“When the company does well, everybody will be happy, and not just the controlling shareholder”

Saturday September 10, 2011

Major advantages need major caution

OPTIMISTICALLY CAUTIOUS

By ERROL OH

THE oddest (and most misguided) view on corporate governance I've ever heard came from an independent director of a listed company several years ago. He pooh-poohed the idea that the protection of minority shareholders should be a pillar of the capital market. He questioned the fuss over the safeguarding of the rights of the minorities, suggesting that it was unnecessary and overblown. Let a company's board and management do what they need to do, he insisted, and that would take care of everybody's interests.

“When the company does well, everybody will be happy, and not just the controlling shareholder,” he argued. An accountant with many years of experience, this guy was then the chairman of the listed company's audit committee. And he still is. For the sake of the company's minority shareholders, I hope he has different thoughts on this subject these days.

What's really scary is that such lack of respect and recognition for minority shareholders is not rare at all. Maybe others don't say it openly, but through their actions or inaction, we can tell that they don't see the rights of the minorities as a priority.

It's naive and careless for anybody to believe the board and management will always do what's best for the company, and by extension, for the minority shareholders. This would be true only if the directors and management have no reason to favour one shareholder or a group of shareholders over the rest. That's often not the case in Malaysia.

It's rare for a listed company here to be without a dominant shareholder, and in many instances, the companies have majority shareholders, that is, those that own more than 50% equity. It's standard practice for these large shareholders to place their nominees as directors and top managers. In fact, many of these shareholders (if they are individuals) are directors themselves and usually in an executive capacity.

The ultimate form of this phenomenon is the big shareholder doubling up as chairman and chief executive, which means that he heads both the company's board and management. A 2009 survey by the Securities Commission found that 27.5% of the 949 companies listed on Bursa Malaysia didn't separate the roles of chairman and CEO.

With strong representation in the board and management, a shareholder has overwhelming advantages over the other shareholders, by human design or by the sheer nature of things, or both. And many times, the major shareholders aren't shy about exploiting this edge. We have to properly understand this because it's the basis for the need to protect the minority shareholders.

We are frequently told to maintain healthy scepticism, to not swallow everything we're told and to seek information that people prefer us not to have. Indeed, healthy scepticism is a useful thing to have when evaluating the deeds of the listed companies' large shareholders. Here's why:

Selecting the stewards

Sure, minority shareholders too get to vote for or against the re-election or re-appointment of directors at AGMs. But it is the major shareholders who normally choose those who are appointed as directors in the first place. This is why the concept of independent directorship is slippery. How is a director wholly independent if he serves on the board with the tacit consent of the controlling shareholder? Why do boards sometimes get new faces, including the independent directors, after significant stakes change hands or in the aftermath of a corporate battle? Such developments are of little comfort to minority shareholders who are hoping that their rights are under the protection of independent directors.

All-day access

Typically, big shareholders have a direct line to the board and management of a listed company. After all, they have a say in who are made directors and key managers. They can probably pick up the phone at any time to talk to a director or a senior executive. Plus, because the shareholders have nominees on the board and in management, there are likely to be regular meetings and reports to keep the shareholders updated on what's happening at these companies. In this situation, it's easy for the shareholders to give instructions and suggestions. And of course, if these shareholders are directors with executive powers, they are already at the centre of it all. A minority shareholder will never come close to having this kind of access and influence.

Knowledge is an advantage

Major shareholders will always know more than the minorities about the companies and industries. The former will know first when things are picking up or when the numbers are pointing to a slide. They have a deeper understanding of the trends and developments that affect the businesses. They know better if share price changes are knee-jerk reactions or not. They have a keener sense of whether the market has grossly undervalued the company. And if the major shareholders are involved in the board and management's decision-making, they will know just about everything there is to know about the companies. Unless he's an employee, no minority shareholder can even dream of matching this extent of knowledge.

More shares, more power

Most major shareholders can do a lot more than the minorities simply because they have a far higher number of shares in hand. The large stakes mean stronger voting power at AGMs and EGMs, and more to gain when share prices climb and dividends are declared. Also, when majority shareholders take on executive roles, they are almost always handsomely remunerated, in cash and in kind. Considering that majority shareholders have deeper pockets and potential veto power, the minorities are puny players in the corporate scheme of things.

Beware the RPTs

Neutral observers are seldom happy when listed companies do deals with their majority shareholders. Although related-party transactions (RPTs) are not necessarily unfair to the companies, they inevitably benefit the majority shareholders more than they do the minorities.

There is a cost to having a large investment in a business, and therefore we can't expect a large shareholder to settle for the same benefits as those of the other shareholders. But we can and so do the authorities expect controlling shareholders to be conscious of the fact that they are not the only shareholders. If the rights of the little people are trampled again and again, it won't be long before healthy scepticism turns into unhealthy distrust.

● Executive editor Errol Oh is not even a majority shareholder in his family. That's why the AGMs at home can be wild and wooly affairs.

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