Tweet
FT REPORT - FT FUND MANAGEMENT: ONE SHARE, ONE VOTE DOES NOT MEAN DEMOCRACY
By Arman Khachaturyan
Financial Times
Published: Feb 19, 2007
Establishing shareholder democracy and enforcing a mandatory
one-share-one vote rule in the European Union have drawn
controversy. In the pursuit of popular appeal for the proposal,
European Commission policymakers have tried to tie equiproportional
representation to corporate egalitarian sentiments underscoring
justice, fairness and ethics.
However, an economic justification of the move as a way of enhancing
value through corporate governance and fostering efficiency and
competitiveness across the EU has been stunningly absent from the
Commission's agenda.
Proponents of shareholder democracy in the EU have erroneously
associated the conceptual doctrine of political democracy with a
corporate voting rule and, consequently, argued such a rule is needed
to promote more fairness, accountability, liquidity and more active
takeover markets. Such a perspective is flawed.
First, shareholder democracy, as it emerged and evolved in the US,
is generally associated with shareholder empowerment and managerial
accountability not with the one-share-one vote rule. In the US, where
a board's response is disproportionate to a threat posed and defensive
measures create a preclusive or coercive effect on shareholders in a
takeover, the shareholders can discharge the board from effectively
continuing its fiduciary duties.
Moreover, after being in place in the US for 60 years, the
one-share-one-vote mandatory rule was abolished because of the growing
recognition that it encouraged neither high standards of corporate
democracy nor individual standards of corporate responsibility,
integrity or accountability.
Second, academic literature is at best inconclusive on whether
differentiated voting rights lead to lower performance, managerial
entrenchment or impaired value. There is no clear evidence on whether
one-share- one-vote companies outperform those with multiple voting
rights.
Third, the mandatory one- share-one-vote rule can exacerbate
the dark side of institutional shareholder activism -
short-termism. Institutional shareholders have supported the rule
but for their own interests rather than for minorities.
With derivative techniques - stock lending, equity swaps, direct
and indirect hedges - hedge funds in particular can retain formally
more voting control compared with cash flow rights. This, in effect,
allows them to vote more shares compared with cash flow ownership and
compromises long-term profitability for the sake of short-term payoffs.
Fourth, the one-share-one- vote rule combined with these derivative
techniques will allow hedge funds to destroy shareholder value through
proxy fights for corporate control if the hedge fund's net holding
position of shares is negative.
This destruction can take two forms. The hedge fund with a net negative
position can block value-enhancing takeovers since any value-enhancing
takeover will result in a net negative cash flow and hence losses
from short positions.
Alternatively, the hedge fund can vote for suboptimal tender offers
to maximise payoffs associated with net short positions. In both,
the more stock prices slide and shareholder value is destroyed,
the more profits are made from short positions.
Generally, there is nothing undemocratic or unfair about differentiated
voting rights. It is no more "unfair" to protect shareholders through
differentiated voting rights structures than to invite destruction of
shareholder value by activist hedge funds. The one-share- one-vote
rule is simply one corporate decision-making rule among many, and
not necessarily the best one.
If EC policymakers opt for a one-share-one-vote rule across the board,
it will entail significant regulatory costs, foster inefficiency
and impair competition. Paradoxically it can also demote shareholder
rights and disenfranchise minorities.
One alternative is to minimise legal intervention constraining
investors' and issuers' choice with respect to voting and
decision-making rules. As soon as companies make their corporate
governance arrangements publicly available during the IPO and the
post-IPO stages, there is no reason to believe investors are unable
to make informed decisions and legal intervention is justified.
It remains to be seen whether an economic rationale will prevail over
political rhetoric and delusory traps on the way to making corporate
Europe more dynamic and efficient.
Arman Khachaturyan is a re-engineering director at the Armenia
Telecom Company and an associate research fellow at the Centre for
European Policy Studies. His paper, One-Share-One-Vote Controversy
in the EU (2006), is at _http://ssrn.com/abstract=908215_
(http://ssrn.com /abstract=908215)
By Arman Khachaturyan
Financial Times
Published: Feb 19, 2007
Establishing shareholder democracy and enforcing a mandatory
one-share-one vote rule in the European Union have drawn
controversy. In the pursuit of popular appeal for the proposal,
European Commission policymakers have tried to tie equiproportional
representation to corporate egalitarian sentiments underscoring
justice, fairness and ethics.
However, an economic justification of the move as a way of enhancing
value through corporate governance and fostering efficiency and
competitiveness across the EU has been stunningly absent from the
Commission's agenda.
Proponents of shareholder democracy in the EU have erroneously
associated the conceptual doctrine of political democracy with a
corporate voting rule and, consequently, argued such a rule is needed
to promote more fairness, accountability, liquidity and more active
takeover markets. Such a perspective is flawed.
First, shareholder democracy, as it emerged and evolved in the US,
is generally associated with shareholder empowerment and managerial
accountability not with the one-share-one vote rule. In the US, where
a board's response is disproportionate to a threat posed and defensive
measures create a preclusive or coercive effect on shareholders in a
takeover, the shareholders can discharge the board from effectively
continuing its fiduciary duties.
Moreover, after being in place in the US for 60 years, the
one-share-one-vote mandatory rule was abolished because of the growing
recognition that it encouraged neither high standards of corporate
democracy nor individual standards of corporate responsibility,
integrity or accountability.
Second, academic literature is at best inconclusive on whether
differentiated voting rights lead to lower performance, managerial
entrenchment or impaired value. There is no clear evidence on whether
one-share- one-vote companies outperform those with multiple voting
rights.
Third, the mandatory one- share-one-vote rule can exacerbate
the dark side of institutional shareholder activism -
short-termism. Institutional shareholders have supported the rule
but for their own interests rather than for minorities.
With derivative techniques - stock lending, equity swaps, direct
and indirect hedges - hedge funds in particular can retain formally
more voting control compared with cash flow rights. This, in effect,
allows them to vote more shares compared with cash flow ownership and
compromises long-term profitability for the sake of short-term payoffs.
Fourth, the one-share-one- vote rule combined with these derivative
techniques will allow hedge funds to destroy shareholder value through
proxy fights for corporate control if the hedge fund's net holding
position of shares is negative.
This destruction can take two forms. The hedge fund with a net negative
position can block value-enhancing takeovers since any value-enhancing
takeover will result in a net negative cash flow and hence losses
from short positions.
Alternatively, the hedge fund can vote for suboptimal tender offers
to maximise payoffs associated with net short positions. In both,
the more stock prices slide and shareholder value is destroyed,
the more profits are made from short positions.
Generally, there is nothing undemocratic or unfair about differentiated
voting rights. It is no more "unfair" to protect shareholders through
differentiated voting rights structures than to invite destruction of
shareholder value by activist hedge funds. The one-share- one-vote
rule is simply one corporate decision-making rule among many, and
not necessarily the best one.
If EC policymakers opt for a one-share-one-vote rule across the board,
it will entail significant regulatory costs, foster inefficiency
and impair competition. Paradoxically it can also demote shareholder
rights and disenfranchise minorities.
One alternative is to minimise legal intervention constraining
investors' and issuers' choice with respect to voting and
decision-making rules. As soon as companies make their corporate
governance arrangements publicly available during the IPO and the
post-IPO stages, there is no reason to believe investors are unable
to make informed decisions and legal intervention is justified.
It remains to be seen whether an economic rationale will prevail over
political rhetoric and delusory traps on the way to making corporate
Europe more dynamic and efficient.
Arman Khachaturyan is a re-engineering director at the Armenia
Telecom Company and an associate research fellow at the Centre for
European Policy Studies. His paper, One-Share-One-Vote Controversy
in the EU (2006), is at _http://ssrn.com/abstract=908215_
(http://ssrn.com /abstract=908215)