Hedge funds as “Activist Shareholders”:

Passing Phenomenon or Grave-Diggers of Public

Corporations?

Yvan Allaire, PhD, FRSC,*

Mihaela Firsirotu, PhD**

(Draft #4- for comments only)

*Chairman of the board, Institute for governance of public and private organizations
(HEC-Concordia), emeritus professor of strategy (UQAM), adjunct professor (HEC-
Montreal).
** Professor of Strategy, UQAM, holder of the J.A. Bombardier chair in transnational
management.

January 27th, 2007

Copyright Allaire and Firsirotu, 2006, 2007

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Introduction

The recent wave of corporate scandals has placed corporate executives and boards of
directors in the cross hairs of public opinion. However, the tactics of some new wave
“investors”, particularly some breed of hedge funds (which would be more aptly called
“speculative funds”), and their relentless efforts to “commoditize” industrial firms may
bring the investor community under closer scrutiny.

By their very actions and successes, hedge funds of the speculative kind are raising a
number of very serious issues about the future of corporations and even about their
impact on the industrial structures of countries. Are these funds forcing companies to
carry out short-term initiatives to boost stock prices but to the detriment of the
companies’ long-term health? Are these funds distorting, through various means and
tactics, the functioning of corporate democracy, taking advantage of flaws in the system
of proxies and elections of publicly-listed corporations? Are these funds exacerbating the
short-termism of corporate management brought about by the intense focus on short-
term earnings data? Are they pushing for the sales of companies to realize a quick profit
from such transactions? What role do these funds play in the outcome of situations of
the Falconbridge-Phelps-Inco type, situations with very large stakes for the whole
country?

These concerns have taken on a pressing actuality with the rise of hedge funds and their
aggressive, opaque, hence possibly malevolent, strategies. Having grown at a
phenomenal rate over the last ten years, there are now more than 9,000 funds managing
assets in excess of $1 trillion. For the single year 2006, $126.5 billion in new money
flowed into U.S. hedge funds (Siegel, 2007).

Of course, it could be argued that because of this very growth and the resulting,
inevitable, drop in average returns posted by these funds, hedge funds will pass from the
financial scene, fade into the night harmlessly, or transform themselves into more
conventional investment vehicles. Already, for the year 2006, the benchmark
CS/Tremont Hedge Fund Index shows a 13.9% return, well below the S&P 500 index
(15.8%), the Russell 2000 (18.4%) and the TSX (14.5%) (Reguly, 2007). Only foolish

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Investors would agree to continue reward such mediocre performance with the usual 2%
management fees and 20% of the return1.

But that would be a premature, probably misguided, conclusion. The humongous

compensation of hedge funds managers ($130 million in 2005 to get on the top 25 list)
makes them a very adaptive breed of investment managers, morphing from one type of
strategy to another in a continuous search for new, “creative” ways of making money. In
some ways, the more difficult it becomes for them to reap huge rewards from their
former tactics and maneuvers, the more hazardous to society they become in their
pursuit of high yield.

This text describes and documents some of the issues and defines a range of options to
curtail their ability to do harm. In particular, their ability and willingness to capitalize on
the weaknesses of corporate democratic processes raise serious issues, which have led
to calls for measures to fence in these funds and limit the damages they may inflict on
societies.

The transformation of shareholding

In 1960, the average holding period for American publicly listed company shares was
seven years; it shrank to two years by 1992 (Porter,1992) and is now estimated at some
seven and a half months for companies listed on the New York Stock Exchange
(Odland, 2006). Stated differently, the average annual share turnover was:
1 12% in 1960;
2 73% in 1987;
3 86% in 1999;
4 87% in 2005.

For companies listed on NASDAQ in 1999, annual turnover was three times higher. In
1999, the shares of Amazon.com turned over every seven days! (Bratton, 2006)

Hedge funds have played a major role in this transformation of shareholding. Hedge

1
These funds would be quick to point out that their value comes, not solely or mainly, from their absolute performance but
from their performance on the downside of markets, that their “hedges” put a floor under their returns, thus delivering
stable yields to their investors even in bad times.

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funds are holding about 5% of total equity assets but represent between 30% (Moyer,
2006) and 50% (Campos, 2005) of all transactions on the New York and London Stock
Exchanges, a remarkable statistic that explains, in part, the stock churning statistics
presented above.

Advocates and defenders of hedge funds argue that these statistics only prove the
beneficial nature of hedge funds in enhancing the liquidity of markets and hence in
reduced cost of capital for companies. But that is a fallacious argument. The cost of
equity of a company, the largest component of its cost of capital, is but the “expected
return” of shareholders. In traditional assessments of the cost of equity, via CAPM
(capital asset pricing model), liquidity indeed influences the market risk premium and the
specific risk of a company. However, that’s a theoretical view of the world.

The particular type of hedge funds we are singling out, the so-called “event-driven
funds”, or, more accurately, the speculative funds take a position in the equity of a
company and agitate for actions that, in their view will produce a 20-25% yearly return.
(Remember that these are speculative funds, not strictly speaking “hedged” funds. To
generate the return of 12 to 15% promised to their investors, they must produce gross
returns, i.e. before their fees are subtracted, of 20 to 25%. See Ibbotson and Chen
(2005) for a useful discussion of returns from hedge funds).
Let’s assume that all shareholders of company were hedge funds of this sort, all
expecting, indeed demanding, 20% or 25% return on their investments, then 20% or
25% becomes the cost of equity of the firm! That would be a huge increase in the cost
of equity, and thus in the cost of capital, for this company.

Clearly, returns in that range are targeted by hedge funds. Management could meet
such targets only by adopting radical measures to bump up the value of its shares; but
these measures are likely to produce a one-time jump in share price, difficult, indeed
impossible, to repeat year after year. Therefore, hedge funds, having achieved their
desired return for a particular year, fully aware that it is not repeatable, will exit the
company and look for another target where the same tactics may be implemented.

It is axiomatic that a high cost of capital means a short-term horizon and conversely for a
low cost of capital. A 20% cost of capital means that a $1 dollar in expected profits five

4
years hence is worth but 40 cents today. It is ironic that in a period of generally low
interest rates and otherwise low cost of capital, hedge funds may be increasing the cost
of capital of firms and lead management to adopt a short-term horizon to placate them.

Hedge funds as arbitrageurs of governance

As the returns from the more traditional hedge fund strategies have leveled off, many
funds have migrated closer to the hunting grounds of private equity firms (and
conversely for private-equity funds!). They take a sizeable equity position in a company
and singly, or, in cooperation with other funds, push management and the board of
directors to take actions that they consider likely to swiftly enhance shareholder value.
These “activists” funds have recognized that private equity firms create value from two
market imperfections:
1. A fiscal “imperfection” whereby interest are deductible from corporate revenues
for income tax purposes, while dividends are not; by loading debt on the balance
sheet of a newly privatized firm, the cash previously spent on taxes and dividend
payments may now be used to pay the interests and pay down the debt; after a
few years, the debt load has been reduced and the equity (much smaller than
before) becomes increasingly valuable.
2. A governance “imperfection”; the conventional forms of governance for a
company with a dispersed shareholding (i.e. without a large or controlling
shareholder) are weak and sub-optimal. Even with (some would say because of)
the “improved” regimen imposed by Sarbanes-Oxley and by similar initiatives
worldwide, corporate governance by a group of part-time “independent” people
with little or none of their wealth at risk, remains deeply flawed, incapable of
extracting the full economic potential from a business. Private-equity firms bring
in a hands-on, no-nonsense, high-intensity governance, including forms and
levels of management incentives that a public corporation cannot match.

Event-driven hedge funds zero-in on this second type of market imperfection. They
believe that they can create substantial value by becoming “governance arbitrageurs”,
moving from company to company pushing for the kind of value-enhancing moves that a
well-governed company, intent on maximizing the value of its shares, should undertake
and would surely undertake if governed by a private equity firm.

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However, to achieve their ends, hedge funds have used many “innovative” tactics and
have taken advantage of flaws in the workings of corporate democracy. They are widely
perceived as driven by their incentive system to seek quick returns with little concern for
the longer term welfare of a company and its shareholders The role played by these
activist hedge funds in shaping equity markets do raise fundamental questions about
practices, rules and principles of corporate democracy which were conceived and
fashioned for another time and for different circumstances.

The new game of corporate democracy

In the business of electing board members and voting on shareholder issues, the
traditional practice of granting an immediate right to vote upon the acquisition of shares
is predicated on the customs of an earlier time when shareholders were assuming the
full economic risks of owning shares, a time of stable shareholding. There were a
specific set of circumstances on which this traditional approach was based:
1. New shareholders are few during any period of time; i.e. there are few recent
“immigrant” shareholders participating in the voting process; stability in the
shareholder base of a company is the norm;
2. Limited use was made of derivative products (puts, calls and other variants) to
hedge against the economic risks of owning shares;
3. Short selling of shares, borrowed from bona fide shareholders, was rare and
viewed as an aberrant practice;
4. Shareholders on the record date would still own their shares by the time of the
annual shareholder meeting;
5. The buying of votes was rare; shareholders would not sell their right to vote by
loaning their shares for a short period around the record date, the so-called
“record date capture”;
6. Shareholders did not hide their economic interest by entering into equity swaps
or similar arrangements to disguise their level of equity participation in a
company;

These conditions do not hold anymore. Largely as a result of the mushrooming of hedge

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funds, all the “deviant” practices described above are now common-place occurrences in
developed equity markets. They have created a disconnect between, on the one hand,
the theory underpinning the rights of shareholders and the practice of shareholder
democracy, and, on the other hand, the current realities of share ownership and trading.

Several American legal scholars have become increasingly perplexed and troubled by
what’s going on. They are questioning arrangements devised for another time and
another context.

Hu and Black (2006a, 2006b) have carefully documented, and illustrated with several
eloquent examples, the gamut of stock market operations carried out by hedge funds
and like-minded investors which may result in “empty voting” ( that is, holding more
votes than economic ownership) or hidden ownership (that is: holding greater economic
interest than is disclosed). Vote buying (or “empty voting”) is not a marginal
phenomenon. Hu and Black (2006a) report on a study that examined 341 contested
shareholder votes in 2005; the study found over-voting in all cases,

Hedge funds, they write, have been particularly creative at decoupling voting rights from
economic ownership. The authors argue that the potential costs and the risk of abuse
outweigh the putative benefits from these financial acrobatics. They review cautiously a
set of measures that might be adopted to curtail or regulate these operations:
1 Matching economic interest with voting rights; this approach would seek to
remove the voting rights in any case where a supposed shareholder, through
derivates or short-selling, had in effect eliminated most or all economic risks
from such shareholding; however, in an age of Depository Trust and Clearing
Companies (DTCC) in the U.S. or, in Canada, the Canadian Depository for
Securities, the latter holding securities worth $3 trillion on deposits and
handling over 77 million securities trade annually, such a matching process
appears unworkable.
2 Time-phased voting; requiring a minimum holding period before acquiring the
right to vote would delay the implementation of these tactics and increase their
cost to hedge funds, both undesirable outcomes for hedge funds in their pursuit
of high short-term returns; however, because of the prohibition of the NYSE on
time-phased voting, the authors do not retain this option;

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 3 Fuller disclosure; the authors propose better disclosure as a near-term
approach and “outline a menu of longer-term regulatory choices”; they call for
full disclosure of over-the-counter (OTC) derivatives as well as short selling
activities, both under-reported under the present regimen of regulations.
Longer term, they propose, among several measures, that large funds restrict
their stock lending activities, ensure that they are informed of the identity of the
borrowers of their shares, and generally retain the voting rights attached to the
shares they are lending; Hu and Black (2006) mention that CalPERS, the large
Californian public-sector pension fund, earned $103 million from securities
lending for its fiscal year 2004. Some institutional investors (including some of
Europe’s biggest pension funds) have stopped their share lending activities.

Martin and Partnoy (2005) claim that “encumbered” shares are now a common
phenomenon. By “encumbered” shares, they mean:
1. Shares held by shareholders who do not incur the economic risks of ownership
(because of their short-selling activities and/or their use of derivative products);
2. Shares loaned to short sellers with the real possibility that, as a result, the same
share will be entitled to two votes.

The authors argue forcefully that, in a context where encumbered shares represent a
substantial proportion of total shareholding, the “one share-one vote” rule is flawed,
economically sub-optimal and deleterious in its consequences.

Their list of adverse consequences includes: distortion of quorum and regulatory

requirements; ill-advised approval of mergers and acquisitions; undervaluation and
incorrect compensation in securities class actions; simultaneous over- and under-
inclusion in bankruptcy distributions; and preference of fixed-ratio stock offers over
economically superior alternatives.

They conclude: “Given the proliferation of financial innovation and economic and legal
encumbrances, the one-share/one-vote principle no longer constitutes a uniformly
efficient rule of corporate governance, if it ever did.” (p.813)

Another legal scholar (Nathan, 2006) concurs with Hu and Black and Martin and

8
Partnoy. In his view, these trends have been evident for a number of years but were
relatively harmless and could be ignored until the emergence of event-driven hedge
funds. These funds “recognized the disconnects between the theoretical model of
shareholding democracy and the actuality of equity trading markets and used the
resulting fault lines to advance their economic interest, often at the cost of the goals and
theory of shareholder democracy” (Nathan, 2006).

Nathan concludes that most of the “empty voting” issues could be resolved by allowing
companies to adopt a time-phased voting system whereby a holding period is required
before acquiring the right to vote; however, the author notes that time-phased voting
rules are now prohibited by the NYSE and NASDAQ listing standards as a result of
pressures from the SEC. The few American companies with time-phased voting, such as
Aflac, have been grand-fathered. However, Canadian regulations and listing standards
would allow a company to adopt a time-phased voting system.

Skeel (2005) describes the by-now notorious case of Mylan Laboratories’ botched
acquisition of King Pharmaceuticals, for it provides a rare instance where the financial
shenanigans of a hedge fund, in this case the Perry Corporation, became public
knowledge. Perry resorted to the paraphernalia of long-short positions, undisclosed
economic interest, empty votes through shares swap, and so on. The details of Perry’s
vote buying stratagems became public knowledge as a result of a suit filed by another
“activist” shareholder, Carl Icahn. While the Perry maneuvers did not succeed, Icahn
kept on harassing the management and board of Mylan, who eventually gave in to some
of his demands, bought back shares for $1.25 billion, which it financed by issuing new
debt.

When Icahn exited, having realized a large profit for his 13-month tour, the company had
been changed and not for the better. Before the involvement of Icahn, the company had
shareholders’ equity of $1.8 billion and no debt. After Icahn, its shareholders’ equity was
down to $787 million and long-term debt stood at $685 million, a financially much weaker
company, possibly constrained in pursuing its growth options. (Bratton, 2006)

Kahan and Rock (2006) provide a thoughtful discussion of hedge funds as critical

9
players in both corporate governance and corporate control. They make an important
distinction between the shareholder activism of hedge funds and the activism of
traditional institutions:
1 Hedge funds seek significant changes in individual companies, rather than
small, systemic changes;
2 Their activism entails higher costs;
3 It is strategic and ex ante, rather than intermittent and ex post ;

The authors argue that these differences may be due to the fact that the widely
diversified portfolio of traditional institutions makes it difficult to engage in strategic
activism. Although Kahan and Rock consider it plausible that such activism may be
designed to achieve short-term payoff at the expense of long-term profitability, they
“conclude that a sufficient case for legal intervention has not been made,” (p.ii) It is their
view that market forces are more effective than regulation to curtail the negative effects
of hedge fund short-termism “while preserving the positive effects of hedge-fund
activism”.

How market forces would actually play out to achieve this outcome is not made clear.

Bratton (2006) has carried out an extensive review of 130 cases, reported in the
business press between January 2002 and June 2006, where a U.S. firm was the target
of an activist hedge fund. His study provides interesting statistics. For instance, because
of the funds’ strategy to get the biggest bang for a given investment, 87% of cases
involved small-cap or mid-cap companies, companies with less than U.S. $5 billion in
market capitalization. In most countries, certainly in Canada, the $5 billion figure would
include most companies listed on their domestic stock exchanges. The study also points
out that the mean target size has grown substantially between 2002 and 2006.

Bratton classifies the cases in his sample according to the type of actions demanded by
the hedge funds:
1. Selling the company – 33% of cases.
Simply put, these hedge funds took an equity position and then agitated for the
firm to be sold, so they could pocket the usual control premium, ranging between
30% and 50% when a sale transaction is completed.

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 2. Unbundling- 32% of cases.
Here the funds push the company to get rid of specific “under-performing” or
unrelated subsidiaries or divisions by selling them or spinning them off to the
market; not only will that produce immediate cash but it should result in a better
performance for the residual company, and hence for the company’s stock price.

3. Disgorging cash- number of cases unspecified.

Here the game plan is to force the company to use any “excess” cash to buy
back shares or increase dividend payments, both measures likely to increase
share value in the short term.

4. Good Assets-Bad Managers – number of cases unspecified.

Hedge funds, in these cases, become expert at running companies; they will
offer specific criticisms of the current management and strategy, and argue
forcefully for a change in direction and game plan; they will ask for board
representation to influence the management and strategy of the company; here
they act in some ways like the general partners of private equity firms but without
the legitimacy that comes from owning the company outright.

Bratton strives valiantly to demonstrate that hedge funds are really quite benign and not
really that short-term in their investments. However, given that 65% of his cases
occurred in 2005 and during the first six months of 2006, it is a bit premature to declare
hedge funds long-term investors because they still held their position on June 30th 2006.

Furthermore, the four types of hedge fund activism described by Bratton (and presented
above) certainly point to a short-term investment horizon. Because hedge funds cannot
always get management and directors to quickly implement their desired course of
actions, they have to stick around and keep the pressure on; indeed it may take some
time for them to achieve their ends but that does not make these funds other than short-
term investors.

Most tellingly, Bratton relies on public information to establish the strategies and
holdings of hedge funds; but the very point made by Hu and Black and several others is
that these are very secretive funds that will resort to any clever, yet legal, stratagem to

11
skate around disclosure rules. The funds involved in the transactions reviewed by
Bratton may well show up as still holding a position in a company’s equity, yet may have
engaged in derivative transactions that effectively remove all economic risks from their
position. Protected against downside risk, they may keep their position in case there’s
still some upside potential to come,…or to fool casual observers into thinking that these
hedge funds are not such short-term investors after all.

Finally, Bratton’s study would not capture cases like the Falconbridge-Inco-Phelps saga
where hedge funds were not the initiators of the merger/acquisition moves but became
the ultimate deciders of the fate of these companies. Driven by their appetite for short-
term gains, they tilted the scales in ways that may not be in the in the long-term interest
of these companies and of Canadians generally. (McNish, 2006)

Short-term investors and the management of corporations

There is good empirical evidence that short-term investors do influence the way
companies are managed. For instance, the presence of significant transient
shareholders determined to leverage their position to influence the outcome in takeover
situations, or to provoke such situations, may result in these takeovers being carried out
at less than optimal terms for the shareholders of the target company. That is one of the
conclusions of a recent study of takeovers by Gaspar, Massa, and Matos (2005).

These researchers conclude that short-term investors in a target company “enhance the
likelihood of a takeover and lower its cost. At the same time, short-term shareholders in
the bidder give managers more leeway to carry out value-reducing acquisitions. Long-
term investors defend management from takeovers (by making bids more expensive) but
also prevent overbidding and value-reducing acquisitions.” (p.163). Their Figure 2,
presented hereafter, summarizes their empirical findings. It shows that, on average, the
shareholders of target firms received less value and the shareholders of bidding firms
lost more value, when short-term investors were a significant presence among the
shareholders of the relevant companies.

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Transient investors may also induce in managers a short-term perspective attuned to the
expectations of these shareholders; for instance, a study by Brian Bushee concludes
that “…high levels of transient ownership are associated with an over-weighting of near-
term expected earnings….This finding supports the concerns that many corporate
managers have about the adverse effects of an ownership base dominated by short-
term focused institutional investors” (Bushee, (2004).

In another paper about the general influence of stock market pressures on company
management, Graham, Harvey, and Rajgopal (2005) report on a survey of some 400
financial executives in the U.S. They found that financial executives “would take real
economic actions such as delaying maintenance or advertising expenditure, and would
even give up positive NPV projects to meet short-term earnings benchmarks.…. In the
end, many of our results are disturbing. The majority of CFOs admit to sacrificing long-
term economic value to hit a target or to smooth short-term earnings.” (p.36-36) This
study does not indict hedge funds specifically but the whole system of consensus
quarterly earnings forecasts and the severe penalties inflicted on any management that
does not deliver. Hedge funds of the speculative kind, though, may have an
exacerbating influence on this deeply rooted problem.

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Finally, the most logical, peremptory argument that hedge funds, as activist
shareholders, induce, or seek to induce, management to adopt a short-term
horizon, rest with their explicit statement of targeted returns. As we argued
above, the cost of capital of a company is one side of a coin where the other side
is the time horizon for investment purposes; and the cost of equity, the largest
component of the cost of capital, is defined as the returns “expected by
shareholders/investors”. Hedge funds of the speculative kind cannot have it both
ways: target high returns for their equity investments and claim that they are not
short-term investors nor do they induce short-term orientation in the management
of companies.

The Way Forward

Let’s summarize the arguments made thus far:

1 The realities of contemporary stock markets are made of high stock churn rate,
short holding period, vote buying activities, record date capture, short selling,
stock lending, huge volume of stock derivatives, fairly long period of time
between record date and date of annual meeting. As a result, the common
assumptions underlying “corporate democracy” have been made obsolete; the
huge volume of share trading by hedge funds is a major contributing factor to
these developments;
2 Some variants of hedge funds are now in the business of pressuring
management and directors to undertake actions they deem likely to boost share
prices; to enhance their ability to achieve their ends, they take full advantage of
the anomalies and imperfections of corporate democracy;
3 A significant presence in the shareholder base of a company of short-term,
transient investors does have an impact on the way a company is managed;
4 In the contemporary world of finance, the “one-share/one-vote” incantation rings
hollow; it may be sub-optimal and a source of serious distortions;
5 Unfettered trading in the control of companies, as if they were a commodity, a
metal, or a piece of commercial real estate, may be the goal of some players in
the financial markets; but the aggressive pursuit of that goal may bring about
government policies and popular attitudes far less beneficial to reasonable

14
 investors. Because of their secretive nature and their financial cleverness, often
flirting with the limits of legality, because of their warped incentive systems
motivating a ferocious quest for high short-term yield at all costs, hedge funds
raise particular concerns about their long-term effect on companies and on
societies where they choose to ply their peculiar brand of capitalism.

There are several options to curtail the negative influence of hedge funds.
1. Certainly, fuller disclosure, as advocated by Hu and Black, makes sense.
2. Voting caps whereby a shareholder may not acquire more than a stated
maximum number of votes, irrespective of the actual number of shares
held. We believe this approach would cause more harm than good and
could be easily circumvented.
3. Time-phased voting and other Incentives to motivate shareholder
stability. There are some examples of this practice even in the U.S.; the
Aflac corporation, for instance, still grants ten votes to shareholders
holding their shares for 48 months or more. It is also quite common for
French companies to provide several benefits to their “loyal”
shareholders, i.e. shareholders holding their shares for two years or
more get two votes for every share; French companies often pay a
“loyalty premium” dividends (usually + 10%). Furthermore, French
shareholders also enjoy reduced rates of taxation on capital gains as a
function of the length of their share ownership (the lowest rate is
achieved after a seven-year holding period!).
4. Granting the right to vote to a shareholder only after a specific period of
time, say one year. In the final analysis, the real challenge is to find ways
to enhance shareholder stability and loyalty with a minimum of disruption
to the financial markets. This recommendation may require, in the U.S., a
change in listing requirements of the NYSE and NASDAQ. It is not the
case in Canada.
5. Provided proper legal and regulatory safeguards are in place to protect
the rights of minority shareholders, capital structures consisting of dual
class of shares with different voting power, a fairly common occurrence
in Canada, in Europe (except for the U.K.) and in Asia, have merit as a
means of taming hedge funds.

15
Conclusions and recommendations

1. It is time to impose a minimum period (say one year) before a shareholder can
exercise its voting rights. This practice would call for an affirmative statement by
shareholders that they have held their shares continuously for a period of at least
one year as of the record date.
2. Dual class of shares, with strong protection of the rights of minority shareholders,
should be viewed positively in a context where stable and sizeable shareholders
provide companies with the proper time horizon and a quality of governance that
is comparable to that of private-equity funds.(Allaire, 2006)
3. The time lag between the record date and the date of the annual meeting should
be shortened. Anachronistic procedures for proxy distribution and voting should
be replaced by modern means of communications, such as the Internet.
4. Better, more transparent disclosures should be mandated for OTC derivatives,
short selling, equity traded derivatives, equity swaps, shares lending and
borrowing, so that the true economic and voting positions in the equity of a
company may be assessed; such disclosure would go a long way towards
eliminating “empty voting” and hidden ownership.
5. Share lending by institutional investors for “vote buying” purposes (or so-called
“record date capture”) should be prohibited.
6. Share lending by institutional investors for short selling purposes should be
subjected to a couple of constraints:
• Institutions should ascertain the identity of the borrowers of
their shares, both having to report the transaction under the
expanded disclosure rules described above.
• Institutions should retain the voting rights attached to these
shares.

Howls of calumny, chagrined outrage and dire forecasts of terminal tampering with
efficient markets are bound to greet such proposals. So be it. The long-run welfare of
societies and the economic vigor of companies are more important than the spurious
lure of “shareholder value” and the freedom to practice financial legerdemains. Granted

16
total freedom to act as they wish, hedge funds, or more accurately a subset of funds,
could well become the grave-diggers of public corporations.

The concept of shareholders as the only and ultimate stakeholder of publicly traded
companies received a rare level of support during the 1990’s. It is increasingly coming
under attack. A company is not just a piece of property, but a social system with an
economic finality; boards of directors do have a fiduciary responsibility to shareholders,
but they also have a moral responsibility to other stakeholders.

Society at large may rightfully claim that it has a stake in companies operating in its
midst, a stake just as important as that of shareholders (Brennan, 2005). No doubt that a
fickle, volatile, ever-changing shareholding base provides arguments for a different
concept of “who owns the company”.

In the current stock market context, we argue therefore that the practice of granting the
full and immediate rights of corporate citizenship, including the right to vote, to
shareholders immediately upon their appearance in the rostrum of shareholders, does
not make sense anymore. The democratic equivalent to this practice would consist of
granting the right to vote to anyone who happens to be in the country on Election Day
(recent immigrants, tourists, business travelers, etc.). Every democracy imposes a
minimum period of time before a newcomer acquires the full rights of citizenship,
particularly the right to vote. Corporate democracy likewise should call for a modicum of
commitment from a shareholder before he or she can influence the destiny of a
company.

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 References

Allaire, Y. and M. Firsirotu. « Changing the Nature of Governance to Create Value »,

Institut C.D. Howe 189, November 2003.

Allaire, Yvan, “Dual class of shares in Canada: some modest proposals”, SSRN Paper
#952043, December 2006.

Bratton, William W., “Hedge Funds and Governance Targets”, SSRN Paper #928689,
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