Strategic Information Management Third Edition Challenges and Strategies in Managing Information Systems_8 potx

The amendmentsprovide for a set of annual disclosures pertaining to the governance, own-ership and control arrangements of the company.13 All companies incorpo-rated in EU Member States,

through directives that set a minimum standard for all Member States, whileallowing for customisation to address local idiosyncrasies.

Nevertheless, the amount of EU legislation related to company law, ernance and equity market transparency has been quite impressive: more thantwelve directives and implementing directives, two recommendations and oneregulation have entered the books between 2003 and 2007 As noted in theCommission’s report on the results of the 2006 consultation on the future of theECAP, ‘a number of respondents stated their regulatory fatigue and called for

gov-a stgov-abilisgov-ation period’.9 In many instances, the Commission has made it clearthat it will heed these calls, take it easy on primary legislation and allow timefor bedding-in the changes

Transparency

Turning to the first of the EC’s regulatory objectives in the corporate nance area, the most important development is the emergence of harmonisedstandards of transparency and disclosure of governance, ownership and controlarrangements This is in addition to earlier harmonisation measures in finan-cial reporting, where IFRS compliance has been implemented since 2005 Atthe end of the implementation period, investors should benefit from a uniformtemplate for the supply of non-financial information across the EU This mayfacilitate the growth of institutional portfolio internationalisation discussed inthe first part of this chapter, putting issuers on a competitive footing as theyseek capital across borders

gover-Comply-or-explain

The first, and most important, element of governance transparency has been thepositioning of national, comply-or-explain voluntary codes at the heart of Euro-pean corporate governance policy The Commission accepted that ‘the adoption

of detailed binding rules is not necessarily the most desirable and efficient way ofachieving the objectives pursued’.10It has adopted the UK approach of lettingmarkets regulate governance of listed companies Investors and other stake-holders benchmark governance arrangements in individual companies against

a national codified body of best-practice principles and provisions These Codesare typically the result of negotiation between market participants, blessed bythe regulator Thus, a key recent regulatory trend has been the proliferation ofnational corporate governance codes in Member States that are implemented

on a comply-or-explain basis As of July 2007, there is only one Member State,

9 European Commission, Report on consultations for future priorities for Action Plan, July 2006,

p 7 http://ec.europa.eu/internal market/company/docs/consultation/final report en.pdf.

10 Commission Recommendation 2005/162/EC on the role of non-executive directors or sory directors of listed companies and of the committees of the (supervisory) board.

supervi-Greece, that does not have a comply-or-explain Code A recent review11of theseCodes found that their substantive, normative content is broadly similar across

EU borders and follows the lines enshrined in the OECD Principles,12 which

is considered the global benchmark for the development of national policies.This confirms the Commission’s initial view that national Codes should act asbottom-up drivers of convergence

While the Commission decided not to regulate core governance issues that

go beyond transparency and shareholder empowerment, it did issue two binding Recommendations whose primary purpose is to provide guidance todrafters of national codes The first EC Recommendation addresses the role ofnon-executive directors and that of board committees in ways that will seemvery familiar to any company that implements the UK Combined Code Com-mission officials have made it clear on a number of occasions that, shouldthe Recommendation not produce greater voluntary convergence, they mightconsider direct regulatory action

non-The second Recommendation addresses the issue of director remunerationand lays down basic principles on accountability and transparency in settingpay In a nutshell, shareholders should be fully informed about the executiveremuneration policies of issuers and the remuneration of individual directors,and be given an opportunity to express their views at the annual general meeting;they should also have the right to approve share-based incentive schemes.Reportedly, the EU remuneration Recommendation strongly influencedthe adoption of German legislation in 2005 mandating the detailed disclo-sure of individual executive pay packages It was felt that such legislation wasneeded because of the ineffectiveness of the relevant provisions in the GermanCode

Annual disclosures

In order to underpin and consolidate the role of national codes in governancetransparency and convergence, the EU has adopted amendments to the fourthand seventh company law directives (the ‘amendments’) The amendmentsprovide for a set of annual disclosures pertaining to the governance, own-ership and control arrangements of the company.13 All companies incorpo-rated in EU Member States, and whose securities are traded on a regulatedmarket in the EU, must include a specific corporate governance statement intheir annual reports The statement must be included as a separate part of theannual report (or as a separate report) and must contain at least the followinginformation:

11 Holly J Gregory, International Comparison of Selected Corporate Governance Guidelines and

Codes of Best Practice, Weil, Gotshal & Manges, July 2005.

12 See OECD, Principles of Corporate Governance, available at www.oecd.org.

13 EU Directive 2006/46/EC.

r a reference to the national corporate governance code applied by the pany, and an explanation as to whether and to what extent the companycomplies with that corporate governance code; if the company does notapply a code, it should explain its corporate governance in the report;

com-r a description of the company’s internal control and risk managementsystems;

r the information required by Article 10 of the Directive on Takeover Bids(see below);

r the operation of the shareholder meeting and its key powers, and a tion of shareholders’ rights and how they can be exercised;

descrip-r the composition and operation of the board and its committees;

r to the extent a company departs from the national corporate governancecode, the company must explain from which parts of the code it departsand its reasons for doing so

Article 10 of the Takeover Bids Directive, adopted in 2004, requires that theannual reports of companies should include information regarding:

r the structure of their capital and any restrictions on the transfer ofsecurities;

r significant direct and indirect shareholdings;

r the system of control of any employee share scheme where the controlrights are not exercised directly by the employees and restrictions onvoting rights;

r the rules governing the appointment and replacement of board membersand the amendment of the articles of association;

r the powers of board members, and in particular the power to issue or buyback shares;

r any significant agreements to which the company is a party and whichtake effect, alter or terminate upon a change of control of the companyfollowing a takeover bid;

r any agreements between the company and its board members or ees providing for compensation if they resign or are made redundantwithout valid reason or if their employment ceases because of a takeoverbid

employ-Moreover, according to the amended eight company law directive, adopted in

2006, the audit committee (or, under certain circumstances, other equivalentbodies or the board as a whole) is obliged ‘to monitor the effectiveness of thecompany’s internal control, internal audit where applicable, and risk manage-ment systems’.14 The audit committee’s monitoring responsibility extends tothe whole of the internal control and risk management system, a remit thatmirrors the UK Turnbull guidance

14 EU Directive 2006/43/EC.

In addition to the general requirement to describe internal control and riskmanagement systems, the amendments also require the management and super-visory bodies of listed companies to include a description of the group’s internalcontrol and risk management systems in relation to the process for preparingconsolidated accounts This requirement should be read in conjunction with theprovision which stipulates the collective responsibility of the board (or super-visory board) for ensuring the integrity of the annual report and accounts.15

On the one hand, the board’s collective responsibility for financial ing contrasts sharply with the US approach, which places this responsibilitysquarely on the shoulders of management (the Chief Executive and the ChiefFinancial Officer) On the other hand, the EU stops short of requiring cer-tification and auditor attestation of the effectiveness of internal control overfinancial reporting The high-level responsibility of the board is seen as aguarantee that protects investors while allowing companies to tailor their con-trol system to their special needs and their capacity to absorb control-relatedcosts

report-Given the US regulatory paradigm, there is a real risk that Member States,

in transposing minimum harmonisation directives, might goldplate them byadding requirements which create onerous and costly obligations for boardsand external auditors to certify and provide assurance on the adequacy of finan-cial internal control With this in mind, the European Corporate GovernanceForum, a body set up to advise the Commission on governance issues, issued astatement which underlines that ‘the general purpose of risk management andinternal control is to manage the risks associated with the successful conduct

of business, not to eliminate them’ The Forum ‘considers that there is no need

to introduce a legal obligation for boards to certify the effectiveness of nal controls at EU level’ and ‘urges Member States to take account of thesepoints when implementing in national law the associated requirements of thenew directives’.16

inter-Interim and ad hoc disclosures

In addition to annual reporting on governance issues, EU issuers will have toreport, on an interim and ad hoc timely basis, important governance-relatedinformation These new reporting obligations are found in the TransparencyDirective which was adopted in December 2004 as part of the Financial Ser-vices Action Plan.17 First and foremost, the Directive requires issuers to file,

in addition to their annual report and accounts, non-audited half-yearly results.Along with the financials, the Directive requires half-yearly interim manage-ment statements which:

15 COM (2004)725 final, amendments to Directive 83/349/EEC article 36a, Section 3A.

16 European Corporate Governance Forum, Annual Report 2006, February 2007, p 10, http://ec.europa.eu/internal market/company/docs/ecgforum/ecgf-annual-report-2006 en.pdf.

17 EU Directive 2004/109/EC.

r explain material events and transactions that have taken place during therelevant period and their impact on the financial position of the issuer’sgroup;

r generally describe the financial position and performance of the issuerand its group during the relevant period

As regards control transactions, shareholders should inform issuers within fourdays at the latest of the acquisition or disposal of voting control above certainthresholds starting at 5 per cent of relevant voting rights The Directive requires

an issuer to disclose publicly the information contained in the notification given

by the shareholder, no later than three days after receiving the notification

Hedge fund and stock lending

As noted above, hedge funds play an increasing role in corporate control lenges Some companies have voiced fears that these ‘short-termist speculators’might hijack corporate strategy and control and that they might be prepared tosacrifice long-term shareholder value for short-term gains by, for example, forc-ing the company to distribute its cash reserves, or incur excessive leverage, orsell important assets

chal-The claim that hedge funds are becoming the scourge of issuers is somewhatoverstated A 2007 study by the OECD concluded that activist hedge funds andprivate equity firms could help strengthen corporate governance practices byincreasing the number of investors that have the incentive to make active andinformed use of their shareholder rights.18Despite the publicity around activisthedge funds, they remain a small part of the capital market: there are only some

120 funds (managing around US$ 50 billion (excluding leverage)) that pursueinvestment strategies explicitly aimed at influencing publicly held companybehaviour and organisation.19

Activist hedge funds seek to influence corporate behaviour without ing control They often focus on the company’s operational strategies and itsuse of capital Their targets are mostly companies that lack a credible long-termstrategy or maintain large cash reserves without being able to communicate acredible investment strategy Hedge funds seem to have a 60–75 per cent suc-cess rate in preventing mergers or in supporting takeovers, in changing ChiefExecutives and board composition, and in altering the capital structure of acompany through share buybacks

acquir-Notwithstanding their overall beneficial role, there are two concerns withhedge funds that seem to be justified: the first one regards accountability Com-panies need to know who are their important shareholders, and whether theyare there for the long term or just a few weeks Companies should be given the

18 See OECD, The Role of Private Pools of Capital in Corporate Governance: Summary and Main Findings about the Role of Private Equity and ‘Activist’ Hedge Funds, May 2007, p 2.

19 By way of comparison, the global mutual funds industry alone has US$ 18 trillion under agement See OECD, p 2.

man-possibility to engage with them In this respect, the regulatory framework mightnot be capturing the vesting of significant control rights (de facto or de jure) tostock borrowers in some stock-lending situations Stock-lending transactionsare typically structured in two ways: either as outright sales of stock with a putoption on the seller; or as contracts for difference (CFDs), which do not requireany transfer but stipulate a certain payment to the borrower At first glance, theformer method would result in the full vesting of control rights to the borrower,who would then presumably be liable to report the crossing of any importantregulatory control threshold as set in company law or securities regulation Inthe case of CFDs, no transfer of control would normally occur However, explicit

or implicit side arrangements as regards control rights (from an outright proxy

to an informal agreement as to how the shares should be voted by the lender)can be made Any such arrangement that crosses relevant thresholds should, inprinciple, be captured by disclosure regulation and treated no differently fromany other type of change in control The broad language of the TransparencyDirective on this point seems to cover these instances which should thus besubject to timely notification However, the transposition of these provisions by

EU Member States has not yet been tested in the courts As regards the US,20the regulatory framework might be too fragmented to produce comprehensive,timely disclosure of hedge fund positions

The second concern arises on the investor side, when institutions (usuallytheir back offices) or, even worse, custodians without their client’s expressauthorisation, lend shares with their votes attached to third parties during gen-eral meeting periods A recently issued ICGN code of stock-lending best prac-tice establishes three fundamental principles: transparency of stock-lendingpractices, especially towards the beneficiaries of the institution’s investments;consistency, meaning that ‘a clear set of policies which indicates with as littleambiguity as possible when shares shall be lent and when they shall be withheldfrom lending or recalled is necessary in order to ensure that similar situationsare handled in the same way’; and responsibility, meaning that ‘responsibleshareholders have a duty to see that the votes associated with their sharehold-ings are not cast in a manner contrary to their stated policies and economicinterests’.21Many institutions will be looking at the tension between the backoffice’s legitimate objective to earn some extra cash from their stock inventory,and the overall objective to create long-term value and respond to stewardshipimperatives If institutions do not manage to address these issues effectively, it

is likely that regulators will take up the baton and impose solutions that limitcontractual freedom to a greater extent than the market would like to see

20 As per Hu and Black, see above note 5.

21 The International Corporate Governance Network is an investor organisation, grouping some of the world’s largest institutional investors, whose members manage collectively more than US$

10 trillion worth of assets globally The code can be found at www.icgn.org.

The second objective of EU action, according to Commissioner McCreevy, is

to empower shareholders Indeed, a high level of transparency is of little use

if shareholders cannot take action to address the incompetence of the directors

or straightforward expropriation by unscrupulous managers and/or controllingshareholders

Here too there are some important emerging regulatory trends Whereas, inthe area of transparency, the European Commission has succeeded in settingthe stage for the emergence of a single disclosure system for all Europeanissuers, the jury is still out when it comes to the empowerment of owners tohold companies accountable across EU borders

Shareholder rights and participation

The key legislative measure in this area is the Commission’s directive on holder rights.22The directive has been hailed by most market participants as along-needed levelling of the playing field between companies and shareowners.According to the directive’s preamble, ‘Significant proportions of shares inlisted companies are held by shareholders who do not reside in the MemberState in which the company is registered Non-resident shareholders should beable to exercise their rights in relation to the general meeting as easily as share-holders who reside in the Member State in which the company is registered.’The directive facilitates shareholder access and empowerment in the followingways:

share-r A record date will determine the eligibility of investors to participate inthe general meeting, as opposed to current requirements in several EUmarkets for the blocking of shares, sometimes for several days before theannual general meeting Blocking has been advanced by many institu-tional investors as a reason for not voting, as it restricts their ability tomove fast when unexpected risks arise

r Companies will need to publish the AGM agenda well in advance ofthe meeting, so that it can be transmitted through the custodian chain tothe beneficial owners of shares Most importantly, relevant backgroundinformation on the decisions shareholders will be asked to make mustalso be published at the same time as the agenda

r Member States’ laws must not prohibit or create obstacles to the use

of electronic shareholder voting Furthermore, Member States must notovercomplicate the assignment of proxies and thus create obstacles inshareholder participation

22 See Provisional text of the Directive on the exercise of certain rights of shareholders

in listed companies, June 2007, available at http://ec.europa.eu/internal market/company/ docs/shareholders/dir/draft dir en.pdf.

r Shareholders will be allowed to ask questions before the AGM.

r Shareholders will have an opportunity to put items on the agenda of thegeneral meeting

The adoption of the Shareholder Rights Directive should increase the level

of participation and engagement of institutional investors in the affairs ofEuropean companies Hitherto, many large institutions have shied away fromvoting given high share-blocking risks, the disproportionate cost of voting, andthe paucity of AGM-related information These obstacles will be consideredlater Facilitation of shareholder engagement should focus boards on addressinginvestor concerns and raise their shareholder value consciousness Companiesshould also start to feel less concerned over the possibility of certain smallminorities, hedge funds or other short-termist investors, hijacking shareholdervoice to the detriment of long-term shareholder value

The market for corporate control

From Vodafone’s acquisition of Mannesmann in 2000 to the saga of E.ON’sbid for Spanish Edensa in 2006, cross-border consolidation has been one of thethorniest areas of EU economic integration It should come as no surprise thatnegotiations for the adoption of the EU 2004 Directive on Takeover Bids hasbeen by far the most politically charged of all corporate governance related mea-sures The Directive was meant to be a legislative lever to limit entrenchment

of national elites in inefficiently controlling economic resources by enabling

a truly market-driven allocation of these resources through the emergence of

an efficient pan-European market for corporate control The adoption of theDirective came after twenty years of discussions and the last-minute thwarting

of a previous draft by a rebellious European Parliament in 2001 The issue overwhich the earlier draft fell was the protection of large German companies frommostly foreign predators For over three decades, these large corporates hadserved masters other than their shareholders By law employee interests were(and still are) considered equal to those of shareholders, and worker repre-sentatives fill half of the seats on supervisory boards of companies Employeeco-determination combined with a vast network of cross-shareholdings hadmanaged effectively to shield managers from serious shareholder scrutiny forthe better part of the twentieth century No surprise then that German com-panies had become laggards in generating shareholder wealth This resulted

in their undervaluation, which made them attractive to various bidders ing private equity and hedge funds Ironically, one of the reasons that Germancompanies became fair game was an earlier round of domestic company lawreform aimed at enhancing shareholder power by outlawing most anti-takeoverdefences (most importantly board-driven poison pills)

includ-Being the outcome of this twenty-year policy wrangle, the Takeover BidsDirective is unlikely to bring about the changes of momentum sought by the

Commission Moreover, some of the regulatory solutions it has espoused mayprove to be counterproductive.

There are, certainly, some positive aspects to the Directive It sets a minimumlevel of transparency requirements regarding ownership structure and controlarrangements (discussed above) It requires timely and orderly provision ofinformation to the market in the form of an offer document, and it establishessqueeze-out and sell-out rights for small stranded minorities after a takeoverbattle The Directive also spells out the principle of a mandatory bid to allholders of securities when control is sought – although it does leave a lot ofleeway to Member States in shaping mandatory bid thresholds, thus providingthe potential for regulatory arbitrage and divergence rather than convergence ofregulatory regimes For example, an Italian shareholder holding 40 per cent ofshares may be able to sell for a substantial control premium without extendingbenefits to free float shareholders, while bidders of UK companies will need

to launch expensive bids for 100 per cent of the equity once they acquire morethan 29.9 per cent of voting securities

The most sensitive issue was the regulation of anti-takeover defences Theapproach of the Directive is three-pronged: limiting the power of the board toraise obstacles by calling for shareholder approval of any major defence move; atemporary non-applicability of special voting rights or voting limits when suchdecisions are taken – so that minority shareholders with multiple voting rightscannot impose their will on the majority holding one vote per share; and theso-called breakthrough clause allowing bidders who have acquired more than

75 per cent of outstanding voting stock to adopt amendments to the articles

of association during the first post-bid general meeting that remove multiplevoting shares or other control arrangements This solution was advocated bythe Winter Report and effectively addresses two difficult policy tradeoffs:

r a fair and effective balance between the often conflicting objectives ofaccountability to outside investors and the existence of strong, responsibleowners;

r a balance between the need to protect existing, long-standing tual arrangements (such as multiple voting rights) and the public policyimperative of making the European takeover market more efficient andintegrated

contrac-The final compromise made the above approach optional for Member States

by giving countries the choice to allow individual companies to opt out ofthe regime Moreover, even when companies are subject to the regime, the

‘reciprocity exception’ allows them to opt out when they are the target of

a bidder who is not subject to the same regime This optional approach iscounterproductive first, because of its complicated and unpredictable nature It

is difficult, for example, to predict the defensive options available to a targetcompany, as these depend on whether potential bidders are themselves subject tothe Directive’s regime It is also unclear what will happen in a three- or four-way

contested bid Investors will find it hard to price the availability of takeover exitsinto the share price In addition to the lack of transparency, the Directive mayactually be setting the clock back in terms of company law in some countries.

A 2007 European Commission report on the implementation of the Directiveconfirms our view of the Directive being rather counterproductive According tothe Report, two Member States, Cyprus and Spain, which had board neutrality(i.e the board was not able to adopt anti-takeover measures without shareholderapproval) in place by the time of the publication of the report, have decided

to implement the Directive by introducing reciprocity Italy may also decide to

do the same As regards the breakthrough rule, the vast majority of MemberStates have not imposed (or are unlikely to impose) this rule, but have made itoptional for companies Just 1 per cent of listed companies in the EU will applythis rule on a mandatory basis since only the Baltic States have imposed therequirement in full In contrast, Hungary had a partial breakthrough rule beforetransposition, which has been eliminated.23

One-share-one-vote

The unsatisfactory regime of the 2004 Takeover Bids Directive suggests thatthe EU corporate control market will continue to be marked by regulatorydivergence Nevertheless, consolidation is continuing to occur The significantincrease in the level of transparency, combined with the expected increase

in shareholder engagement by Anglo-American institutional shareholders inEuropean cross-border situations, should limit the damage from regulatoryback-stepping on poison pills

But poison pills are only part of the anti-takeover arsenal In many pean large companies there are important asymmetries between pecuniary rightsrelated to shares (cash flow rights) and control, most importantly voting rightsattached to shares A 2007 study on the proportionality principle in the EU(‘Proportionality Principle study’) commissioned by the European Commis-sion found that Control Enhancing Mechanisms (CEMs), enabling asymme-tries between cash flow rights and voting rights, are widely available in Europe:

Euro-44 per cent of the 464 European companies considered in the study have CEMs;this includes a majority of large caps (52 per cent of the companies analysed)and one quarter of recently listed companies.24

In principle, markets welcome flexibility in shaping rights along the risk–return curve For example, most company laws uncontroversially allow votingrights to be forfeited in return for privileged status in cash distributions, as

23 European Commission, Report on the Implementation of the Directive on Takeover Bids, February 2007, pp 6 and 7.

24 See ISS, Shearman & Sterling & ICGN, ‘Report on the Proportionality Principle in the pean Union’, May 2007, p 9 The study covers sixteen Member States (Belgium, Denmark, Estonia, France, Finland, Germany, Greece, Hungary, Ireland, Italy, Luxemburg, The Nether- lands, Poland, Spain, Sweden and the United Kingdom) and three other jurisdictions (Australia, Japan and the United States).

Euro-is the case with most classes of preferred stock Investors, however, recoil atarrangements that undermine one-share-one-vote where the only purpose is toprotect and entrench management, even if such arrangements are described asprotecting the long-term stability of the company Voting rights ceilings are agood example of such an arrangement The EU study found that voting rightsceilings, along with priority shares, golden shares and multiple voting rights,are among the CEMs that are most negatively perceived by investors According

to the study, voting rights ceilings ‘hinder the emergence of large shareholders,thereby making takeovers virtually impossible At the same time, they fragmentpower and impede effective monitoring That is, they simultaneously underminethe two primary mechanisms for disciplining managers: outside monitoring andcontrol contestability.’25

What should EU public policy have to say about the most prevalent ofasymmetries, that of multiple voting rights? In Sweden, where these rights aremost popular among large listed issuers, block holders typically hold morethan 50 per cent of control rights while being exposed to between 12 and

20 per cent of the equity risk That is because the risk–return characteristics ofthe multiple voting class of securities are identical to those of the single voteclass According to their proponents, multiple voting rights allow companies tohave their cake and eat it: strong, engaged owners with the power to act as trueprincipals in overseeing and remunerating management, on the one hand; and

a wide equity base and capital market access providing companies with growthfunding, on the other hand Conceptually, however, this arrangement is suspectbecause it makes little economic sense for the controlling owners Like privateequity investors, they put in the effort and underwrite the cost of long-term activeengagement in the governance of the company But unlike them, they agree toshare disproportionately the resulting benefit with other shareholders As thetheory goes, rational economic actors would have to compensate for this freerider loss by appropriating private benefits of control These may range fromcompany perks to much more serious appropriation of corporate opportunities

and, in extremis, to the ‘tunnelling’ of assets and cash flows The latter is often

the case in emerging market companies where large cash flow to control rightsasymmetries exist in the context of a weak legal and institutional environment.Ultimately, the question is whether, and to what extent, in an environment wherethe rule of law is highly developed, the risk of private benefits outweighs thepublic benefits of better managerial monitoring combined with broader capitalmarket access

In an FT op-ed, two prominent investor representatives support the idea that

the EU should adopt rules imposing one-share-one-vote on listed companies,albeit recognising that this might, in the short term, be politically unfeasible Intheir words, ‘distortions of the proportionality between voting rights and share

25 See ‘Report on the Proportionality Principle in the European Union’, May 2007, p 16.

capital should not be part of the solution’.26 And yet, the world’s deepest andmost liquid capital markets have no rules outlawing such distortions, as testified

by the 2005 listing of Google with its two classes of voting shares, allowing thetwo founders a free hand in most strategic decisions It is also interesting to notethat the UK has never used regulation against multiple voting shares as a tool

of shareholder empowerment One-share-one-vote became the overriding (butnot universal) standard in the London market as a result of investor pressure.Because of the higher cost of capital for companies that do not espouse theprinciple, an issuer now needs a very good reason to maintain control structuresthat do not conform to the standard

The EU Commission’s 2007 study on one-share-one-vote confirmed thepoor case for any legislative action in this area Commissioner McCreevy hasbacktracked from his earlier position in favour of a recommendation promotingone-share-one-vote, as even a set of soft law principles might prove to be hard toagree on What might prove more effective, and less costly in political capital,

is to wait for the new transparency and shareholder rights regime for EU issuers

to be fully implemented, and give the market another chance to develop its ownways to value asymmetric control arrangements

Shareholder communications

One area which straddles both objectives of the Commission’s agenda for parency and empowerment is that of communications between shareholders andthe company, and communications among shareholders themselves with respect

trans-to a particular company Both are essential for active shareholder engagementand for a board to understand the views and wishes of its shareholders beforecrises break out

Communications between shareholders and the board became a central issue

in the highly contested, albeit unsuccessful, cross-border bid by Deutsche B¨orse(DB) to acquire the London Stock Exchange (LSE).27 When such a strate-gic move is anticipated, the clear agreement of the non-executive directors isimportant in winning the support of investors Indeed, the UK Combined Codeexplicitly stipulates that, while the Chief Executive and Chief Financial Officershould be the main parties regularly talking to shareholders, the board as a wholebears responsibility for maintaining a good dialogue The Combined Code alsorecommends that the Chairman and senior independent director should regu-larly meet with large shareholders, update them on the situation and gauge theirfeelings In contrast, the DB supervisory board never took a proactive stancewith investors Rolf Breuer, its Chairman, started taking an active part in dis-cussions with investors only a few days before the deal died His intervention

26 Peter Montagnon and Roderick Munsters, ‘One share, one vote is the way to a fairer market’,

Financial Times, August 2006.

27 A more extensive discussion of these issues can be found in the article by Stilpon Nestor, ‘How

board governance cost Deutsche B¨orse its deal’, International Financial Law Review, 13, 2

(March 2005), pp 137–55.

came too late to reverse the ill-feeling created between DB and its investors.

It is worth noting that Rolf Breuer’s absence from the dialogue was not anexception to the German practice, nor was it contrary to the German code ofcorporate governance (Cromme Code), which does not have provisions equiv-alent to those of the UK Combined Code In Germany it is the Chief Executive(the ‘spokesman of the Vorstandt’) not the Chairman of the Supervisory Boardwho talks to investors This seems an aberration, given the fact that it is thesupervisory board alone that is directly accountable to shareholders, according

to German corporate law

A key task of the non-executive Chairman should be to build and maintainstrong relationships with the company’s key investors Part of his role is topresent to the board investor concerns independently of management In thecase of Deutsche B¨orse, it was the Chief Executive who reported to the Super-visory Board on these matters Yet, the Chief Executive was the person mostcommitted to pursuing the LSE’s takeover Continental European boards are

at the very beginning of a steep learning curve in their communications policytowards investors While there is no regulatory solution to this problem, manycontinental European boards will need to review and redefine their role, dutiesand limits in communicating with investors, especially as the latter step up theirengagement activities, whether friendly or hostile

As regards communications among shareholders, it is becoming apparentfrom recent shareholder engagement actions (such as the DB/LSE bid) that there

is a risk of consultations between investors regarding the corporate governance

of a specific company being viewed as a concert party practice by securitiesregulators If found to be in concert, investors might be asked to place a bid forthe company Such a prospect would obviously deter them from engaging in anysuch dialogue, even in the face of the most flagrant managerial incompetence

or expropriation of shareholder wealth Clarity and predictability on this issueare essential if investors are to meet their stewardship obligations As long asthe objective is not to take control of the company, communications amongshareholders should be allowed, and not just on the issue of director elections.Dialogue between shareholders enhances the capacity of markets to arrive atefficient solutions that are good for companies It also helps to avoid publicconfrontation between companies and major shareholders In the context ofthe 2006 consultation on ECAP, the ICGN proposed that the Commission takeaction to clarify and, if needed, limit concert party action rules in MemberStates, in a way that promotes shareowner empowerment and legal certainty.28Trends in the US

While the EU regulatory environment is entering a stabilisation phase, the

US is still reeling from the realisation of the inadequacies in its corporate

28 See ICGN submission on the Consultation on the EU Action Plan at www.icgn.org.