The Implications of Increasing Shareholder Democracy

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The Implications of IncreasingShareholder
Democracy
2

• 2011
• The Arab Spring

• 2012
• The Shareholder Spring

3
Shareholder voting in the Internet age Coho
Energy, 1999

• Company files for bankruptcy, cancels annual
  meeting
• Angry shareholders on Yahoo! message board
• David Marx, real estate appraiser, aka
  Stockmeister7
• I would vote for a new CEO and I have 125,000
  shares toward that end. Who else would support
  this. Please post your vote and the number of
  shares you have to vote for a replacement.
• J.D. Davis, header of truck drivers union
  controlling 742,000 shares
• Stockmeister you have our total support and
  proxie. Lets get together on this and oust the
  guy. Its time he got a job driving a forklift.
• 13,000,000 shares, or 52 outstanding, are
  pledged to Stockmeister7. Judge names him head
  of the shareholders committee in Chapter 11.

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Is anything wrong with this?

• Violates anti-fraud proxy disclosure rules
• Solicits votes for an election that will never be
  held
• CEO is not elected by shareholders
• No elections are held by companies in Chapter 11

5
Whats interesting about this

• Internet dramatically reduces time and cost
  required for shareholder communication
• Seems to resolve collective action problems
  that are the rationale for limited shareholder
  participation in governance

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Shareholders
Elect / delegate
Board of Directors
Monitor day-to-day

• Managers

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Shareholder voting is changing

• More direct involvement in governance
• Say-on-pay
• Majority board elections
• Proxy access
• Regulatory reform to improve transparency
• End of broker voting in 2010 (c. 15 cushion)
• Publicity of mutual fund votes
• Aggressive tactics by active investors
• Empty voting
• Loan to own

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Why should we care?

• 1. The good reasons
• Surprisingly large effects on value of equity and
  debt
• Effective communication channel with management
• 2. The troubling reasons
• (a) Very frequent shareholder voting may be
  destabilizing
• (b) Weaknesses of technology and regulation
  create opportunities for vulture investors

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Votingand the value of the firm
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Stock 3.2 3 billion gain in market
cap Pandits 2011 pay - 1.6 mm salary - 5.3
mm bonus - 7.8 mm options - retention award
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(No Transcript)
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Shareholder value impactwhen a takeover defense
proposal passes

• All votes 0.01
• 60 or less 0.21
• 55 or less 0.94
• 52 or less 1.62
• 51 or less 2.21
• Most vote outcomes are easy to forecast close
  votes implicitly show the value of governance
  changes

Source Cunat, Gine Guadalupe (2011)
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These results are surprising

• Large magnitude
• The proposals are non-binding
• Management can greatly influence the outcome
• Management can surrender and avoid the value
  loss

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Votingas a channel of communication
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Director elections in the U.S.
Average Yes vote 94.3
Disclosed conflict of interest -2.1
Attendance problem -14.0
ISS "No" recommendation -18.7
-20
0
20
40
60
80
100
Source Cai, Garner and Walkling (2009)
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Real effects

• Director resignations no clear pattern
• CEO dismissals One standard deviation drop in
  voting for outside directors increases CEO
  turnover by 121
• CEO compensation 1 reduction in votes for a
  comp. committee member reduces CEO pay by
  143,000 in the next year.

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Example News Corp. in 2011
James R. Murdoch
35
65
Lachlan K. Murdoch
34
66
Natalie Bancroft
Andrew S.B. Knight
Arthur M. Siskind
David F. DeVoe
For
Sir Roderick I. Eddington
Against
Viet Dinh
K. Rupert Murdoch
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86
John L. Thornton
Peter L. Barnes
Jose Maria Aznar
Chase Carey
Joel I. Klein
James W. Breyer
-100
-50
0
50
100
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Example News Corp. in 2011
James R. Murdoch
35
65
18
Lachlan K. Murdoch
34
66
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Natalie Bancroft
Andrew S.B. Knight
Arthur M. Siskind
David F. DeVoe
For public
Sir Roderick I. Eddington
Against public
Viet Dinh
Murdoch family
K. Rupert Murdoch
14
86
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Prince al-Waleed
John L. Thornton
Peter L. Barnes
Jose Maria Aznar
Chase Carey
Joel I. Klein
James W. Breyer
-100
-50
0
50
100
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Example News Corp. in 2011
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Example Bank of America in 2009
Tommy R. Franks Thomas J. May John T. Collins William Barnet, III Walter E. Massey Charles K. Gifford Patricia E. Mitchell Gary L. Countryman Charles O. Rossotti Joseph W. Prueher Virgis W. Colbert Thomas M. Ryan Frank P. Bramble, Sr. Robert L. Tillman Monica C. Lozano Jackie M. Ward Kenneth D. Lewis (Chairman CEO) O. Temple Sloan, Jr..(Lead Director) 92 92 92 92 92 91 87 86 85 85 85 83 77 75 74 71 66 62 Resigned Resigned Resigned Resigned Resigned Resigned Resigned Resigned Resigned Resigned Resigned Resigned
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Weakness of regulation and vote-counting
technology
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Management-initiated propoalsFrequency of vote
outcomes around 50 passage threshhold
Source Listokin (2008).
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Over-voting

• 3 to 4 of all votes cast are legitimate
  over-votes
• Securities Transfer Assoc. in 2005 studied 341
  companies, and found over-voting at all 341
• Generally caused by stock lending by brokers,
  without attributing lent shares to a particular
  client
• Stock lending will increase voter turnout
• Will impact elections with a quorum requirement,
  such as bylaw amendments

Source Smith (2012)
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Proposals that appear to have passed only due to
Over-votes
Source Smith (2012)
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How accurate are corporate elections?

• Not very. /- 5 is the consensus.
• Inaccurate shareholder lists
• Incomplete ballot distribution
• Irregular vote counting by subcontractors
• Seems to be the consequence of an archaic system
  designed for a world of paper share ownership
• Important not only for identifying the winner,
  but for enabling shareholders signal to
  management to be read clearly

Source Kahan and Rock (2007).
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Manipulation of elections viaEmpty voting
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Empty voting through the stock lending market
Source Christoffersen, Geczy, Musto and Reed
(2007).
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Empty voting more complex exampleMylan Labs
2004 bid for King Pharmaceuticals
Source Kahan and Rock (2007).
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Empty voting observations

• Some of these strategies appear unbelievably
  cheap and low-risk.
• Some temporary owners of voting rights may vote
  against the companys best interests.
• Remedy seems to be better disclosure, but that
  alone may not stop all moral hazard problems.

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Empty voting the backlash

• Many major institutional investors now recall
  their shares from the loan market prior to the
  ex-vote date

Source Aggarwal, Saffi Sturgess (2010)
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Empty creditors

• Bondholders have voting rights in Chapter 11
• A bondholder can become an empty creditor by
  using CDS to protect cash flow rights
• In a distressed firm, bondholders can displace
  equity and take its voting power.
• Buy distressed bonds / insure through CDS
• Refuse to waive covenants force a default
• Inherit shares

Source Subrahmanyam, Tang Wang (2012)
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Debt takeovers
Source Wall Street Journal (2009)
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Debt takeovers
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The value of a vote
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What are voting rights worth?

• Research into stock lending suggests value is low
• In nearly all elections, value of a marginal vote
  is meaningless
• But sometimes it matters a lot

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What are voting rights worth?

• Zingales (1994) study of dual-class shares on
  the Milan stock exchange

Source Zingales (1994)
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What are voting rights worth?A contingent claims
approach

• By put-call parity,
• Stock call option
• put option
• bond
• Compare the value of this synthetic share of
  stock with the market price of an actual share

Source Kalay, Karakas Pant (2011)
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Put-call parityStock Call Put Bond
60
Call
40
20
Payoff
0
- Put
(20)
(40)
(60)
0
10
20
30
40
50
60
70
80
90
100
Stock price
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The value of a voteat Heinzs 2006 shareholder
meeting
Nelson Peltz addresses the meeting
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Trian Partners sought five seats on the Heinz
board in 2006
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Voting results2 of 5 insurgent candidates elected
Management candidates Management candidates Insurgent candidates Insurgent candidates
Dean R. OHare Thomas J. Usher Edith E. Holiday Lynn C. Swann Candace Kendle Leonard S. Coleman Jr. William R. Johnson (CEO) Charles E. Bunch John G. Drosdick Dennis H. Reilly Mary C. Choski Peter H. Coors 233.6 million 231.0 226.9 224.1 217.8 208.9 200.3 128.0 127.9 127.9 Lost Lost Unopposed Unopposed Unopposed Unopposed Unopposed Unopposed Unopposed Greg Norman Peter W. May Edward P. Gardner Michael F. Weinstein Nelson Peltz Lost Lost Lost 138.8 million 135.8
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Value of a Heinz vote
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
-0.10
-0.20
-10
-8
-6
-4
-2
0
2
4
6
8
10
-9
-7
-5
-3
-1
1
3
5
7
9
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Speculating in vote values(if it were possible)

• Value of a Heinz vote on June 1 0.150
• Value of a Heinz vote on June 8 0.238
• One-week investment return 59
• Annualized return
• (1 r)52 1
• 1.5952 1
• 2.5 trillion

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Lessons learned

• Shareholder voting is much more confrontational
  than in the past
• Leads to real changes in boards, compensation,
  takeover defenses, and share values
• Can be very destabilizing