The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership – Article by Henry T.C. Hu & Bernard Black

From Volume 79, Number 4 (May 2006)
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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.


 

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