Shareholder action is restricted to a binary choice, a decision that requires a “yes” or a “no.” For example, shareholders may be asked whether or not to participate in a tender offer, redeem SPAC shares, exercise preemptive rights, or approve a proposed shareholder resolution.
My forthcoming article, The Case for Non-Binary, Contingent, Shareholder Action, challenges this limited binary regime and calls for amending the law so that shareholders could act contingently, thus allowing more nuanced decisions. They could incorporate relevant information without having to rely on costly disclosure rules and condition their actions on the acts of others, such as majority shareholders.
Contingent shareholder action could also include a limit that would prevent dilution. The limit could restrict the shareholder’s participation in programs such as preemptive rights, buybacks, or tender offers so that the shareholder’s percentage of stock would not exceed or fall below a specified threshold, regardless of the actions of the other shareholders.
A shareholder’s vote on a corporate action could be separate and different from the choice to participate in the action itself. Thus, my article analyzes two examples that demonstrate this distinction and the benefit of using a contingent shareholder action regime in these cases. The case of shareholder redemption rights in Special Purpose Acquisition Companies (SPACs) is the first example. The case of shareholder preemptive rights is the second.
SPACs are companies that go public with no operations but with the intent to make an acquisition within, usually, two years after the IPO. Since the beginning of 2020, the majority of U.S. IPOs involved SPACs. SPACs offer a tempting solution for investors in times of uncertainty, allowing them to take advantage of underpriced acquisition targets while avoiding the loss of their investment, a protection resulting from a requirement that most IPO proceeds be held in escrow until an acquisition is approved or the SPAC is dissolved. In recent years, SPACs have grown in popularity, with respected and well-known sponsors and underwriters joining and promoting SPAC IPOs.
However, one curious aspect of SPACs, highlighted in my article, is that, even when shareholders vote on a proposed acquisition, the shareholders can redeem their shares regardless of their vote. The result is not just odd, allowing an investor to support the transaction but exit the investment before the closing of the transaction, it creates an unusual separation of ownership and control and potentially exposes retail investors to a misleading signal when making the decision about redemption of their shares. The holders of the majority of the shares will not necessarily put their money where their vote is; thus, an acquisition that receives the approval of the holders of the majority of the shares is not necessarily a deal that is good for retail investors. The article considers a few reasons why sophisticated investors may vote for the acquisition while at the same time redeem their shares. These reasons include ownership of warrants that unlike the shares may benefit from the acquisition. Another reason is the general interest of investors in maintaining a good relationship with the promoters of the acquisition.
Without this ability to both approve the deal and ask to redeem the shares, a passive strategy would have benefited retail investors: If the deal is good, the sophisticated investors will approve it, and thus there is no need for the retail investors to redeem their shares; and if the deal is bad, the sophisticated investors will not approve it, and again there is no need for the retail investors to redeem their shares. However, in the reality of SPACs, retail investors cannot assume that, even if they do nothing, the sophisticated investors will vote against and stop undesirable acquisitions, leading the SPAC to an outcome that is also good for the retail investors. Dual class capital structures, where the managers of the SPAC own superior voting rights, exacerbate the problem by requiring less than the majority vote of the investors to approve the deal.
The article proposes adopting a contingent shareholder action regime to protect unsophisticated retail investors who cannot rely on the approval of a transaction. Under this regime, shareholders can make a contingent decision to redeem their shares, instead of passively relying on the results of the vote on the deal. For example, retail investors can tell the company that they will redeem their shares if at least a certain percentage of the shares will be redeemed unconditionally, thus relying on the personal economic decision of the sophisticated investors rather than on their vote.
Contingent shareholder action can also help shareholders make a better decision and protect retail investors from abuse in cases involving, for example, preemptive rights or coercive tender offers. In a contingent shareholder action regime, shareholders could copy acts of other shareholders. For example, shareholders could tender their shares contingent on other shareholders tendering at least 30 percent of the company’s shares unconditionally. Copying the acts of other shareholders could substitute for expensive communication and prior coordination among shareholders and mitigate collective action problems.
The article argues that contingent shareholder action is similar to mandatory disclosure requirements, in that it allows retail investors to benefit from the choices of other shareholders. However, on one hand, contingent shareholder action treats all shareholders equally and allows for simultaneous actions by all shareholders, while giving shareholders the option to follow those who decide to act unconditionally. On the other hand, mandatory disclosure requires costly dissemination of the information disclosed by the select shareholders to the remaining shareholders ahead of their action.
This post comes to us from Mira Ganor, the Judge Solomon Casseb, Jr. Research Professor in Law at The University of Texas School of Law. It is based on her recent article, “The Case for Non-Binary, Contingent, Shareholder Action,” available here.