Istituto Universitario di Studi Superiori di Pavia (IUSS)
PhD Program in Economics, Law and Institutions (ELI)
Università di Pavia – International Summer and Winter Schools
Corporate governance:
Board Representation of
Activist Shareholders
Matteo Erede
(Università Bocconi – Dipartimento di Studi Giuridici)
(University of Pennsylvania Law School – SJD
Candidate)
Summer School 2011
“Corporate Governance After the Financial Crisis”
Pavia – June 9, 2011
Introduction
• Berle & Means, The Modern Corporation and
Private Property (1932)
• Shares’ value maximization and agency costs
• Switch from executive to monitoring board of
directors
• Shareholder activism: defined as proactive
efforts to change firm behavior or governance
rules (Black 1998)
• The role played by institutional investors in a
transforming financial market
Economic and legal factors affecting
institutional investor activism
• Size and liquidity of shareholding > collective action
• Investment strategies > indexing vs stock picking
• Ownership structure of institutional investors > conflicts
of interest towards prospect clients
• Ownership structure of issuers > dispersed vs
concentrated
• Degree of cooperation among institutional investors >
costs, risks, and structure forms
• Legal framework > Corporate vs securities law, State vs
federal law
Hedge funds vs. Institutional investors
• HF pursue shareholder activism as a profitable strategy
to effectively increase earnings.
• Endogenous advantages:
– Economic incentive through managers’ compensation;
– No serious conflict of interests;
– Strategic and ex ante activism.
• Exogenous advantages:
– Less intense or rather absent regulatory framework,
affecting disclosure requirements, limits on
investment choices, ability to take on debt, ability to
limit investors’ right to withdraw funds.
Activist HF strategies
• Undervalued, profitable, financially healthy companies
are more likely to be a HF activist’s target.
• Two ways to increase shares value:
– Redirection of investments;
– Reduction of excess cash holdings (through increased
dividends, higher debt loads, shares buybacks).
• No need to acquire the control.
• Strategies aiming to either block or facilitate an existing
M&A transaction (by monitoring empire building and
cash-out).
• Strategies directed to change a company business plan
(offer to buy the company, cash payments, sale of
assets, governance changes).
Activist HF strategies and the legal
structure of the corporation
• Shareholders rights are limited:
– Vote on directors and on structural corporate
changes;
– Sell the stock;
– Sue directors and officers.
• But HF know how to boost their voting power through:
– Short-selling;
– Share lending and empty voting;
– Proxy solicitations, “short slate” and proxy access.
• HF reputation helps collecting other investors’ support.
Voting systems
• Plurality voting – just more votes than anybody
else + policy for resignation when receiving less
than 50% of the votes cast
• Majority voting – “absolute” or “simple”
• Straight voting – for each open directorship
• Cumulative voting – on a single candidate
• Dual class shares
• One-share/one-vote
Cumulative voting
• Cumulative voting allows minority SH to
accumulate all of their votes and allocate them
among a few or even one candidate
• votes = shares owned * number of directors to
be elected
• It’s tricky! A majority SH may vote in such a way
that he elects only a minority of the directors.
• This is more likely to occur when one SH votes
“straight” and another cumulates.
Cumulative voting / 2
• If A has 60 shares and B 40, with five directors
to be elected, and B can cumulate:
– A1-60, A2-60, A3-60, A4-60, A5-60
– B1-67, B2-66, B3-65, B4-1, B5-1
• If B decides to do this, and A knows that B will
try to elect three persons, then A, by properly
cumulating his votes, can react and get four
directors elected, in effect “stealing” one of B’s:
– A1-73, A2-74, A3-75, A4-76, A5-2
– B1-67, B2-66, B3-65, B4-1, B5-1
Cumulative voting / 3
• The following formula can be used to determine
how many votes of those present is sufficient to
elect a specified number of directors using
cumulative voting: x = [(a * b) / (c + 1)] + 1
–
–
–
–
“a” is the number of directors the SH seeks to elect
“b” is the number of shares present and voting
“c” is the number of directors being elected
“x” is the number of shares needed to elect the
specified number of directors.
Cumulative voting / 4
• Another formula allows you to determine how
many directors you can elect with a given
number of shares: x = (n – 1) (d + 1) / s
– “n” is the number of shares to be voted by the SH
– “d” is the number of directors to be elected
– “s” is the total number of directors that can be
elected by n shares
The nominees
• A slate of director nominees is selected by the
issuer’s board. It is included in the issuer’s proxy
materials, paid for by the issuer.
• SHs may nominate different candidates:
– By showing up in person at a meeting
– By preparing and distributing its own proxy materials,
obtaining a list of SHs from the issuer, all at SH’s cost
– “Advance notice” bylaws – 60 to 90, or 90 to 120 dd
before the annual meeting – detailed information
about the nominating stockholder, its nominees and
its security holdings
• “Proxy contests” vs “SH proposals”
SHs proposals
• Precatory proposals
• Under Rule 14a-8 typically including proposals to:
–
–
–
–
–
–
Redeem or weaken a company’s poison pill
Eliminate staggered board terms
Make SH voting confidential
Adopt cumulative voting for directors
Put the company up for sale
Separate the positions of chairman of the board and
chief executive officer
– Create a nominating or compensation committee of the
board composed entirely of independent directors
Proxy contests
• Typically occuring in connection with the
company’s annual meeting of stockholders.
• Submission of the nomination notice does not
mean that a proxy contest will ensue. The
dissident can withdraw its nominations at any
time.
• Parties generally have ample time for dialogue
before the contest is truly joined and many
proxy contests settle before a proxy statement is
even filed.
Proxy contests / 2
• Key aspects of Section 14, Securities Exchange
Act of 1934:
– The meaning of “solicitation”
– The ability to engage in solicitation before furnishing
a proxy statement
– Exemption of certain communications from the proxy
rules
– The content of the proxy statement and proxy card
– Filing requirements for written soliciting materials
– Disclosure and anti-fraud rules
Solicitation rules
• Pursuant to Rule 14a-1(l)(1), the terms “solicit”
and “solicitation” include the following:
i.
Any request for a proxy whether or not
accompanied by or included in a form of proxy;
ii. Any request to execute or not to execute, or to
revoke, a proxy; or
iii. The furnishing of a form of proxy or other
communication to security holders under
circumstances reasonably calculated to result in the
procurement, withholding or revocation of a proxy.
• SEC: including communications prior a formal
solicitation aiming to influence voting decisions
The free-communication rule
• Rule 14a-12 allows an insurgent to solicit an
unlimited number of shareholders before any
proxy statement is filed, so long as no proxy
card is furnished.
• Written materials must be filed with the SEC,
and give full disclosure.
• By the time an actual proxy statement is finally
ready to mail (if ever) a proxy participant can
send all this information out to shareholders and
the press, so that few fights will be more likely
to be practically over or entirely settled.
Important exemptions
• Rule 14a-2:
– Solicitations by certain persons not seeking proxy
authority;
– Solicitations of ten or fewer stockholders (the “Rule of
Ten”).
• Rule 14a-4:
– It allows a dissident to run a slate of fewer directors
than there are seats up for election by obtaining
authority to vote for some of the registrant’s own
nominees (the “Short slate” rule);
– In 2009 the SEC permitted each of two dissidents to
round out its slate by including nominees of the
other, not merely nominees of the issuer.
The proxy card
• In traditional proxy contests, both sides
distribute voting forms which permit SHs to vote
only for that side’s nominees.
• In short slate contests, the dissident may
complete the by listing specific company
nominees in addition to the dissident nominees.
The company’s forms, in turn, will only list its
nominees.
• Rule 14a-4 specifies requirements for the form
of proxy card, designed to ensure that the proxy
card itself is an impartial document.
The new proxy access rule
• Under Rule 14a-11 the company will be required
to provide on its proxy card a means to vote for
each company and proxy access nominee,
enabling investors to vote for any combination
of company and dissident nominees.
• Limitations:
– 3% ownership requirement;
– 3 year (+120 days) holding period;
– Nominations for up to 25% of the seats on the board
of directors
– Nominees must meet independence criteria
Is proxy access really effective?
• “Just vote no” campaigns.
• Switch from plurality to majority voting
• Elimination of discretionary voting by
brokers for “routine” issues, such as all
uncontested director elections, absent
voting instructions by the customer.
• Delaware law now permits SHs to adopt
tailor-made proxy access rules.
Italy’s slate vote
• Article 147-ter, TUF - Election and composition
of the Board of Directors:
1. The Statute provides for members of the Board of
Directors to be elected on the basis of the list of
candidates and defines the minimum participation
share required for their presentation, at an extent
not above a fortieth of the share capital or at a
different extent established by Consob with the
regulation taking into account capitalization, floating
funds and ownership structures of listed companies.
Italy’s slate vote / 2
• Article 144-quater, Consob Rules on Issuers:
Submission of lists of candidates for the election of the board of
directors Shareholdings required
Company’s market capitalization
> €15 Bio.
0.5%
€3.75 Bio. < x ≤ €15 Bio.
1%
€1.875 Bio. < x ≤ €3.75 Bio.
1.5%
€750 Mio. < x ≤ €1.875 Bio.
2%
€375 Mio. < x ≤ €750 Mio.
2.5%
≤ €375 Mio.
4.5% or 2.5%
Italy’s slate vote / 3
• Article 147-ter, TUF:
3. … at least one member shall be elected from the
minority slate that obtained the largest number of
votes and is not linked in any way, even indirectly,
with the shareholders who presented or voted the
list which resulted first by the number of votes.
Italy’s slate vote / 4
• Compared to traditional proxy contests:
– Lower costs
– Dissemination of information
• Compared to proxy access:
– Lower shareholding
– No minimum holding period
• Compared to cumulative voting:
– No tricks
– More flexibility in using a ready at hand tool to obtain
board representation