#16466 - The Voting System - Corporation

A. Corporate Voting and the Collective Action Problem

Public Corporations and the Voting system

• When and how do shareholders vote

  • AGM

  • Special meetings – convene as prescribed by law/ written consent if permitted in co./ board called

• What do shareholders vote on

  • Election of directors

  • Things board cannot do on its own: merger, dissolution, changes to certificate of incorporation, action plan

    • Cleansing acts: sometimes things that board cannot do on its own

  • In public co. - say on pay, a non-binding vote on executive compensation

  • Resolutions under rule 14A(a)

• How many votes

  • One share on vote in general

• Required votes for passage

  • General rule: mergers and charter amendment – majority of shares entitled to vote

  • Everything else (other than election of directors) majority of shares voting

  • Election of directors: people with most votes get elected (but now most large co. requires majority of the votes)

• Record dates, record holders – how are votes collected

  • Proxy info given to shareholders Votes collected

  • Some co. have lawyers that is in charge of the mechanics of vote, complaining purposes, lopsided 90% would vote one way, hard task would be to get enough people to be bothered to vote

  • Complaints

    • Shareholders resolution 14A(a) – low level of complaining who gets to insert statement into the co. proxy statement

    • Intents complaint

    • Background

  • Record holders:

    • Previously shareholders himself would be the record holder (if certificate is lost can get another one)

    • Nowadays if you buy shares through banks no longer registered as the shareholder investment banks would act as intermediate record holders and passes voting instructions from the company to the owner

    • Record date – voting date vote still counts even if you sell the shares on the day you voted you vote will still count

Collective Action problem: cost of meaningful collective action paradigm/ model example

• Unlike co. wholly owned by a single shareholder (no costs of collective action)

• Co. held by 100,000 shareholders collective action costs are likely to be preclusive rational shareholders will never challenge board decisions/ inform themselves about co.’s performance beyond following the price of its stock Voting system largely a formality

  • Too many shareholders, who would pay no attention to what’s going on

  • So severe that it makes voting almost meaningless

  • Board likely to be dominated by top corporate officers (the insider directors), who control the board’s agenda and info

• Cost of acquiring info

• Benefits depend on

  • Likelihood that info will change one’s own vote

  • Likelihood that change in one’s own vote will change outcome (vote pivotal)

  • Change in value of stock if outcome is changed (= change in co. value x stake)

• Example 1

  • Assume a co. with value of $10B asked to vote on deal that may lower value by 5% (i.e. 500M)

  • You are suspicious and think chances of this happening are 40%. If you decide to become ‘informed’, you will know for sure

  • You own 0.1% of the stock (10M value) a lot of money, few would own so many in a co.

  • You think that likelihood that your vote is outcome determinative is 0.2%

  • Benefit of becoming informed

    • Likelihood deal is bad: 40%

    • Expected loss to company from bad deal: $500M x 40% = $200M

    • Your portion of expected loss: $200M x 0.1% = $200,000

    • But you only benefit from casting informed vote if vote is pivotal.

      • So expected benefit: $200,000 x 0.2% = 400 pretty low for $10 stake

      • $400 (~30 mins legal advice) most shareholders would not bother to vote

• Example 2

  • Assume co. that you own 3% other shareholders have raised questions about the deal, that you believe vote will be close and the likelihood that your vote is outcome determinative is 7%

  • Benefit of becoming informed is now: 200M x 3% x 7% = 420,000

  • Less severe if less diverse; more severe if more diverse

• S. 14(a) of the Securities Exchange Act (SEC) was designed to introduce more ‘democracy’ by promulgating a set of proxy rules to encourage informed shareholders to be able to vote knowledgeably in corporate elections

  • As most do not attend shareholder meeting in person to cast their votes, but give proxies

  • Proxy = authorization to vote on their behalf for a certain candidate/ proposal

    • vote authorisation to other people – to vote my share in a following way in the next AGM

    • co. distribute proxy statements – disclosure statement relating to the vote, recommendation on how to vote

    • seeking return of a proxy marked voting the way you want them to vote

    • before AGM, vote is mostly settled

How has the paradigm changed? [11/1]

• Reasons:

  1. Ownership structure changed

  2. People have observe that shareholders do not vote in accordance to their paradigm

     • Corporate election are less one-sided

• Changes relating to voting: considered more important now (than 30 years ago)

  • Increased concentration of ownership

    • companies are often held by large shareholders less severe collective action problem

  • Increased institutionalization of voting:

    • large banks, mutual fund companies (usually own 2-9% in a co.), own a lot of stocks in many companies

    • With economies of scope, a company can be helpful to another company

    • Professionally managed, with a lot of advisers

    • ISS would issue voting recommendations to institutional investors

    • Proxy advisors

• Shareholders’ precatory resolutions more likely to get implemented

  • Not all management proposals would get majority, sometimes it fails

• Hedge fund: unregulated mutual fund, smaller, only very rich people buy shares in them

  • Some are smaller and have more specialised investment strategies

  • Active hedge fund: figuring what co. will benefit from the input that would increase in stock price – some are friendly and some are not

• “Just say no” campaigns: shareholders vote against management

• Voting is taken more seriously - ,ore contested issues:

  1. Shareholders often win

  2. Low no. of no votes will embarrass the board motivate them to do things differently

     • Board react to how shareholders vote their votes would move the board

• Voting is regulated by State law (how to vote) and federal law (solicitation)

• Development of shareholders vote

  • 1980s new shareholder’s right movement allowing investors to exercise their power through voting system; SEC amended proxy rules in 1992 to further lower the organising costs of large investors

  • No longer have collective action costs that are either non-existing (co. only have controlling shareholders) or preclusive (stock held by thousands of small stockholders)

  • For typical public corporation today, collective action costs may be large, but not large enough to prevent shareholders from monitoring managerial performance, depending on legal constraints, payoffs to shareholders, large culture of shareholder activism structure of the proxy rules and state regulation of voting rights matters the most to these co.

  • Voting standard in most director election

    • Plurality voting: nominees with the most votes are elected as director, but need not be majority

    • Uncontested election:

      • Previously: if no. of nominees is equal to the no. of vacant seats, a nominee could be elected by a single shareholder (even if all other shareholders refused to vote for that nominee)

      • Since 2006: companies shifted to majority voting, sometimes implemented via a by-law or a corporate governance guideline

      • Either case: nominee who receives an uncontested election more “against (or withhold)” votes than “for” votes is either not elected or is supposed to offer her resignation

      • Where no. of nominees exceeds no. of vacant seat plurality regime

• Voting in Corporate Law – Frank Easterbrook & Daniel Fischel

  • Corporate form allows division of labor between people who have money but not managerial skills and those who have managerial skills but not capital

  • Legal rules serve as a standard form contract for issues of corporate structures – but structural rules and fiduciary principle together cover only the outline of the relationship and right to voting (including right to delegate such right) is needed to make all decisions that are not provided by the contract (e.g. electing directors and give them discretionary powers over things voters otherwise could control)

  • Delaware permits firms to give shareholders any no. of votes (including none), and give votes to bondholders in addition to (or instead of) shareholders

  • Firm may choose to cumulate votes: allowing shareholders to cast multiple votes

    • [thus a candidate may be elected by less than a majority of the shares]

  • Those with power to vote may

    • choose to vote in person or by proxy,

    • choose mangers directly or through mediation of the board, and

    • permit directors/ managers to serve full terms or oust them for any or no reason in mid-term

  • Necessary quorum may be set at less than half of the votes, and the firm may require supermajority approval on selected questions

  • Any of these rules may be set/ altered at any time by those with power to vote

  • Similar situation in other states - though different states create different presumptive rules, e.g. cumulative voting

    • Almost all shares have one vote; only shares possess votes

    • Preferred shares or bonds may acquire votes when the firm is in financial difficulty

    • Cumulative votes/ nonvoting stock/ stocks with seriously limited voting rights are rare in publicly-held corporations

  • Statutory limits on the ability of firms to create a voting structure

    • Investors may sell votes by selling the instrument to which the votes are attached

    • But cannot sell the votes independent of the instrument

    • Statute limit shareholders’ ability to grant...