Dominant shareholders have the ability to influence an outcome, for better or worse. “This usually only manifests itself above a holding of about 10 per cent,” says Fiona Harris FAICD, chairman of the Barrington Consulting Group and director of BWP Trust and Infigen Energy. “At 10 per cent you have a blocking stake in a takeover and at 30–35 per cent you can be deemed to have de facto control if there are no other shareholders with holdings that offset yours.”
But dominance isn’t always a function of size. “If there are two shareholders with 20 per cent each then it’s possible that neither is dominant,” Harris continues. “And shareholders with an even smaller holding have the potential to exert influence over particular agendas – for example, by using protest votes at annual general meetings (AGMs).”
A double-edged sword
Shareholders with a significant amount of “skin in the game” may fight hard for a company’s success. They can help to protect a company from a hostile takeover – for example when the largely family-owned Coopers Brewery fended off a $420 million bid from Lion Nathan in 2005. They can also bring relative ease and certainty to the process of gaining shareholder approval if the board obtains their support before putting a proposal to members as a whole.
“Some have the incentive and influence to ensure that the chief executive officer (CEO) is creating value for all shareholders,” says Frank Lancione MAICD, a partner at Piper Alderman, immediate past president of the Heart Foundation in South Australia and a former director on the national board. “This can be particularly useful when there are many small investors across diverse geographical locations.”
They might even have the power to influence government. “This could generate great personal benefits as well as driving the adoption of policies to benefit the company, including minority shareholders,” says Lancione.
However, influence can also facilitate the abuse of power. “Minority shareholders can be subject to oppression or unfair prejudice as a result of excessive executive remuneration, the improper restriction of dividends, exclusion from salaried positions in the company, or the improper issue of shares to reduce a shareholder’s interest,” says Lancione. “Large private benefits of control could also be extracted at the expense of minority shareholders through tunnelling – contractual dealings with the company that favour the controlling shareholder.”
Once a shareholding exceeds 20 per cent there is a danger that regular creep will give the owner de facto control without having to pay a control premium to other shareholders.
Sometimes, a major shareholding arises at the same time as an initial public offering (IPO), when the dominant shareholder is still part of the management team or, worse still, chairman and CEO.
“In the bad old days, they may have also pledged their shareholding as security for a loan and, therefore, be particularly averse to having any bad news come to the attention of the market,” says Harris.
A dominant shareholder with strong views on management decisions which differ from those of the board will may instigate a behind-the-scenes call for director resignations, a new CEO or a change in strategy. Occasionally, they take a more public approach, requisitioning resolutions to be put to shareholders in order to force the board’s hand.
“If they don’t want to requisition resolutions, they could air their disapproval by voting against the company’s remuneration report and commenting publicly on their reasons for doing so,” says Priscilla Bryans MAICD, a partner at Herbert Smith Freehills, chairman of the Victorian State Council of the Governance Institute of Australia and a member of the Australian Institute of Company Directors Law Committee.
“Dominant shareholders are more likely to be comfortable using the media to influence other shareholders and the business community than the boards of listed companies, who often feel that it is inappropriate for the directors to use this as a means of response,” she says.
In some cases, the capital market will actively dismantle a controlling position. “If a company requires additional capital – in response to globalisation and increased foreign competition, for example – external suppliers of debt or equity may insist on this,” says Lancione.
“It happened in 2002 when the prominent Italian Agnelli family, which has controlling ownership of Fiat, was raising €3 billion from Italy’s largest banks to finance a restructure. Fiat had to accept debt that could be converted into Fiat shares if certain financial targets were not met. They were not, and the lenders became Fiat’s largest shareholder with a 30 per cent interest.
“The Agnelli family invested €535 million to increase its shareholdings back to 30 per cent via a holding company, which resulted in a sharp increase in the controlling shareholder’s equity and a reduction in the level of private benefits that could be extracted.”
A challenge for the board
A holding of 10 per cent or more can bring the expectation of a board seat. “This does not have to be taken up by a representative of the shareholder organisation,” says Harris. “In some cases, where shareholders are entitled to multiple seats, they may be persuaded to nominate a suitably-qualified independent director.”
When a dominant shareholder has board representation there must be appropriate separation between the representative and the person who makes the buy and sell decisions.
“Proper email segregation and other Chinese walls are likely to be part of this,” Harris continues. “The person in charge of the buy and sell decisions should be visited and briefed on a regular basis as any other shareholder would be, and without sharing any non-public information.”
Dominant shareholders can be inside or outside the boardroom but, when they are inside, they can be particularly difficult to manage. “You have a legal duty not to act when you have a conflict of interest, but someone sitting at the table has a substantial shareholding,” says Julie Garland McLellan FAICD, director of Bounty Coal and a partner at O’Leary and Partners.
“You also have to consider how dominating this person is in terms of personality, and whether your board rules are sufficiently rigorous to prevent any dominance from being brought to bear.”
When Garland McLellan was chairman of Oldfields Holdings, the company’s survival depended on an injection of capital. One of the directors, who also happened to be a dominant shareholder, offered to underwrite the necessary capital raising.
“The first thing we did was make a very serious and concerted effort to find an alternative underwriter,” she says. “We needed to be able to tell the other shareholders with absolute honesty that this was our only option.”
From the outset, the board was committed to taking meticulous care with procedure. “When we had to make a decision about the capital raising, we sent the director out of the room then gave him an opportunity to comment on the decision when he returned,” Garland McLellan continues.
The recapitalised company survived – and, when a disgruntled shareholder complained to the regulator about the choice of underwriter, the complaint was quickly dismissed. “If you’re doing the right thing, records are your friend,” says Garland McLellan.
Lynn Wood FAICD, a trustee for the International Financial Reporting Standards Foundation (IFRS Foundation) and a director of Save the Children Australia, once had a dominant shareholder on her board who responded to probing questions by asking: “Don’t you trust me?”
“I was initially taken aback, then I realised I had to explain that this was not a matter of trust but of understanding,” she says. “This stopped the defensive responses and led to more constructive discussion.”
Experience has also taught her not to rely on existing policy. “I was once on the board of a subsidiary investment company when management wanted us to pursue an investment which was favourable to the parent company but exceeded the subsidiary’s investment policy,” she continues.
“The conflict of interest policy we had in place didn’t adequately address this situation, so the independent directors worked together to improve it. Under the revised policy the proposed investment still could not be approved. The parent company was initially disappointed with this result but, as it enhanced the reputation of both the parent and subsidiary companies, it helped us to gain support for future investments.”
The need to speak out
Directors must always act in the best interests of the company as a whole – but a dominant shareholder can put this to the test. “If a dominant shareholder starts requisitioning resolutions that the board does not believe are in the best interests of the company it will need to reach out to the rest of the shareholders,” says Bryans.
“This can involve letters from the chair, face-to-face meetings with representatives from other large shareholders and proxy advisers, and the use of proxy solicitation firms.”
A director who suspects a problem has no choice but to speak out. “This is never going be easy, and it can be particularly difficult if the biggest shareholder is also the chair and in a position to vote you straight off the board,” says Garland McLellan. “Then you have to ask yourself whether you’re willing to stay on and be seen as a lapdog.
“If someone should ask for your resignation you have the right to call a meeting and put a resolution to all shareholders. You might be concerned that your reputation will be damaged by having a public fight with the board, but I think it’s more likely to be enhanced by the fact that you are clearly strong, independent and working for the best interests of the company as a whole.”
During the technology boom, Wood was on the board of a technology company with a venture capitalist who attempted to do deals that favoured his other interests.
“As an independent director I reinforced the need for a focused agenda,” she says.
“Later, when he wanted to take out preference share capital which the CEO and I believed was important to the company’s financial sustainability, I made it clear that I would resign if that decision was carried.”
In the extreme, directors can apply for permission to bring proceedings on behalf of the company for conduct amounting to oppression, unfair prejudice or unfair discrimination against a member or members of the company.
“Anecdotally, in 2003, the board of Hollinger International ousted Conrad Black, its chairman, and sued him for $200 million for misuse of funds,” says Lancione. “At the time, Black owned 17 per cent of Hollinger Inc, which owned 30 per cent of the cash flow rights and 78 per cent of the voting rights.”
Disruption and conflict is never good news but good governance is the best defence. “I believe you should have someone on every board who understands boards, governance and good board process because you never know when you’re suddenly going to need that level of expertise and support,” says Garland McLellan.
“If that’s not possible, the company is probably not big enough to have a properly-qualified company secretary either so I would recommend bringing one in from outside. A good company secretary is one of the best assets a board can have. Good process may not always save the company, but it will save the directors.”
Fiona Harris shares her tips on managing a dominant shareholder in the boardroom
- Where the shareholder is not part of management team or the board, schedule regular briefings on matters relating to strategy and remuneration as well as anything else that is likely to be contentious.
- If the shareholder is also a part of the management team, appoint a very strong chairman or lead independent director and try to put independent governance in place over issues that are likely to be contentious, such as the release of profit warnings to the market.
- Ensure that a representative director has received appropriate governance training so that they understand the distinction between the two roles.
- Be as open as possible with the representative director while keeping them separate from the final decision-making process if there is a conflict.
- Make it clear that all directors are expected to attend board meetings regularly and function as part of the team.