One of the most controversial topics in corporate law scholarship has been whether there is a ‘short-termism problem’ in equity capital markets, and if there is such a problem, how to remedy it. One possible solution is to grant ‘loyal’ shareholders additional voting rights, so-called ‘loyalty voting rights’. This has been allowed in the Netherlands, France and Italy, as well as in a recent proposal for company law reform in Belgium. On 8 June 2018, an ECGI Roundtable was held in Brussels on this topic, hosted by Jones Day.
Zacharias Sautner (Frankfurt School of Finance) opened the roundtable by presenting some of the evidence on whether short-termism is present in stock markets. He first presented a paper on myopic behaviour by executives in the United States, which investigated the effect of firms adopting stock option plans that vest quicker, giving executives short-term incentives. Consistent with the idea of managerial short-termism, the paper found that those firms cut long-term investment, which had positive effect on shareholder returns in the short-term, but a negative effect in the long-term.
The second paper presented by Sautner found evidence that in the United States managerial short-termism is driven by short-horizon investors. It revealed that the arrival of short-term investors led to pressure on executives to cut long-term investments, to increase short-term earnings, which led to a temporary boost in the stock price, after which short-term investors exited and firm value gradually decreased again to below the original value.
In the second briefing, Alessio Pacces (University of Rotterdam) discussed loyalty shares and dual-class shares in the Netherlands. First, Pacces discussed how dual-class share structures can be implemented in the Netherlands despite the ‘nominal value constraints,’ which state that shares with different voting rights must also have different nominal value. In practice, dual-class shares can be implemented by requiring different contributions on the shares, where a lower nominal value is compensated by a higher share premium.
Pacces then explained how loyalty shares are structured in the Netherlands, and how they can even be introduced midstream, as all shareholders are treated equally. Under a loyalty share scheme, shareholders can list their shares in a loyalty register; after the stipulated amount of years, they will receive additional shares (with voting rights) for free, which they have to hand in again (for free) if they deregister the shares to trade in them. Pacces also examined the use of loyalty shares in several deals and concluded that loyalty shares are nothing else than a control-enhancing mechanism, as only controlling shareholders make use of them.
The third briefing was given by Zsofia Kerecsen from the European Commission, who discussed the policy of the Commission regarding sustainable finance and the relationship with loyalty shares. Kerecsen noted that the Commission has been working towards better corporate governance and a more sustainable and long-term oriented share ownership after the financial crisis, and pointed specifically to action 10 of the action plan on sustainable finance, which centres on ‘fostering sustainable corporate governance and attenuating short- termism in capital markets.’ At the moment, however, the Commission is not taking action concerning loyalty shares, although it would seem to be an obvious candidate to solve short-termism and despite the fact that it has been on the EU agenda twice before.
In the next briefing, Genevieve Helleringer (Essec and Oxford) gave an overview of loyalty shares in France after the Loi Florange. She noted that ‘one share, one vote’ was the general principle for some time, but that since 1933, multiple voting rights have been possible, subject to legislative constraints: shareholders could only be granted double voting rights; the minimum holding period was two years; and the articles of association or the EGM had to provide for it. Such loyalty voting shares were used in 50% of the top 40 listed companies and in 60% of the top 120.
In 2014, the so-called Loi Florange changed the law on loyalty voting rights by switching from an opt-in to an opt-out system. Loyalty voting rights are now the default option for listed companies, unless a company opts out with a two-thirds majority. Officially, the goals of the Loi Florange were to increase the weight of long-term shareholders over short-term investors and to embed the power of controlling shareholders, as solid investors with a long-term commitment, but Helleringer also noted ‘officious’ goals, such as giving the state the opportunity to further privatize companies while retaining control and protecting companies against takeovers.
In the fifth briefing, Anete Pajuste (Stockholm School of Economics Riga) provided some empirical evidence on the Loi Florange, referring to a paper co-authored with Marco Becht and Yuliya Kamisarenka. The hypothesis of the paper is that the switch from an opt-in to an opt-out system should not matter for firms that do an IPO, because according to the Coase theorem, firms could simply opt out of the default rule, given the low transaction costs. However, the paper found that this was not the case: before the Loi Florange, 36.5% of the IPO firms had loyalty shares, while afterwards, this was the case for 53.5% of the firms.
Pajuste also presented evidence on companies that switched to loyalty voting rights midstream. The paper found that 14 firms switched from ‘one share, one vote’ to loyalty voting rights after the Loi Florange. In seven cases, there was no vote proposing to retain the ‘one share, one vote’ structure: there was no point in having one, as one shareholder had a blocking minority of at least one-third in each of those cases. In the seven firms that switched to loyalty voting rights, but did vote on whether to retain a ‘one share, one vote’ structure, the vote failed in five cases even though a simple majority of the shareholders had voted in favour of ‘one share, one vote,’ because the two-thirds majority was required. The paper also found evidence that the state was dominant in six out of seven of these cases.
Finally, the paper did not find a significant difference in the average holding periods between firms with and without loyalty voting shares. Pajuste concluded from this that loyalty voting shares do not actually stimulate loyalty to the company, and that loyalty voting shares are only about enhancing the control of the controlling shareholder.
The sixth briefing was given by Ettore Croci (Università Cattolica Del Sacro Cuore) on loyalty shares in Italy. Loyalty voting shares and multiple voting shares were introduced in Italy in 2014. Croci pointed out that, unlike in France, a vote at the EGM is needed to introduce loyalty voting shares or multiple voting shares (an ‘opt-in’ regime). Under Italian law, loyalty voting shares do not create a separate category of shares and all shares that meet the requirements of registration in the special register for a period of at least two years will receive double voting rights. These double voting rights are lost when the shares are transferred. Unlike in France, the double voting rights are also lost if control over a holding company that holds the loyalty voting shares is transferred.
Croci then presented some empirical evidence. In a sample of all listed companies, only 2 of them had multiple voting shares and 35 had loyalty voting shares. Croci found that loyalty voting shares were mainly adopted by family firms, even though they already had control over the company. Croci also found evidence that stock prices reacted significantly negatively to the announcement of the legislation introducing loyalty shares, but slightly positively to the announcement of the introduction of loyalty voting shares at individual companies. In addition, the presence of loyalty voting shares did not cause a change in the percentage owned by institutional investors. Finally, Croci found that loyalty shares are negatively associated with the probability of receiving a takeover offer or of being delisted.
After Croci’s briefing, Luca Garavoglia (Chairman of Davide Campari-Milano S.p.A.) discussed how loyalty voting shares operate in practice in Italy. He argued that loyalty shares are just another form of control-enhancing mechanism and that they will definitely not lengthen the holding periods of institutional shareholders. According to Garavoglia, institutional investors would have very few benefits from loyalty voting rights, as they do not necessarily want to influence governance, but prefer to exit if they do not like management. Garavoglia concluded that loyalty voting shares are nothing more than a control-enhancing mechanism and that the debate should focus on the desirability of this phenomenon. Garavoglia then argued that multiple voting shares should be allowed, provided that the extraction of private benefits is curbed. Garavoglia also pointed out that Italy did not have an exemption for the mandatory bid rule for loyalty voting rights, unlike France, which prevented the Italian government from lowering its stake in Enel, for example.
In the eighth briefing, Philippe Lambrecht (Secretary General FEB-VBO and Université Catholique de Louvain) discussed loyalty shares under the proposed Belgian company law reform. Multiple voting shares have not been possible in Belgium since 1934. Under Belgian company law reform, multiple voting shares will become possible, but for listed companies this will only be possible in the form of loyalty voting shares: only shareholders who have held registered shares for more than two years will enjoy double voting rights.
In contrast to the Loi Florange in France, loyalty voting rights only apply when this is provided in the articles of association. However, the traditional 75% majority for amendments to the articles of association has been permanently lowered to a two-thirds majority, and even to a simple majority for a transition period of six months from 1 January 2020 to 30 June 2020, similar to the Italian transition period. The reason behind this, according to Lambrecht, is that it would have otherwise been impossible for any of the existing listed companies to make use of loyalty voting rights, as the threshold of 75% would have been too high to reach. Lambrecht also discussed the relationship between loyalty voting rights and the mandatory bid rule: under the current proposals, only the number of shares is counted towards the 30% threshold, not the number of voting rights.
In the final briefing of the day, Kobi Kastiel (Tel Aviv University and Harvard Law School Program on Corporate Governance) discussed the implications for the loyalty shares debate of his paper on the untenable case for perpetual dual-class shares (co-authored with Lucian Bebchuk, Harvard Law School). He argued that, as time goes by, the benefits of dual-class shares are likely to erode, while the costs are likely to increase. This means that even if dual-class shares are efficient when they are adopted, this may not be the case after some years. For this reason, he argued that dual-class shares should be subject to a sunset provision, which requires that such a structure must be approved by shareholders unaffiliated with the controller every 10–15 years. Finally, Kastiel argued that this reasoning should be extended to loyalty voting shares, noting that the previous briefings viewed loyalty voting shares as akin to dual-class shares. According to him, even if the mandatory statutory limits to loyalty voting rights ensure that they pose less of a risk than dual-class shares in the United States, the problem of an increased risk of inefficiency over time is not solved completely.
Finally, Marco Becht (Université Libre de Bruxelles) summed up the conclusions drawn from the briefings and the roundtable discussion on loyalty shares. Convincing evidence was presented that short-termism is a problem, but it is far less clear whether loyalty voting shares are a solution to it. The consensus among the roundtable participants seemed to be that loyalty voting shares do not promote longer holding periods and with them long-term behaviour with regard to institutional or retail investors. Most agreed that loyalty voting shares mainly act as a control-enhancing mechanism for controlling shareholders, which can insulate them from short-term market pressures. Whether this outweighs the agency costs associated with control-enhancing mechanism is part of the (ongoing) debate on dual class shares in general.
Becht concluded that loyalty shares constitute a topic worthy of further discussion and announced a second ECGI roundtable on this topic in New York on 7 December 2018 and a conference in Tel Aviv on December 12, 2018.
Tom Vos is a PhD Candidate in Corporate Law at the Jan Ronse Institute of Company and Financial Law at KU Leuven (Belgium).