Shareholder rights

Shareholders, as owners of corporations, have several rights that enable them to govern the corporations, either directly or through their elected representatives on the board of directors. The most important shareholder right is the right to vote at the annual general meeting. Through the exercise of their voting rights, shareholders elect the board of directors and make decisions of fundamental importance to the corporation. If shareholder voting rights are to be used effectively, shareholders must have the right to make proposals at the general meeting and the right to receive timely, adequate and correct information from the company.

Shareholder democracy

The term “shareholder democracy” is commonly used to describe the exercise of voting rights and is a fundamental part of the different processes that govern a corporation. A well-functioning shareholder democracy must at least ensure that the board of directors consists of qualified individuals who promote the interest of all shareholders and is able to effectively control the management of the company. Another important function of shareholder democracy is the resolution of conflicts between shareholders. Large corporations typically have many shareholders who may have different interests and may disagree about what strategy the company should pursue. Therefore, it is necessary to have procedures that combine and unite these different views into a coherent policy for the corporation.

While there are interesting analogies between political democracy and shareholder democracy, there are important differences as well. A fundamental difference is that shareholders have the right to sell their shares, while citizens in a democracy do not have a similar right to sell their citizenship. To the extent that shareholders have this right they can “vote with their feet” by selling their shares if they disapprove of the management. However, the possibility of selling shares is often limited. The company may, through the use of different anti-takeover measures, limit shareholders’ possibilities for selling their shares to bidders that the board dislikes. An important function of shareholder democracy is to protect shareholders’ rights to sell their shares.

A common view has been that it is unnecessary for investors to exercise their right to vote at general meetings when shareholders are able to sell their shares. However, shareholders are increasingly realising that it is important to participate in the various processes associated with shareholder democracy even when they can sell their shares. One reason for this is that some investors must retain their shares in certain companies even though there are basically no limitations on their right to sell. For example, many large international pension funds, like the Government Pension Fund - Global, are widely diversified in markets worldwide and have a long time horizon for their investments. These funds will have to retain these diversified investments, and selling their shares will often not be an alternative. Another reason for the increased focus on the democratic rights of shareholders is the realization that the right to sell is not sufficient to protect minority shareholders from being exploited by management or controlling shareholders.

The exercise of democratic shareholder rights enables minority shareholders to protect their financial interests. Shareholder democracy and corporate governance can thus be seen as addressing the agency problems that arise with the separation of ownership and control in the corporation. Agreements between shareholders and management cannot completely solve agency problems and full control of the company cannot be transferred to the management.

Shareholder democracy also differs from political democracy with respect to its justification since financial interests are the main reason why investors are interested in and work for shareholder democracy and good corporate governance. However, there are also important ethical arguments for investors’ participation in shareholder democracy. Corporate governance can be seen as a public good because all shareholders, and possibly also other stakeholders, benefit from resources spent on corporate governance, but only those who engage in corporate governance bear the costs. It may be argued that one result of this public good aspect of corporate governance is that inadequate resources have been spent on corporate governance in the past and that this in turn has contributed to the numerous corporate scandals and to mismanagement of society’s resources. It may therefore be argued that shareholders have a moral responsibility to reduce this problem and that large institutional investors have a particular obligation to engage in corporate governance work.

Voting rights

Not all share classes give the owner a formal right to vote, and the voting rights are not always equally divided among all holders of the same share class. However, there is a common perception that shareholders’ voting rights should be distributed in relation to the capital commitment by each shareholder. In the US, most listed companies follow the “one-share-one-vote” principle, meaning that each share carries the same voting right. In Europe, large shareholders who control a majority of the voting rights without owning the majority of the equity capital dominate one-third of the companies in the FTSE Eurofirst 300, which includes the 300 largest companies in Europe. We discuss deviations from the “one-share-one-vote” principle and their consequences in Box 1.

There are no uniform standards to regulate a wide range of voting practices. Even within a single market, the requirements may vary. The European Union, in its second public consultation round on its “Action plan on Modernizing Company Law and Enhancing Corporate Governance in the EU”, comments on the obstacles to cross-border voting for international investors. In European countries, between 30 and 80 per cent of the shares in listed companies are held by foreigners. The report argues that national laws governing general meetings and voting have not been updated to reflect this.

Large institutional shareholders often own shares in several thousand companies and it would be virtually impossible for them to attend all of these companies’ general meetings. Therefore, investors will typically appoint a proxy that attends the meeting and votes on their behalf. This representative has the same right as a shareholder to speak and vote at the meeting. In many countries, voting practices that may have been justifiable earlier have not been adjusted to account for this type of investor.

Below we present a list of important obstacles to the exercise of shareholder voting rights:

· Strict eligibility requirements: Most markets require investors to present valid powers of attorney to enable others to vote proxy for them. Other markets require investors to re-register their shares in their own name rather than in the name of their custodian to become eligible to vote. Both processes are time-consuming and exacting.

· Share blocking: In a number of markets, especially European ones, the shares of an investor who wishes to vote will be blocked, i.e. the investor will not be permitted to sell the shares for a set period of time until the general meeting is over. In essence, the investor must choose between exercising the voting right and maintaining the freedom to sell shares without restrictions. Even if changes in this practice can be observed in many markets, this is still a major obstacle to voting in many markets.

· No electronic voting: In most countries, electronic voting is not allowed. Some markets, including the US, Australia, Japan, the UK and Germany, allow electronic voting, but this practice has not been implemented in all companies. Allowing electronic voting would reduce voting costs for shareholders.

· Proxy votes are not counted: In most markets, proxy votes are only counted if a vote has been submitted in writing and not if a vote has been decided by a show of hands. With a show of hands, each person has one vote, regardless of the size of the shareholding.

Setting the agenda

Effective shareholder democracy depends not only on the ability to vote, but also on which issues shareholders can vote. It is typically the management that calls the general meeting and thereby sets the agenda. There are typically some issues that have to be approved by the general meeting, but there are differences among jurisdictions with respect to such requirements. The various stock exchanges may also require that certain important decisions be submitted to the shareholders for approval. Most international corporate governance guidelines and many national corporate governance codes acknowledge that shareholders should have the power to remove directors, appoint and remove auditors, and approve certain fundamental changes in the company and some transactions that involve a particular risk to corporate capital.

Although the general perception is that shareholders should have the right to remove directors, there are many obstacles which vary from one country to another. In the US, board members are elected by plurality voting, and in Box 2we describe how this system, combined with the practice that the current board selects the new board candidates, limits shareholder influence over board elections. In Europe, the tradition of staggered boards makes it difficult to change the current board when there are opposing candidates or in the case of a hostile takeover. In general, however, shareholders in Europe, at least majority shareholders, have more influence on board appointments than shareholders in US companies. One important reason for this is the fact that ownership is more dispersed in US companies and this tends to reduce the power of shareholders relative to management.

The board of directors, often through a remuneration committee, is formally responsible for deciding the incentive structures for the chief executive officer. Lack of shareholder control over the board and boards that are too closely tied to the management have therefore led to a reduction in shareholder control over incentive structures, a problem that is more pronounced in the US than in most other countries.

There is general agreement that shareholders should have the right to decide on issues of fundamental importance for the corporation, such as mergers, consolidations, and sales of all assets or dissolution of the company. However, this right is often restricted. In many jurisdictions, the board has the right to introduce different types of anti-takeover measures without the approval of the shareholders. In Box 3, we discuss one such measure, i.e. poison pills.

The OECD Principles of Corporate Governance state that shareholders should have adequate opportunities to place items on the agenda at general meetings, subject to reasonable limitations. Most countries operate with a percentage of the company’s share capital as a threshold for allowing shareholders to demand that their proposals be considered at a general meeting. Some jurisdictions also have an alternative threshold in the form of amount of paid-up capital or minimum number of shareholders. In Europe, the share capital threshold generally ranges from 5 to 20 percent. A few countries such as Denmark, Sweden and Canada permit any shareholder to add items to the agenda. In most European countries, information on shareholder proposals must be circulated to all shareholders at the company’s expense. In the US, any shareholder who has held at least 1 per cent of the shares or USD 2 000 in market value for at least one year may submit one proposal to be circulated at the company’s expense.

Shareholders may also put items on the agenda by calling a general meeting. In some jurisdictions, the threshold for shareholders to call a general meeting is very high. In most of the main markets, the threshold varies from 5 to 20 per cent of the voting capital. In the state of Delaware, where most US companies are incorporated, only the board of directors has the statutory right to convene an extraordinary meeting.

There are also important international differences regarding the extent to which the general meeting’s decisions on shareholder proposals are binding. In the US, a shareholder proposal is usually not binding and is only a recommendation that the board can follow or ignore. In the US, a shareholder proposal need not be included at the general meeting if it deals with a matter relating to the company’s “ordinary business operations” on the grounds that shareholders should not have the power to “micro-manage” the company. Nor do shareholders’ proposals have to be discussed at the general meeting if the proposal relates to operations that are not important to the company.

Another important difference between companies in the US and Europe is the ability to initiate changes in the corporate charter. In most US companies, only the board can initiate such changes. In Europe, shareholders may initiate such changes, often conditional on a certain shareholding and that the proposal gains a supermajority, i.e. satisfies a given majority requirement that is stricter than a simple majority.

Shareholders’ right to information

Shareholders are dependent on receiving information about the company’s ongoing activities to be able to exercise their voting rights effectively. The growth in international institutional share ownership raises issues of effective communication between institution and company. All shareholders, as far as possible, should have equal and simultaneous access to significant information from a listed company.

Companies can inform the shareholders through several channels such as the annual report, information sent out in advance of general meetings, the general meetings, their web pages, press releases and meetings arranged with the management and the board. The annual report is perhaps the most important of these channels. However, requirements concerning the type of information in the annual report vary across countries. As an example, in the US, the Securities and Exchange Commission has recently proposed that companies must disclose remuneration details for top management, while in most other countries this is not required, or at least not to the same extent.

In many emerging markets, companies often do not provide voting ballots and information on the general meetings at all, as the law may be weak and there is no regulatory agency overseeing disclosure requirements. Shareholders obviously need to know when the meeting will take place and what the agenda is in order to participate in shareholder democracy. However, some companies send meeting notices and information concerning items on the agenda only in the country’s own language. Some provide translations, but often at a later date. Therefore, foreign investors frequently do not receive information in time to make informed voting decisions.

In most developed markets, there are statutory requirements concerning the information to be included in a notice of a general meeting, but these are not always sufficient for shareholders to make informed voting decisions and the quality of proxy information varies widely across markets. The information problem is amplified by the fact that there is often a chain of financial intermediaries between the company that issues the shares and the investor. Through this chain, involving registrars, depositories, sub-custodian banks, global custodian banks, investment managers and third-party providers, information and ballots are in theory supposed to flow from issuer to beneficial owner, and then back again with voting instructions. In the US, the Securities and Exchange Commission has recently proposed that companies shall be able to use the Internet to supply information about the general meeting and ballots.

The general meeting is another important source of information for the shareholders. At the general meeting, the shareholders have an opportunity to receive information about the board’s past performance and future plans and otherwise to hold the board accountable by posing questions. However, in many markets, shareholders’ access to these meetings is limited by a requirement that investors may only attend a general meeting if certain requirements are satisfied, e.g. having a shareholding above a certain level, or having owned the shares for a certain period.

Shareholders also have the right to communicate and meet with company management and the board. However, not all company management is willing to meet with shareholders. This depends on the type and size of owner, and on how this right is regulated in the different markets. It may often be difficult for shareholders to gain direct access to the board.

Improving corporate governance

Institutional investors engage in corporate governance activities to improve the shareholders’ ability to influence the management of the companies they own. In the light of the discussion above, three issues may be identified as important for institutional investors.

First, it is important to improve shareholders’ possibilities to use their voting rights. This applies in particular to foreign investors. Such issues are on the agenda of investor networks like the International Corporate Governance Network (ICGN).

A new draft for EU rules that has now been approved by the Commission aims at removing many of the obstacles facing shareholders when they operate across national borders. The draft must also be approved by the European Parliament and EU member states before the rules enter into force.

Second, shareholders’ control over the board and their right to make proposals at the general meeting could be improved in many markets. The introduction of majority voting in the US and the implementation of the “one-share-one-vote” principle in European countries would be a step in the right direction. More generally, institutional shareholders like Norges Bank should work to increase the influence of shareholders and the number of independent board members. Good corporate governance requires as a minimum that the shareholders are able to remove the board. Norges Bank supports shareholder proposals that increase shareholder influence, such as proposals requiring annual elections of all board members and majority voting on board members. Norges Bank may also vote against or withhold votes on board members if there is not a majority of independent board members or if the board has failed to take the necessary steps to implement shareholder proposals that received majority support at previous years’ general meetings.

Finally, a fundamental principle of good governance is transparency. Some legal and regulatory reforms, as well as new technology, have improved transparency. However, it is necessary to work with both the corporations and the regulatory authorities to ensure that all shareholders receive timely, adequate and correct information from the company.