Voting rights of hedged equity

US SEC Commissioner Paul Atkins in his talk at the Corporate Directors forum this week raised the issue of "empty voting" by those who have used derivatives to hedge the economic risk of their shareholding.

First of all, it is unfortunate that Atkins raised this issue in the context of the debate about giving shareholders more rights in the election in the directors. If “empty voting” is a problem at all, then it is a problem for all shareholder resolutions and not just the election of directors. By raising the issue in this context, Atkins sends an unfortunate and inappropriate signal to the investors about the SEC’s approach to the problem.

Second, the potential for the separation of voting rights and economic rights existed even without derivatives. Supervoting shares is one way in which separation occurs. For example, in the case of Google, each of the Class B shares held by the founders has ten times the voting rights of the Class A shares held by others. Google management controls a majority of the voting rights with a much smaller economic interest in the company.

Tracking shares are another way in which separation happens. Holders of tracking shares in a division of a company own the entire economic interest in the division, but the board has no obligation to them as opposed to their obligations to the company as a whole. This means that holders of the tracking stock own a division without controlling it and the holders of the regular stock control the division without owning it.

When all these mechanisms have been in existence for decades, it is strange that the SEC finds only the use of derivatives troubling. The nice thing about derivatives is that they are traded in an open market where everybody is welcome to play the game. You do not have to be the founder of a company to unbundle a share into economic rights and voting rights using total return swaps or other means. In an efficient market, the economic interests and the voting rights will both be valued in the market and anybody can buy or sell voting rights at this market price. Once everybody realizes that this can be done, both sides in any proxy battle or takeover struggle will use this method. It is then a level playing field.

Posted at 4:51 pm IST on Wed, 24 Jan 2007         permanent link

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