Transcript No Slide Title

One Share One Vote Controversy in EU : Hype or a Genuine
Need?
Dr. Arman Khachaturyan
Associate Research Fellow, CEPS
One Share One Vote: A Means for Corporate Control
A CEPS Roundtable
07 December 2006
Presentation Outline
 Part I. Introduction
 Part II: History and the New Phase of Corporate
Governance Reform in the EU
 Part III: 1S1V Definition and Background in the EU
 Part IV: Shareholder Democracy Argument
 Part V: Cost of Capital and Minority Protection Argument
 Part VI: Efficient Capital Market Argument
 Conclusions and Policy Recommendations
Part I: Introduction: Corporate Frauds: What Happened?

Schemes: siphoning off corporate assets
• Enron: SPE, market-to-market accounting and “third party”
hedging transactions
• Parmalat: simple theft through offshore accounts

Governance Dimensions
• accounting: largely enforcement failure
• auditing: largely enforcement failure
• corporate governance: minority abuse by managers or minority
abuse by a majority shareholder

Gatekeepers
• collusion with the auditor despite legal prohibition to do so
• phenomenal lack of due attention and due care by the market

Legal Dimensions
• Legal loopholes: company law, securities law
Part II. EU Company Law Reform: Past and Present

In 1995, a study conducted by Ernst & Young: the EU should set framework
principles for corporate governance of large companies in a directive, which
could be transposed into the individual national legal systems either by law or
within the framework of a national “best practice” code

Dec 1998 Commission Hearing: No regulatory EU level intervention on
corporate governance is necessary nor desirable
Priority items to be tackled
Take-over bids and defensive actions
Auditors
some emphasis on 5th directive on harmonizing company structures in
the EU?

November 2002, HLG-Winter II: Two level approach
• general principles in a directive
• more detailed rules in a self-regulatory code of conduct
Part II. EU Company Law Reform: Past and Present

May 21, 2003, the EC Communication : 17 legislative and 7 non-legislative
measures !
“ A dynamic and flexible company law and corporate governance framework is essential
for a modern, dynamic, interconnected industrial society…An effective approach will
foster the global competitiveness of businesses in the EU and strengthen shareholders
rights and third party protection

New policy dynamics of EU company law reform
•
•
•
•
•
•
•
•
board structures
More shareholder empowerment
more disclosure
more independent directors: nomination, remuneration and audit
stricter remuneration policies
more directorial liability for financial and non-financial information
disclosure by institutional investors
EU corporate governance forum
Part III: 1S1V Definition and Background in the EU
 What is 1s1v?
• Cash flow rights=voting rights
• Rationale:
- Shares entail to economic ownership (cash flow rights) and
voting power (voting rights)
- Shareholders have identical preferences
- Shareholders equally vote to max the firm value
- Stocks are valued so does price reflects governance and
operations
Part III: 1S1V Definition and Background in the EU

Deminor (2005) examines the FTSE–Eurofirst 300 companies,
highlights that:
• The 1S1V rule is already applied by 65% of all companies
analysed.
• There is variety of exceptions to the 1S1V rule notably in in
France, the Netherlands and Sweden
- Multiple voting rights 44%; Priority shares 8%;
Depository receipts 4%; Ownership ceilings 11%, Nonvoting Stock 6%; Golden shares 4%; Non-voting shares;
Voting right ceilings 23%
Part III: Ownership Concentration in the EU
Fig. 1
Percentage of Listed Companies Under Majority
Control
Source: Barca and Be cht 2001
70
60
68
65.7
64.2
Austria
56.1
Belgium
50
40
Germany
Italy
39.4
NL
32.6
30
Spain
26.3
Sweden
UK
20
Nasdaq
10
NYSE
2.4
0
2
1.7
Part III: Private benefits of Control
Table 1: Control blocks in selected countries
Germany
Italy
Table 2: Controlling vs. Minority Shares
Sweden
Control
>25 %
82.5%
65.8%
64.2%
Control
>50 %
64.2%
56.1%
26.3%
Mexico
Italy
Sweden
PBC
measured by
the
difference in
the market
price
36%
29%
1%
PBC
measured by
the control
block
premium
34%
37%
7%
Part III: Instruments of separation of ownership and
control in the EU
Country
Number of companies
Proportion of companies with differentiated voting
rights (%)
Sweden
334
0.55
Italy
208
0.41
Finland
129
0.36
Denmark
210
0.33
1,953
0.24
Ireland
69
0.23
Austria
99
0.23
Germany
704
0.18
France
607
0.03
Spain
632
0.00
Portugal
87
0.00
Belgium
130
0.00
UK
Source: Bennedsen & Nielsen (2002).
Part III: Instruments of separation of ownership and
control in the EU
Member
states
Sample
Controlling
owner (%)
Pyramid
ownership (%)
Cross-ownership
(%)
Owning
family (%)
AT
88
81.82
20.78
1.14
80.00
BE
104
71.15
25.00
0.00
80.00
FI
92
41.30
7.46
0.00
69.23
FR
522
64.75
15.67
0.00
62.20
DE
631
59.90
22.89
2.69
61.46
IE
26
42.31
9.09
0.00
77.78
ES
465
44.30
16.00
0.22
62.50
IT
181
58.76
20.27
1.13
70.00
NO
98
38.78
33.90
2.04
66.67
PT
68
60.29
10.91
0.00
50.00
SE
149
48.32
15.91
0.67
73.47
UK
721
43.00
21.13
0.00
75.85
Source: Faccio & Lang (2002)..
Arguments
 Pro-market argument: deviations from one share
one vote are economically efficient and so do
controlling shareholder structures since, otherwise,
competitive evolutionary processes would have
eliminated them; or
 Market failure argument: deviations from one share
one vote persist because of inefficiencies in the
market processes and so do inefficient controlling
shareholder structures
 How to deal with (in)efficient controlling shareholder
structures? Mandatory 1s1v rule, more laws or
market exposure?
Part IV: Shareholder Democracy Argument

Political vs. Corporate Democracy

Shareholder Democracy in the US:
• Blasius Standard
• Unocal Standard
• The end goal: disciplining wayward managers through active takeover
markets
• Conclusion: 1s1v does not promote corporate democracy, integrity and
accountability to shareholders

Shareholder Democracy in the EU:
• Proportionality between non-voting (risk-bearing) capital and voting stock
• Break-through rule/One-share-one-vote
• The end goal: ???
• Conclusion: conceptually-empty rhetoric: procedurally- political
complications and problems
- Primacy of shareholder decision-making
- Take-over independent BTR
- Inconsistency between the BTR and MBR
Part V: Cost of Capital and Minority Protection Argument

Dispersed vs. Concentrated

Managers vs. Minority Shareholders (US, UK): Collective action
Problem! Separation of ownership and control: PROBLEMS:
- Organizational structure that makes it impossible for
shareholders to monitor and discipline managers effectively
- Professional managers are said to be virtually unaccountable
to shareholders

Diversion of corporate resources
• related-party transactions
• projects targeted to their needs and ends
• pursuing visionary projects
• enhancing their human capital
Part V: The Structure of Corporate law: DOS
 Three sets of rules designed to induce directors to
govern in the interest of shareholders

• Shareholder voting rules which allow shareholder to replace
directors
• Fiduciary duties and procedural rules that provide shareholders
with incentives to enforce those duties
• Disclosure rules that require management to disseminate
information about a company’s finances and operations
-
Item 9 of Form S-1 with respect to the corporate governance rights of the securities being sold,
Item 11(k) of Form S-1 with respect to directors and officers,
Item 11(l) with respect to executive compensation ;
Item 16(a) with respect to the articles of incorporation, bylaws and other documents or contracts
specifying the rights of security holders.
• Rules governing the market for corporate control: 1S1V
reinforcing shareholder primacy through monitoring and
disciplining corporate boards.
Part V: Cost of Capital and Minority Protection Argument:
Ownership Concentration
 Majority vs. Minority (continental Europe): Collective action
problem solved!
• CG problem: Majority abuse of minority: disproportional
control benefits through ownership cascades, pyramids
and voting trusts
- related-party transactions,
- control premia;
- freeze-out transactions
- Misjudgement and overconfidence
- Gravity of generations
Part V: The Structure of Corporate law in COS: law and market
exposure
SOLUTION: to constrain PBC and ensure equitable treatment of all
shareholders
Corporate Law
- business judgement and intrinsic fairness rules
- fair dealing and fair price rulesIAS 24: related party disclosure:
resources, services and obligations
Securities Law/disclosure
• IAS 24: related party disclosure: resources, services and obligations
• IAS 24.16: disclosure of managerial pay
• IAS 1.96-97: disclosure of changes in equity
• 4th Company Law directive: reporting standards on balance sheets, P&L’s
and annual reports

What about mandating 1s1v???
•
•
Ineffective as curbing majority abuse!
Can lead to pyramidal structures
Part VI: Efficient Capital Market Argument: the
optimality debate

1s1v maximizes the value of the firm (Grossman & Hart
(1988) and Harris & Raviv (1988).

Assumptions
•
•
•
•
•
shareholders have the same identical preferences;
control is concentrated through a dual-class structure with a
50:50 split between the voting and non-voting shares that have
equal cash flow rights;
the incumbent management does not enjoy private benefits;
there is only one party in the control contest obtaining significant
private benefits; and
the bidder bids only for the voting stock, while the holders of
non-voting stock incur the costs of inefficient management
without benefiting from any control premium.
Part VI: The sub-optimality debate

deviations are necessary to extract the highest value from the bidder
(Shleifer & Vishny (1986 and 1988), Hirshleifer &Thakor (1994) and
Hirshleifer (1995);

deviations from the 1S1V rule can create more shareholder wealth
since they allow for capturing more benefits of control from the
successful bidder (Jensen & Warner (2000))

deviations from the 1S1V rule might be desirable to mitigate posttakeover agency problems in the absence of the mandatory bid rule
(Burkart, Gromb & Panuzzi (1998))

Deviations can create more value increasing bids (At, Burkart & Lee
(2006)
Part VI: The sub-optimality debate

The imposition of the 1s1v rule is tantamount to creating
a takeover independent break-through rule (Mulbert
2006)
•
•

Inability of the BTR to achieve pyramidal structures
Mandatory bid eliminates the need for a BTR/1s1v
Deviations are necessary to avoid value destroying
voting arbitrage (Martin and Partnoy 2005)
•
Promotes self-interested incentives, value-destroying takeovers
and worse yet can become a takeover defense.
Part VI: 1s1v and market for corporate votes

wholesale and retail vote-trading in the market for corporate votes:
•
stock lending, equity swaps, direct and indirect hedges

stock lending allows for separating cash flow rights from voting power so
that the borrower ends up with enough voting power while the lender
retains cash flow rights in exchange for some fee: 99% of market
capitalisation in the US can be lent and borrowed

Collars allow corporate insiders hedge by taking put and call positions
simultaneously to limit their possible risk through fixing the downside and
upside : US senior executives of listed companies use collars for 36% of
their holdings, which allows them to outsource 25% of their cash flow
exposure

Direct and indirect hedges allow combing pure positions with short positions

CONCLUSION: such separation can indeed be value-destroying, and worse
yet, as compared with dual-class recapitalisation, does not require a
shareholder vote
Conclusions

EC policy-makers have not submitted the burden of proof that the 1S1V rule
will rebuild investor confidence, protect shareholders and third parties as
well as foster business competitiveness and efficiency across the EU.

standards of subsidiarity and proportionality are not adequately justified

disregard to the diversity of the core and supporting institutions of corporate
governance in the EU, such as traditionally-concentrated ownership
structures, multiple classes of votes, and complex mechanisms of retaining
control and balancing the liquidity of shares.

1S1V is neither a sufficient nor a necessary condition for shareholder
democracy in general or shareholder empowerment in the EU in particular.
-
Switch to pyramidal structures conferring high level of PBC and minority
abuse
Decomposition through derivative techniques leading to further
heterogeneity, incentives for value-destroying voting arbitrage and approval
of value reducing transactions
worse yet, as compared with dual-class recapitalisation, decomposition
does not require a formal shareholder vote
What is next?

First: No EU level action in light of possible perverse effects of a mandatory
1S1V rule.

Second: reinforcing the role of non-executive directors as well as
transparency and disclosure rules

Third: A self-regulatory approach as well as transparency and disclosure
rules