United Kingdom: Law of Business Organisation - Essay Example

?The Osov Rule Hinders Good Corporate Governance Introduction Recent discussions about giving some particular shareholders more power in decision-making than the rest have revolved around the advantages and disadvantages of this practice. Various firms in the United Kingdom like Berkshire Hathaway have been successful without allowing all their shareholders to hold voting power. However, more companies are moving towards the system of one share one vote. This paper seeks to support the former trend since one share one-vote system hinders good corporate governance. During general shareholder meetings, the shareholders make decisions essential matters on ownerships inclusive of the board of director’s approval, as well as merger approval. These decisions, in principle, are made through a majority of the votes as exercised by the shareholders. Thus, the decisions that are made at meetings of general shareholders are affected significantly, by allocation of voting rights among the shareholders. Company law in the United Kingdom stipulates that shareholders will be entitled to a single vote for every share that they hold at a meeting of shareholders. This can be doctrinally interpreted as a provision for the principle of one share one vote, which is the basic rule that governs voting rights allocation among shareholders. Essentially, the principle of one share one vote comprises of three major elements. One, all who are shareholders through acquisitions of company shares are entitled to exercise their voting rights in the general shareholders’ meeting of the company. The voting rights of a shareholder that he/she is entitled to are proportional to the shares that the shareholder has in the company. The third principle is a value judgment, which underlies the other two. The voting rights exercised by shareholders are proportional to the risks associated with the company as assumed by the shareholders. Rethinking One Share, One Vote One share one vote is Anglo-Saxon governance, bedrock principle, which has worked its way back into the spotlight. However, the aim now is to diminish the application of this principle instead of expanding its footprint. Investor short-termism has threatened to destabilize companies and entire economies, prompting companies to reconsider the principle to ensure that all shareholders have an equal say1. Commentators like Dominic Barton have strongly advocated for the strengthening of voting rights in the long term or rescinding of voting rights from short-term investors. Significantly, the European Commission is preparing a proposal that seeks to give loyal shareholders more influence in voting. Various companies, like Manchester United, seeking protection from short-term pressures, have gone public with dual class shares, which seek to give their owners voting power over 150 times more powerful than for outside investors2. This is informed by the belief that these people are more concerned about the long-term success of the company. Companies that adopt similar structures during their IPOs have gone on to issue non-voting stock. The fact that respected policy makers, commentators, and companies are proposing for the apportioning of voting rights in an unequal manner among shareholders indicates its attractiveness3. Beginning in the early 90s as corporate governance started its rise to prominence; the principle of one share one vote has been seen as a gold standard. Even those countries that preferred dual class shares have sought to lessen the power distance that this structure creates. For example, Sweden amended company law to reduce disparity that was permitted in voting rights from 1000:1 to a current maximum of 10:14. In addition, research studies have discovered that letting shareholders accumulate power disproportionate to his/her economic stake could cause abuse, especially in those regions with weak minority shareholder protection. There are various suggestions on how to countenance shareholder discrimination. In order to be fair and not entrench control, voting rights can be enhanced in a way that does not favor only the founders and other insiders. This enhancement of shares can be done via bonus shares, additional votes, a share class that possesses superior rights to vote, and other instruments5. Instead, every investor can be eligible to receive them as long as they comply with qualifying conditions that can be defined by criteria like the holding period. For instance, companies in France, and some in the UK, now make double voting rights available to investors who have had shares for at least two years. Considering this, a dual class shares system like the one adopted by American Silicon Valley companies are problematic6. This risk of founder entrenchment, as is witnessed in Silicon Valley companies, can be lessened by implementing limits on the validity of superior shares to a maximum of five years. After the five years, ordinary and superior shareholders merge to form a single class. Another system that maintains accountability is the requirement of renewal for superior shares by ordinary shareholders every 5 to 10 years. To make sure that superior voting right will not enable large shareholders to make unilateral decisions, companies are also finding it prudent to cap the amount of votes that qualify a shareholder to get them7. One possibility involves giving extra votes, for example, up to the point where the combined enhanced and ordinary shareholder voting rights reaches 30%. The companies are also looking at the types of investors that will likely want to use superior voting rights. For example, if a company’s overall aim is to improve stewardship behavior and encourage ownership in the long term, the company should debate whether index investors should undergo similar treatment to active shareholders. In the same vein, they should explore whether superior rights would benefit certain sectors8. For example, they could argue that the financial system’s soundness would be improved if the banks had an increased number of long term and committed shareholders. Irrespective of the structure of enhanced voting rights, every shareholder should be given their voice. This means that those shares that have diminished rights will be preferred to those without votes9. Giving every shareholder a voice via voting gives them a crucial chance to give their concerns and views. In addition, losing effective control could prompt the shareholders who dominate to take more care when making strategic choices, although this possibility is remote. Care should also be taken during the setup of administrative requirements and qualifying criteria. A minimum holding period that lasts more than five years, to illustrate, may likely benefit the founders and owners of the firm, instead of institutional and outside investors10. Complaints have been raised concerning the burden of procedural requirements required to claim double rights to vote. Being attentive to these issues can aid in ensuring that moving away from one share, one vote to encourage ownership in the long term will come with the intended benefits with no accompanying unintended or adverse outcomes11. One Share, One Vote The concept of one share, one vote, is a common assumption that underlies owning stock in firms or corporations. Since citizenship is operated on the premise of conferring one with the right to vote in politics, it can also be assumed that one needs corporate citizenship through ownership of stock to vote in their elections. The foundation of this reasoning is that if one owns stock in a firm, the assumption is that one has an interest in doing the best for the firm and will maximize the value of their shares. Unfortunately, financial market innovations in the last 20 years have made it possible that the link could be severed between economic interest and share ownership that leads to an incentive in order to maximize a corporation’s value and that of its shares12. Capital markets, today, have made it simple to divorce ownership of shares and the voting rights associated with them from proportional economic interests that cause an incentive to maximize a firm’s value, as well as that of its shares13. This separation can be caused by many transactions, for instance, in the form of calls, puts, futures, forwards, or equity swaps that call into question the basic one share, one vote assumption. When there is separation of share ownership and ownership attendant rights from economic interest proportional to the value of the firm’s shares, raising the possibility of empty voting. This possibility comes with a danger that those who do not have an objective to maximize corporation value and that of its shares, will enjoy similar rights to vote as those held by traditional shareholders14. This phenomenon is called empty voting, and it has a negative effect on the corporate governance of a company. Empty voting happens when the power of a shareholder to vote is substantially over the shareholder’s corporate interest. This could occur in various factual situations; where a shareholder sells his/her stake after the date recorded for a shareholders meeting, although before the date of the meeting15. In this case, the shareholder has the ability to use his/her shares to vote even though they do not own them. There are no current legal requirements that holder continues to be in position after the date recorded through to the date of the meeting. Therefore, the shareholder can maintain, effectively, their right to vote as it removes threats of economic loss or any economic interest. For instance, shareholders with 2% voting power could sell its shares following the record date and come up with a short position and by the voting day, it can promote economic interests through favoring a position decreasing the firm’s share value16. Second, if a hedge fund utilizes an arrangement to lend shares via borrowing stock shares on the record date or engages in trading in the short term, there is a resulting decoupling of the right to vote from share economic ownership. This can be viewed as a description of empty voting17. Investors today are utilizing basic contracts to create portfolios, which improve in value with a decline in the firm’s stock prices while also maintaining voting rights in elections by shareholders. This gives empty voting its life. Additionally, if a hedge fund borrows a lot of shares in order to vote against the corporation’s best interests, makes a profit from the resultant share price drop, there is an obvious dissociation of the economic rights and voting rights. Empty voting avenues like these present major challenges to the shareholders in existence, as well as governance practices18. This issue raises various essential questions, for instance, whether record shareholders need to hold shares to the date of election. In addition, it also raises the problem of whether voting rights should be given to people who have economic interests in the firm via derivative sans acquiring any shares. It would seem that this practice has benefits and dangers. Dangers and Potential benefits of One Share, One Vote Empty voting has potential dangers that are obvious, although some suggestions show that there are benefits to the practice. There are inherent hazards in the practice of empty voting, especially based on opposing incentives for voting for individuals without any interest economically in the corporations or with an interest economically that seeks to benefit from a decline in the corporation’s value19. The phenomenon could see an increase in the risk of various investors playing the system through voting that is contrary to desires traditionally held by shareholders20. Hedge funds, as well as proxy advisory firms; in fact, have an opportunity to utilize the practice to manipulate the results from shareholder voting and generation of gains. A danger that is related has to do with traditional shareholders being deterred from exercising using their right to vote, believing that the hedge funds control the vote. Empty voting, therefore, gives those with “power in the game” the ability to affect the corporation, the value of its stock, and its governance. There are, however, those who believe that strategic traders and financial market savvy traders can access unique information that has to do with the decision of a corporation and how it impacts on the value of the firm21. Thus, they can gather this information efficiently and quickly, allowing the investors and traders access to the vote without regard as to whether they have economic interests or not. This increases efficiency, in addition to increasing the ability of investors to influence positively the firm through making the right decision. In other words, shareholders who are informed need permission to attain large voting positions from shareholders who are less informed, enhance shareholder value, increase electoral outcome accuracy, and improve the voting process efficiency22. However, despite the possible benefits and the argued overall increase in the corporate voting process efficiency, there should be an alignment of voting power and the economic interest of the voters. Empty voting has surfaced recently because of a concept, which was released last year that sought public comments on proxy systems that are currently in use in the United Kingdom23. This concept specifically sought comments from the public with regards as to whether the rules require revision in the promotion of transparency and efficiency. The concern is that proxies rules have not undergone revamping in over thirty years even though there have been important and substantial innovations in the markets. The concept seems to acknowledge that the laws in place have not gone along with these innovations in the financial markets. The issues it raises related to this system include beneficial ownership systems, role of advisory firms, proxy voting totals, proxy distribution fees, and the related problems regarding empty voting and decoupling issues24. There were varied responses to empty voting with some arguing that the practice needs to be eradicated; while others promoted the fact that, there were possible benefits, such as the ones discussed25. Suggestions that were received for the handling of empty voting were an increase in transparency concerning the existence, as well as the extent, of derivative transactions and hedging that could affect the shareholders’ voting motivation and economic rights. To this end, some suggestions indicate that there should be registration and an increase in disclosure from firms that are proxy advisors, as well as increased disclosure by the various hedge funds. This will seek to bring these within reach of national proxy rule 18. Increased communications between the shareholders and the board, via the use of technological improvements, can be used to improve methods via which the board can gather information and gauge the outlook of the shareholders26. However, more extreme suggestions include requirements that record shareholders go on holding their positions via meetings for shareholders. This allows corporations to make amendments to their corporate charters to limit empty voting, as well as requirements on shareholders to certify, before the voting date, that their position is not that of an empty voter27. With empty voting and other issues that arise from one share one-vote principle, it is clear that the practice has negative effects on a firm’s corporate governance. It is, therefore, up to the relevant bodies to consider the pitfalls and benefits of increased controls and regulations, or even the elimination of the practice of empty voting. Bibliography Adams, R. & Ferreira, D. 'One Share-One Vote: The Empirical Evidence' [2008] Review of Finance 51, 60. Burkart, M. & Lee, S. 'One Share - One Vote: the Theory' [2010] Review of Finance 1, 8. Ferrarini, D. 'One Share – One Vote: A European Rule?' [2010] European Company and Financial Law Review 147, 150. Grossman, S. & Hart, O. 'One share-one vote and the market for corporate control ' [2009] Journal of Financial Economics 175, 182. Harris, R. 'corporate governance: Voting rights and majority rules' [2012] Journal of Financial Economics 203, 210. Joel, S. 'Equal Protection in Shareholder Voting Rights: The One Common Share, One Vote Controversy' [2011] Review of Finance 687, 670. Klapper, L. & Love, I. 'Corporate governance, investor protection, and performance in emerging markets' [2011] Journal of Corporate Finance 703, 709. Nenova, T. 'The value of corporate voting rights and control: A cross-country analysis ' [2009] Journal of Financial Economics 325, 329. Piet, S. & Vinaimont, T. 'One share, one vote?' [2012] DTEW Research Report 1, 11 Porta, R. Silanes, F. Shleifer, A & Vishny, R. 'Investor protection and corporate governance' [2011]. Journal of Financial Economics 3, 11. Read More