Financial Markets Operations Management (44 page)

The ways in which corporate entities are governed and controlled are known collectively as
corporate governance
. In particular, corporate governance refers to the ways in which corporations interact with their internal stakeholders (e.g. boards of directors, senior managers and employees) and external stakeholders (e.g. shareholders, bondholders, suppliers, customers, governmental agencies, etc.).

For the purposes of this book, we are only concerned with the relationship between the corporation and its shareholders and bondholders.

[The European Corporate Governance Institute has some useful information on its website (
www.ecgi.org
) including the full texts of Corporate Governance Codes for the United Nations and the many countries from which the membership is drawn.]

It is the responsibility of the corporation's board of directors to maintain a dialogue with its shareholders based on the mutual understanding of its objectives. This includes discussions with major shareholders on the corporation's governance and strategy and listening to its shareholders' views.

Corporations use the AGM to communicate with shareholders and to request them to vote on resolutions on issues such as:

• Electing directors;
  
• Appointing auditors;
  
• Approving by-laws and by-law changes;
  
• Fundamental changes, for example:
  
  • Amending the company's name, or
    
  • Amending the articles regarding such matters as the location of the registered office, restrictions on share transfers, restrictions on activities and changes involving such matters as amalgamation, dissolution and continuance;
    
• Selling all, or substantially all, of the company's assets.
  

You should be aware that shareholders are not involved in the day-to-day management of the company; this is the responsibility of the company's directors and managers.

Typically, shareholders with ordinary shares/common stock receive one vote per share. Other variations include:

• Each Class B ordinary share/common stock is entitled to ten votes;
  
• Each non-voting ordinary share/common stock does not carry a vote.
  

These proposed changes are summarised in the information circular sent to shareholders prior to the AGM. The share register is closed at least ten days before the AGM to enable the company secretary to prepare a list of shareholders and the number of shares held by each.

However, this means that, in theory, the shareholder must attend the AGM in order to exercise his/her vote.

Since the early 1990s and especially since the Cadbury Report was published in the UK during 1992,
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there has been a growing move to encourage investors of all sizes (the owners of the company) to pay more attention to corporate governance in the companies in which they have invested. Consequently, there has been an increasing need to vote one way or the other on the resolutions presented at the AGM.

With the challenges noted above, there had to be alternative solutions to enable voting to take place. Three solutions have been introduced:

• Electronic voting (i.e. there is no requirement to attend an AGM in person);
  
• A reduction in the costs involved;
  
• Allowing a third party to vote on behalf of the investor (i.e. proxy voting).
  

So, proxy voting occurs when a shareholder appoints a third party to vote on his/her behalf, usually in the absence of the shareholder. Depending on the local conventions, the investor
can either instruct his custodian to vote or send a proxy card to the company's agent. For each resolution placed before the AGM, shareholders have the option to instruct their proxy to vote:

1. For the resolution;
   
2. Against the resolution;
   
3. To withhold their vote.
   

We have noted above that voting was not normally an issue for the majority of shareholders unless there was some kind of conflict between shareholders and the directors of the company. In the 21st century, this attitude has changed and shareholders are more willing to express an opinion through the voting mechanism.

This presented the industry with a number of problems, not least of which was the communication chain between the company (issuer) and the shareholder. If proxy voting was to become the norm, then there had to be a degree of standardisation on timing and information issues. In its 1992 symposium, ISSA reported on cross-border proxy voting and made recommendations on improving procedures and looking at the data content of any information.

Preference shares (preferred stock) are a class of shares that contain one or more features that ordinary shares (common stock) do not. These features can include:

• Dividends:
  Most preference shares have a fixed dividend amount; either quoted as a percentage or as an amount per share. The company must pay the preference shareholders before the ordinary shareholders.
  
• Liquidation:
  Preference shareholders rank senior to the ordinary shareholders but junior to the remaining creditors.
  
• Convertibility:
  The investor has the right to exchange preference shares for ordinary shares if the preference shares have a conversion feature.
  
• Voting rights:
  Normally, preference shareholders do not have the right to vote. Under certain circumstances, however, shareholders may gain the right to vote should dividends not be paid.
  

Bondholders are creditors of the company and do not have the right to vote. By contrast, shareholders legally own a share in the issuing company. In the normal course of events, the company has a fiduciary obligation to its shareholders but not to its bondholders.

These relationships can change in the event that the company gets into financial trouble prior to going into administration or filing for bankruptcy. In this case, a committee is appointed to look after the bondholders' interests. Should a company become bankrupt or go into administration, then the company's creditors are repaid, subject to sufficient assets being liquidated. In the
meantime, bondholders will not receive any further coupon payments or shareholders any further dividends.

There is an order in which creditors are repaid, usually based on the degree of risk when issuing money to the company (see
Table 11.34
).

In all probability, this may not be a good idea from the company's point of view. With the use of nominee names, it can be possible to build a substantial holding in a company without the company knowing who the stakeholder is. For this reason, companies are entitled to know who the underlying beneficial owner is and this can be achieved by demanding that the nominee reveal who the underlying investors are. Failure to declare the information will result in the holding being frozen (e.g. no share transfers or dividend payments).

Depending on the market, investors holding less than 1% of the voting shares in a company are regarded as
minority shareholders
and more than 5% as
majority shareholders
. Reporting rules have a provision that once a shareholder becomes a majority shareholder, the shareholder (or its agent) must disclose that fact to the appropriate authorities. In addition, further disclosure is required when the holding increases past the next whole percentage point and/or decreases likewise. This enables the company's directors, employees and shareholders (together with
the relevant authorities) to ascertain who is in a position to control or influence control of the company. On reaching a predefined level, the investor can be forced either to dispose of some shares or to make a formal bid to the company.

Examples of large holdings limits are shown in
Table 11.35
.

On 11 October 2013 the British Government floated the Royal Mail at an IPO price of 330p per share. The IPO proved to be such a success that by the end of the month the price had risen to 560p per share. It was reported in the
Financial Times
that the following institutional investors had acquired major shareholdings in the company:

• GIC (Singapore's sovereign wealth fund) – 4.1%;
  
• The Children's Investment Fund (a hedge fund) – 5.8%.