Hedge Funds, Insiders, and the Decoupling of Economic and Voting Ownership: Empty Voting and Hidden (Morphable) Ownership

Abstract

Most U.S. public companies have a single class of voting common shares: voting power is proportional to economic ownership. Linking votes to shares is often thought to be desirable, because, as residual claimants, shareholders have an incentive to exercise voting power well. The linkage also facilitates the market for corporate control. On the other hand, decoupling is efficient in some situations. Equity derivatives and other capital market developments now allow shareholders to readily decouple voting rights from economic ownership of shares, often without public disclosure. Hedge funds are prominent users of decoupling. Sometimes they hold more votes than economic ownership (a situation we term empty voting). Sometimes they hold undisclosed economic ownership without votes, but often with the de facto ability to acquire votes if needed (a situation we term hidden (morphable) ownership). This Article analyzes empty voting and hidden (morphable) ownership, which we term the new vote buying. We offer a framework for unpacking its functional elements and assess its potential benefits and costs. Two companion legal articles (Hu and Black, 2006a, 2006b) provide more details on current disclosure rules and offer a disclosure reform proposal.

** The companion legal articles provide additional details on current disclosure rules, our disclosure proposal, and other possible reforms. For the companion directed at an academic legal audience, see Hu & Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 Southern California Law Review 811-908 (2006), http://ssrn.com/abstract=904004. For the companion directed at legal practitioners and regulators, see Hu & Black, Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms, 61 Business Lawyer 1011-1070 (2006), http://ssrn.com/abstract=887183. **

Keywords: bank regulation, banking, corporate control, corporate governance, derivative, disclosure, dual class stock, equity swap, financial innovation, hedge fund, hedging, insider, Mylan Laboratories, option, Perry, Securities and Exchange Commission, securities regulation, shareholder, takeover, voting

JEL Classification: G14, G18, G20, G24, G28, G30, G32, G34, K22, L20