The Voice: The Minority Shareholder’s Perspective

Dov Solomon is an Associate Professor at the College of Law and Business, Ramat Gan Law School. This post is based on his recent article, The Voice: The Minority Shareholder’s Perspective, forthcoming in the Nevada Law Journal.

Minority shareholders tend not to participate in the decision-making process of public companies with a controlling shareholder, and their voice is rarely heard. Even when they disagree with how the company is being managed, they prefer to express this dissatisfaction through exit, i.e., by selling their shares, rather than by expressing their voice at a shareholder meeting. Contrary to the prevailing view, my article, The Voice: The Minority Shareholder’s Perspective, suggests that minority shareholder voice is important and desirable.

On the deontological level, this article asserts that shareholder voice has intrinsic value that is independent of any utility it may yield. Corporate democracy legitimizes the exercise of power by the public corporation’s insiders: the controlling shareholder, directors, and managers. Without the mechanisms of corporate democracy and, specifically, minority shareholder suffrage, the exercise of power and control by the public corporation’s insiders is stripped of its ideological foundation and, accordingly, its legitimacy. Indeed, the shareholder’s right to vote is the foundation upon which the public corporation is constructed and sustained. According to this approach, shareholder suffrage is a fundamental right and should therefore be granted special status and protection under corporate law.

On the utilitarian level, this article examines the influence of minority shareholder involvement in a corporation’s decision-making process on aggregate welfare, and argues that shareholder suffrage is efficient and contributes to the development of financial markets. Shareholder’s right to vote ensures that directors and officers are held accountable for their actions. Accountability lowers agency costs, since the threat of replacement pressures directors and officers to align their interests with those of the shareholders. This alignment of interests ultimately leads to greater efficiency and increases financial returns, as it serves to neutralize insiders’ ex-ante incentive to self-deal or expropriate funds. Furthermore, active involvement of minority shareholders in a firm’s decision-making process improves the quality of the protection of the investment community as a whole, which boosts public trust in the stock market and, consequently, increases investors’ willingness to invest in corporations. This, in turn, supports the development of capital markets as well as expands the pool of financial resources available for production and growth.

However, corporate democracy has many detractors, who claim that the shareholder’s right to vote is an evil and not inevitably a necessary one. This article challenges three arguments commonly made for restricting shareholder suffrage, showing that they are neither theoretically convincing nor supported by the empirical research. First, advocates of the contractual approach to corporate law, who view the public corporation as a “nexus of contracts,” might be willing to do away with all constraints and mandatory rules that limit the ability of managers and shareholders to shape their legal relationship. From this perspective, voting rights are a mere matter of private contract between the corporation and its investors. The contractual approach to corporate law is not flawless, however. This article analyzes both theoretical and practical difficulties in using the contractual approach to limit shareholder suffrage.

Second, some may argue that promoting shareholder suffrage will lead to suboptimal decisions that are rooted in short-term interests and will cause harm to the company’s long-term interests. However, this argument does not reflect reality. A significant proportion of the public’s investment in publicly traded companies is managed by institutional investors. Empirical studies show that institutional ownership is associated with higher long-term investment. These findings refute the premise that institutional investors push managers into adopting myopic policies aimed at reaping quick profits. Even regarding investors that are more likely to be concerned about the short-term value of their investments, such as hedge funds, it seems that the criticism of their activism is unjustified. Findings from recent studies have undermined the prevailing view that activist shareholders, seeking short-term profits, cause harm to the company in the long run. Instead, it emerges that activist shareholders benefit the company in both the short term and long term.

Another argument contesting the desirability of minority shareholders’ exercising their voting rights derives from the common preconception that these shareholders lack expertise and have less information than the controlling shareholder and management. Therefore, they might make wrong or suboptimal business decisions that will not maximize shareholders’ profits. However, the wisdom of the multitude of retail shareholders might actually lead to better decisions than the wisdom of the few (controlling shareholder or managers). Moreover, shareholders, particularly institutional investors, acquire knowledge, experience, and expertise through their investments in many corporations. Therefore, at least with regard to matters that are frequently debated at shareholder meetings in different corporations, managers and controlling shareholders do not necessarily wield superior knowledge or expertise as compared to the minority shareholders. But even if we accept that controlling shareholders and managers enjoy better access to information and have a higher level of expertise, there is no guarantee that these advantages will be applied to enhance the corporation’s decision-making process in a way that will maximize the aggregate shareholder wealth. Quite the contrary: controlling shareholders and managers might exploit their superior information and knowledge to derive private benefit by diverting funds into their own pockets, away from the corporation and its investors. Shareholders should exercise their voting rights to thwart such underhanded maneuvering. In this way, agency problems will be kept at bay.

Concentrated ownership companies predominate in capital markets around the world. Given their prevalence, the insights offered in this article should not be taken as solely theoretical. Rather, they can serve as an important normative basis for policymakers in designing reforms aimed at incentivizing minority shareholders to exercise their voting rights and make their voices heard.

The full article is available for download here.

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