In 30% of Europe’s largest companies, insufficient entrepreneurial democracy has strengthened central power-holding groups and limited minority shareholders’ realm of activity. That is the conclusion of a study by research firm Deminor, prepared on behalf of the Association of British Insurers (ABI). The study criticizes the fact that 35% of all companies in the select FTSE Eurofirst 300 index have some sort of mechanism in place for defending themselves against the principle of ‘one share, one vote.’


Corporate reformers who want to prevent corporate scandals have not tackled this problem, despite the fact that equality is the most fundamental principle in politics. In Europe, this failure is an especially serious problem because most governments have opted to carry out the recommendations of the European Union, using the formula of ‘comply or explain.’ This system has allowed them to avoid writing regulations that cover all the ins-and-outs of good governance. Instead, companies that fail to comply with a corporate principle must explain why they are doing so, and expose themselves to possible punishment by their shareholders.


If the voting rights of minorities are restricted, a relatively futile reprimand is applied. “The formula of ‘comply or explain’ is only viable if all shareholders can exercise their rights,” warns Mary Francis, general manager of the ABI, in the introduction to the study. In her opinion, if power holders in a high percentage of companies continue to accumulate more power than they deserve, they could face legal penalties from Brussels. However, Vicente Salas, professor of economics and business management at the University of Zaragoza, doesn’t believe it will be possible to impose such penalties.


Although empirical data is lacking, Salas argues that this sort of behavior “will not be regulated until we reach the point where the principle (‘one share, one vote’) is strictly imposed on every publicly traded company in every country of the European Union.”


When voting rights are concentrated in the groups that run the company, it distorts the reality of the marketplace. Among the 300 largest companies in Europe, 35% of all voting rights are given to those who own 22% of the total shareholdings. There are several ways this is accomplished, and it depends on the country. However, the favorite way to achieve this concentration is to create shares that have multiple voting rights. That happens in 20% of Europe’s leading companies. Quite a few companies (10% of the total) opt to limit voting rights, and 5% of all companies prefer to impose limitations on share ownership. With that sort of approach, shareholders need to own a minimum number of shares [before they can vote.]


In contrast, “Golden Shares” [a golden share gives its shareholder veto power over changes to the company’s charter] have been losing popularity because they have repeatedly been condemned by Brussels. Despite the opposition of European regulators, some companies maintain this mechanism. Examples include BAE Systems and Rolls Royce, in which the British executive has a Golden Share. Likewise, the Portuguese chief executive has a Golden Share in Portugal Telecom.


In Spain, the government does not have its own “Golden Shares.” However, it has maintained the right to veto certain activities in Endesa, Repsol-YPF, and Telefónica, despite the fact that the European Court of Justice in Luxembourg declared such vetoes illegal in May 2003.


“Our study shows that there is still a long road ahead before there is a democratic system for all shareholders in European markets,” says Peter Montagnon, director of investments at ABI. In his view, if companies make progress along this road, they will avoid the risk of being subjected to stricter regulations, such as those in effect in the U.S. “The key to achieving this goal is to respect the rights of shareholders, and develop just one market for [all] European shares,” he adds. Jean-Nicolas Caprase, a partner of Deminor, is not confident that companies will react quickly. “There are many exceptions to the principle of ‘one share, one vote,’ and the situation is changing too slowly,” he says.


José Luis Álvarez, assistant dean of the Instituto de Empresa, argues that minority shareholders’ ability to take action is the principal weapon for avoiding the abuse of power by groups that are in control. “The fundamental thing is to improve the functioning of shareholder groups because that is one of the only places where corporate directors are weak,” says Álvarez, an expert on corporate affairs.


Justifications and Exceptions


Salas defends the idea of approaching this from the viewpoint of self-regulation. However, he recommends “prescribing norms that, while maintaining the liberty of companies, also protect the interests of minority shareholders. When companies issue shares, they should be obligated to inform shareholders, in a totally transparent way, about the relationship between control over corporate earnings (where the equality principle applies) and control over decision-making (where there may be a lack of compliance because voting is weighted.) This relationship derives from the statutory norms that each company establishes when it issues its shares. Once a company has gone public, any changes in relevant statutes must be approved by the general meeting of shareholders. At that time, if a change is approved by a majority, the company should offer to buy out its dissident shareholders, offering them a fair price.”


Companies defend their rights to continue concentrating additional voting rights in just a few hands. They say this practice gives stability to their company’s shares, and prevents speculation [in their shares]. However, Alvarez wonders “if we should ask ourselves if insiders are more truly owners than minority shareholders are, from a business point of view. After all, in many cases, minority shareholders invest today and sell tomorrow. We should even ask ourselves if they are owners in terms of their commitment.”


Thanks to a 1959 law, the German state of Lower Saxony controls 20% of the voting rights in Volkswagen, despite the fact it owns only 14% of the automaker’s shares. To guarantee shareholder stability in the company, 80% of all votes were required for adopting important decisions. In addition, the law set a 20% limit on the voting rights of any single shareholder. In effect, this guaranteed that no shareholder has a greater voice than Lower Saxony. Although this regulation might have made sense 47 years ago, it has been condemned by Brussels, which believes that the state is using the original justification to guarantee its control over the company.


Companies offer another justification for deploying mechanisms that set limits on corporate democracy. They say these provisions make investors more loyal to the company. For example, in France, where 69% of all companies have some type of limitation, several companies provide double voting rights to those investors who have held their shares for more than two years. The goal is to make these investors more loyal. Nevertheless, the Deminor study is critical of this practice, arguing that it is being used to reinforce the position of groups that hold power.


“Even if they want to change, there are probably some factions within the companies who fail to comply with the principle, and defend the status quo,” says Salas. “One extreme example of non-compliance with this principle is the existence of shares that have no voting rights. No one questions this practice, and no one doubts they can exist.”


Shares without voting rights are common among companies that are family owned, where the founders continue to control the majority of the shares, or a large portion. In such a case, the main goal of issuing shares is to gain access to capital, without altering managerial control of the company. However, there are some economic benefits from owning shares that have no voting rights, including preferential access to dividend payments.


Country-by-Country Contrasts


Although the overall landscape is quite negative, there are significant differences from country to country. Belgium provides the best example of corporate democracy. No company in that country imposes limits on minority voting rights, despite the fact that Belgian law recognizes some ways that such a goal could be achieved. Neighboring Holland is one of Europe’s most transparent countries, and a champion of good governance. However, Holland is the country that imposes the most restrictions on minority shareholders; 86% of all Dutch companies have some sort of system for preventing minorities from imposing their views. They do this, most often, by issuing shares with multiple voting rights. Sweden, where 75% of all companies are “armed” against minority shareholders, is among the least democratic countries when it comes to corporate governance. In addition, every Swedish company that sets limits on voting rights also has shares that have multiple voting rights.


Germany is a special case. German companies have two councils. One is composed of executives of the company. In the second council, half of the members represent the workers. This set-up explains, in part, why no German company except Volkswagen sets limitations on voting rights. In most cases, this is because employees are also shareholders in the company.


The United Kingdom, considered the paradigm of good governance in Europe, is also one of the countries with the most corporate democracy. This is true despite the fact that 12% of all companies have some sort of limitation, largely through limitations on ownership.


“We believe that if you create a market based on corporate governance, while defending the interests of minority shareholders, it is a good thing for each individual market; for the European economy, and for the millions of individual savers whose money we invest,” says Mary Francis.


Nevertheless, wouldn’t it be possible to justify limitations on voting rights under some circumstances? That depends on which company you’re talking about, says Salas. “I can imagine, for example, a family-owned company that wants to issue shares, but also wants to keep a large portion of the shares in the hands of their family, while also shielding it, so that the family maintains control.” However, Salas stresses, “The market will decide what discount to apply to such a company’s shares when they are issued, with that goal in mind.”