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Draft 1
Capital structures and control rights
Patterns, policy issues
Content
Page
I.
Introduction
2
II.
Asymmetries between voting and cash flow rights
A. Concentration of control rights
1 Non-voting shares
2 Multiple voting shares
Shares with preferential rights/golden shares8
3 Pyramid structures, cross shareholdings
4 Shareholder agreements
B. Diffusion of control rights
1 Voting on a show of hands
2 Capital requirements to initiate corporate actions
3 Minority veto rights/supermajority requirements
4 Cumulative/proportional voting
5 Voting caps
6
6
6
7
10
11
12
12
13
14
15
16
III.
Consequences of deviations for investors
17
IV
Policy implications
21
IV.
Annex
22
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I.
Introduction
1. This paper shows how the capital structures of public corporations affects the
allocation of control rights among shareholders. It discusses under which
circumstances the diffusion/concentration of control rights is desirable from the
point of view of investors and draws policy implications.
2. The motivation for writing this paper arose out of the corporate governance
country assessments carried out by the authors at the World Bank under the
ROSC and FSAP initiatives.1 The corporate governance framework of a series of
assessed countries included such provisions as voting caps, voting on a show of
hand, and multiple voting shares. The question arose as to whether such
provisions are compatible with the OECD Principles of Corporate Governance
and whether the World Bank should recommend that such provisions should be
abolished. This prompted a thorough analysis of the effects of deviations from the
one share/one vote principle.
3. The second motivation for writing this paper is the forthcoming reassessment of
the OECD Principles of Corporate Governance. In response to the corporate
scandals that surfaced in the United States and Europe in 2002, some quarters
have called for greater convergence of countries’ corporate governance standards
in order to strengthen market foundations. This paper endeavors to contribute to
this debate by showing that “one size does not fit all,” and that effective corporate
governance reform must take account of countries’ ownership structures, level of
development, specific policy objectives, and idiosyncratic constraints of the
political economy.
4. Section I defines the one share/one vote principle and deviations thereof. It
introduces the idea that deviations can lead to concentration and diffusion of
control rights and briefly explains how policy makers can use these deviations to
fulfill their policy agendas. Section II reviews in detail a total of ten deviations
from the one share/one vote principle as they occur in 62 low, middle and high
income countries from all major geographic regions. Half of these deviations lead
to the concentration of control rights in the corporation, and the other half to their
diffusion among all shareholders. Section III considers the consequences of such
deviations from the point of view of portfolio investors. Section IV discusses the
policy implications of capital structures on capital allocation and shows under
what scenaria it may be desirable for policy makers to tilt the corporate
governance framework in favor of concentration or diffusion to further the
development agenda.
5. Capital structures and voting arrangements define the degree of control that
shareholders have in the corporation. Capital structures can consist of a single
class of shares where every share has one vote, or include several classes of
shares with different voting rights. One share/one vote means that there is equality
between voting rights and cash flow rights.
1
The Reports on the Observance of Standards and Codes (ROSC), and the Financial Sector Assessment Program
(FSAP) are two joint IMF/World Bank initiatives to strengthen the international financial architecture.
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6. A classic definition of one share/one vote is that of La Porta, Lopez-de-Silanes,
Shleifer and Vishni.2 A jurisdiction complies with the principle if the Company
Law or Commercial Code stipulates that ordinary shares carry one vote per share,
and/or if the Company Law or Commercial Code prohibits the existence of
multiple voting and non-voting ordinary shares, and prohibits voting caps.3
7. In this paper, the principle of one share/one vote is defined as pure symmetry or
equality between cash flow rights and voting rights. In addition, any instance
where minority shareholders can impose their will over the majority is treated as a
deviation.
8. Among the most prominent advocates of the one share/one vote principle are the
European Association of Securities Dealers (EASD), the International Institute of
Finance (IIF), the Danish Shareholders Association, the pension fund manager
Hermes in the UK, the Pension Investment Research Consultants (PIRC) in the
UK, the Hellebuyck Commission in France, and the Peters Commission in the
Netherlands. These organizations largely represent the view of institutional
investors as minority shareholders. The Organization for Economic Cooperation
and Development (OECD) deos not advocate mandatory one share/one vote, but
rather recommends that when deviations occur, they should be disclosed to
shareholders. The International Corporate Governance Network (ICGN) and
CalPERS in the U.S. tend to follow the same view, but are somewhat more
conservative. Table 1 overleaf summarizes the views of these organizations.
9. Deviations from the one share/one vote principle result in a transfer/delegation of
power to those with voting rights greater than their cash flow rights. For example,
holders of non-voting shares delegate the power to take corporate decision to
holders of voting shares.
10. The redistribution can also take place in the opposite direction, whereby those
with smaller cash flow rights have the same say as those with greater cash flow
rights. For example, voting on a show of hands4 gives each shareholder the same
voting rights irrespective of the number of shares s/he owns. In all cases,
asymmetries between voting rights and cash flow rights create agency costs. In
other words, those with disproportionate voting rights have the opportunity to
further their own interests at the expense of those who have delegated control
rights.
11. Asymmetries between voting rights and cash flow rights resulting from capital
structures or voting arrangements lead to the concentration or diffusion of control.
Capital structures or arrangements leading to concentration of control rights
include multiple voting shares, non-voting preference shares, shares with
preferential rights like golden shares, pyramid structures and cross shareholdings,
shareholder agreements and other arrangements, such as voting by partly paid
shares. The result is control by few and ownership by many.
Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Schleifer, Robert W. Vishni, “Law and Finance,” Journal of
Political Economy, 1998. Table 1.
2
4
Where a show of hands does not simply designate a procedural convention for voting.
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12. Capital structures or arrangements that lead to diffusion of control include voting
on a show of hands, minimum capital requirements to initiate corporate actions,
minority veto rights and supermajority requirements, cumulative/proportional
voting and voting caps.
13. In the late 1980s, a number of countries, such as Mexico and Korea, introduced
deviations from their one share/one vote principle in the corporate governance
framework that led to the concentration of control rights. The rationale for such
provisions was to allow foreign investors to enter the domestic capital market
without allowing them to gain control. More recently, there is a trend toward
greater diffusion of control rights worldwide.
14. A review of the corporate governance laws and regulation of the countries
surveyed reveals that all countries combine provisions that concentrate corporate
control with provisions that diffuse control. The combination of provisions that
create asymmetries between cash flow rights and voting rights are ubiquitous in
all legal frameworks. While a country might abide by the one share/one vote
principle, its legal framework always includes a mixture of provisions to
concentrate and diffuse control.
15. Countries tilt in one direction or the other as a result of political compromises and
the relative strength of the constituencies that drive the political agenda. For
example, if the dominant constituency driving the political agenda is the business
community, it is likely that laws and regulations will favor concentration of
control rights. If on the other hand, the dominant lobby group is the constituency
representing pension holders and employees, laws and regulations will likely
favor minority shareholder rights.
16. If policy makers find it impossible to cancel existing privileges of powerful lobby
groups, they can introduce counter measures to achieve the same objective,
without having to overhaul the entire legal and regulatory framework. For
example, rather than abolishing multiple voting rights, they can introduce
cumulative voting, which will give minority shareholders a means to elect
directors to the board and thereby obtain better protection.
17. Provisions that tilt the corporate governance framework in the direction of more
diffused control are arguably better for richer countries that want to foster the
growth of their pension fund and insurance industries. Provisions that tilt the
corporate governance framework in the direction of more concentrated control
rights are better for countries that want to attract FDI.
18. As discussed in Section IV, a significant role exists for policy makers to shape the
corporate governance framework and practices. However, the advisability of
certain actions necessarily depends on the existing corporate structure.
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TABLE 1: Overview of Selected International and Institutional Guidelines on “One Share/One Vote”
Guidelines
OECD Principles of Corporate
Governance, 1999
International Corporate Governance
Network (ICGN) Global Share Voting
Principles, 1998 and Statement on Global
Corporate Governance Principles, 1999
European Association of Securities
Dealers (EASD) Corporate Governance
Principles and Recommendations, 2000
Danish Shareholders Association
Guidelines, 2000
Hermes Statement on UK Corporate
Governance and Voting Policy, 2001
Pension Investments Research
Consultants (PIRC) Shareholder Voting
Guidelines, 1999
Peters Commission, Recommendations
on Corporate Governance in the
Netherlands, 1997
Hellebuyck Commission
“Recommendations on Corporate
Governance,” (France), 1998
Euroshareholders Corporate
Governance Guidelines, (EU), 2000
California Public Employees’
Retirement System (CalPERS) Global
Corporate Governance Principles, 1997
International Institute of Finance
Policies for Corporate Governance and
Transparency in Emerging
Markets,(International), 2002
Stand on one share/one vote
Principle IIA sets forth that “all shareholders of the same class should be
treated equally.” The annotation to the Principle notes that participation
shares and preference shares with no voting rights may efficiently distribute
risk and reward and affirms that the Principle is not intended to
unequivocally advocate one share/one vote under all circumstances. Voting
rights ceilings and shareholder agreements should be disclosed.
Go beyond ICGN’s own original Voting Principles and articulates its
adoption of OECD Principle II. However, it also goes beyond OECD in
cautioning capital markets that maintain unequal voting rights to beware
that they may not be able to effectively compete for capital. Deviations
from one share/one vote should be disclosed and justified.
Disapprove of deviations from one share/one vote, but concur with OECD
Principle II that if deviations are unavoidable, they should at least not apply
in the same share class.
State that shares with disproportionate voting rights should be abandoned
altogether.
Article 4.1 disapproves of the issuance of shares with reduced or no voting
rights.
Part V states that “Dual share structures with different voting rights are
disadvantageous to many shareholders and should be reformed.”
Advocates one share/one vote, except under certain circumstances.
However, priority shares, preference shares could be used if the annual
general shareholders meeting (AGM) agrees.
Under I.C.3. recognize double voting rights as a “way to reward the loyalty
of certain shareholders.” Nonetheless, favor one share/one vote, conceding
that double voting rights can be abused and allow firms to be controlled by
minority shareholders, “contrary to the spirit of…corporate governance.”
Guideline II states, “The principle of one share/one vote is the basis of the
right to vote. Shareholders should have the right to vote at …meetings in
proportion to …shareholder capital. …Certification (the Netherlands)
should be terminated, (as) it deprives the investor of this voting right and
transfers influence to a trust office which lies within the (firm’s) own
sphere of influence.” Firms also should not issue shares with
disproportional voting rights to influence balance of power with the AGM.
CalPERS has adopted the ICGN Statement in its entirety, adapting it under
its own Global Corporate Governance Principles. The major difference is a
preferred distinction favoring the term “shareowner” over “shareholder.”
Maintain one share/one vote as a top priority and advocate that new issues
adhere to one share/one vote. Consider one share/one vote capital structures
to be simplest, guaranteeing maximum accountability as influence is
proportional to ownership. Other capital structures promote management
entrenchment, which diminishes long term shareholder value. In addition,
the interests of those with voting control may differ from those of
shareholders holding a majority of company capital. Hold that best practice
for existing issues would be to gradually eliminate non-voting shares and
shares with super-voting rights; hold that multiple voting rights can
facilitate abuse and are generally inconsistent with good governance.
Sources:
California Public Employees’ Retirement System (CalPERS) Global Corporate Governance Principles, 1997; Danish Shareholders Association
Guidelines, 2000; Euroshareholders Corporate Governance Guidelines, (EU), 2000; Hellebuyck Commission “Recommendations on Corporate
Governance,” (France), 1998; Hermes Statement on UK Corporate Governance and Voting Policy, 2001; International Corporate Governance
Network (ICGN) Global Share Voting Principles, 1998 and Statement on Global Corporate Governance Principles, 1999;Deminor Nederland,
“Comparison of Corporate Governance Guidelines,” 2001; Pension Investments Research Consultants (PIRC) Shareholder Voting Guidelines, 1999,
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II.
Asymmetries between voting and cash flow rights
19. The following section reviews the occurrence of asymmetries between cash flow
rights and voting rights in 62 countries encompassing high income, middle
income and low income countries5. An asymmetry between voting and cash flow
rights is a deviation from the one share/one vote principle. Another way of
looking at asymmetry is a separation of voting rights from economic rights.
20. Ten deviations are reviewed. Half of these concentrate control, while half diffuse
control. Section A focuses on concentration of control rights, discussing nonvoting shares, multiple voting shares, shares with preferential rights/golden
shares/partly paid, pyramid structures, cross shareholdings and shareholder
agreements. Section B focuses on diffusion of control rights, discussing voting on
a show of hands, capital requirements to initiate corporate actions, minority veto
rights/supermajority requirements, cumulative/proportional voting, and voting
caps.
A.
Concentration of control rights
1
Non-voting shares
21. Non-voting shares may be ordinary or preference shares. Non voting ordinary
shares are shares that retain their economic right to receive dividends, but that are
stripped of their political right to vote. In many countries, bearer shares do not
convey a right to vote.
22. Non-voting preference shares distribute risk and reward between different
categories of investors. They are also a useful instrument to allow corporations to
enter capital markets gradually by letting owners retain control of the company,
while allowing financial investors to participate.
23. Non-voting preference shares are quasi-debt instruments. In this case the absence
of voting rights is accompanied by a compensating right with regard to dividend
distribution and/or seniority in the winding up of the company. The preferred
dividend can, for example, have seniority over the dividends for ordinary shares
or can be fixed as a percentage of the nominal value of shares or as an increment
over the dividend pay-out for ordinary shares.
24. The preferred dividend can be cumulative, i.e. if it is not paid one year, the
following year the unpaid dividend must be distributed in addition to the current
year’s dividend. Holders of preference shares also often acquire the right to vote if
the preferred dividend is not paid for a number of years. For example, if preferred
dividends are not paid for three years in the case of Latvia, the owners of nonvoting preference shares acquire the right to vote at the Annual General Meeting
(AGM) until the AGM decides on the payment of the preferred dividend.
5
Argentina, Australia, Austria, Belgium, Bolivia, Brazil, Bulgaria, Canada, Chile, China (PRC), Colombia, Croatia,
Czech Republic, Denmark, Egypt, Finland, France, Georgia, Germany, Greece, Hong Kong (SAR), Hungary, India,
Indonesia, Ireland, Italy, Japan, Jordan, Kenya, Korea, Latvia, Lebanon, Lithuania, Luxembourg, Malaysia, Mauritius,
Mexico, Morocco, Netherlands, New Zealand, Norway, Nigeria, Peru, Philippines, Poland, Portugal, Romania, Russia,
Senegal, Singapore, Slovak Republic, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Turkey, Ukraine, UAE,
UK, U.S., Zimbabwe.
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25. Most countries grant limited voting powers to owners of non-voting preference
shares in matters concerning the special rights of their class. This is, for example,
the case in the UK and Greece. In some countries, owners of preference shares
have a limited say in the corporate governance of companies, e.g. the power to
elect fiscal boards6 in Brazil. Companies listed on the Novo Mercado must even
grant non-voting shareholders a say in fundamental corporate decisions, such as
mergers and acquisitions.7
26. Non-voting shares are an option in most countries surveyed. However, there are
exceptions. They do not exist in Denmark, Poland and Sweden. In Hong Kong,
preference shares holders have the same voting rights as ordinary shares unless
the memorandum or articles of association provide otherwise. This option is also
available in the U.S. (double check with OF re Tatiana’s list on dual-class firms,
pg 3*)
27. Brazil is perhaps most famous for the widespread use of non-voting shares. They
represent the majority of traded shares, and 46 percent of the total equity of listed
companies. Until 2000, it was possible to structure the capital of a corporation
with 2/3 of non-voting shares, the rest being in the form of ordinary voting shares.
Thus, a corporation could be controlled by shareholders owning only 16.7 percent
of its total share capital. This practice was criticized by domestic and institutional
investors. This criticism prompted the introduction of an amendment to the
Corporation Law to limit the authorized percentage of non-voting shares to 50
percent for new companies or IPOs.8 The Slovak Republic and the Czech
Republic are examples where the percentage of non-voting preference shares can
represent up to 50 percent of capital. In Morocco the percentage is capped at 25
percent.
28. In Brazil, issuers may offer one of three privileges when issuing non-voting
shares: (1) priority in the distribution of dividends corresponding to at least three
percent of the net equity value per preference share; (2) “tag along”9 rights at 80
percent of the price paid to the controlling shareholder in a change of control; or
(3) dividends at least ten percent higher than those paid to ordinary shares. Most
companies opt for the spread of ten percent.
2
Multiple voting shares
29. Multiple voting shares give their owners the right to cast more than one vote per
share. They are powerful instruments that concentrate control in the hands of
controlling shareholders. Multiple voting shares are an option in the following
6
The fiscal board is not a board subcommittee, and its members are not directors of the board. Under civil law in some
countries, the fiscal board is elected by shareholders and has potentially wide powers to supervise management, oversee
financial reports, consult with external auditors, issue opinions on the annual report and major corporate transactions,
report criminal acts, and call the AGM.
7 Companies listed on the São Paulo stock exchange, BOVESPA’s Nivel II of the Novo Mercado, must grant voting
rights to preferred shareholders in certain circumstances, such as transformation, spin-off and merger, approval of
contracts between the company and other companies of the same group and other matters that may involve conflicts of
interest between the controlling shareholders and the company.
8 Article 15 of Corporation Law (10,303).
9 Equal treatment in change of corporate control, i.e. the control premium is equally distributed to majority and
minority shareholders alike.
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countries surveyed: Argentina, Denmark, Egypt, Finland, France, Hungary,
Latvia, Lebanon, Mauritius, Morocco, Netherlands, Poland, Portugal, South
Africa, Sweden, Turkey, United States. Sweden is notorious for its use of
multiple voting rights. There, Swedish companies can issue shares with up to
1000 times the voting power of ordinary shares10.
30. Multiple voting shares also serve the purpose of protecting the corporation from
unfriendly takeovers. In France for example, corporate by-laws may grant double
voting rights to share owners who hold their shares for at least two years. It is
then virtually impossible for a hostile predator to control the nomination of the
members of the board of directors and the decisions of the AGM. The corporation
is thus bid proof. In Morocco, double voting rights can be granted to certain
registered shareholders in the by-laws of the corporation or by decision of an
extraordinary shareholders meeting, provided the shares are fully paid up and
have been registered in the shareholder’s name for at least two years.11 However,
the double voting right disappears if the shares are sold or converted to bearer
shares. Such schemes violate the principle of equal treatment of shareholders
within the same class of shares. For this reason, Austria, Belgium, Czech
Republic, Georgia, Germany, Greece, India, Ireland, Italy, Luxembourg,
Malaysia, Norway, Spain, Ukraine and the U.K. have banned multiple voting
shares.
31. In some countries, the law limits the number of voting rights that can be attributed
to any class of shares. This is the case in Latvia and Poland, where multiple
voting rights are capped at five and three votes per share respectively.
32. In Lithuania, the voting rights attached to each class of shares in determined by
their nominal value. The class with lowest nominal value grants its owners one
vote per share. The number of votes attached to the other classes of shares is
determined by the ratio of their nominal value to the nominal value of the class of
shares with one vote per share.
33. In Egypt, the legal framework allows preference shares multiple voting rights.
Owners of preference shares on the other hand, not only receive a fixed dividend
to be paid before other dividends (which may be cumulative), they have priority
in liquidation and capital increases and also multiple voting rights.
34. In the U.S. state of Delaware, firms can issue shares with as many voting rights as
they want and bond holders can be given voting rights in addition to
shareholders.12
3
Shares with preferential rights/golden shares
35. In capital structure with shares with preferential rights, there is a special class or
classes of shares that carry a greater right on a per share basis for certain specific
matters. Typically, the class of shares with preferential rights grants the
controlling shareholder the right to elect more board members than those of the
For example in Ericsson, Investor, the country’s biggest industrial holding company, has 22 percent of
the voting rights with only 2.7 percent of the cash flow rights.
10
11
12
Article 257.
Del. Code §§ 151 (a), 221.
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ordinary shares. Such shares are used in Mexico and Chile by controlling
shareholders to secure the control of the board of directors, while letting outside
investors enter the corporation’s share capital. The share capital of the Chilean
chemical company SQM, for example, is structured with two classes of shares,
the A and B shares. Both classes have the same economic rights and the same
voting rights at shareholders meetings, except that holders of Series A can elect
seven out of eight board members, while those holding Series B can elect only
one board member.13
36. Golden shares are special shares created by law or by the company’s articles of
association for the specific purpose of according their holders special rights that
go beyond those attached to ordinary shares.
37. Golden shares have been traditionally used by governments to maintain a degree
of control over privatized corporations after their transfer to the private sector.
They are most commonly used for companies in strategic industries, for example
in the airline industry, the oil and gas sector and in infrastructure. The UK was the
first country to introduce golden shares, but many countries have followed suit,
including Belgium, Brazil, France, Malaysia, New Zealand, Spain, and Turkey.
The objective of governments is generally to prevent privatized corporations to
pass under foreign control. However, the rights conferred by golden shares can
extend to other decisions of the company. This is the case for example in Senegal,
where golden shares protect the state’s interests as creditor of privatized
enterprises that have repayment or guarantee obligations to the state.14
38. In some countries, such as the UK, golden shares have a fixed life span. They
expire after a limited number of years. Since management is, to a large degree,
immune from takeovers as long as the golden share is active, it has been argued
that the presence of such a share diminishes performance incentives for
management and adversely affects the operating results of privatized corporations.
In addition, as companies are bid proof, their share price is often negatively
affected.
39. Special shares have features similar to those of golden shares but their
beneficiaries can be either the state, a regional government, or even a
municipality. Germany, Hungary, Lithuania and Malaysia have used them. In
Lithuania, special shares grant greater rights to the state or municipal holders. The
German state of Lower Saxony, for example, may veto certain key decisions of
Volkswagen AG, such as a merger or acquisition.
40. Some countries, like the UK and Morocco, allow shareholders to pay for shares in
installments. A first installment (usually the nominal value of the share) is paid at
the time of issuance, and a second installment some time later. Since the shares
are traded at the time of their issuance, this creates an arbitrage situation for
investors between the fully paid shares and the partly paid shares until the second
payment is due. For example, in 1987, partly paid shares were used by the UK
13
In addition, nobody can own more than 37.5 percent of Series A. Therefore no-one can elect more than three board
members, and no-one can control the board.
14 Article 14 of the Privatization Law provides that the golden share allows the minister in charge of state holdings,
under conditions and procedures to be prescribed by decree, to ensure that the enterprise takes all necessary measures
to provide for repayment of the loans guaranteed or lent by the state.
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government in the privatization of British Petroleum as a means of attracting
small investors in the privatization transaction.
41. In Morocco issuers can buy back the economic rights of a share while the voting
right attached to the share remains in the hands of the shareholder. This allows
certain registered shareholders to recover the nominal value of their shares from
the company. Such shares (“actions de jouissance”) then no longer receive
dividends, but they continue to have voting rights.15
42. Partly paid shares may carry the same voting rights as the fully paid shares. In
Egypt, for example, shareholders who have paid up 50 percent or less of the share
issue price have full voting rights, but they receive dividends in proportion to the
amount disbursed. This creates a distortion between their cash flow rights and
their voting rights until the partly paid shares are fully paid. Ultimately, the
scheme can then be used to control the company. In Croatia, the Company Law
indicates that voting rights may be acquired only upon full payment for shares;
however, company statutes may allow voting rights for lower levels of payment
proportional to the amount of paid up shares. Singapore also allows for voting
rights attached to partly paid shares.
4
Pyramid structures, cross shareholdings
43. When the corporate governance framework does not provide entrepreneurs with
options to to concentrate control rights in the ways discussed above, thelatter
often seek to obtain the same results through capital structures such as as
pyramids and cross shareholdings.
44. Pyramid structures and cross shareholdings are used across the world to extend a
controller’s reach, while limiting his/her monetary investment. .Cross
shareholdings are reciprocal shareholdings between two companies. For example,
Company A owns 25 percent of Company B, which in turn owns 25 percent of
Company A. When combined with a pyramid structure, cross shareholdings can
be used to create a maze, where beneficial ownership and control are difficult to
determine. Cross shareholdings are common throughout continental Europe and
Asia; Belgium, Hong Kong and Korea are examples where such practices are
widespread. While pyramid structures are prevalent in Chile, cross shareholdings
are prohibited.
45. Pyramid structures and cross shareholdings diminish the capability of noncontrolling shareholders to influence corporate policy. They entrench
management and make takeovers potentially costly to those who attempt them.
46. Claessens et al explain how typical pyramidal and cross holding structures in East
Asia work through an example: Suppose that a family owns ten percent of the
stock of public Company A, which owns 20 percent of Company B. The family
also owns 30 percent of Company C, which owns 15 percent of Company B. By
summing the ownership stakes of the “weakest” links in the ownership chains, ten
percent and 15 percent, the family’s “control” of Company B can be determined
to be 25 percent. However, by summing the product of the ownership stakes
along the two ownership chains, we see that the family “owns” only 6.5 percent of
15
Article 202 ff of SA Law 17/95.
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Company B. “Ownership” relates to cash-flow rights, while “control” denotes
voting rights. The pyramid and cross shareholding structures have allowed the
family to gain a degree of control far greater than its equity stake in Company B.16
Hong Kong’s Li Ka-Shing Family Conglomerate is an example of a pyramid and
cross shareholdings’ ownership structure. See Box 1 below.
47. According to Claessens et al, the average minimum book value of equity needed
to control 20 percent of voting rights was 18.84 percent in Honk Kong, 19.17
percent in Indonesia, 19.89 percent in Japan, 19.64 percent in Korea, 18.11
percent in Malaysia, and 18.71 percent in the Philippines.
Stijn Claessens, Simeon Djankov, and Harry H.P. Lang “Who Controls Asian Corporations?” and “The Separation of
Ownership and Control in East Asian Corporations.” The countries surveyed are HKSAR, Indonesia, Japan, South
Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand.
16
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Box 1: Li Ka-Shing Family Conglomerate Pyramid and Cross Shareholding Ownership
Structures (Hong Kong)
50%
Li Ka-shing and family
(Largest business group in Hong Kong)
Ownership &
Control
35%
Ownership &
Control
StarTV
Cheung Kong
(5th largest firm in Hong Kong)
34% Ownership
40% Control
32% Ownership
27% Control
Hutchison Whampoa
(3rd largest firm in Hong Kong)
The above depicts a partial diagram of the Li Family Conglomerate. “Ownership” relates to cash-flow rights, while “control”
denotes voting rights. Principal shareholders, i.e. the Li family, are shown in the heavily bolded box. Continuous lines
denote pyramidal holdings, and dotted lines indicate cross shareholdings. Source: Claessens, Djankov and Lang, “The
Separation of Ownership and Control in East Asian Corporations,” World Bank, 2000.
5
Shareholder agreements
48. Shareholder agreements bind a group of shareholders, who individually may hold
a relatively small percentage of shares in a firm, to act in concert so as to
constitute an effective majority, or at least the largest single block of shareholders.
This gives shareholders who are parties to a shareholder agreement a degree of
power disproportionate to their equity ownership. The parties to the agreement
usually agree to vote as a block, in line with the instructions of a lead shareholder.
49. Shareholder agreement often give those who are a signatory to the agreement a
right of first refusal to purchase the shares of another signatory who wishes to
sell. They also may contain provisions that require the parties not to sell their
shares for a fixed period of time (lock-in).
50. In Brazil, shareholder agreements not only give the signatories the right to elect
directors to the board, but makes them binding on board decisions. Board
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members representing shareholders bound by a shareholder agreement must vote
in accordance with the stipulations of the agreement or their vote will not be
counted. In the case of abstention, the aggrieved party may vote in the place of the
silent director in accordance with the terms of the agreement. If the shareholder
agreement is worded in generic terms, the chairman of the board, who is usually
appointed by the controller, has the power to decide what matters fall under the
agreement. This seriously undermines the independence of judgment and
fiduciary duties of the members of the board.
51. The government of France has used shareholder agreements to put in place
“Groups of Stable Shareholders” (GSS) in the privatization of corporations
through mixed sales. Morocco has also used them for the same purpose.
B.
Diffusion of control rights
52. Provisions that diffuse control rights include voting on a show of hands, capital
requirements to initiate corporate actions, minority veto rights/supermajority
requirements, cumulative/proportional voting, and voting caps.
1
Voting on a show of hands
53. The practice of voting on a show of hands is a remnant of 19th century corporate
governance practices where investors in a corporation were members rather than
shareholders, each member had one vote, proxy voting did not exist, and votes at
shareholder meetings were cast on a show of hands among gentlemen (see Box 1).
The practice has remained in most common law countries. The Mexico still has
it.
54. Voting on a show of hands means that every shareholder has one vote and one
vote only, irrespective of the number of shares she or he owns in the company.
55. In addition, in some countries the shareholder must be physically present to
participate in the vote on a show of hands, because proxy votes are not taken into
account in this procedure. This is the case in South Africa, for example, where the
Companies Act provides that shareholders may appoint a proxy to attend and
speak at any meeting of the company. However, unless the articles provide
otherwise, a proxy is not entitled to vote on a show of hands.
56. In other countries, proxies may vote on a show of hands; however, like all
shareholders, they have only one vote, regardless of how many shareholders they
represent. In Hong Kong, for example, most of the traded shares are immobilized,
and it is the clearing house of the stock exchange that appears in the company’s
register as shareholder. However, on a show of hands, the nominee has only one
vote, which is cast according to the balance of voting instructions received.
Consequently, these votes cast by custodians or nominees may not reflect the
instructions of the beneficial shareholder, unless a poll is demanded. Thus, when
the registry is the nominee for all registered shares, this practice actually serves to
concentrate control.
57. Usually, the Companies Act or its equivalent makes provisions for changing the
voting procedure from a show of hands to a poll which grants a shareholder as
many votes as s/he holds voting shares. For example, in Hong Kong, the
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companies’ ordinance stipulates that a poll can be demanded by three to five
registered shareholders, (a) shareholder(s) owning at least ten percent of the
company’s voting capital, or the chairman of the meeting.
58. In the UK, under the system of nominee accounts, the holder of the share in the
share register (which may be a custodian or a fund manager) inherits these votes,
and the beneficial owner must give specific instructions to the holder to ensure
voting in line with his/her wishes. A problem arises when the nominee account is
used by more than one shareholder, and there is disagreement among them on
how to vote. It is also legal, and quite common, for the chairman of the company
to be nominated on the proxy form as the holder of the proxy votes. If the proxy
forms are not submitted with full voting instructions, then the chairman has
discretion on how they are cast in a poll.
2
Capital requirements to initiate corporate actions
59. All corporate governance frameworks give minority shareholders special powers.
Such powers include provisions that allow minority shareholders to initiate a
shareholders meeting, add items on the agenda of the shareholders meeting,
nominate board members, or file suit. To the extent that a minority can impose its
will on the majority, this represents a deviation from one share/one vote.
60. In most countries the percentage of capital/voting rights needed to call a
shareholders meeting is generally set at five or ten percent. However, there are
exceptions. Fore example, the minimum capital requirement is 25 percent in
Colombia, 20 percent in Belgium, Italy and Luxemburg, and 15 percent in Jordan.
In the United States the percentage is usually ten percent, but it can be as low as
one percent in some states.
61. Generally, the higher the threshold, the more difficult it is for minority
shareholders to initiate a corporate action. However, depending on the ownership
structure of company and its free float, a five percent threshold might be low or
high.
62. Some countries, like Australia and Morocco, require that shareholders own a
minimum number of shares to attend the AGM. In Morocco SA Law 17/95 allows
companies to request that a shareholder own a minimum of ten shares in order to
attend the AGM.17 In this case, minority shareholders can form a pool to gather
the required number of shares.
63. Many countries have provisions that permit shareholders to add items to the
agenda prior to the AGM, although this right may have capital requirements,
deadlines or other restrictions attached. In Hong Kong, for example, shareholders
representing five percent of capital or 100 shareholders owning an average of HK
$2000 of par value may add items, but they must pay the costs for circulating the
new agenda as determined by management. Croatia’ s Company Law also
includes a provision that permits shareholders to introduce items to the agenda.
Within ten days after publishing the proposed agenda in the official gazette,
shareholders in Croatian companies may request amendments or present
counterproposals to issues requiring a vote; however, these are not circulated to
17
There is no share minimum for extraordinary meetings per Article 127 of SA Law 17/95.
14
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the other shareholders. While Chile has no such provision, shareholders may
discuss items not on the original agenda at the end of the meeting.18
64. In Brazil, shareholders representing ten percent of capital may request cumulative
voting. In addition, shareholders representing 15 percent of voting capital or ten
percent of non-voting may elect a director to the board.
65. Countries’ provisions vary regarding the right of shareholders to redress either on
their own behalf or on behalf of the company. While shareholders of Hong Kong
companies have no statutory right to file a derivative action, in Chile,
shareholders representing five percent of capital may sue a party for
compensation on behalf of the company. In Malaysia, if the board fails to heed a
shareholder’s requests to act when those shareholders believe the board has not
acted in their or the company’s best interest in a certain decision, then
shareholders with ten percent of share capital may call a meeting to pass a
resolution on litigation. If this also fails, the shareholder may approach the court
on behalf of the company. However, in Malaysia, as in many countries, the costs
and complexities of litigation may be overly burdensome and protracted to make
this an effective venue for redress. In India, court proceedings initiated by
shareholders have taken between six and 20 years to resolve.
66. There are no threshold requirements for shareholders to file suit in the Czech
Republic. In Poland, shareholders must hold more than one percent of share
capital in order to file suit. In Croatia, a ten percent threshold is required for
appointing a third party to review the financial accounts of the company (revisers
– double check*). Also to add Hungary, Latvia, Slovenia, Romania, other ECA
countries.*
3
Veto rights/supermajority requirements
67. Veto rights and supermajority requirements ensure that certain corporate
decisions are taken with the assent of minority shareholders. Such provisions
include, for example, pre-emptive rights in capital increases, super-majority
requirements/blocking minority for fundamental decisions, and opt-out rights.
68. Supermajority requirements and blocking minority (veto) rights may be seen as
“two sides of the same coin.” For example, if the supermajority requirement is 75
percent, then the blocking minority is 25 percent plus one vote. Depending on the
voting procedure, however, (i.e. quorums and/or procedures for calling a second
meeting) there may be subtle differences.
69. The efficiency of redress mechanisms when shareholders rights have been
violated also seems to influence policy makers in the allocation of minority
shareholders rights. For example, in some Latin American countries, like Chile or
Bolivia, where the court systems are notoriously slow and ineffective, a
supermajority of 2/3 of the shareholders is required to declare a dividend less than
30 percent of earnings for the year. In Bolivia, the same supermajority is needed
to approve director remuneration; appoint external auditor; increase or decrease
capital; merge with another company; share repurchase; and issuing stock options.
18
Current proposals would change this to 50 shareholders.
15
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70. At the same time, certain provisions may exist that allow minority shareholders to
block certain fundamental decisions. Supermajority requirements may commonly
be 67 percent or 75 percent. Whether it should be one or the other depends largely
on capital structures. In most countries, decisions about amendments to company
by-laws, winding of the company or capital increases allow for a blocking
minority veto of 25 percent plus one vote. In Egypt, France and the Czech
Republic, this minimum level is 33 percent plus one vote.
71. The Czech Republic presents another interesting example. Czech law recognizes
the concept of “legal” minority shareholders (those with ten to 33 percent of share
capital) in addition to “blocking” minority shareholders (those with 33-50 percent
of share capital). “Legal” minorities may call shareholder meetings and obstruct
corporate decisions with protracted litigation.19
72. In countries such as the United States, Korea and Germany the corporate law
provides the right to a dissenting shareholder to have the company redeem all of
his/her shares if the shareholder did not vote in favor of a merger, a sale or
exchange of substantially all assets of the company, or material and adverse
charter amendments. Dissenters’ rights are, in effect, one way of ensuring
equitable treatment for all shareholders in major corporate decisions affecting the
latter.
73. While dissenters’ rights may be particularly attractive in developing countries and
transition economies, the problem is determining the valuation at which
shareholders may exit.
4
Cumulative voting
74. Cumulative voting permits minority shareholders to elect at least one director on
the board, even if one shareholder or a group of shareholders control an absolute
majority of the voting rights. With cumulative voting, there is no deviation from
one share/one vote in the sense where some shareholders carry voting rights
greater than their cash flow rights. Rather the deviation occurs as a result of the
voting procedure which allows shareholders to concentrate their voting rights on
one preferred candidate. A description of how cumulative voting works is
provided in Box 1.
Box 1: Cumulative Voting Procedures
Imagine a hypothetical board with five seats. All seats are up for reelection at the AGM. For each
seat, a resolution proposing the election/reelection of a candidate is put to the vote of the shareholders.
Ultimately, to elect/reelect all five directors, shareholders will have voted a total of five times. The
procedure of cumulative voting consists of allowing minority shareholders to cast all their five votes
on one single candidate.
Kocenda and Svejnar in “The Effects of Ownership Forms and Concentration on Firm Performance after Large-Scale
Privatization,” William Davidson Working Paper No. 471, May 2002, report that Czech portfolio companies that are
interested largely in capital gains may buy ten percent stakes in companies where they can sell their holdings at a
premium to the dominant shareholder(s), who may not wish to be subjected to scrutiny by strong minority shareholders.
19
16
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Consider what happens if the corporation has two shareholders, one with 80 voting rights and
another with 20 voting rights. Without cumulative voting, the majority shareholder will outvote the
minority shareholder each time by 80:20. He will therefore win all five seats. However, with
cumulative voting, the minority shareholder can cast 100 voting rights (20X5) in favor of her preferred
candidate against 80 voting rights for the controlling shareholder. S/he will then win that seat.
75. Cumulative voting can be optional, through a clause in the articles of association
of the company, or mandatory by special provision in the Companies Act or the
Securities Act. Countries where the procedure is optional include Canada,
Finland, Italy, Latvia, the UK, the U.S., Bulgaria and Croatia. Sometimes,
shareholders representing a minimum percentage of the voting rights, can demand
it. This the case for example in Korea with shareholders representing one percent
of voting rights can insist on cumulative voting. However, in Korea the articles of
association can explicitly opt out of this option, and more than 80 percent of listed
companies have done so.
76. Russia is one example where cumulative was made mandatory by the law makers.
Under Article 66 of the Joint Stock Company Law (JSC), open joint stock
companies with more than 1,000 shareholders must: (i) have at least seven
members of the board of directors and (ii) use cumulative voting in the election of
their directors. Companies with more than 10,000 shareholders must have at least
nine members and must also use cumulative voting. Other companies may have
fewer board members and may use either proportional or cumulative voting. The
use of cumulative voting has been important in fostering equitable treatment in
Russia, particularly since the procedure was combined with a requirement that
some key decision need unanimous approval of the board of directors.
77. There are other methods to ensure that minority shareholders are represented on
the board. The most common is a system of proportional voting that gives
shareholders representing a fixed percentage of the voting rights, say ten percent,
the right to elect one board member. This is the case for example in Mexico.
Sometimes the law allows shareholders to appoint an additional director for each
additional ten percent holding.
78. Another method consists of calculating, at the request of a shareholder or group
acting in concert, the number of board seats proportional with their shareholding
(rounding down, usually) and then allowing the shareholder or group to appoint
the calculated number of directors.
79. Cumulative voting has strength and weaknesses from the standpoint of minority
shareholders. On the one hand, it can help minority shareholders to obtain
representation on the board. On the other hand, it polarizes interests and does not
foster the development of a fiduciary model of corporate governance where board
members are required to treat all shareholders equally when taking corporate
decisions.
5
Voting caps
80. Like the practice of voting on a show of hands, voting caps are remnants of 19th
century corporate governance practices (see Box 2). Voting caps are special
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provisions (usually in the articles of association) that limit the voting rights of
shareholders. The limit can either take the form of a sliding scale, or a maximum
number of votes per shareholder, or both.
81. Voting caps are an available option in many countries, including Australia,
Austria, Belgium, the Czech Republic, Finland (particularly in the insurance
sector), France, Germany, Hungary, Ireland, Italy, Korea, the Netherlands,
Norway, Poland, Portugal, Spain, Sweden, Switzerland, and Turkey.
82. In some countries like Sweden, Norway, and until recently Korea, law makers
introduced provisions in the laws to limit the percentage of shares that can be
owned by foreign investors. Such limitations are a form of voting cap.
83. In France, the articles of associations may limit the number of votes that each
shareholder has at the AGM, on the condition that the limitation be imposed on all
shareholders, with no distinction by classes of shares.20 The limitation can apply
to a specific number of votes or to a percentage of the total voting rights
represented at the meeting. Voting entitlement may also decrease with a sliding
scale over the total number of shares held. For example, 100 votesfor the first
tranche of 100 shares, 50 votes for the second tranche of 100 shares, and ten votes
per 100 shares thereafter. In Denmark and Luxemburg, voting caps may be
limited to certain major decisions such as modifying the articles of association. In
Portugal, the voting restraint may be stipulated for all shares or for shares of a
certain class, but may not depend on individual shareholders.
84. Voting caps can be used as a poison pill to prevent a change of control of the
corporation. For this reason, France and Hungary have introduced a disposition in
their Commercial Code stipulating that provisions in corporate by-laws that
restrict voting rights become null and void, if by way of a public bid, a controlling
interest is acquired. The controlling interest is defined as 50 percent of the total
voting rights in Hungary and 66 percent in France.
85. Korea has used voting caps in the specific case where companies ask their
shareholders to opt out of cumulative voting. In this case, each shareholder’s
voting rights are capped at three percent, irrespective of economic rights in the
company.
20
Article L.225-125 of the Commercial Code.
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Box 2: Historical Overview of Voting Caps
It is interesting to note that the principle of one share/one vote was once considered a dangerous
concept. Early corporations were governed by a one member/one vote system. In the U.S., corporate
charters were originally granted by the state legislatures through special legislation, especially to
corporations fulfilling a public good, e.g. railway companies. Therefore, to protect ‘the permanent
welfare of the companies’ from being ‘sacrificed to the partial and interested views of the few,’ sliding
scales and voting caps were deemed necessary. For example, an 1827 South Carolina law spelled out a
graduated voting scale with eleven steps to be used in electing the company’s president and directors. It
began with one vote for one or two shares, and specified gradually widening increments up to ten votes
for 34 to 40 shares. Thereafter, shareholders received one additional vote for every ten shares above 40
(See Figure 1 below). Secretary of the Treasury Alexander Hamilton supported this graduated voting
scale, arguing that it would be a “prudent mean” between one share/one vote - which would too easily
allow a monopoly of power between a few principal stockholders - and equal votes to each stockholder,
which does not allow a greater degree of weight to large stockholders. Today, we tend to believe that
public goods are better safeguarded by government regulation.
Figure 1: Shareholder Voting Rights: One Share/One Vote,
Voting Caps (One Person/One Vote) and Sliding Scales
15
10
Votes
Sliding Scale
One Share/One Vote
Voting Cap
5
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Shares
Note: Sliding scale data points are for illustration purposes only.
Source: Corporate Governance in the Late 19th-Century: Europe and the U.S. – The Case of Shareholder Voting Rights. By
Colleen A. Dunlavy.
III.
Consequences of asymmetries for investors
85. The previous sections showed how certain legal provisions and capital structures
either concentrate or diffuse control rights. From the point of view of portfolio
investors, concentration or diffusion is preferable depending on which mechanism
will ultimately maximize their financial returns.
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86. Deviations from one share/one vote that concentrate control rights empower
controlling shareholders to extract private benefits of control. These benefits are
extracted at the expense of firm value accruing to non-controlling shareholders.
87. Examples of such benefits include the ability to influence who is elected on the
board of directors or as the CEO, the power to build business empires, the
diversion of corporate assets to other corporate entities controlled exclusively by
the controlling shareholders, other beneficial related party transactions,
perquisites for top management, or simply the satisfaction from being in control.
88. Two recent studies have attempted to measure the magnitude of the private
benefits of control in different countries. The first study by Tatiana Nenova of the
World Bank compares the share price of voting and non-voting shares for the
same company, and derives the value of corporate votes and control benefits21.
The second study by Professor Zingales of the University of Chicago and
Alexander Dyck of Harvard Business School compares the price of block trades
that result in a change of control with the market value of shares the day after the
announcement of the transaction and derives control premia22. Both studies come
up with strikingly similar results. These are summarized in Table 2 overleaf23. In
both studies, the countries with the highest private benefits of control are Brazil,
Italy and Mexico. The Czech Republic and Turkey also come high on the list
produced by Zingales and Dyck, but these countries were not covered in Nenova.
89. According to Zingales and Dyck, the levels of private benefits of control are not
only related to the degree of statutory protection of minority shareholders, but
also to law enforcement, the level of diffusion of the press, the rate of tax
compliance, and the degree of market competition. Reputational or moral
considerations and labor also play a role in limiting the consumption of private
benefits. Newspaper circulation and tax compliance seem to be the dominating
factor.
90. These findings suggest that legal provisions that concentrate control rights do not
necessarily lead to high private benefits of control if other factors are in place
such as high ethical norms, a high level of diffusion of the press, a high rate of tax
compliance, and a high degree of market competition. The case of Sweden, a
country well know for large deviations from one share one vote, but a high level
of enforcement, a powerful press, high tax compliance, and high ethical norms in
general, corroborates this inference.
91. In fact, concentrating control rights in the hands of a controller may be optimal
for non-controlling shareholders if the agency costs resulting from the deviation
are perceived to be less than the transactions costs that would be incurred when
exercising power directly. Ultimately, the decision rests on trust – the trust that
those who delegate power place in those who assume power to generate returns
for all shareholders, in spite of the anticipated private benefits of control.
21
The Value of Corporate Votes and Control Benefits: A cross-Country Analysis, Tatiana Nenova, Sept.
2000, Harvard University
22
Private Benefits of Control: An International Comparison, Alexander Dyck and Luigi Zingales, The
Center for Research in Security Prices; Working Paper Nº535
23
In few cases Zingales & Dyck differ from Nenova. The differences can be explained by the different
samples selected by the authors.
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92. Concentrated control rights may also sometimes be preferable from an investor’s
point of view in developing countries, not because it will lead to reduced private
benefits of control, but rather because it is the least worst option. In other words,
controlling shareholders will likely extract high private benefits of control,
expropriating minority shareholders, but tilting the corporate governance
framework towards more diffusion of control rights might produce worse results.
93. This is because in countries where there is a limited pool of competent managers,
extra incentives may be necessary to attract the most competent managers that
will generate the highest returns to portfolio investors in spite of the private
benefits of control that they will secure for themselves. In addition, if the
enforcement environment is particularly weak and disclosure and transparency is
poor, the most efficient way to monitor the corporation may be by concentrating
control in the hands of responsible owners.
94. Thus, depending on whether investors believe that concentration/diffusion of
control rights is desirable, the differential between the market price and the price
per share paid in transactions involving a change of control, can be interpreted as
either a premium or a discount to the price paid by controllers/minority
shareholders.
95. Finally, statutory deviations from one share/one vote may result in more
transparency. In an environment with poor disclosure, limited independent board
oversight, and weak enforcement (i.e. an environment of large private benefits of
control), expropriation takes place even with a one-share, one-vote regime
(Ukraine is a good case in point). While one share/one vote does make the
acquisition of control more expensive, it may also result in the diversion of
entrepreneurial energy into the creation of other mechanisms to obtain
inexpensive control, namely, pyramid structures and cross-shareholding
arrangements. It could be argued that the transparency of having fully-disclosed
deviations from one share/one vote is superior to opaque pyramid structures that
invite tunneling and similar abuses.
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Table 2: Private Benefits of Control (as a share of total market value)
Vote Value (as
Block Premium (as a % of market
Argentina
Australia
Austria
Brazil
Canada
Chile
Colombia
Czech Republic
Denmark
Egypt
Finland
France
Germany
Hong Kong
Indonesia
Italy
Japan
Malaysia
México
Netherlands
New Zealand
Norway
Peru
Philippines
Poland
Portugal
Singapore
South Africa
South Korea
Spain
Sweden
Switzerland
Turkey
United Kingdom
United States
Average
a % of market value)
cap)
27
2
38
65
1
15
27
58
8
4
2
2
10
1
7
37
-4
7
34
2
3
1
14
13
11
20
3
2
2
4
6
6
30
2
2
14%
17
18
2
12
1
5
27
9
-3
29
46
6
6
34
1
5
9
1
12.5%
Adapted from sources: Zingales and Dyck (2002), Table 2 and Nenova (2000), Table 6. This table presents descriptive statistics by
country on select block premia in a sample of 412 control block transactions. The block premia is computed taking the difference
between the price per share paid for the control block and the exchange price two days after the announcement of the control
transaction, dividing it by the exchange price two days after the announcement and multiplying the ratio by the proportion of cash
flow rights represented in the controlling block. In column 2, missing values represent missing data.
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IV.
Policy implications
95. Concentration of corporate control is not necessarily worse than diffusion of
corporate control. Both methods can be efficient, depending on the specifics of
the country. One striking observation from the previous section is that all
countries combine provisions/corporate structures that concentrate corporate
control with provisions that diffuse control. In Chile for example, the practice of
cumulative voting counterbalances the prevalence of pyramid structures and
business groups.
96. Some asymmetries can work in both directions. For example, by adjusting the
threshold required to call a shareholder meeting, the provision can favor
concentration or diffusion of control rights. Similarly, the practice of voting on a
show of hands normally diffuses control rights. However, when the registry is the
nominee for all registered shares, the result is an increase in the concentration of
control rights.
97. Some provisions cancel each other out, creating an equilibrium between cash flow
rights and voting rights under certain circumstances. For example some countries
like France and Hungary allow companies to issue shares with multiple voting
rights while at the same time, allowing for voting caps. Under this scenario,
faithful shareholders who hold their shares for two years, have more say than
short-term investors. However, the power of shareholders with multiple voting
rights is capped in fundamental corporate decisions.24
98. Some provisions are more or less effective, depending on the country’s ownership
structure. For example, voting caps are ineffective and can be pernicious where
diffused ownership structures exist. On the other hand, they may be effective
when ownership structures are characterized by several large block holders.
99. Countries combine some but not all of the provisions that concentrate or diffuse
control. The introduction of specific legal provisions and the relative
preponderance of measures from one set or the other may make a country’s
general corporate governance framework tilt in one direction or the other.
100.
Countries tilt in one direction or the other as a result of political
compromises and the relative strength of the constituencies that drive the political
agenda. For example, if the dominant constituency driving the political agenda is
the business community, it is likely that laws and regulations will favor
concentration of control rights. If on the other hand, the dominant lobby group is
the constituency representing pension holders and employees, laws and
regulations will likely favor minority shareholders rights.
101.
Understanding the characteristics and implications of the various
components that form the corporate governance framework can help policy
makers further their reform agenda. Rather than attempting to remove existing
privileges that would create political opposition from entrenched interest groups,
policy makers can introduce counterbalancing provisions that tilt the balance in
favor of their policy objective. This approach takes into account the various
24
This was the case until recently in the French company, Vivendi Universal. The company combined multiple voting
shares and voting caps.
23
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traditions and characteristics of each county and avoids the pitfalls of a “one size
fits all” solution.
102.
From a policy perspective, some combinations are preferable to others.
Non-voting preference shares, for example, co-exist well with strong minority
rights, as long as the preference shares do not represent a majority of the capital
structure. Likewise, it is arguably better to use cumulative voting and/or strong
minority veto rights/supermajority requirements rather than preferential rights.
103.
Provisions that tilt the corporate governance framework in the direction of
more diffused control are arguably better for richer countries that want to foster
the growth of their pension fund and insurance industries. Provisions that tilt the
corporate governance framework in the direction of more concentrated control
rights are better for countries that want to attract foreign direct investment.
104.
In general, concentration of control rights favors large shareholders, while
diffusion of control rights protects minority shareholders. If policy makers wish to
strengthen the protection of minority shareholders, they can introduce and/or
modify provisions to diffuse control in the corporate governance framework. For
example, they can lower the capital requirements to initiate corporate actions, ban
cross shareholdings, require disclosure of shareholder agreements, introduce
supermajority requirements for certain corporate decisions that until now only
required a simple majority, and introduce cumulative voting or voting caps.
105.
If policy makers wish to attract foreign direct investment, they can
introduce and/or strengthen provisions that favor concentration of control. For
example, they can introduce provisions for non-voting shares, multiple voting
shares, or shares with preferential rights in the corporate governance framework.
They can also raise the ratio of non-voting/voting shares that can be issued by
corporations.
106.
As this paper shows, this objective can be achieved without having to
overhaul the entire legal and regulatory framework. If policy makers find it
impossible to cancel existing privileges of powerful lobby groups, they can
introduce a counter measure to achieve the same objective. For example rather
than abolish multiple voting rights, they can introduce cumulative voting, which
will give minority shareholders a means to elect directors to the board and thereby
obtain better protection.
107.
It is perhaps appropriate to conclude this paper by discussing the very
provision that prompted its drafting, namely voting caps. Voting caps are perhaps
the most difficult provision from a policy stand point. As argued by French policy
makers, voting caps can be effective in preventing large block holders who do not
control an absolute majority of the voting rights from exercising a
disproportionate influence on the company. However, voting caps also exacerbate
agency problems, can entrench management, and prevent large shareholders to act
as responsible owners. On balance, they create more negative externalities than
positive ones and should therefore be used be the greatest care. Voting on a show
of hands creates the same problem. They might have been useful in the 19th
century, but more efficient methods have been developed since to safeguard the
public good dimensions of corporations.
24