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In ancient Rome, there was a flourishing market in votes for public offices: voting syndicates were formed to buy votes and re-sell them to the candidates or their friends at the best prices. This allowed some voters to have more than one vote.
Today, we have a strong aversion to such practices, at least when it comes to electing those in public office. In the corporate world, views on the merits of allowing markets in votes are divided. We allow companies to issue dual-class shares – multiple classes of shares with different voting rights attached to each. But should some shareholders have more votes than others?
In the drive for unified capital markets in the EU, Charlie McCreevy, internal market and services commissioner, has started a debate on the need for legislation that would enforce a one share, one vote rule in European capital markets. In a speech to the Transatlantic Corporate Governance Dialogue in June, he said: “Numerous mechanisms exist that allow limited numbers of shareholders to exercise significant influence on companies without any relation to their financial contribution to the wealth of the company.” This suggests that he is uncomfortable with violations of the one share, one vote rule, and is considering whether a company’s ability to introduce these voting structures should be restricted.
Mr McCreevy’s idea is radical, since in most EU countries, large shareholders sustain voting control by violating the one share, one vote rule. These violations take different forms: pyramid structures; dual-class shares; and poison pills. All are designed to give one class of shareholder more voting rights than their cash flow rights should allow. Potentially, this reduces the possibility of takeovers and the restructuring of underperforming companies.
In Germany, for example, the Porsche family own 100 per cent of the voting stock in Porsche and only 10 per cent of the non-voting stock. Ferdinand Piech, grandson of the company’s founder and chairman of the supervisory board, argues that this allows them to invest for the long term and take a stakeholder approach to their business. As he told the FT last year: “Yes, we have heard of shareholder value. But we put customers first, then workers, business partners, suppliers and dealers, and then shareholders.”
Some shareholders, however, regard restrictions on voting rights as a way of entrenching policies that reduce shareholder value. Such restrictions are, in general, legal in all countries, including the Anglo-Saxon capital markets of the US and the UK. In the UK, where News Corp has non-voting and voting shares, most of the non-voting shares are held by Rupert Murdoch and his family. In the case of the Daily Mail and General Trust, non-voting shares make up 95 per cent of the share capital, and the voting shares are largely controlled by one group of shareholders.
In the US, Google has class A and class B shares, and while the A shares have one vote, the B shares have ten votes and are not quoted. The Ford Motor Company has class A and class B shares, where the A have 60 per cent of the voting power, while the B have 40 per cent, are not quoted and are mostly held by the Ford family.
The question is: what are the advantages and disadvantages of these restrictions on one share, one vote, and should they be made illegal or at least curbed? This requires an analysis of the market failures associated with voting restrictions and whether they justify regulatory intervention.
Violations of the one share, one vote practice in Europe
Regulatory restrictions on a company’s ability to enhance or restrict the votes of one shareholder relative to another would have a radical impact on the ownership landscape of Europe. In a recent survey of shareholder rights in Europe, Deminor described the prevalence of voting rights restrictions. They reported that in the FTSE Eurofirst 300 index, 35 per cent of the companies violate the one share, one vote rule. Since these companies are among Europe’s largest, this figure probably understates the restriction on the one share, one vote rule by excluding smaller companies in which dual-class shares are more prevalent.
A range of mechanisms are used to restrict voting rights, including:
■ multiple classes of shares, where one class of shares is voting and the other is non-voting, as in the Porsche case;
■ shares with multiple voting rights which allow one class of shares to have more votes per share than another;
■ voting rights ceilings, which provide a maximum number of votes that can be held by any single shareholder, irrespective of the number of type of shares held – for example, there is a ceiling of voting rights of 20 per cent for any single shareholder in Volkswagen;
■ ownership ceilings, which place a maximum on the number of shares that can be held by any one shareholder or group of shareholders;
■ priority shares, which give specific powers to holders;
■ golden shares, which allow the holder to block a change in ownership or prevent block ownership by a party that the holder considers unsuitable – these are often held by governments that wish to be able to block ownership changes to privatised companies.
The most common mechanisms for restricting the one share, one vote rule are voting rights ceilings, multiple voting rights, and ownership ceilings, in that order.
Deminor finds that the UK has one of the lowest incidences of violations of the one share, one vote rule: only 12 per cent of UK companies in the index have violations, in comparison with 86 per cent and 69 per cent in the Netherlands and France, respectively. This suggests that, in these two countries at least, the majority of companies have a block holder with disproportionate control of the company.
Deminor did not include companies with non-voting preference shares as violations of the one share, one vote rule, although these are common in many countries of the EU.
The case against regulation
Advocates of the status quo provide a series of arguments.
■ Let investors decide Why should regulators interfere with the freedom of contracting between the shareholders? Provided the restrictions on voting are transparent and reflected in the price of the shares when they were initially sold to outside investors, they are not disadvantaged. The non-voting shares, for example, will be sold at a lower price than the voting shares to reflect any potential disadvantages. Regulators should only interfere with freedom of contracting if there are obvious market failures. Even then, the advantages of allowing voting restrictions may outweigh the costs of such failure.
■ Outside investors can be myopic Voting restrictions allow the original owners, often families, to adopt a longer-term horizon than other investors in the capital market. In today’s capital markets, investor horizons can be very short. During a bid situation, hedge funds, holders of contracts for differences and other professional investors can acquire a large proportion of the shares quickly, as longer-term investors sell out. In the bid for Arcelor by Mittal Steel, for example, these professional investors acquired a large stake in Arcelor, with a view to holding the shares for a short period.
The question is whether maximising share value over relatively short horizons is compatible with long-term value maximisation. Moreover, the presence of these investors might encourage management to go for suboptimal decisions just to satisfy the short-term holding horizons of these investors.
■ Restrictions will discourage many companies from listing Any attempt to impose restrictions on family-owned companies may discourage them from listing and tapping the public capital markets for new funds. This may increase their costs of capital and limit their growth. Already, listing rules are prejudiced against family-controlled businesses coming to the stock market by requiring them to hire the “best senior executives”, and placing no explicit value on kinship or family succession. Restricting their ability to retain control of their companies may simply drive these companies out of the public markets.
Disadvantages to violating the one share, one vote rule
There are important disadvantages to violating the one share, one vote rule.
■ Violations may allow expropriation of minorities They may allow a block holder to extract private benefits of control. These restrictions can take many forms, including: entrenching management in the face of poor performance; excessive salaries and perks; limiting management succession to family members and thereby reducing the performance of the company.
A 1994 study by Luigi Zingales, of the University of Chicago Graduate School of Business, looked at the Italian stock market and found that voting restrictions resulted in a huge premium for voting shares, about 82 per cent, which was largely explained by private benefits of control. He estimated that these private benefits could explain more than 60 per cent of the non-voting premium, or about 30 per cent of the total value of the shares. These large private benefits are also the result of low protection for minority investors. By contrast, in another study, of US markets, Prof Zingales found the voting premium to be much lower, about 4 per cent, although much of this can also be explained by private benefits of control.
Why is the voting premium so much lower in the US than in Italy? One reason is that protection of minorities is greater in the US. Thus, the higher the protection of minorities the lower the value of the voting premium and the less potential there is for the large blockholder or management to divert part of the value of the company to their own private benefit. It may be that allowing parties to violate the one share, one vote rule should only be permitted if there is minority protection. Only then can we be sure that the controlling shareholder’s ability to extract private benefits will be curbed.
■ Violations make changes in corporate control more expensive One share, one vote can impede an efficient market in corporate control. Thus, hostile takeovers could be made more difficult in the face of a blockholder who has disproportionate voting rights and wants to entrench the current management. This issue may be important while the European Commission is trying to improve the flow of capital and management expertise across countries. It is also given greater importance by the failure of the EU takeover directive to provide what some call a level playing field in European control contests.
■ How does recontracting happen? The freedom of contracting view may be regarded as naïve. Assume a company’s management persuades the present set of shareholders to impose restrictions on one share, one vote. What are the voting arrangements if future shareholders think those reasons are no longer valid and wish to abolish them? In ancient Rome, the Senate would give extraordinary powers to a dictator in times of difficulty but then would also restrict his tenure. Should violations of one share, one vote have a time limit? And should the vote to retain them be on the basis of one share, one vote?
Even if the founding family includes voting restrictions in the articles with the IPO, it could be argued that circumstances change over time and there is always a need for shareholders to renew the restrictions. Like patents where the inventor has a license that is limited by time, violations of one share, one vote should also have a time limit and then shareholders would be free, on the basis of one share, one vote, to vote on them again.
■ There is a public good that mitigates against violations Although allowing violations of one share, one vote might be in the private interests of an individual company, it may not be in the interests of the corporate sector as a whole, or in the interests of shareholders who wish to hold diversified portfolios. Capital markets can only bear a certain amount of private benefits or expropriation before they contract in size, thereby making them less efficient and less attractive as a source of capital to the corporate sector. In addition, shareholders are limited in their ability to diversify their risks. This is a public good argument and suggests that either we ought to restrict a company’s right to violate the one share, one vote rule or introduce rules to protect minorities so that there are limits to expropriation by the controlling shareholders.
While voting syndicates in public elections may no longer be common, differential voting rights in companies remain widespread. They vary in frequency across countries, however, it is not a straightforward Anglo-American/continental Europe distinction; there are some continental European countries with few violations and a relatively large number in the US.
The debate that Commissioner McCreevy has initiated goes straight to the heart of freedom of contracting versus public good aspects of voting. Imposition of one share, one vote violates freedom of contracting with all the economic inefficiencies that this entails. On the other hand, once recontracting and the public good aspects of minority investor protection and markets in corporate control are introduced into the analysis, then the merits of one share one vote are less clear-cut. Evidently, this is a debate that is just in its infancy.
Colin Mayer is Peter Moores Dean and Professor of Management Studies and at the Saïd Business School, University of Oxford. His research focuses on corporate governance, financial systems and regulation.
Julian Franks is professor of finance at London Business School, and head of the Centre of Corporate Governance. His research focuses on regulation, bankruptcy and financial distress, European corporate restructuring and mergers.