Finance research: Shareholders of non-U.S. firms can vote effectively

global investingImagine being a shareholder in a company who couldn’t vote to change how that company is run.

It’s not something that would likely occur in the United States, but little to no finance research exists on the situation outside the U.S. So, Dr. Karl Lins, finance professor at the David Eccles School of Business, decided to explore the issue. He co-authored the paper “Shareholder Voting and Corporate Governance Around the World,” which has been accepted for publication in the Review of Financial Studies.

In it, he and his colleagues researched more than 8,000 firms in 43 non-U.S. countries and found largely consistent results.

“What we find overall is that laws and regulations allow for a meaningful vote to be cast because around the world — in general for the countries we studied — shareholder voting is both mandatory and binding for important corporate elections,” Lins said. “So, it looks like shareholders do have the ability to vote when there are important issues at hand.”

The paper details research on dissent voting, which the researchers found happens more often when there is a fear of expropriation by managers — that is, situations in which managers are likely to be using the shareholders’ money for purposes that serve the managers’ interests rather than the company’s best interest.

“When there is greater dissent voting, that is voting against the recommendations of the management of these firms, then you see more outcomes that are in favor of what the outside investors want,” Lins said.

The three other researchers who co-authored the paper are Peter Iliev, Pennsylvania State University; Darius P. Miller, Southern Methodist University; and Lukas Roth, University of Alberta.

A full podcast and written transcript of Lins describing the paper’s findings is below.

Eccles School: Dr. Karl Lins is the Spencer Fox Eccles chair in banking and professor in finance at the David Eccles School of Business at the University of Utah. Karl researches primarily in the areas of International Corporate Governance and Capital Markets and presents his research at academic and practitioner conferences worldwide. He recently co-authored the paper “Shareholder Voting and Corporate Governance Around the World” and it has been accepted for publication and the review of financial studies. Karl, thank you for joining us. Tell me about your findings.

Karl Lins: The general theme is to test what the title implies which is whether shareholder voting is an important way that investors can exercise corporate governance around the world. And in general what we do in the paper is try to get a broad sample of countries; in particular we were able to find data in 43 countries and that winds up giving us a sample of more than 8000 non US firms; we’re looking outside the US in particular—at this particular topic. And we’re investigating whether laws and regulations as well as the votes cast by an important group of investors, US institutional investors are consistent with an effective shareholder voting process. And what we find overall is that laws and regulations allow for a meaningful vote to be cast because around the world —in general for the countries we studied, shareholder voting is both mandatory and binding for important corporate elections. So it looks like shareholders are having the ability to vote when there are important issues at hand. For the votes cast, we find that there is greater dissent voting when investors fear expropriation. So they’re voting as though they are concerned about having things taken away from them as far as their shareholder rights and therefore, they’re exercising these votes when they fear this extra level of expropriation. And we also find that these are related to outcomes, so when there is greater dissent voting, that is voting against the recommendations of the management of these firms, then you see more outcomes that are in favor of what the outside investors wanted.

So you’ll see more director turnover for instance when there’s greater dissent voting against the directors that are up there on the election slate. And we’ll see more merger and acquisition withdrawals when there’s greater dissent voting against approving the merger in acquisition deal. So overall, our results suggest that the shareholder voting is an effective mechanism for exercising governance around the world.

Eccles School: Tell me about the motivation behind the research.

Karl Lins: Well big picture when you think about it, who owns the firms that are publicly traded firms all around the world? The shareholders own the firms that they invest in, obviously but you think about how they exercise power to try to get the firms to take actions or adopt policies that might be in the shareholders interest. And really the way you exercise power like in any country that has a voting democracy is you vote. So you vote for the board of directors, you vote for important issues when these votes come up as firm policies change overtime or annually for instance for corporate directors. And you want to wonder is this process of voting really effective because it really underpins the whole corporate governance issues that we see today. So for instance without the credible threat of voting against management for instance, other mechanisms used by shareholders to get engaged in activism like registering complaints privately with the management or actually publicly with the media are not going to be as consequential because there’s no power of voting to essentially throw the bums out so to speak if there is a problem. And in the US, people have of course investigated this because it’s a very activism, friendly environment based on the securities and exchange laws. And the research finds that even though votes cast by institutional investors are overwhelmingly in favor of what the management wants, when there is a significant amount of dissent voting, there are meaningful changes such as a board of director member not being reappointed next year or a merger not being approved even though there were enough votes for approval.

So the idea here is that you can conclude at least in the US that meaningful changes in policies do occur when a significant amount of the shareholder votes are cast against the proposals by management. So it seems that there is an effective governance process in the US but if you really think about it, shareholders would definitely want to use this process to engage in activism for the non-US firms that they hold in their portfolios because almost all institutional investors of course invest globally. But it’s going to be even more consequential given the potential for high levels of what we call shareholder expropriation that exists in these firms. And we test whether this voting process works for the non-US firms.

Eccles School: Excellent well tell me more about the expropriation that shareholders may face in settings outside of the US.

Karl Lins: What happens outside the US is that in general companies are owned differently; we’re talking again about publicly traded companies. With the exception of the UK, which has a system very much like the US in which there is a large number of dispersed shareholders or a large number of institutional holders. Other countries especially Europe, Japan, many other places in Asia and even for sure the emerging markets tend to have highly concentrated ownership where a founding family or larger block holder might own more than 50% of the shares for instance or certainly a large block, 10, 20% and sometimes several blocks are held. So this makes you wonder whether the outside small shareholders ever going to get their voice heard and even if they do, would the management act on it because the expropriation can happen when the managers are essentially firmly in control because they have enough of a block of voting power to block anybody else from gathering enough votes to try to say no to have more than 50% no votes. And they really increasingly are seen as facing governance challenges where the investors just don’t want to invest in these firms or the management team and the board of directors have a large chunk of shares because research is uncovering that they often don’t have very shareholder friendly policies. They often pay themselves a lot; they often take actions that seem to be beneficial for their own friends and cronies and not so much for the outside shareholders. So research shows that outside shareholders tend to under invest in these firms; causes them to have a higher cost of capital.

So it’s a real problem for trying to get global growth around the world in the publicly traded firms that investors hold. So this core idea of corporate governance is important to learn more about and that’s why we’re investigating the voting process.

Eccles School: Great, so what essential parts would a voting process need to make it effective?

Karl Lins: Well what we posit in our paper is a voting process to be effective it’s really going to have three important components. And we can analyze these and that’s of course what we do. First of all you have to look at the core laws and regulations of each country and see whether they even exist on the books in a way that makes sense for shareholders to spend some time trying to learn whether they should vote yes or no for a management proposal. And so we say that laws and regulations need to allow meaningful votes to be cast. If you can’t vote on anything important then why waste your time and then we investigate the procedures for what happens when you do make your vote known. And then second, if outside investors fear there’s a governance problem, if they fear expropriation, they should cast their votes in a way that indicates they are indeed exercising governance that is more voting against or dissent voting as we call it, should be correlated with a greater expected potential to have their shareholder interest be harmed by management actions. And third, if it’s an effective voting process, the management should take action when they get a signal that there’s a lot of dissent voting out there so when they tally up the votes and see an unusual amount of no so to speak votes coming through from these outside shareholders, they should take the action. Even though the outside shareholders don’t have enough to mechanically have a 51% no vote, they still are sending a signal and the managers should take that signal seriously and change their actions. That we think would be part of an effective voting process and just to carry it a little bit further, let me first start with the laws.

We research whether a country’s laws and regulations state that shareholder voting is mandatory versus just voluntary, that is the firm can have a vote if they want but they don’t have to. That’s important and when the votes cast are binding versus just advisory, so clearly if it’s mandatory and binding, then this is going to allow for a stronger corporate governance capability whereas if it’s managers call in for votes only when they see it in their best interest, there’s no way you’re going to expect the voting process to even have a chance to work. And if the managers don’t have to implement the vote’s outcome when it is a vote no, then there’s no reason the vote would be important either because they just—if they’re just advisory then they don’t have any teeth to them. So we try to look at that and we try to do this for the most important corporate elections and those would be for directors which tend to happen annually as well as merger in acquisition deals which usually can put a lot of shareholder money at risk. And what we find is that the elections are indeed around the world mandatory and binding. That’s true for director elections for sure and they can’t easily be bypassed by company bylaws and temporary director employments and things like that have to be confirmed at each year’s annual meeting.

So we see that the director laws on the books around the world and the different countries are very, very consistent with an effective shareholder voting process. For the M and A approval, it’s a little more nuanced if you’re an owner of a firm that is the target of a merger, that is somebody’s wanting to take you over then we find that those votes are mandatory and binding. But if you’re the owner of a firm that’s bidding for another in which case oftentimes we see in research that these firms overbid that is they basically agree to pay too much. Those shareholders don’t always have a chance to vote no. The voting rules on the bidder merger and acquisition deal is nuanced and they’re very much dependent on a lot of country and legal factors that use a lot of lawyers. So definitely target shareholders seem to be getting the voting process to be effective but not necessarily the bidding shareholders. But overall our conclusion on that is that the laws and regulations around the world that govern shareholder voting do allow for meaningful votes to be cast.

Eccles School: OK, that cover the laws, what about the firms themselves? After looking at firms in dozens of countries, you found there is a pretty consistent behavior pattern for shareholders. What was that pattern?

Karl Lins: Well what we did find which is kind of what we expected was a large variation in the levels of dissent voting across the 43 countries that we studied but we did also hope to find and did find that they’re consistent. This variation is consistent in the sense that if you look at the country level, how do these institutional investors vote when they expect that there are going to be some of these expropriation problems at the country level? We find lower levels of shareholder support for managements’ recommendations in the countries with weak investor protection laws, weak legal enforcement, low levels of corporate disclosure and a few other areas which would indicate that the shareholders are probably going to find it difficult to understand everything that is going on at the firms. So these are countries where they face more potential expropriation and we find that they engage in greater no voting or greater dissent voting as we call it.

Then at the firm level you can also have these expropriation problems. I was mentioning earlier that many firms have a high level of insider ownership and after effectively fully control the firm. And so what we find is that when there are these high levels of insider control in which they either have an outright majority or have a significant enough block, we find again a greater level of dissent voting. So the voting is happening in situations where the dissent voting that is, where the investors expect greater expropriation. And equally important we find this dissent voting has a governance related outcome that would be important if the investors just vote no when they feel they might be getting their interest hurt but the management doesn’t do anything about it, then we would not have an effective voting process. So what we do on this particular set of tests is search media sources all around the world for descriptions of the voting process for the 8000 firms we have on our sample. And we document cases in which the US institutions’ votes were indeed pivotal for obtaining these governance related outcomes. And then we do the separate set of tests with regression analysis that basically looks at whether the voting support is correlated with the outcomes of the number of directors that might leave the board or the mergers in acquisition deals that are being proposed being cancelled.

And that’s exactly what we find; when there’s less support in favor over directors significantly less, we find the directors in general are not there the next year. This is not of course one to one but it’s consistent with the dissent voting having an influence on whether management or the board of directors removes that direct in the next year. And we also find when there’s less approval ratings for the mergers in acquisition deals, the deals are more likely to be cancelled. So our complete package of research, both the laws and institutions, the way in which the investors vote and the outcomes from their dissent voting do indicate that around the world, our shareholder voting processes that we observe are an important mechanism through which corporate governance is exercised for the firms outside of the US. And this is a new finding and we think that it’s a very important one.

Eccless School: Excellent. Well thank you so much for joining us today and for sharing your research.

Karl Lins: I appreciate having the opportunity to share the research. That’s the only way it gets out there. Thank you.

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