Encumbered Shares

Abstract

The fundamental assumptions in the law and economics literature about shareholder voting and the one-share/one-vote rule are flawed. The classic view is that share ownership is necessary and sufficient to create voting rights and that such rights should be directly proportional to share ownership. We demonstrate that this assumption is unfounded, both for shares that are economically encumbered (held by shareholders who are not pure residual claimants; e.g., a shareholder who owns one share and is also short one or more shares) as well as shares that are legally encumbered (held or associated with more than one shareholder; e.g., shares that are loaned to a short, who sells that share to another buyer).

The one-share/one-vote rule is not only economically suboptimal, but results in substantial deleterious consequences. Quorum and regulatory requirements are distorted; mergers and acquisitions are too easily approved; securities class actions are undervalued and simultaneously under- and over-compensate; bankruptcy distributions are over- and under-inclusive; and fixed-ratio stock offers are preferred over economically superior alternatives. These results all derive from an unfounded reliance upon the one-share/one-vote principle and the belief that even economically or legally encumbered shares are entitled to vote.

Keywords: shareholder, shareholder voting, law and economics, encumbered shares, one-share one-vote principle

JEL Classification: E44, G1, G34, K1, K22