December 02, 2004

The End of Corporate Democracy?

Corporate democracy is an interesting concept. Briefly, it means that if you own an interest, a share, of a corporation, you are entitled to vote on matters which are required to be put for a vote before the shareholders. What matters? Well, elections of directors, corporate and shareholder resolutions, mergers and acquisitions, and certain kinds of asset sales. This right to vote is a fundamental aspect of corporate and share ownership. It may not apply to all classes of stock, of course.

The system is premised on the following concept: those with an economic interest should be permitted a voice in proportion to that economic interest. One share, one vote, in other words. This system has worked pretty well up to now and courts take very seriously issues of shareholder disenfranchisement, freeze out, and other maneuvers by which shareholders are pushed out of their rights to vote.

The system, however, has just been totally gamed. It may not be a bad thing, but it is certainly very interesting.

The NY Times reported this morning on a technique used by the "owner" of 10% of a corporation's outstanding and issued shares in regard to a merger vote. Why is owner in quotes? Simple. The owner of the shares simultaneously bought them while another party, a counterparty (I think), sold the shares short. Result? He owns the shares with absolutely no economic interest or risk. In other words, he has the voting rights but no exposure to the fluctuation of the share price in the market place. Shareholder rights activists are up in arms over this. I, too, was initially quite disturbed by it. But the article, at the absolute very end, quotes a law professor who points out that shareholders in a large public company have no fiduciary duty to each other. I forgot that as I got caught up in the drama of the article. This is important. Shareholders voting on a merger are under no compulsion to vote anything other than what is in their best interests, not the best interests of their fellow shareholders. To require otherwise would be unwieldy at best and at worst would require a level of care in a relationship of co-shareholders that is absolutely unwarranted.

This is an interesting issue, I think. Gaming the corporate democracy system by holding voting shares with no economic exposure. It raises the question of why you would want to do it at all if you don't stand to gain by any price movement in the shares you "own". The article in the Times did not address this question. But suppose the "owner" really did own shares in the other company in the merger. . . Maybe that's where the play is. Very clever, if so.

Posted by Random Penseur at December 2, 2004 08:58 AM
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