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E-MailHenry T. C. Hu is the Allan Shivers Chair in the Law of Banking and Finance at the University of Texas Law School, and Lawrence A. Hamermesh is an Emeritus Professor at Widener University Delaware Law School. This post is based on their recent paper.
“The shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests.” In the generation since Chancellor William Allen’s soaring rhetoric in Blasius, the “transcending significance” of the franchise has become corporate governance catechism. His hope, if not expectation, was that the rise of the institutional investor would help the franchise transition from an “unimportant formalism” to an importance of source of discipline.
This catechism has motivational alignment as its foundational premise: a shareholder’s economic ownership will generally motivate her to use the associated voting rights to promote share value. Implicitly, the premise assumes that the voting rights and the economic rights of share ownership are inextricably linked—i.e., are “coupled.” Transformative institutional investor changes are increasingly undermining the premise, animated in large part by an accelerating, but insufficiently recognized, severing of that link—“decoupling.”
Such institutional investor voting misalignments—from decoupling such as “empty voting” and “empty voting with negative overall economic interest”—are increasingly pervasive. They are no longer limited to hedge funds affirmatively deploying motivational misalignments as a strategy, based on decoupling through byzantine, often derivatives-laden, financial stakes and novel uses of longstanding organizational voting dynamics such as share borrowing. Our 2023 article showed that decoupling-related motivational misalignments were now also occurring with surprising frequency at mainstream institutional investors. With these investors, such decoupling-related misalignments are not matters of strategy, but instead are byproducts of transformative changes in financial stake patterns (e.g., the now-gargantuan size of certain asset managers and the rise of indexing) and in a variety of organizational voting dynamics (e.g., the emergence of value-destructive versions of ESG-based investing and voting) occurring for independent reasons.
This Article adds to the existing literature on decoupling-based motivational misalignments in four major ways.
First, this Article offers a baseline and terminology for the systematic analysis of the direction and magnitude of such misalignments. We show that to ascertain incentives of an institutional investor in this context, it is necessary to determine the combined effect of: (a) the investor’s positive, negative, or zero “overall economic interest” in the host shares (flowing from the investor’s holdings of “host shares,” “coupled assets,” and “related non-host assets”); and (b) the investor’s “organizational voting dynamics.”
Second, this Article refines our 2023 article’s analysis of the failure of the core judicial response to departures from the foundational premise to come to grips with the transformative investor changes. That response is animated by the construct of a “disinterested shareholder”— in essence, a shareholder whose financial stakes incentivize them to vote or tender their shares in value-maximizing ways. In challenges to transactions otherwise subject to judicial review under enhanced scrutiny or entire fairness standards, Delaware courts have long given validating effect only to uncoerced, informed “disinterested” stockholder votes. The core response is embodied in two well-known lines of cases—the “MFW” line and the “Corwin cleansing” line. With the April 2024 Delaware Supreme Court Match Group decision, the role of such votes will likely increase and with it, the importance of the judicial construct.
Our 2023 article warned that institutional investors—including the largest asset managers—would be disqualified from being considered “disinterested” with surprising frequency. This would, ironically, and through complete inadvertence, shift voting power to individual investors, the very group at the core of Berle-Means concerns, as well as to activist investors.
Beyond urging a reconceptualization of “disinterestedness” to comprehend misalignments flowing both from financial stakes and from organizational voting dynamics, this Article shows that there is an even more basic problem with the doctrine. It is close to impossible to accurately and comprehensively assess the disinterestedness of most large institutional investors. Even with the most transparent of institutional investors, the gap between the data that is available to the public or the host company and what is needed is stunning. Voluntarily supplied and subpoenaed information cannot fill the gap.
Third, this Article shows that, notwithstanding the power of the vision for the role of the stockholder franchise and its ostensible foundational premise, in reality, the law insists only erratically on alignment of voting power and economic interest. We offer a taxonomy showing contexts reflecting varying degrees of such insistence.
This taxonomy helps unveil new insights as to the entirety of the shareholder franchise. We show, for instance, how the relatively stringent judicial constraints on transfers of “decoupled” voting rights could be interpreted to not only limit certain misalignments in the direction of incentives but also certain misalignments in the magnitude of incentives flowing from such transfers. Such constraints would potentially affect all contexts in which shareholder voting occurs, even extending to the exercise of statutory voting rights (e.g., voting as to election of directors and fundamental transactions such as mergers)
Fourth, and most important, this Article offers a focused, scaled, and cost-effective solution that overcomes the daunting informational challenges posed by insistence on shareholder disinterestedness. That solution begins with a presumption of disinterestedness. Failing to adopt such a presumption – in effect, requiring affirmative proof of disinterestedness – would be tantamount to a blanket rejection of decades of precedent giving validating effect to shareholder approval in important contexts. Such a striking diminution of the role of shareholders and a corresponding enhancement of the roles of judges and boards should occur, if at all, only after careful debate–not by fluke. Moreover, such a diminution of the role for the stockholder franchise would be inconsistent with the incremental and thoughtful approach Delaware courts have taken in addressing cases of transfers of voting rights without accompanying economic rights.
The Article further outlines a workable, focused process that, notwithstanding the daunting informational challenges, would help identify material instances of institutional investor departures from disinterestedness. The proposed presumption would be rebuttable through the use of readily available public information about institutional investor holdings, and would allow for a full evidentiary review of disinterestedness where such an investor’s holdings or disinterestedness are not clearly too insignificant to affect its vote or to influence the overall outcome of a shareholder vote.
The gap between the vision and reality of the stockholder franchise is increasing in undesirable ways due in large part to transformational investor changes. This Article shows that vision and reality should not and need not always be binary opposites.
The complete article is available here. http://ssrn.com/abstract=4803339
