Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T.C. Hu
University of Texas at Austin - School of Law
Bernard S. Black
Northwestern University - School of Law; Northwestern University - Kellogg School of Management; European Corporate Governance Institute (ECGI)
As published in Business Lawyer, Vol. 61, pp. 1011-1070, 2006
European Corporate Governance Institute - Law Research Paper No. 64/2006
University of Texas Law, Law and Economics Research Paper No. 70
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' separation of ownership and control suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers not to stray too far from shareholder wealth maximization.
The derivatives revolution and other capital market developments threaten this familiar pattern. Both outside investors and insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling - which we call the new vote buying - is often hidden from public view and is largely untouched by current regulation. Hedge funds have been especially creative in decoupling voting rights from economic ownership. Sometimes they hold more votes than economic ownership, a pattern we call empty voting. That is, they may have substantial voting power while having limited, zero - or, indeed, negative - economic ownership. Sometimes they hold undisclosed economic ownership, a pattern we call hidden ownership. Often, the hidden owners also have morphable voting rights - the de facto ability to acquire the votes if needed. Insiders can also use empty voting techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other shareholder oversight. We also propose a disclosure-based regulatory response. Our disclosure proposal would integrate and simplify five existing, inconsistent share ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, substantive responses to empty voting may be needed; we sketch some possible responses.
** This article has two companion works, one directed at an academic legal audience and the second at a finance audience. For the former, see Hu & Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 Southern California Law Review 811-908 (2006), also available at http://ssrn.com/abstract=904004. For the latter, see Hu & Black, Hedge Funds, Insiders, and Empty Voting: Decoupling of Economic and Voting Ownership in Public Companies, Journal of Corporate Finance, vol. 13, pp. 343-367 (2007), nearly final version available at http://ssrn.com/abstract=874098. **
Number of Pages in PDF File: 61
Keywords: bank regulation, banking, corporate governance, derivative, disclosure, dual class stock, equity swap, financial innovation, hedge fund, hedging, insider, Mylan Laboratories, Perry Corp., Securities and Exchange Commission, securities regulation, shareholder, takeover, voting
JEL Classification: G14, G18, G20, G24, G28, G30, G32, G34, K22, L20Accepted Paper Series
Date posted: February 28, 2006 ; Last revised: March 11, 2008
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