Shareholder Votes for Sale



Reprint: F0506D

To make legitimate and effective use of vote buying, managers should act with the company’s best interests in mind, say Luh Luh Lan at the National University of Singapore and Loizos Heracleous at Oxford.

Whatever you think of Carly Fiorina’s management style, she is a shrewd tactician. In the acrimonious proxy battle surrounding the 2002 Hewlett-Packard–Compaq merger, the promerger group, headed by the former HP CEO, squeaked by the antimerger dissidents with less than a 1% margin. But before Fiorina’s side could claim victory, the dissidents brought suit, accusing Fiorina’s group of, among other things, buying votes to push the merger through.

Buying votes? It may be illegal in politics, but in the corporate arena, it is a legitimate, if controversial, strategic tool. In essence, to achieve a corporate goal, management can give cash, loans, or business opportunities to shareholders in exchange for the voting rights attached to their shares. Indeed, the promerger side in the HP-Compaq affair secured its hair-thin lead with the help of 17 million Deutsche Bank votes that HP management had allegedly bought from the bank. In a decision on the case, the judge addressed HP’s vote buying, finding that it did not violate Delaware law governing corporate fiduciary duty. The judge also laid down guidelines that have important implications for managers and directors contemplating vote buying.

Some background: The law states that stockholders have proprietary interests in the stock they have purchased, and neither the corporation nor anyone else can interfere with the exercise of those interests. The interests include the right to vote on mergers and acquisitions, sales of assets, and governance matters such as director elections. In the absence of fraud, shareholders can legally choose to separate their ownership and control over the shares so that they can continue to enjoy the economic benefits of owning the shares while relinquishing the voting rights attached to them.

This all makes legal sense, but, not surprisingly, vote buying is controversial because management can use it to push through unpopular transactions that a stockholder majority could otherwise thwart. Perhaps inevitably, vote-buying agreements can attract charges of unfair diversion of corporate assets, self-dealing, and board entrenchment, especially in takeovers, so they are frequently challenged in court.

To make effective and legitimate use of vote buying, and to head off lawsuits, managers would do well to follow a few basic principles:

First, managers should scrupulously act with the company’s best interests in mind, even though vote buying is protected by the “business judgment rule,” which says managers are presumed to have acted in good faith unless a claimant is able to prove that there was illegal behavior or a conflict of interest.

Second, management should ensure that the transaction does not defraud or disenfranchise any group of shareholders. Even though stockholders’ voting rights are proprietary, courts will closely scrutinize vote buying in cases where a sale appears to violate the interests of shareholders.

Finally, management should build into the transaction protective measures to safeguard against the abuse of shareholders’ rights. These measures would include, for example, forming a special committee with independent counsel to advise on the vote-buying agreement and related deals, and putting the agreements before a full board. In addition, the vote-buying proposal should be separately voted on by the shareholders before it is entered into by the board on behalf of the corporation. As a condition for passing the proposal, a majority of outstanding shares (as well as a majority of the shares neither participating in the agreement nor owned by directors and officers of the corporation) have to be voted in favor of the proposal.

Legal history shows that courts have been tolerant toward management. Business history shows, in addition, that there can be legitimate, strategic reasons for management to buy control of voting rights of certain shareholders. However, managers who engage in vote buying still face a high threat of litigation. It should go without saying, but the management team that pays vigilant attention to the interests of shareholders and keeps its dealings transparent is most likely to avoid legal entanglements and help the corporation benefit strategically from vote buying.

A version of this article appeared in the June 2005 issue of Harvard Business Review.


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