic Barton and blog, and Vanguard Group founder John Bogle have advocated bolstering the voting rights of long-term shareholders or, conversely, withholding them from short-term investors. Significantly, the Financial Times reported last week that the European Commission was preparing a proposal to give “loyal” shareholders extra voting influence.

Seeking insulation from near-term pressures, Facebook, LinkedIn, Groupon, and other Silicon Valley outfits went public in recent years with dual-class shares that gave their founders — believed to be the most committed to their long-term success — voting power of up to 150 times greater than those accorded outside investors. Google, which adopted a similar share structure at the time of its initial public offering in 2004, has gone further with its decision last spring to issue non-voting stock.

…continue reading: Rethinking “One Share, One Vote”

In our paper, Should Shareholders Have a Say on Executive Compensation? Evidence from Say-on-Pay in the United States, which was recently made publicly available on SSRN, we examine the SEC 2011 regulation requiring an advisory (non-binding) shareholder vote on the compensation of the top five highest paid executives – “say-on-pay” (SOP). In July of 2010, Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law requiring all public companies to give their shareholders the opportunity to cast a “non-binding” advisory vote to approve or disapprove the compensation of the 5 highest paid executives at least once every 3-years. The Securities and Exchange Commission (SEC) implemented “say-on-pay” (SOP) in January of 2011, and since then, shareholders in the US have “had their say” on executive compensation packages for two years: 2011 and 2012. To date, the SOP shareholders’ votes overwhelmingly approved the executive compensation proposals by a majority of votes (>than 50 percent) giving broad support to management pay packages (Cotter et al., 2012). Only 1.2 percent of the Russell 3000 failed the SOP proposal in 2011 and 2.5 percent failed in 2012 obtaining less than 50 percent approval. However, around 10 percent of firms received more than 30 percent opposition or “rejection” votes.

…continue reading: Should Shareholders Have a Say on Executive Compensation?

This post provides a summary of certain principles of English law and UK and European regulation applicable to UK-listed public companies and their shareholders that may affect shareholder activism, namely (i) stake-building, (ii) shareholders’ rights to require companies to hold general meetings, (iii) shareholders’ rights to propose resolutions at annual general meetings and (iv) recent developments in these and related areas.

I Own or Am Intending to Acquire Shares; Do I Need To Make Any Disclosures?

The UK’s disclosure obligations (under the UK Listing Authority’s Disclosure and Transparency Rules (the “DTRs”)) apply once a person (or persons acting in concert) has (or together have) a holding of 3 per cent. or more of a listed company’s total voting rights and capital in issue (either as a shareholder or through a direct or indirect holding of relevant financial instruments) unless the relevant listed public company enters an “offer period” (as to which, see below). Thereafter, any changes to that holding that cause the size of the holding to reach, exceed or fall below every 1 per cent. above the 3 per cent. threshold (i.e. reaching, exceeding or falling below 4, 5, 6 per cent. etc.) must be disclosed by the relevant shareholder(s) to the listed company and the listed company is then obliged to announce those disclosures to the market. In addition, the disclosure obligations extend to the disclosure of voting rights held by a person as an indirect holder of shares, such as where a person is entitled to acquire, dispose of or exercise the voting rights attaching to shares (for example, via synthetic holdings or contract(s) for difference). It is important to note that any indirect holdings must be aggregated and separately identified in the relevant notification(s).

…continue reading: Shareholder Activism in the UK: An Introduction

In the past decades the Brazilian economy has undergone major changes such as macroeconomic stability; achievement of investment grade status for the debt of the government and many individual firms; strong economic growth; and development of pension funds, which became major investors in public company shares. Significant changes were also observed in the stock market. Through the early 2000s, Brazil was seen as having relatively weak corporate governance. Examples of expropriation of minority shareholders by controlling shareholders were common.

In 2000, in response to concern about weak protection for minority shareholders (including extensive use of non-voting shares, few outside directors, and low levels of disclosure), the São Paulo Stock Exchange (BM&FBovespa) created three high-governance markets (Novo Mercado, Level I and Level II). This contributed to a surge in initial public offerings, which had been nearly nonexistent until 2004; a leveling off in the number of listed companies, which had been shrinking; and sharply rising trading volume and liquidity. Most new listings were at one of the premium listing levels; some older companies also migrated their listings to a higher level. In spite of these major changes in the economy and the stock market, little is known about how corporate governance standards have been changing. This article, The Evolution of Corporate Governance in Brazil, aims at filling this gap by providing a picture of the evolution of corporate governance practices in Brazil.

…continue reading: The Evolution of Corporate Governance in Brazil

In our recent paper, On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership, we build and explore a formal theoretical framework to understand interactions between derivatives markets and shareholder voting behavior.

Ownership of stock in a corporation entails two types of rights with respect to that corporation. First, shareholders have economic ownership rights that entitle them to share in corporate profits. Second, they have certain legal rights of control over the corporation. These economic and control rights come bound together with each share of stock, but they can be separated, or decoupled. Decoupling can result in empty voting, in which an actor’s voting interest in a corporation is larger than her economic interest. It can also lead to hidden ownership, in which an actor’s economic interest in a corporation exceeds her voting interest. Decoupling raises a host of concerns because it turns the conventional logic for granting shareholders voting rights—their economic interest in the corporation—on its head. (See references here.)

…continue reading: A Theory of Empty Voting and Hidden Ownership

Executive Summary

At most U.S. firms, ownership is dispersedly-­held and voting power is proportionate to capital at risk. At a minority of firms, however, a significant amount of the vote is controlled by one party through a sizeable ownership stake or, alternately, through a multiclass capital structure created specifically to allow voting power to be disproportionate to capital commitment. These controlling parties often include company founders and/or insiders whose interests may or may not conflict with those of unaffiliated shareholders.

The issue of control has received much attention since the initial public offerings of LinkedIn Corp., Zynga Inc., Groupon Inc., and Facebook Inc. While these firms were taken public amid great fanfare and high expectations, the results have been mixed. As of Aug. 31, 2012, the market price of LinkedIn Corp. had risen over 138 percent from its Sept. 16, 2011, initial public offering but Zynga Inc., Groupon Inc., and Facebook Inc. had fallen 72.0 percent, 79.3 percent, and 52.5 percent, respectively, from their IPO prices. A common feature of these firms is a capital structure that allows founders to control a majority of the voting stock while holding a comparatively small portion of their firm’s economic value.

Supporters of these structures claim that control of a firm’s voting power enables management to govern with minimal outside interference and focus on long-term business growth, ultimately delivering shareholders higher returns in exchange for control rights. Detractors, however, claim that control mechanisms misalign interest between affiliated and external shareholders and allow insiders to operate without the normal accountability mechanisms. This study attempts to contribute to that debate by examining the prevalence, characteristics, and relative performance of controlled companies listed on exchanges in the United States.

Key findings of the study include:

…continue reading: Controlled Companies in the S&P 1500: Performance and Risk Review

In the post-financial crisis regulatory reforms, emphasis has been placed on creating recovery and resolution frameworks for banks, which ensure that the costs of failure are born by private parties (primarily shareholders), instead of taxpayers and the wider economy. Supervisors have (or will have) extensive powers on banks, e.g. to remove and replace directors, to appoint “special managers”, to transfer shares and assets of banks to third parties, and even to cancel existing shares and issue new shares in order to “replace” existing shareholders. The purpose of this article, Bank Recovery and Resolution: What About Shareholder Rights?, is to examine the potential impact of bank recovery and [1] and of the United Kingdom (the special resolution regime for banks established by the Banking Act of 2009).

The article begins by studying the rationale for shareholder protection, especially in the banking sector. It subsequently studies the main shareholder rights, which include: property rights, governance rights (including pre-emption rights, appointment of directors and involvement in management), procedural rights, protection of minority shareholders, and protection of shareholders in banking groups (through the principles of separate legal personality and limited liability).

…continue reading: Bank Recovery and Resolution: What About Shareholder Rights?

The arguments over the merits of dual class share structures have been heating up of late. The issue has resurfaced as institutional investors have complained about the increasing number of IPO companies (Facebook, Groupon, Zynga being the most notable) who have gone public as dual class stock companies limiting the rights and influence of shareholders and turning them into economic bystanders.

One of the stories we cited comes from IR Magazine “CalPERS Strategy Could Avoid IPOs with Dual Class Share Structures” discussing how the fund giant is planning to advocate against the use of dual class structures for companies exiting private equity and entering the public market. Earlier in August, at the ABA Business Section CLE conference, in Chicago, there was a panel discussion on the topic (“Dual Class Stock: Value Enhancer or Corporate Governance Killer?”) The panel comprised of institutional investors, a corporate director (and former investment manager), as well as a corporate attorney and Delaware jurist, all squared off on the issue.

…continue reading: Dual Class Share Structures: The Next Campaign

As private equity giant Carlyle Group LP prepared to join rivals Blackstone Group LP and KKR & Co. as a publicly traded company this year, it made headlines with a stunningly “shareholder-unfriendly” proposal to eliminate the litigation rights of its future public owners.

On January 10, Carlyle amended its registration statement in advance of its forthcoming initial public offering (“IPO”) to include a provision declaring that any and all investor disputes would be decided in private arbitration proceedings rather than in a court of law.

Although Carlyle ultimately removed the provision after widespread publicity and SEC objections, it is likely only a matter of time before more companies attempt to insert similar provisions in their registration statements and corporate charters. Because class action claims are usually unavailable in arbitrations — Carlyle’s clause explicitly prohibited them — and because arbitration proceedings generally disadvantage individual plaintiffs to the benefit of corporate defendants, if such clauses become widespread, it will take away an important check on corporate conduct and deal a tremendous blow to investor rights.

…continue reading: The Carlyle Group Tries to Bar Investors From Court

The Journal of Financial Economics has recently accepted for publication our study, Learning and the Disappearing Association between Governance and Returns. The paper, which was earlier issued as a working paper of the Program on Corporate Governance, is available here.

Our study seeks to explain a pattern that has received a great deal of attention from financial economists and capital market participants: during the period 1991-1999, stock returns were correlated with the G-Index based on twenty-four governance provisions (Gompers, Ishii, and Metrick (2003)) and the E-Index based on the six provisions that matter most (Bebchuk, Cohen, and Ferrell (2009)). We show that this correlation did not persist during the subsequent period 2000-2008. Furthermore, we provide evidence that both the identified correlation and its subsequent disappearance were due to market participants’ gradually learning to appreciate the difference between firms scoring well and poorly on the governance indices. Consistent with the learning hypothesis, we find that:

      (i) The disappearance of the governance-return correlation was associated with an increase in the attention to governance by a wide range of market participants;
      (ii) Until the beginning of the 2000s, but not subsequently, stock market reactions to earning announcements reflected the market’s being more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms;
      (iii) Stock analysts were also more positively surprised by the earning announcements of good-governance firms than by those of poor-governance firms until the beginning of the 2000s but not afterwards;
      (iv) While the G-Index and E-Index could no longer generate abnormal returns in the 2000s, their negative association with Tobin’s Q and operating performance persisted; and
      (v) The existence and subsequent disappearance of the governance-return correlation cannot be fully explained by additional common risk factors suggested in the literature for augmenting the Fame-French-Carhart four-factor model.

Here is a more detailed account of our analysis:

…continue reading: Learning and the Disappearing Association between Governance and Returns