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

31 Pages Posted: 10 Jan 2006  

Henry T. C. Hu

University of Texas at Austin - School of Law

Bernard S. Black

Northwestern University - Pritzker School of Law; Northwestern University - Kellogg School of Management; European Corporate Governance Institute (ECGI)

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

Suggested Citation

Hu, Henry T. C. and Black, Bernard S., Hedge Funds, Insiders, and the Decoupling of Economic and Voting Ownership: Empty Voting and Hidden (Morphable) Ownership. Journal of Corporate Finance, vol. 13, pp. 343-367, 2007; ECGI - Law Working Paper No. 56/2006; McCombs Research Paper Series No. FIN-02-06; U of Texas Law, Law and Econ Research Paper No. 53. Available at SSRN: https://ssrn.com/abstract=874098

Henry T. C. Hu (Contact Author)

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States
512-232-1373 (Phone)
512-471-6988 (Fax)

Bernard S. Black

Northwestern University - Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States
312-503-2784 (Phone)

Northwestern University - Kellogg School of Management

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-5049 (Phone)

European Corporate Governance Institute (ECGI)

Brussels
Belgium

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