<B>What’s up with minority shareholders?</B>

Manuel Romera. Professor. Instituto de Empresa

21 March 2006

Minority shareholders often feel defenceless. Spain’s new corporate governance code seeks to encourage the appointment of truly independent directors to company boards in an effort to increase transparency and protect minority interests.

The trendy-- and now widely-used--concept of ‘corporate governance’ is aimed in theory at striking a fair balance between shareholders with large stakes in a company and those who are known as ‘minority shareholders’. What corporate governance suggests is that the administrative body of a company-- i.e. the board--should appoint directors who are independent of both the executives and the shareholder representatives on the board. These independent board members should work in the general interest of the company and not for its top-ranking executives or majority shareholders. Unfortunately, this does not happen as often as it should. In fact, according to the latest ‘Spencer Stuart’ index for boards, the candidacies of 94% of independent directors are proposed by the company chairman or by the stake-holding board members, i.e., the majority shareholders. This brings into question the real ´independence´ of the independent directors, as well as their willingness to defend minority shareholders.

However, minority shareholders aren’t necessarily defenceless. Indeed, small shareholders have proven willing recently to exercise their rights, often with certain success. A case in point is the legal action that minority shareholders of Urbanor-- the owner of the land where the Kio Towers were built in central Madrid- took against the powerful Albertos—the wealthy businessmen and cousins, Alberto Alcocer and Alberto Cortina-- for their role in a financial scandal involving the Spanish realtor. After a lengthy trial, the Supreme Court ruled in favour of the company’s minority shareholders.

A survey by the Foundation of Sociological Studies concluded that 80% of small shareholders complain that no mechanisms exist in Spain to defend their interests. The profile of the average minority shareholder is as follows: 58% are men of between 35 and 54 years of age, are of middle-to-high class, are reasonably well-informed-- more than half read about the stock market at least once a week—and have a rational attitude towards the risk-profitability profile of the shares they trade. Most prefer to invest in large companies.

Because public takeover bids result in a change of company owners, they tend to attract minority shareholders. This type of deal usually benefits minority shareholders because they offer cash for shares—a proposal that minorities can either leave or take as they see fit. However, these bids also have their flip side: When management changes hands, minority shareholders often feel impelled to sell their shares when they don’t like the buyer; otherwise, they could end up owning shares in a company whose management they are uncomfortable with. A case in point is Telefónica’s takeover bid for Terra, its Internet unit, in February 2005. Individual shareholders and associations of minority shareholders, such as Adicae, took Telefónica to court, claiming it was responsible for decapitalising Terra, which enabled it to buy the unit on the cheap. Telefónica was accused of manipulating Terra’s share price, appointing directors who were far from independent and breaching shareholder trust.

Currently, a working group organized by the National Stock Market Commission has drawn up a new draft of the ‘corporate governance code’ in Spain. The project is titled ‘Unified Code’ and its aim is to ensure that corporate boards appoint independent directors willing to defend the interests of minority shareholders. In particular, independent directors must number more than three and represent more than a third of the board. The draft code also describes potential conflicts of interest that directors should avoid, such as being employed by the same company or its auditors during the previous three years. Another case is when a director has been an executive adviser for the same company at some time during the previous five years or a supplier of financial services or goods in the last year. The code also highlights the difficulties of achieving independence when a ‘family relationship’ or a ‘similar relationship of affection’ exists between an executive adviser and a director at the company. Finally, it underscores the important role the ‘appointments committee’ plays in winning board approval for the independent candidatures.

I hope these reforms become reality because they would prevent majority shareholders from dominating the interests of minorities. Corporate governance must not be just a trend. Rather it must be looked upon as a serious legal obligation for all the boards in our country. In this way, we would not only defend the right of all shareholders to speak and to vote, we would also improve the transparency and good governance of our business community and, consequently, of our stock exchange. These achievements will help our economy progress, develop and prosper. The need for independence is clear; more than half of Spain’s listed companies have boards that fail to meet the one third rule for independent directors. In fact, quite a few listed companies do not have a single independent director on their board.

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