The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership
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 Southern California Law Review, Vol. 79, pp. 811-908, 2006
University of Texas Law, Law and Econ Research Paper No. 53
Corporate law generally makes voting power proportional to economic ownership. This serves several goals. Economic ownership gives shareholders an incentive to exercise voting power well. The coupling of votes and shares makes possible the market for corporate control. The power of economic owners to elect directors is also a core basis for the legitimacy of managerial authority. Both theory and evidence generally support the importance of linking votes to economic interest. Yet the derivatives revolution and other capital markets developments now allow both outside investors and insiders to readily decouple economic ownership of shares from voting rights. This decoupling, which we call the new vote buying, has emerged as a worldwide issue in the past several years. It is largely hidden from public view and mostly 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. In an extreme situation, a vote holder can have a negative economic interest and, thus, an incentive to vote in ways that reduce the company's share price. Sometimes investors hold more economic ownership than votes, though often with morphable voting rights - the de facto ability to acquire the votes if needed. We call this situation hidden (morphable) ownership because the economic ownership and (de facto) voting ownership are often not disclosed.
This Article analyzes the new vote buying and its potential benefits and costs. We set out the functional elements of the new vote buying and develop a taxonomy of decoupling strategies. We also propose a near-term disclosure-based response and outline a menu of longer-term regulatory choices. Our disclosure proposal would simplify and partially integrate five existing, inconsistent ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed: we discuss strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
** This Article has two shorter companions. One is directed at an academic finance audience and the other is directed at legal practitioners and regulators. For the former, see Henry T.C. Hu & Bernard 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 at http://ssrn.com/abstract=874098. For the latter, see Henry T.C. Hu & Bernard Black, Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms, Business Lawyer, vol. 61, pp. 1011-1070 (2006), also available at http://ssrn.com/abstract=887183 **
Number of Pages in PDF File: 99
Keywords: Bank regulation, banking, corporate governance, derivative, disclosure, equity swap, financial innovation, hedge fund, hedging, insider, Mylan Laboratories, Perry Corp., Securities and Exchange Commission, securities regulation, shareholder, shareholder voting, takeover, vote buying, voting
JEL Classification: G14, G18, G20, G24, G28, G30, G32, G34, K22, L20Accepted Paper Series
Date posted: June 5, 2006 ; Last revised: March 10, 2008
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