Analysis: European Defenses
Submitted by: Subodh Mishra, Publications
Investors in European companies may sharpen their focus on takeover defenses this year following a recent decision by Europe’s top regulator to pull back on plans to promote the principle of one-share, one-vote.
The future of European corporate takeover defenses--such as multiple voting rights, voting rights caps, and “golden-shares”--has been a key focus of debate in recent months as governance watchers closely monitor the words and deeds of regulators, who, some argue, have taken an inconsistent approach to curbing their use.
For years, key European Union (EU) officials voiced support for investor efforts to promote the concept of one-share, one-vote, arguing the right was consistent with broader EU efforts to dismantle takeover defenses.
"The [c]ommission intends to undertake a study into the way in which the principle of one-share, one-vote can be translated into reality," Frits Bolkestein, head of the European Commission's (EC) Internal Markets, said in a 2004 speech. Ireland native Charlie McCreevy would succeed Bolkestein shortly after that speech, but the commitment remained, with McCreevy backing the right of one-share, one-vote during his own confirmation hearings.
In 2006, investors concerned with the widespread prevalence of takeover defenses on the continent again took heart when the European Court of Justice ruled against the use of “golden share” takeover defenses--giving the holder veto rights over certain transactions--at Holland's dominant telecommunications provider and postal carrier, holding that the use of such defenses restricted the free movement of capital.
To investors, regulators were taking the right approach, despite ongoing calls (and actions) by politicians in some member states to allow for the use of poison pills and other defenses.
But that sentiment would begin to change this summer when a key EU official backed calls by politicians to implement defenses as foreign investors took equity positions in European aerospace giant EADS. The German and French governments sought to install a golden share at the company following equity purchases by a state-controlled Russian bank and the investment arm of the government of Dubai.
EU Trade Commissioner Peter Mandelson tacitly backed their calls, arguing such a defense was warranted on national security grounds, despite the European high court ruling that just one year earlier that had chastised the Dutch government for doing so.
More recently, those who now question regulators’ commitment to dismantling corporate takeover defenses in Europe point to an October decision by McCreevy to back away from his long-held position on equal voting rights. Indeed, on Oct. 3, McCreevy told European lawmakers that he would no longer push companies to adopt a one-share, one-vote capital structure, leaving investors and other proponents of shareholder democracy frustrated.
“It's a shame that the capital markets integration project can’t muster the strength to take on entrenched positions,” noted Anne Simpson, executive director of the International Corporate Governance Network, on the heels of McCreevy’s announcement. McCreevy’s decision effectively sanctions companies’ continued use of the most common defenses, dubbed “control-enhancing mechanisms,” such as multiple voting rights and voting right limitations, which are common in markets ranging from France to Sweden.
In his comments to lawmakers, McCreevy said that shareholders should use their existing voting rights to push for better dialogue and enhanced transparency. But, he noted, a further layer of EU action is “not the right way to go,” given that existing legislation now helps ensure transparency. McCreevy defended his reversal on the one-share, one-vote principle by citing the results of an EU-commissioned study, published in May, which found control-enhancing mechanisms had little effect on a company’s financial performance and governance.
The EC has in recent years weighed the merits of two distinct approaches to concerns over control-enhancing mechanisms. One has centered on the so-called “proportionality approach” to shareholder rights, underpinned by the one-share, one-vote principle, while the other centers on the principle of the freedom of contract, whereby companies can choose the capital structure they deem most appropriate, and investors can choose to invest or overlook the stock.
The study, conducted by RiskMetrics Group’s ISS Governance Services unit and others, examined 464 listed European companies and the regulatory framework in 16 EU jurisdictions as well as Australia, Japan, and the United States. The study found that control-enhancing mechanisms are widely available in all those markets. That, the report's authors say, suggests the principle of freedom of contract is rooted in all legal cultures.
“The general conclusion is that [the study] is a balanced piece of work, which indeed sheds some useful light on this complex subject,” McCreevy told lawmakers.
But weeks later, investors would hear a different, albeit welcome, assessment on takeover defenses when, on Oct. 23, the European high court ruled that Volkswagen, Europe’s biggest carmaker, could no longer employ a 47-year-old takeover defense that capped voting rights at 20 percent regardless of a shareholder’s equity stake. The decision was a major victory for investors and was lauded by regulators as a boost to the nascent EU Takeover Directive, which since 2004 has struggled to level the playing field for defenses among member states.
In its decision, the court criticized provisions of the so-called “Volkswagen Law” that give the federal government and State of Lower Saxony--where Volkswagen is based--the right to appoint two supervisory board members, as well as an 80 percent supermajority requirement required to pass proposals at shareholder meetings. Lower Saxony holds roughly 20 percent of Volkswagen, while the court noted that just 75 percent support is required for the passage of proposals under German law.
The court dismissed arguments by the German government to keep in place protections for Volkswagen on the grounds that failure to do so would have social, regional, economic, and industrial consequences, stating it was unable to explain or demonstrate why the law was necessary to protect workers or minority shareholders. “By maintaining in force the provisions of the Volkswagen Law concerning the capping of voting rights … the Federal Republic of Germany has failed to fulfill its obligations,” to allow for the free movement of capital, the court held.
German justice ministry officials said the government “regretted that the court did not recognize [Berlin's] arguments about protecting Germany as a business location” but added the government would move quickly to rewrite the law, the Financial Times reported.
The European Court of Justice again struck down a national, defense-friendly law when it ruled in December that authorities in the Italian city of Milan could not appoint a majority of energy company AEM's board members. The city, which held 51 percent of the company’s outstanding stock when it was listed in 1998, now holds just 33 percent of the firm, the court noted in its decision.
“In that way they may exercise influence exceeding their levels of investment; that constitutes a restriction on the movement of capital,” the court wrote. Regulators also are weighing potential legal action against Hungary, which recently adopted a law to protect its national energy champion, Magyar Olaj-Es Gaz (MOL).
But while investors and capital markets have signaled their approval of the court’s stance on such defenses, regulatory action on shareholder democracy will not be forthcoming. Speaking to members of Britain’s House of Lords on Dec. 6, McCreevy reaffirmed his intent to take no action on one-share, one vote. The net effect may well mean a spike in shareholder activism in 2008 to dismantle takeover defenses.
This story first appeared in the December issue of RiskMetrics Group’s Corporate Governance Bulletin.
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