Monday, 10 December 2007

The Corporate Governance Of Listed Companies: A Manual For Investors (Part 3)

This is my last post of the Corporate Governance of Listed Companies. In this last post, I’m going to discuss about the companies’ policies relating to voting rules, share owner sponsored proposals, common stock classes and takeover defenses.

The ability to vote proxies is a fundamental shareholder right. If the firm makes it difficult to vote proxies, it limits the ability of shareholders to express their views and affect the firm's future direction. Investors should consider whether the firm:
  • Limits the ability to vote shares by requiring attendance at annual meeting.
  • Groups its meetings to be held the same day as other companies in the same region and also requires attendance to cast votes.
  • Allows proxy voting by some remote mechanism.
  • Is allowed under its governance code to use share blocking, a mechanism that prevents investors who wish to vote their shares from trading their shares during a period prior to the annual meeting.

Investors should determine if shareholders are able to cast confidential votes. This can encourage unbiased voting. In looking at this issue, investors should consider whether:

  • The firm uses a third party to tabulate votes.
  • The third party or the firm retains voting records.
  • The tabulation is subject to audit.
  • Shareholders are entitled to vote only if present.

Shareholders may be able to cast the cumulative number of votes allotted to their shares for one or a limited number of board nominees. Be cautious in the event the firm has a considerable minority shareholder group, such as a founding family, that can serve its own interests through cumulative voting. Information on possible cumulative voting rights will be contained in the articles of organization and by-laws and the prospectus.

Changes to corporate structure or policies can change the relationship between shareholders and the firm. Watch for changes to:

  • Articles of organization.
  • By-laws.
  • Governance structures.
  • Voting rights and procedures.
  • Poison pill provisions (these are impediments to an acquisition of the firm).
  • Provisions for change-in –control.

Regarding issues requiring shareholder approval consider whether shareholders:

  • Must approve corporate change proposal s with supermajority votes.
  • Will be able to vote on the sale of the firm, or part of it, to a third-party buyer.
  • Will be able to vote on major executive compensation issues.
  • Will be able to approve any anti-takeover measures.
  • Will be able to periodically reconsider and re-vote on rules that require supermajority voting to revise any governance documents.
  • Have the ability to vote for changes in articles of organization, by-laws, governance structures, and voting rights and procedures.
  • Have the ability to use their relatively small ownership interest to force a vote on a special interest issue.

Investors should also be able to review issues such as:

  • Share buy-back programs that may be used to fund share- based compensation grants.
  • Amendments or other changes to a firm's charter and by-laws.
  • Issuance of new capital stock.

Investors need to determine whether the firm's shareholders have the power to put forth an independent board nominee. Having such flexibility is positive for investors as it allows them to address their concerns and protect their interests through direct board representation. Additional items to consider:

  • Under what circumstances can a shareholder nominate a board member?
  • Can share owners vote to remove a board member?
  • How does the firm handle contested board elections?

The proxy statement is a good source document for information about these issues in the United States. In many jurisdictions, articles of organization and corporate by-laws are other good sources of information on shareholder rights.

The right to propose initiatives for consideration at the annual meeting is an important shareholder method to send a message to management. Investors should look at whether:

  • The firm requires a simple majority or a super majority vote to pass a resolution.
  • Shareholders can hold a special meeting to vote on a special initiative.
  • Shareholder-proposed initiatives will benefit all shareholders, rather than just a small group.

Investors should find out if the board and management are required to actually implement any shareholder approved proposals. Investors should determine whether:

  • The firm has implemented or ignored such proposals in the past.
  • The firm requires a super majority of votes to approve changes to its by-laws and articles of organization.
  • Any regulatory agencies have pressured firm s to act on the terms of any approved shareholder initiatives.

Different classes of common equity within a firm may separate the voting rights of those shares from their economic value. Firms with dual classes of common equity could encourage prospective acquirers to only deal directly with shareholders with the super majority rights. Firms that separate voting rights from economic rights have historically had more trouble raising equity capital for fixed investment and product development than firms that combine those rights. When looking at a firm's ownership structure, examine whether:

  • Safeguards in the by-laws and articles of organization protect shareholders who have inferior voting rights.
  • The firm was recently privatized by a government entity and the selling entity retained voting rights. This may prevent shareholders from receiving full value for their shares.
  • Any super-voting rights kept by certain classes of shareholders impair the firm's ability to raise equity capital. If a firm has to turn to debt financing, the increase in leverage can harm the firm.

Information on these issues can be found in the proxy, web site, prospectus, or notes to the financial statements.

Examine whether the investor has the legal right under the corporate governance co de and other legal statutes of the jurisdiction in which the firm is headquartered to seek legal redress or regulatory action to enforce and protect shareholder rights. Investors should determine whether:

  • Legal statutes allow shareholders to take legal actions to enforce ownership rights.
  • The local market regulator, in similar situations, has taken action to enforce shareholder rights.
  • Shareholders are allowed to take legal or regulatory action against the firm's management or board in the case of fraud.
  • Shareholders have “dissenters ' rights" which require the firm to repurchase their shares at fair market value in the even t of a problem.

Takeover defenses include golden parachutes, poison pills, and greenmail (use of corporate funds to buy back the shares of a hostile acquirer at a premium to their market value). All of these defenses may be used to counter a hostile bid, and their probable effect is to decrease share value. When reviewing the firm's takeover defenses, investors should:

  • Ask whether the firm requires shareholder approval to implement such takeover measures.
  • Ask whether the firm has received any acquisition interest in the past. Consider that the firm may use its cash to "pay off" a hostile bidder. Shareholders should take steps to discourage this activity.
  • Consider whether any change of control issue s would invoke the interest of a national or local government and, as a result, pressure the seller to change the terms of the acquisition or merger.

Although most of the points mentioned here are based in the US contact. However, the points served as a guideline to take note of when investing in stock anywhere in the world. Personally I feel that this is an area where investors will not spend much time with although it is equally important to know about the corporate governance as well as what and how the company is doing.

The few recent cases that happened here in Singapore are good examples. We may not be able to identify them and avoid it but some understanding how the corporate governance may help investors to be smarter in their next investment.

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