Loyalty shares v. one share – one vote: The Florange Act

Voters’ rights are about to change significantly in France at the beginning of next month. The Florange Act, which was adopted on 29 March 2014, provides for the automatic granting of double-voting rights to stock held by shareholders who have owned it continually for at least two years. These “long-term” holdings are known as “loyalty shares.” Companies can either opt out of the Act’s provisions through a management or shareholder resolution, or may already prohibit double voting rights in their bylaws; although many French companies already have double voting rights. The two-year holding period triggering automatic double voting rights started on 1 April 2014 so these rights will automatically apply on 31 March this year, unless companies opt out.

There is some support for long-term shareholders receiving more voting power; it is seen as an encouragement to long-termism. However, much of this support is found mainly among shareholders who already hold large swathes of a company’s vote, which, in the case of France, often means the State—the very agency which introduced the Act. On the other hand, the Act’s provisions created a storm of protest among many other shareholders and their advisory groups, where there is a firm commitment to the one share—one vote principle.

“Overall, there was a very negative reaction from institutional investors regarding the provision since one share – one vote is one of the most important principles of good governance; to have voting power aligned with economic investment. Every deviation from this is a governance problem.”
Rients Abma, Executive Director, Eumedion

Before examining the reactions for and against loyalty shares, the current landscape must be examined. According to QuickScore, proxy voting advisor ISS' governance rating product, 74 percent of the largest French companies either have existing double voting rights (the majority at 62 percent) or are authorized by their bylaws to grant double voting rights in the future (12 percent). The QuickScore figures are based on a sample of 175 French companies, which is made up of 106 SBF120 (Société des Bourses Françaises) companies, including 35 CAC40 (Commissaire Aux Comptes) companies plus 69 companies outside these indices. The graph below, “The Current Picture for Loyalty Shares,” also shows that the proportion of companies with double voting rights, or the ability to introduce them, is even higher for companies outside the SBF120.

Source: ISS Quicksource

The 20 companies that could grant double voting rights in the future can be divided into two groups, as some shareholder or management proposals to opt out were never submitted, with the remainder made up of companies where such proposals were introduced but rejected by shareholders. This group of 20 includes Alstom, Electricité de France, Orange, Renault, Vivendi, Aeroport de Paris, and Air France KLM. Many of these companies were already heavily owned by the French government or, such as Renault, saw the government acquire a larger stake in order to prevent proposals against double voting from passing, or they already had controlling shareholders, such as Vivendi.

The following graph, “Equity Ownership and Voting Power of Significant Shareholders at Companies with Double Voting Rights” shows, for the sample of 109 companies with existing double voting rights, the percentage of shares and the percentage of votes held by significant (defined as greater than 10 percent) shareholders. At these companies, significant shareholders own, on average, 40 percent of the shares and 50 percent of the votes.

Source: ISS Quicksource

Reactions to the Act were immediate and strong. Indeed, some started before the Act was signed into law. On 11 September 2013, a letter from the chairman of the French financial markets regulator Autorité des Marchés Financiers’ (AMF) to the French Minister of Economy and Finance strongly criticised the act’s provisions. And another letter in January 2015, from the Association Française de la Gestion Financière, the French asset management association, also wrote to the ministry to affirm the one share – one vote principle.

Rients Abma, executive director of Eumedion, a Dutch foundation working to develop good corporate governance and managed by representatives of institutional investors who collectively manage €4,000 billion, says, “Overall, there was a very negative reaction from institutional investors regarding the provision, since one share – one vote is one of the most important principles of good governance to have voting power aligned with economic investment.” Abma says, “Every deviation from this is a governance problem.”

The International Corporate Governance Network (ICGN) also came out strongly against the Act:

ALTERNATIVES TO DIFFERENTIAL RIGHTS?

Below, the International Corporate Governance Network talks about promoting responsible stewardship.
If differential ownership rights are not the answer to promote long-term investor thinking, then what alternatives exist? ICGN believes that one answer lies in the ongoing development of investor stewardship practices and their integration into the investment management process. Stewardship codes are developing in many markets to establish more responsible investment practices, relating to monitoring, engaging and voting at company AGMs. While the evidence base relating to the practical impact of stewardship codes remains minimal and somewhat inclusive, we believe there is merit in sticking to the course, and we recognise that developing a culture of stewardship can take time.
Both the ICGN Global Governance Principles and the ICGN Statement of Principles for Institutional Investor Responsibilities6 address the importance of investors assuming the responsibilities for long-term stewardship. These guidance statements outline the importance of investors making effective use of voting rights at shareholder meetings, and to engage intelligently and pro-actively with investee companies on strategy, corporate governance and both financial and non-financial risks related to long-term performance. This in recognition of the fact that both companies and shareholders have a mutual interest in protecting and generating sustainable corporate value over the long term.
A practical way to embed longer-term thinking between asset owners and asset managers is to ensure that investment management agreements contain contractual terms that mandate responsible stewardship practices. In ICGN’s Model Mandate Initiative areas of focus for asset owners are identified to provide a better alignment of interest with their investment managers over the long term. Asset owners should fully align the interests of their fund managers with their own obligations to beneficiaries by setting out their expectations in fund management contracts. Key areas of focus for asset managers which are seeking to align the activities of their fund managers more closely with the long-term interest of beneficiaries include among others:
]ensuring that the timescales over which investment risk and opportunity are considered match those of the client;
]aligning interests effectively through fees, pay structures and cultures;
]effectively integrating relevant environmental, social and governance factors into investment decision-making and ongoing management;
ensuring that portfolio turnover is appropriate to the mandate, in line with expectations and managed effectively.
In summary, it is understandable for regulators and policy makers to encourage more responsible long-term investment practices to promote sustainable corporate performance and economies. But there is no “silver bullet” to achieving this, and the tactic of employing differential voting rights or loyalty shares has the potential to do more harm than good. ICGN believes that continued focus on long-term investor stewardship is likely to achieve the most effective results as responsible investment practices continue to take root in the investment management process. Ultimately there is scope for building trust among both companies and investors. Investors need to gain the trust of companies by demonstrating that their overarching concern is long-term commercial success for companies, not simply short-term. At the same time, companies need to build trust, particularly amongst their minority investor base, that the rights of all shareholders are respected and that controlling shareholders do not exercise a disproportionate or undue influence in ways that might work against the interests of minority shareholders or the long-term success of the company.
Source: International Corporate Governance Network

“At the same time, however, the ICGN is concerned that the introduction of differential ownership rights is a flawed tactic that carries potentially unintended consequences that can affect not only minority investors, but also the long-term performance of companies ...”

The ICGN expressed concerns about governance problems and entrenched management where voting rights are found in excess of the economic stake of a shareholder in a company, even though loyalty shares were introduced in the interests of long-termism. The specific provisions of the Act also mean that, as ICGN says, investor engagement on this issue “is likely to be at a micro level, rather than at a macro public policy level.” In other words, shareholders will have to engage on the issue company by company.

Of course, France was not the only European country considering preferential voting rights for long-term shareholders. A similar law was also contemplated by Italy, but in the case of Italy, investor protest was heeded and the Italian government abandoned plans early in 2015 to allow the introduction of double voting rights without supermajority approval. In addition, MEP Sergio Cofferati proposed, in the Cofferati report to the European Parliament, the introduction of differential ownership rights as part of the revised European Shareholder Rights Directive (SRD). Again, this was successfully opposed. “The Cofferati report that sought to amend the SRD was rejected by a plenary session of the European Parliament last July,” says Abma, “and they are working on finding compromise text. Of course, this does not prevent individual countries from introducing loyalty shares.”

“Of course, loyalty shares are allowed in other countries,” notes Abma. “The Netherlands has a very flexible company law system and allows double voting rights. Some companies seeking such a system have moved their headquarters to the Netherlands, though they are also moving for tax reasons. For example, Fiat moved from Italy to the Netherlands in 2014, and when Ferrari was split off from Fiat, it too was incorporated in the Netherlands, as was another spin-off, truck-maker CNH Industrial. This was largely so that Fiat’s founders, the Agnelli family, could retain voting control at these companies. This was also the case at cable company Altice, where the founder moved the company here from Luxembourg to increase voting control.

Also in early 2015, BlackRock raised several objections to preferential voting rights. The first of these was based on concerns over difficulties in actually voting shares in French companies. Voting would become a manual process in France because of the loyalty shares; this is due to the fact that preferential voting rights could not be taken into account by international voting platforms. This would raise the cost of voting until new processes could be designed to take account of double voting. The firm also expressed concern that difficulties in voting shares could prevent access to non-domestic funds; preventing non-French investors from investing in French companies. Secondly, the firm noted, a survey of investors showed that a discount of up to 30 percent is applied to the value of shares of companies displaying “shareholder control-enhancing mechanisms.” U.S. Public pension fund giant, CalPERS, also affirmed its support for one share – one vote in its Global Governance Principles.

French asset management company PhiTrust Active Investors led a "shareholder engagement campaign" against the Florange Act in 2015. The campaign included investors from Germany, the United Kingdom, and Switzerland holding €2.3 billion in assets. The campaign focused on 11 companies in the CAC 40 including BNP Paribas, Crédit Agricole, L’Oréal, GDF Suez, Vinci, Renault, and Vivendi. As one can see from data from ISS QuickScore, the campaign was unsuccessful at both Renault and Vivendi. It should be noted that retaining or gaining one share – one vote is dependent on the support of a supermajority vote from shareholders of 66.67 percent, no simple hurdle to pass; this means it is even easier for founders or controlling shareholders to hang on to voting power.

Although ISS can only advise its clients on which way to vote, its recommendations carry significant weight on shareholder rights issues. An ISS consultation paper from last year indicated that, for French companies that did not currently have a bylaw prohibiting double-voting rights, or that were not in the process of introducing such a bylaw, it may recommend against either or both of the reelection of directors or supervisory board members, or the approval of a company’s annual report and accounts. Exceptions may have been made if a company has made a commitment to introduce a bylaw to outlaw double voting rights.

Despite this, it seems that the positions of both sides had already solidified.

“We already saw votes during the 2015 AGM [annual general meeting] season,” explains Abma, “where a majority of minority shareholders, including large institutional investors, voted for changes to companies’ articles of association to retain one share – one vote. On the other hand, the French government bought new shares in Air France KLM and prevented a change to the articles of association that would have introduced one share – one vote. Companies such as L’Oreal, Unibail, Vinci, Credit Agricole, and BNP Paribas managed to keep the one share – one vote principle, while companies such as Renault, Air France KLM, Veolia, and Vivendi introduced the double voting regime.”

Unless there are some significant shifts in either ownership or owners’ opinions during the coming AGM season, it seems as if the voting rights landscape in France is set for the near future.