Shareholder Rights and The Equitable Treatment of Shareholders

The Fourth Asian Roundtable on Corporate Governance
Mumbai, India, 11-12 November 2002
Shareholder Rights and the Equitable

Treatment of Shareholders
Manish Singhai
Vice President & Portfolio Manager
Alliance Capital Management, Singapore
Protecting Minority Shareholders from

Improper Dilution
The views expressed in this paper are those of the author and do not necessarily represent the opinions of
the OECD or its Member countries, the ADB or the World Bank
Expropriation
The Risk of Expropriation is the Major Principal-Agent
Problem for Listed Companies !
Three Common Modes Employed by the

“Insiders” (Controlling Shareholders & Managers)
– Profit Appropriation
– Tunnelling of Assets
– Improper Dilution
Manish_Singhai@acml.com
Profit Expropriation
• Transaction of Goods or Services with
Affiliates at Non-Market prices
• Improper Selection of Related Companies
as Vendors
• Disproportionate Allocation of Shared
Revenues/Costs to Affiliates
• Outright Theft or Fraud
Tunnelling of Assets
• Transfer of Assets at Non-Market Prices
• Value-Destroying Acquisitions &
Investments to help Related Companies
• Off-Balance Sheet Loan Guarantees
• Expropriation of Corporate Opportunities
by Related Companies
Improper Dilution
• Exclusive Issuance at a Discount to a Sub-set
of Investors
• Deeply Discounted Rights Issues
• Excessive Executive Compensation by Issuing
Shares at a Steep Discount
• Using Shares to pay for Acquisition of Unlisted
Entities at Inflated Valuations
• Massive Dilution Induced by Financial Distress
5
Dilution - Case Study 1
Private Placement of Convertible Preferred
Stock at a Discount to Market Price
Shinsegae Department Stores, Korea
– 1mn Preference Shares convertible 1:1 into ordinary shares 3 years from
the issue date of 31-Dec-01
– The issue price of W65,000 reflected a 14% discount to the closing price of
similar preferred shares on 17-Dec-01 (the announcement date), despite
the new shares carrying a higher dividend rate (15%) than the old (10%)
– The choice of instrument and the manner of placement led to serious
market speculation that the issuance was intended to shore up the
controlling shareholders’ stake in the firm at a relatively lower cost
6
Rights Issue at a Deep Discount
Thai Farmers Bank, Thailand
– TFB raised US$800mn @ Bt88 apiece in 1998 to re-capitalize its balance sheet.
At the time, it claimed that it would not need to raise any further capital. A year
later, TFB announced a 1:1 rights issue at Bt20 per share, a steep discount to the
prevailing market price of about Bt70.
– Minority shareholders faced a Hobson’s Choice - invest more money to maintain

stake, or face a massive dilution since the ex-rights market price was bound to be
significantly lower.
– Several minority shareholders did not want to invest more money in TFB. Worse
still, several others were not able to participate since the rights offer did not meet
all the requirements under the US securities law.
7
Over-payment for an Unlisted Acquisition
Hyundai Mobis, Korea
– Hyundai Mobis’ proposed the purchase of a 50%+ stake in Bontec from the
family of its own controlling shareholder, MK Chung.
– Hyundai Mobis was to pay for the acquisition with its own shares.
– MK Chung had purchased the stake in Bontec in Oct-2001 at a price of

W13,000 per share, and the sale to Hyundai Mobis at an estimated price of
W60,000 per share represented a capital gain of 360% in a 9 month period
– Negative market reaction forced the management to seek investor feedback;

the transaction was subsequently scrapped
Employee Bonus Share Issue
Mediatek, Taiwan
– 18mn shares (4.1% of total outstanding shares) granted to employees at the par
value of NT$10 apiece, a 98% discount to the prevailing market price **
– The imputed value of NT$8.4bn was 1.25x the entire net profit of NT$6.7bn
earned by the company in FY2001
– Employees had been granted 12.3mn shares in 2000 & 12.5mn shares in 1999
– This is a common occurrence in the Taiwanese high-tech companies. Taiwan

GAAP does not require companies to expense the compensation paid in the form
of such employee share grants in the P&L account, masking the dilution.
Note: ** Both the proportion & the discount are adjusted for a 40% stock-dividend announced simultaneously
Financial Distress Leading to Massive Dilution
Hanvit Bank, Korea
– Formed by the merger of two state-owned banks to become the largest
domestic bank in Korea, post-1997 crisis
– Re-capitalized in Sep-99 with a US$1bn GDR offering to international investors;

foreign shareholders owned about 12% of the company in 1Q00
– However, at the end of 2000, following continuous deterioration in asset quality

and increase in loan losses, total capital was wiped out
– After 100% capital reduction, the government re-capitalized the bank with a
W2.8bn injection
10
Equity Market Response
• Improper Dilution is usually followed by a period of
sustained stock price under-performance
• The ensuing erosion in the firm’s market value may
significantly exceed the immediate dilution, to price in
the risk of future recurrence (de-rating!)
• In other words, the market raises the implicit cost of
equity financing for the firm
• At the macro level, such instances highlight the lack
of protection for minority shareholders, and may raise
the cost of equity for the particular market as a whole
11
Extra-Legal Mitigation
• Firms are Forced to Build a Reputation if they want
Repetitive Access to Capital Markets (e.g. Paying
Dividends, Listing ADRs to show commitment to greater
disclosure, Frequent Interaction with Minority Investors)
• Voluntary Adoption of “Majority Approval by

Shareholders” Clause in Company’s Articles
• Influence by Large Non-Management Share-holders
(e.g. Foreign Institutions or Strategic Investors)
• Extra-Legal Suasion by the Government (e.g. threat of

withdrawal of tax incentives or operating licenses)
12
Stress-Testing The Measures
“If a firm in a weak legal system promises to treat investors well but then suffers an
adverse shock, the manager who controls the firm has an incentive to renege on
this promise. Ultimately, the only way to enforce a contract between managers
and shareholders is through legal action of some kind. ” (Johnson & Shleifer)
“The trouble is that ADRs may help companies opt into a regime of greater
disclosure, but they do not stop expropriation as long as it is disclosed”
(Johnson & Shleifer)
“The outside investors are more vulnerable to expropriation, and more dependent on
the law than either employees or suppliers, who remain continually useful to the
firm” (La Porta, Lopez-de-Silanes, Shleifer & Vishny, 1998)
“Governments may also say that that they want to protect investors, but in a sharp
downturn find that they would rather protect entrepreneurs….,…e.g. Malaysia”
(Johnson & Shleifer)
13
No Substitute to Legal Armor
“…it [legal protection] makes expropriation technology less efficient……At

the extreme of no investor protection, the insiders can steal a firm’s
profits perfectly efficiently. As investor protection improves, the insiders
must engage in more distorted and wasteful diversion practices such as
setting up intermediary companies into which they channel
profits….When investor protection is very good, the most the insiders
can do is overpay themselves, put relatives in management, and
undertake some wasteful projects. After a point, it may be better just to
pay dividends. As the diversion technology becomes less efficient the
insiders expropriate less, and their private benefits of control diminish.”
(Investor Protection & Corporate Governance -

La Porta, Lopez-de-Silanes, Shleifer & Vishny, 2000)
14
Have Laws - Will Enforce !
Effective Legal, Institutional & Regulatory
Framework is an Essential Pre-requisite
• Strong Judiciary, Tough & Fair Regulator, Alert
Stock-Exchanges
• Appropriate, Comprehensive & Clearly Defined
Regulations & Laws
• Enforcement at Reasonable Cost & within an
Acceptable Time-Frame
15
Specific Legal Safeguards ….
To Protect against Improper Dilution, the Company & Security
Laws or Commercial Code should Specifically Provide for :
– Preemptive Rights
• Existing shareholders have the first opportunity to buy new issues of stock
• This right can only be waived by a majority vote of all shareholders
– Oppressed Minority Mechanisms

• Judicial venue to challenge the management decisions e.g. File a Class
Action Suit (as in the US) or Petition the Courts/Company with a Complaint
• Right to exit the firm by requiring it to purchase the minorities’ shares when
they object to fundamental changes such as mergers and asset sales (as in
Korea)
16
….Within a Broader Framework
Anti-Expropriation Elements are Integral to a Broader Legal
& Regulatory Structure for Good Corporate Governance:
– Convergence of Ownership (Cash-Flow Rights) & Control (Voting Rights)
– Independent, Effective, and Accountable Board
– Audit Committee chaired by an Independent Director
– Accounting & Audit Integrity
– Accurate & Timely Disclosure of Material Information about

Ownership, Conflicts of Interest, Related-Party Issues, etc.
17
Alliance Capital & Corporate Governance
As a leading global institutional investor, the firm is highly

cognizant of its responsibility in helping improve governance
standards in the markets and companies where it invests
– Conscientiously exercises its voting rights
– One of the few, if not the only firm to institute a formal CG rating as
a component of our in-house investment research process in
Emerging Markets
• Analysts complete a questionnaire in conjunction with the company management,
which is used to arrive at a CG Rating
• Periodical review helps to establish directional indicators for each company
– Collaborates with other investors and not-for-profit share-holder

activist groups in specific instances of anti-minority behavior
18
References
• La Porta & Lopez-de-Silanes, “Capital Markets & Legal Institutions”
• La Porta, Lopez-de-Silanes, Shleifer & Vishny, “Investor Protection & Corporate
Governance”
• La Porta, Lopez-de-Silanes, Shleifer & Vishny, “Investor Protection & Corporate
Valuation”
• Johnson, La Porta, Lopez-de-Silanes & Shleifer, “Tunnelling”
• Johnson & Shleifer, “Coase and Corporate Governance in Development”
• Bebchuk, Kraakman & Triantis, “Stock Pyramids, Cross-Ownership, and Dual Class
Equity”
• IIF Equity Advisory Group, “Policies for Corporate Governance and Transparency in
Emerging Markets”
• Clasessens, Djankov, Fan & Lang, “Expropriation of Minority Shareholders in East Asia”
I would also like to thank the associates and friends in the Investment Banking
Industry with whom I have had several thought-provoking discussions leading up
to this paper but who have requested that they not be named !
19

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The Fourth Asian Roundtable on Corporate Governance

Mumbai, India, 11-12 November 2002

Shareholder Rights and the Equitable

Protecting Minority Shareholders from

Three Common Modes Employed by the

– Minority shareholders faced a Hobson’s Choice - invest more money to maintain

– MK Chung had purchased the stake in Bontec in Oct-2001 at a price of

– Negative market reaction forced the management to seek investor feedback;

– This is a common occurrence in the Taiwanese high-tech companies. Taiwan

– Re-capitalized in Sep-99 with a US$1bn GDR offering to international investors;

– However, at the end of 2000, following continuous deterioration in asset quality

• Voluntary Adoption of “Majority Approval by

• Extra-Legal Suasion by the Government (e.g. threat of

“…it [legal protection] makes expropriation technology less efficient……At

(Investor Protection & Corporate Governance -

– Oppressed Minority Mechanisms

– Independent, Effective, and Accountable Board

– Audit Committee chaired by an Independent Director

– Accounting & Audit Integrity

– Accurate & Timely Disclosure of Material Information about

As a leading global institutional investor, the firm is highly

– Collaborates with other investors and not-for-profit share-holder

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