DIFFERENTIAL VOTING RIGHTS: THE UNDERLYING LINK BETWEEN ACQUISITIONS AND TAKEOVERS, MANAGERIAL CONTROL, AND OPPRESSION OF MINORITY SHAREHOLDERS BY - BHAKTI MAKHIJA
DIFFERENTIAL
VOTING RIGHTS: THE
UNDERLYING LINK BETWEEN ACQUISITIONS AND TAKEOVERS, MANAGERIAL CONTROL,
AND OPPRESSION OF MINORITY SHAREHOLDERS
AUTHORED BY
- BHAKTI MAKHIJA
In its most
basic form, DVR refers to and include voting or dividend rights. It indicates
that not all equity shares are same in terms of voting rights. It's possible
for shareholders to own shares with fewer voting rights or shares with higher
voting rights. A shareholder must make a compromise in order to receive a
greater dividend rate if he owns equity shares with additional voting rights.
Similarly, a greater dividend rate goes to shareholders who have less or no
voting rights.
This paper
aims to answer “Whether the Differential Voting Rights are used as an
instrument to assert control over a company’s operations by founders and
majority shareholders and does such control obtained is leading to oppression
of minority shareholders? If yes, are these factors of control and minority
shareholders oppression influencing takeovers or acquisitions.”
The answer
to the research issue was reached through theoretical study, which gathered
data to lay the groundwork for determining whether or not minority shareholders
are oppressed. Now that the foundation has been laid, I had to apply the
Deductive research process to establish a connection between the takeover
domain and reality.
This paper
will attract the interest of the legal community because it addresses the legal
gray area where unethical acts exist but aren't strictly unlawful because of
legal loopholes. Minority owners of shares are grey areas in the law, without a
well-drafted framework, including oppression and acquisitions by majority
shareholders without the well-informed permission of other shareholders.
Because there is no framework in place, everyone in the community have an
opportunity to break the law and escape away with it. This essay examines
that grey area. Consequently, assisting in giving the legal community
further information regarding reality.
1.
Managerial Control asserted through Differential
Voting Shares
One of the
most important—and delicate—factors in determining a company's effectiveness is
managerial control over operations and decision-making. Businesses with a dual
class capital structure, are provided control with instruments called
Differential Voting Shares. The promoters and founders company typically
retain shares with superior voting rights so they can run the business in the
way they see fit.
Case study
on Google:
Google's
Board of Directors approved a resolution in 2012 to form a new class of
non-voting Class C shares.[1]
Prior to its scheduled recapitalization, Google's capital structure was made up
of Class A shares, each of which has one vote for each shareholder. In
contrast, each Class B share that a shareholder owned gave them 10 votes. The
founders of Google, Sergey Brin and Larry Page, owned the majority of the
Class B shares.[2]
The founders possess the majority of the Class B shares since they provide them
significant voting power over the corporation. Hence, eliminating the chance of
being outvoted while making important decisions.
Since more
of Class A shares will reduce the voting power of Class B shares, Google
decided to issue new Class C shares rather than more Class A shares. [3]
Control
issues usually occur when an external investor with a stake in the company
tries to challenge the current manager's authority and gain control in
different ways. The authority of owners of distinct class shares to exert
control varies, which impacts the control problem. More voting power might
potentially provide stockholders greater influence over management. [4]
Case study
on Facebook:
Facebook
intended to issue nonvoting shares in order to raise additional funds. The
choice of using nonvoting shares as a funding source was made because
it allows them to raise and use a significant sum of money "without
diluting the ownership stake" of Zuckerberg, founder of
Facebook.[5]
We can see
that the founders of Google and Facebook and Google shared the goal of
raising money "without diluting ownership stake" from the
aforementioned case studies. Raising more money without reducing founder
ownership is a common organizational strategy. Ensuring that the founder
retains managerial and corporate control over the business is the
fundamental goal of implementing this method. A company's founders want to own
a significant enough share to have an impact on managerial control since that would
allow them to run the business in a way that aligns with their vision. Founders
frequently end up with the majority of voting rights because of their concern
that outsiders would not share the same vision for the company. But,
however, the founders are able to follow their goal in spite of investor
opposition because of the power they have gained through their voting rights.
The founders and other investors—minority stakeholders—cause friction between
the two.[6]
Minority
stakeholders place a higher value on corporate control over daily
decision-making because they believe that control over the company will serve
as a buffer against risks that they assume, like poor management agency
expenses, and self-dealing. By using a balanced allocation of cash
flow rights and control rights—the rights that will determine who will receive
capital gains and a share of profits and how much they will
receive—between founders and other stakeholders, the friction caused by the
founders' vision and the risks taken by other investors (minority stakeholders)
is often minimized.[7]
The
founders will receive the majority of the controlling rights, which
will allow them to pursue their objective for the company, and other
stakeholders will receive the majority of the cash flow rights, which will
protect them from agency fees.[8]
For instance, suppose that in the case of Google, the Class A shareholders
disapproved of the capital raising plan that involved the issuance of Class C
shares because they thought it would increase the possibility that the founders
would abuse their position of control and the risk of agency costs. The
founders, after all, had a sincere belief that their plans for the company's
future would result in a significant increase in its value. The Google founders
would now have to give up on their company's goal unless they find another
source of funds.
It’s clear
from the Google different hypothetical scenario above that the founders'
original intentions for the business are sacrificed in order to give minority shareholders
the ability to defend themselves against the possibility of agency expenses.
The parties are therefore forced to choose between two flawed systems: either
permit the controller to unilaterally reallocate control rights, which would
protect the pursuit of their vision but expose the parties to high agency costs
or grant minority shareholders a right of veto, which would protect
against agency costs but might sacrifice their vision for the company.
The parties
are forced to decide which risk is more costly— the founder's vision or
exposure to agency costs —in order to distribute control rights. The
answer to this question is firm- and person-specific, thus the parties will
have to decide ex ante based on their respective bargaining positions and accept
whatever ex post ramifications flow from that decision.[9]
It is clear
from the study of the influence that the company's founders were able to
acquire through differential voting rights that there is an excessive
control and power held by few people—the founders.
2.
Greater the power, the more dangerous the abuse: Oppression
of minority shareholders.
As was
previously said, a company's founders frequently have enough voting rights to
affect the direction and decision-making of the business. Also, it goes
without saying that a business must follow the decisions made by the majority
of its voting members. When founders own 2/3 of the voting rights, or 66% of
the total, they're essentially in a position to make any company decision
without taking the opinions of the remaining minority shareholders into
account. Stated differently, minority shareholders might face oppression
if their beliefs conflict with those of the majority shareholders. The scope of
future exploitation by the majority shareholders is expanding due to the lack
of legal framework remedies available to safeguard the oppressed
stockholders.
Unless the
minority shareholders can provide compelling evidence that the majority
shareholders misused their authority, they've to accept the choices made
by the majority shareholders. Even though common law contains ground rules
designed to safeguard minority shareholders from majority shareholders abusing
their power, courts have been hesitant to apply them because they have upheld
their position of not interfering with a company's internal management
or affairs.[10]
In the case
of Burland v. Earle, Lord Davey ruled that "the court has no
jurisdiction to interfere with the internal management of the companies acting
within their powers."[11]
In essence,
Lord Davey's opinions are correct since, both in practice and in theory,
company decisions should be made in line with the opinions of the majority of
voting shareholders. In situations where the founders possess sufficient voting
rights to impact the decision-making processes and company's governance,
according to law, the majority technically makes the choice.
Therefore, the founders' claims of corporate control
and governance would not be unlawful. Due to this, there is currently
a legal gray area where minority owners' persecution will not be acknowledged
unless they can provide evidence of explicit misuse of power and the
majority shareholders' flagrant.
The
Committee on Company Law Amendment's 1945 Cohen Report was the first to
acknowledge the tyranny that minority shareholders suffered. By extending the
reach of Section 210 of the Companies Act (UK) 1948 (and Corresponding Section
397 of the Companies Act 1956), it cleared the path for giving courts more
authority to interfere with business affairs.[12]
The Jenkins Committee also acknowledged that it was necessary to shield
minority shareholders against injustice. "Section 210 had to be amended to
afford effective protection to minorities in circumstances such as those with
which it is intend to deal," the committee stated in its report.[13]
Section 210
was not amended to include a clause allowing for the determination of whether a
company's operations are oppressive. Despite the fact that two professional
committees were appointed to produce research studies on company law have
acknowledged the idea of minority shareholder oppression and the necessity of
giving them legal protection. There is conflict in law because there is
no legislation that defines oppression because judges are overly
relied upon to make this determination. The main issue facing the minority
is not only that others have expressed a different opinion; but it's also
that they have to accept it, even in cases where their concerns are valid and
well-founded.[14]
To allow otherwise would be to defy the majority vote, which is an extreme
measure made more grave by the fact that the court involved openly asserts its
ignorance of interfering with a company's internal affairs.
Following
the aforementioned advances in corporate law, the judiciary has only
occasionally acknowledged oppression. The first two cases are Re H. R.
Harmer Ltd. and S.C.W.S. Ltd. V. Meyer and Another, where Section
210 was correctly understood and put into practice to shield minority
shareholders against persecution. But because the determination of what
constitutes oppression rests only on judgment, rulings made were not consistent.
In Elder v. Elder, two petitioners made Section 210 assistance requests
where one of the petitioners was forced to resign as secretary and was
dismissed from the Board. The other petitioner lost his job as a manufacturing
facility manager. Both of these petitioners were stockholders. The
reconstituted Board refused to buy the petitioners' shares when urged to do so.
These realities were said to be oppressive. The Scottish Court of Session's
Inner House, however, denied the petition, stating that the facts failed to
show that the petitioners had suffered oppression as shareholders.
Consequently, the ruling restricted the application of Section 210 by
designating it as shareholder-exclusive. [15]
In the
context of Section 397 of the Companies Act, the Supreme Court of India has
accepted and applied the rationale of Elder v. Elder in Shanti Prasad
Jain v. Kalinga Tubes.
Therefore,
before oppression de facto is considered to be oppression de jure, substantial
specific evidence is needed.[16]
That is the point at which conduct becomes “oppressive,” or, to put it another
way, “harsh, burdensome, and unlawful,” or “an element of lack of probity and
fair dealing,” or “a visible deviation from the standards of fair dealings and
a violation of the conditions of fair play.”[17]
While
Section 210 (and related Section 397) can be viewed as a daring endeavour in
and of itself, the Cohen Committee was disappointed that it was unable to
provide the benefits that Minority Shareholders had hoped for.[18] The authority granted by that clause is
unquestionably necessary, but putting it into practice will require
a prudent, daring and well-resourced initiative. I agree that one of
the main responsibilities of the law in this regard is to precisely outline
the obligations and rights of all parties involved, including the
owner/manager, external investors, established employees, in order to
lessen the possibility of abuse and fraud. However, the law also needs to
set reasonable, workable standards of conduct for management
and directors.
When the
minority has barely any voice and too much power is concentrated in a
small number of hands and to make a difference, the boundaries of the
democratic process are certain to become hazy. This phenomena frequently occurs
in businesses, particularly during mergers and acquisitions.
3.
Acquisitions and Takeovers: The relationship between
Minority Shareholders and Managerial Control
Regardless
of whether one believes that hostile takeovers have detrimental effects on
the society and economy or that they greatly improve capital markets,
it is becoming clear that the takeover process needs more democratic and
open democratic procedures. Despite their lack of glamour, ethical
concerns are important and have a bearing on the decision-making process when
it comes to investments. The rapidly evolving sector of corporate takeovers
frequently exhibits legal and ethical overlap. It's important to
understand that moral failings of today can lead to legal violations of
tomorrow.[19]
Analysis of
Facebook acquisition of Instagram:
The $1
billion USD price that Facebook paid for Instagram made it the most expensive
acquisition in the history of Internet corporations. On April 8, 2012, the
acquisition proposal was made to Facebook's board of directors. On the other
hand, the specifics of the agreement have been discussed since April 4, 2012,
when Facebook's founder Mark Zuckerberg and Instagram's Kevin Systrom first
spoke.[20]
Unlike the
customary formal approach of discussing the deal with the boards of directors
of both firms present. The specifics were worked out in Zuckerberg's residence
with just one Facebook representative there. Weeks of work are needed from
the accounting and legal departments to draft necessary documents,
determine the valuation, and other tasks when a $1 billion USD acquisition
takes place. However, since Mark Zuckerberg owns 57% of the voting rights and
28% of the Facebook stock, none of these tasks were necessary for the Instagram
acquisition.[21]
He
coordinated the acquisition on his own without the board's approval by
leveraging the voting rights he acquired through differential voting shares.
The proposal was merely a formality and more of an presenting
information than a consent seeking when it was brought before the board.[22]
From the
acquisition mentioned above, it is clear that acquisitions and
takeovers are largely influenced by the oppression of minority
shareholders and founders ‘combined extreme. The bulk of voting rights are
retained by the founders in order to maintain their influence. Zuckerberg owns
57% of the voting power even though he only owns 28% of Facebook's stock. In
addition to granting the founder authority and huge influence, this
also dehumanizes and makes others voiceless.
It's vital
to remember that in this case, differential voting shares are being used as a
means for control and oppression. Assume for the purposes of hypothetical
discussion that Facebook only has a one share-one-vote policy. In this
scenario, not only will it be nearly impossible for Zuckerberg to maintain the
same level of control that he had with differential voting shares, but it is
also highly unlikely that he will own more than 50% of Facebook, as this would
complicate capital raising. Furthermore, since he does not own more than 50% of
the company, he will not be able to make decisions without first consulting
other shareholders, as he will no longer have the necessary voting power.
This would imply a significant reduction in the potential for power abuse and
tyranny, in addition to the decentralization of authority over company
operations.
Steps
Forward and Conclusion:
One may
view the Differential Voting Rights as a "Double Edged Sword." The
sword's wielder impacts its effectiveness. To keep it from affecting the
corporation itself, the proper distribution of democracy and power in
voting rights must be achieved. Just as a founder's control is crucial to
realizing the company's vision, the remaining shareholders must also have
sufficient clout to have their opinions taken seriously as well. Giving the
minority shareholders' opinions its importance will benefit the company
because it will serve as a second opinion and cautionary tale, making the
founders reconsider their decisions. Consequently, denying the founder free
reins in pursuance of vision.
A
legal framework is required for the lawmakers to take into account
minority shareholder opinions—especially when they differ from those of the
majority—and contact a third-party to consult the decision's logic
and legitimacy will help strike a balance. This would guarantee a
reduction in the conflict b/w minority shareholders and
founders as well as democratic decision-making in important areas
like acquisitions and takeovers.
[1] ‘The New York Times Company’ (The New York Times, 30
April 2012) https://archive.nytimes.com/dealbook.nytimes.com/2012/04/ accessed 31
October 2023
[2] (Harvard
Business Law Review (HBLR)) https://journals.law.harvard.edu/hblr/ accessed 31
October 2023
[3] (Corporate
control, dual class, and the limits of judicial review - jstor) https://www.jstor.org/stable/26915804 accessed 31
October 2023
[4] (Corporate control, dual class, and the limits of
judicial review - jstor) https://www.jstor.org/stable/26915804 accessed 31
October 2023
[5] (Pre 14A) https://www.sec.gov/Archives/edgar/data/1326801/000132680116000053/facebook2016prelimproxysta.htm accessed 31
October 2023
[6] (Corporate
control, dual class, and the limits of judicial review - jstor) https://www.jstor.org/stable/26915804 accessed 31
October 2023
[7] (Corporate
control, dual class, and the limits of judicial review - jstor) https://www.jstor.org/stable/26915804 accessed 31
October 2023
[8] (Corporate
control, dual class, and the limits of judicial review - jstor) https://www.jstor.org/stable/26915804 accessed 31
October 2023
[9] (Corporate control, dual class, and the limits of
judicial review - jstor) https://www.jstor.org/stable/26915804 accessed 31
October 2023
[10] (Wiley Online Library) https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1468-2230.1972.tb01325.x accessed 31
October 2023
[11] Burland v. Earle [1902] A.C. 83, 93.
[12] ‘Arbitrability of Oppression’ (Scribd) https://www.scribd.com/document/449718771/Arbitrability-of-oppression accessed 31
October 2023
[13] (Jenkins Committee on company law - JSTOR) https://www.jstor.org/stable/41139654 accessed 31
October 2023
[14] (Wiley Online Library) https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1468-2230.1972.tb01325.x accessed 31 October 2023
[15] Elder v. Elder &
Watson Ltd.,1952 S.C. 49,57
[16] Rubner
A, The Ensnared Shareholder: Directors and the Modern Corporation (Penguin
1966)
[17] (Wiley Online Library) https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1468-2230.1972.tb01325.x accessed 31 October 2023
[18] (Wiley Online Library) https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1468-2230.1972.tb01325.x accessed 31 October 2023
[19] Gillis J and Casey J, “Securities
Law and Regulation” (JSTOR) http://www-jstor-org.opj.remotlog.com/stable/4478815?searchText=ethical+considerations+in+takeovers&searchUri=%2Faction%2FdoBasicSearch%3FQuery%3Dethical%2Bconsiderations%2Bin%2Btakeovers%26so%3Drel&ab_segments=0%2Fbasic_search_gsv2%2Fcontrol&refreqid=fastly-default%3A195af568fa0ea5dff93446b8ac7dea03#metadata_info_tab_contents
accessed October 31, 2023
[20] ‘In Facebook Deal for Instagram, Board Was All but
out of Picture’ (The Wall Street Journal, 29 October 2012) https://www.wsj.com/articles/SB10001424052702304818404577350191931921290\> accessed
31 October 2023
[21] ‘In Facebook Deal for Instagram, Board Was All but
out of Picture’ (The Wall Street Journal, 29 October 2012) https://www.wsj.com/articles/SB10001424052702304818404577350191931921290 accessed 31
October 2023
[22] ‘In Facebook Deal for Instagram, Board Was All but
out of Picture’ (The Wall Street Journal, 29 October 2012) https://www.wsj.com/articles/SB10001424052702304818404577350191931921290\ accessed 31 October 2023