The Future of Domestic Capital Markets in Developing Countries

Chapter 12. Capital Structures and Control Rights: Patterns, Trade-offs, and Policy Implications

 Capital Structures and Control Rights: Patterns, Trade-offs, and Policy Implications 12     Capital structures and voting arrangements define how control is distributed among shareholders in the corporation. Capital structures may consist of a single class of shares where every share has one vote or several classes of shares with different voting rights. This chapter contributes to the one share, one vote debate by showing that “one size does not fit all” and that effective reform of corporate governance must take into account a country’s ownership structure, enforcement capacity, specific policy objectives, and idiosyncratic constraints of the political economy. The chapter is organized as follows. From a corporate governance perspective , countries can be mapped in a two-dimensional space, with ownership in one dimension and control rights in the other. Four main frontiers arise: (1) dispersed ownership rights and diffused control rights, (2) dispersed ownership and concentrated control rights, (3) concentrated ownership and diffused control rights, and (4) concentrated ownership and concentrated control rights. The topology of ownership and control rights around the world is discussed in detail in the first section. The authors would like to thank Michael Klein, Neil Roger, Alexander Berg, Harry Broadman, Simeon Djankov, Claire Grose, Cally Jordan, Sue Rutledge, and Richard Symonds for their insightful comments during the preparation of this chapter. Special thanks are also due to Victoria Korogodon and Huiwen Leo for their assiduous work in conducting research. The simplest way to ensure that shareholders can exercise their voice is to give each share one vote (see table 12-1 for a comparison of how some international and institutional guidelines address the issue of one share, one vote). In this chapter we define the principle of one share, one vote as pure symmetry or equality between cash flow rights and voting rights.1 Although a country might follow one share, one vote in the sense that each share normally carries one vote, its legal framework or ownership structure may include a mixture of provisions that concentrate and diffuse control rights, such as voting on a show of hands, pyramid structures, or special rights for minority shareholders. In many countries, cash flow rights often deviate from control rights. This occurs largely because the legal and regulatory framework separates cash flow rights from voting rights. Asymmetries between voting rights and cash flow rights lead to the concentration or diffusion of control, and these asymmetries are discussed in the second section. Capital structures or arrangements leading to concentration of control rights include multiplevoting shares, nonvoting shares, shares with preferential rights like golden shares, pyramid structures and cross-shareholdings, shareholder agreements , and other arrangements, such as voting by partly paid shares. The result is control by few and ownership by many. Capital structures or arrangements that lead to diffusion of control rights include voting on a show of hands, minimum capital requirements to initiate corporate actions, minority veto rights and supermajority requirements, cumulative or proportional voting, and voting caps. The Organization for Economic Cooperation and Development (OECD), in its Principles of Corporate Governance, does not advocate one share, one vote. Rather, it recommends that deviations from the benchmark be disclosed to investors. The question arises whether such deviations are fundamentally wrong and should be abolished through strengthening of the OECD principles or whether the OECD principles should remain unchanged. This prompts a thorough analysis of one share, one vote. To put it differently, the question is whether deviations from one share, one vote dilute welfare production, because such deviations do not maximize value. The answer to this question is more complex than anticipated. Under some circumstances, deviations can enhance value, while in others, they can reduce value. For example, Rose investigates the performance of Danish firms with dual-class structures between 1995 and     1. La Porta and others (1998, table 1).       Table 12-1. Overview of Select International and Institutional Guidelines on One Share, One Vote Guidelines Organization for Economic Cooperation and Development (OECD), Principles of Corporate Governance, 1999 International Corporate Governance Network (ICGN), Global Share Voting Principles, 1998, and Statement on Global Corporate Governance Principles , 1999 European Association of Securities Dealers (EASD), Corporate Governance Principles and Recommendations, 2000 Danish Shareholders Association, Guidelines, 2000 Hermes, Statement on U.K. Corporate Governance and Voting Policy, 2001 Pension Investments Research Consultants (PIRC), Shareholder Voting Guidelines, 1999 Peters Commission, Recommendations on Corporate Governance in the Netherlands, 1997 Hellebuyck Commission, Recommendations on Corporate Governance, France, 1998 Stand on one...