Scholars who study activism have researched the value of a shareholder vote for decades. A very small number of activists have attempted to apply that research to actual proxy contests and other AGM matters. The subject was confined to academics and a couple of creative activists until the Shareholder Vote Exchange (SVE) showed up.

SVE now came and went. What remains is the interesting and potentially compelling idea that activists can compensate shareholders in a portfolio company for their votes. At what appears to be less cost than you’d expect, an activist could acquire enough votes to make a difference in a BoD election, deal vote, or other similar matter.

SVE Promoted a Clever Idea

For a moment in time, SVE created a marketplace where shareholders can sell their votes in a company without selling the underlying shares. Activists that need extra votes for an AGM could post bids for shares. Institutional and individual shareholders that were indifferent to the outcome could then sell votes in a continuous auction.

Alas, SVE failed to attract enough buyers and sellers to get to scale. It transacted a total of under 1 million votes in its short lifetime, in tiny blocks. As it scrambled to find buyers and sellers, it proposed companies could use the exchange to find votes to make a quorum. That might interest AMC, GME, and maybe a few others with elusive retail investors, but no one else. After less than a year of trading, a couple of weeks ago it announced it will close by the end of April.

Give its short tenure and small impact, SVE did attract more than its share of attention. The Wall Street Journal wrote a mixed profile, Matt Levine at Bloomberg called it a “fun idea”, and Business Insider profiled its DIS auction. If it did nothing else, SVE prompted activists to consider a novel way to gain an edge in pressuring a portfolio company.

Is This Even Legal?

We’ve studied this idea for a few years, and that’s the first question anyone asks. It seems it is.

Delaware law provides an answer. Even it doesn’t provide a clear statute or extensive case history. One case stands out, involving the HP-Compaq merger in 2002. HP shareholders accused HP of “buying” votes of a significant shareholder as a way to gain approval for the deal. In analyzing the case, Chancellor Chandler writes:

Shareholders are free to do whatever they want with their votes, including selling them to the highest bidder. Management, on the other hand, may not use corporate assets to buy votes in a hotly contested proxy contest about an extraordinary transaction that would significantly transform the corporation, unless it can be demonstrated … that management’s vote-buying activity does not have a deleterious effect on the corporate franchise.

It appears activists have more latitude and thus opportunity than companies. As SVE attempted to show, companies can likely buy votes only to establish a quorum.

An investor that buys votes still may need to disclose the transaction. It’s not completely clear whether buying votes remains within the scope of ordinary proxy solicitation or transforms it into an “arrangement” that merits disclosure in proxy materials or Form 13D (for 5% holders). We tend to think of it as proxy solicitation, but this is not legal advice, nor is anything else here. Consult your favorite securities attorney.

The Cost of a Vote

Ok, if it’s legal to buy votes, then how should the parties price them? The media accounts of SVE noted prices per vote from one basis point on share price to 200 bps or more. Academics have analyzed this problem, and finally have some solid theory and evidence about the answer.

The price should naturally vary based on supply and demand. Demand will increase with the importance of a given vote. Thus, BoD votes in contested elections should cost more than the vote on the auditor.

Researchers have tried a few different methods to isolate the vote value within the price of a share of stock, including analyzing share lending prices around record dates and estimating option prices to simulate the stock cash flows but without voting rights. The most comprehensive analysis comes from Prof. Slava Fos of Boston College (disclosure: business partner of ours), whose seminal paper analyzes changes in share prices before and after record dates. A similar paper analyzes option exercise patterns of CEOs involved in a proxy contest. Both are straightforward to read and worth the time.

The research confirms that controversial votes cost more than routine ones. Votes on proxy contests cost 20-60 bps of the share price, or $0.20-$0.60 per share for a stock at $100 per share. Votes on completely routine matters cost 3-8 bps, or $0.03-$0.08 per share. Acquiring 5% of the votes in a proxy contest at a $1 billion market cap company might cost $200,000, which could make the difference between winning and losing a close vote.

We can also estimate the price of a call option on votes. This becomes interesting and important because of the mechanics of collecting proxies in these deals (more below). The option premium is a relatively small fraction of the vote cost, say 5-15%. The option gives the buyer (activist) the right to acquire the proxy at a later date. For the $1 billion market cap company, an option on 5% of the votes might cost $10,000-$30,000.

Off-Exchange Deals

We contemplate an analogue to private, off-exchange stock trades. Without SVE, an activist can still compensate shareholders for their votes. The activist just lacks the liquidity and price transparency of a robust marketplace. Instead, you negotiate with shareholders directly on price and terms.

The mechanics also need close attention. An activist can’t merely pay a shareholder for a proxy and move along to the next one. The selling shareholder can vote again with a latter-dated proxy card. The activist could find itself paying that shareholder, only to find the proxy it acquired doesn’t count because that shareholder submitted a different proxy card later. Thus the need to buy a call option on the vote.

With an option, the activist pays a small amount now for the shareholder commitment to deliver a proxy card later. Once it becomes clear the activist will need the votes, say rather than settling the contest, it can exercise the option, pay the shareholder, and collect the proxy card. It can also pay the shareholder later, once the activist confirms it acquired the last-dated proxy card.

Not for the Faint-of-Heart

The media coverage of SVE inevitably points out buying votes might look a little bad. Matt Levine asks, “Can you imagine the hay that some corporate managers would make out of an evil activist hedge fund buying votes?”

On the other hand, activists didn’t succeed by caring deeply what other people, particularly company executives, think of them. Buying votes might prompt a few shareholders to oppose such an activist, while locking in others that an activist might not otherwise reach.

An activist now has a choice: try to persuade one or another shareholder to support its thesis and vote for its candidates and proposals, or compensate that shareholder directly. SVE opened up the possibility of the latter as another way for an activist to pursue its goals at a portfolio company.

This post comes to us from Michael R. Levin, founder and editor of The Activist Investor.