Blockholder Votng Hesk Bar-Isaac and Joel Shapro Unversty of Toronto and Unversty of Oxford March 2017 Abstract By ntroducng a shareholder wth many votes (a blockholder to a standard model of votng, we uncover several strkng results. Frst, f a blockholder s unbased, she may not vote wth all of her shares. Ths s eff cent, as t prevents her vote from drownng out the nformaton provded by other votes. Second, f ths blockholder can announce her vote before the vote takes place, other shareholders may gnore ther nformaton and vote wth the blockholder to support her superor nformaton. Thrd, f the blockholder s based, some shareholders wll try to counter the blockholder s vote. The results are robust to allowng for nformaton acquston and trade. Ths suggests that regulatons dscouragng or prohbtng abstenton, strategc behavor, and/or coordnaton may reduce eff cency. Keywords: Blockholder, shareholder votng, corporate governance JEL Codes: G34, D72 We thank Patrck Bolton, Stephen Hansen, Alexander Ljungqvst and Frédérc Malherbe and partcpants n the semnar at UC Dubln for helpful comments. Bar-Isaac thanks SSHRC (435-2014-0004 for fnancal support and the London Busness School for ts hosptalty n hostng hm as a vstor whle much of ths paper was wrtten. Unversty of Toronto, 105 St. George St. Toronto, ON M5S 3E6, hesk.barsaac@rotman.utoronto.ca Saïd Busness School, Unversty of Oxford, Park End Street, Oxford OX1 1HP. Contact: Joel.Shapro@sbs.ox.ac.uk 1
1 Introducton Shareholder votng has a stark dfference wth votng n the poltcal context - a shareholder may have many shares, and thus, many votes. Blockholders, shareholders wth a large fracton (often defned as 5% of the shares of a frm, are ubqutous - n a sample of representatve U.S. publc frms, Holderness (2009 fnds that 96% of the frms have at least one blockholder, and the average stake of the largest blockholder of a frm s 26%. 1 The dentty of blockholders may vary substantally from actvst nvestors to passve ndex funds to even the managers or drectors of the frm. Blockholders play a large role n the governance of frms. The U.S. Securtes and Exchange Commsson (SEC has ncreasngly focused regulatory scrutny on blockholders for ther votng behavor. Investment advsers (ncludng mutual funds have been told to ensure that ther votes are n the best nterests of ther clents and must publcly report ther votes (SEC, 2003. Large nvestors must report ther stakes and ntentons when they reach 5% ownershp of a frm. Nevertheless, groups of actvst nvestors ( wolf packs sometmes act n concert but ndvdually avod the 5% rule, generatng both academc and regulatory debate (Coffee and Pala, 2015. In ths paper, we study blockholder votng n a standard theoretcal framework and fnd several strkng results: Blockholders may prefer not to vote wth all of ther shares, and ths s eff cent: Consder the votng strategy of an unbased blockholder, where unbased means that the blockholder wants her vote to ncrease the value of the frm. Our frst result s that ths blockholder may not vote wth all of her shares. Gven that she wants to maxmze the value of the frm, f she doesn t have very precse nformaton, she would prefer that other shareholders nformaton not be drowned out by her votes. The blockholder s not wastng her unvoted shares; she s actng 1 He also fnds that ths dstrbuton s not very dfferent that n the rest of the world. 2
optmally to mprove the eff cency of the vote. 2 We also demonstrate n an extenson that gven the opportunty to trade shares, the blockholder may not trade her unvoted shares. Gven that evdence suggests that many nvestment advsers try to satsfy SEC requrements by blndly votng ther shares wth the recommendaton of proxy advsers (Ilev and Lowry, 2015, and Malenko and Shen, 2016, our result suggests that such rules may be neff cent. Other shareholders may gnore ther own nformaton to vote wth an unbased blockholder: Our second result looks at the stuaton where the unbased blockholder can observably announce ts votng ntentons before other shareholders vote. Ths could represent an actvst nvestor or a large penson fund usng publc statements to communcate ther poston. In ths case, f ths blockholder s well nformed, some of the shareholders may gnore ther nformaton and vote wth the blockholder. It s perfectly ratonal to gnore ther nformaton; f the blockholder has a lot of nformaton but not enough shares to express that nformaton, the shareholders essentally supplement the blockholder s shares wth ther own. Determnng whch shareholders wll support the blockholder requres coordnaton. Our result then suggests that shareholder coordnaton to support blockholder votng can mprove eff cency; therefore some concerns about coordnaton by groups of nvestors such as wolf packs may be overstated. When the blockholder s based, some shareholders wll try to counter the bas: Now consder the stuaton where the blockholder s known to be based. We defned bas here as the blockholder supportng one sde of the proposal no matter what nformaton t receves. For example, the blockholder could support management s poston because she s a manager or has busness dealngs wth the frm that depend 2 We defne eff cency below to be maxmzng the probablty that the vote matches the true state of the world. 3
on good relatonshps wth management. 3 Our thrd result s that, n ths case, some shareholders may gnore ther nformaton n order to counter the blockholder s bas. Consder the stuaton where a shareholder receves a sgnal that management s poston adds value. Snce the shareholder knows that management s over-weghted n the vote, we show she mght ether vote aganst the blockholder (to cancel out the blockholder s vote or abstan (whch allows some nformaton to enter the vote. The shareholder acts strategcally to counter bas and maxmze the nformatveness of the vote. Notce that ths may requre coordnaton by shareholders; n ths scenaro, coordnaton s also effcency enhancng (as t was n the case of the unbased blockholder dscussed above. The votng model s standard asde from the fact that there s one voter (the blockholder wth more shares than the others. All other shareholders want to mprove the value of the frm and receve a sgnal about whch choce from a bnary decson wll ncrease value. The blockholder also receves a sgnal, whch we assume to be more nformatve than an ndvdual shareholder. abstan. A vote wns by a majorty, and voters may vote strategcally (or Strategc votng s a key element of our model and the focus of our analyss. Allowng the blockholder and shareholders to vote strategcally leads to more nformatve outcomes. Strategc abstenton enhances eff cency alternatvely by ( allowng the blockholder to express ts nformaton precsely, ( allowng shareholders to step asde when the blockholder has very precse nformaton, ( allowng shareholders to express themselves whle stll counterng the bas of a blockholder, and (v forcng the based blockholder to not express ts bas. Beyond strategc abstenton, shareholders may also 3 For example, a mutual fund may support management to preserve busness tes (see Davs and Km (2007, Ashraf, Jayaraman, and Ryan (2012, and Cvjanovc, Dasgupta, and Zacharads (2016. Another example of blockholder bas s documented n Agrawal (2012, where labor unon penson funds may vote for labor-frendly drectors. 4
gnore ther sgnal to ncrease nformatveness when ( they vote wth the blockholder to support ts precse nformaton and ( they vote aganst the based blockholder to allow nformaton to flow through the remanng votes. We offer two extensons of the model to make t more realstc. In the frst extenson, we allow the blockholder to acqure nformaton and trade shares. Ths provdes a robustness check for our result that the blockholder may not vote all of ts shares, as t s natural to ask why the blockholder would not trade shares that t does not vote. We show that the blockholder mght face a lemons dscount when t sells shares as nvestors may nfer that the blockholder dd not acqure nformaton. In the second extenson, we provde a ratonale for the SEC rules for nvestment advsers, gven that they seem contrary to economc ntuton from our man model. In partcular, we show that forcng the blockholder to vote all of her shares could potentally enhance eff cency as t mght provde her wth ncentves to acqure nformaton. Our analyss s kept smple to present the effects clearly and mantan tractablty. We recognze several drectons n whch we have kept the model uncomplcated. Frst, the bas (or lack thereof of the blockholder s common knowledge. Second, the precson of all shareholders and the blockholder s nformaton s common knowledge. Thrd, we focus on the most nformatve equlbrum. There are good reasons to do so, as ths s the equlbrum all agents n the model prefer, however there do exst many other equlbra as n all strategc votng models. In the followng subsecton, we revew the related lterature. In Secton 2, we set up the model. In Secton 3, we analyze the case where the blockholder s unbased and passve n the sense that t makes no announcement. In Secton 4, we have the unbased blockholder make an announcement before the other shareholders vote, whch we call the actve blockholder case. In Secton 5, we extend the model to allow for nformaton acquston, tradng, blockholder bas, and have a further examnaton of votng regulaton. Secton 6 concludes. All proofs that are not n the text are n the Appendx. 5
1.1 Lterature Revew Edmans (2014 and Edmans and Holderness (2016 provde thorough surveys of the theoretcal and emprcal lterature on blockholders. None of the theoretcal papers cted n these papers are about votng - blockholders make costly nterventons n a frm and/or trade the frm s shares n these papers. Yermack (2010 surveys the lterature on shareholder votng and also does not cte any such research. Theoretcal Lterature Feddersen and Pesendorfer (1996 analyze the swng voter s curse, where unnformed voters abstan n order to allow more nformed voters to sway the vote. Ths s the ntuton for why the unbased blockholder may not vote all of her shares n our model,.e. her nformaton has a value, and so does the nformaton of the remanng shareholders. Our result that shareholders may gnore ther nformaton to vote wth the unbased blockholder and mprove the outcome s related. A few other papers use ths type of logc n dfferent contexts. Eso, Hansen, and Whte (2014 study empty votng 4 and fnd that unnformed shareholders and even based shareholders may sell ther votes (at a zero prce to nformed shareholders n order to mprove the outcome. Note that our analyss demonstrates that actvsts don t necessarly have to resort to empty votng strateges to gan votes f they have credblty. Maug (1999, Maug and Rydqvst (2009, and Persco (2004 fnd that nformed voters/shareholders may gnore ther nformaton n response to dfferent votng rules. 5 Ths result s related to our fndngs on based blockholders; n these papers, the voters gnore ther nformaton to correct the bas of the votng rule, whle n our paper the shareholders may gnore ther nformaton 4 Brav and Matthews (2011 also examne empty votng n a model of a hedge fund who may both trade shares and buy votes, whle all other votng s random. 5 Bhattacharya, Duffy, and Km (2014 have a smlar effect when symmetrc voters have a dfferent precson of recevng a sgnal about one state of the world versus the other. 6
to deal wth the bas of the blockholder. Beyond dfferences n the questons we address and the asymmetres present n our model, our model s dfferent n that we allow for abstenton and for communcaton (both of whch affect the results. Malenko and Malenko (2016 look at a common value model where shareholders can acqure nformaton and/or purchase t from a proxy advsory servce. They focus on an envronment where shareholders are symmetrc, whch s crtcally dfferent to our asymmetrc envronment. Harrs and Ravv (1988 and Gromb (1993 study whether t s optmal to allocate unform votng rghts for all shares (one shareholder, one vote but do not ncorporate the role of nformaton aggregaton n votng that s key n our paper. Emprcal Lterature McCahery, Sautner, and Starks (2016 fnd that among shareholder engagement measures, votng aganst management was the second most frequently employed (and the top measure where shareholders exerted voce by surveyed nsttutonal nvestors. Furthermore, many of these nvestors had engaged managers publcly: 30% had aggressvely questoned management on a conference call, 18% had crtczed management at the annual general meetng (AGM, 18% had publczed a dssentng vote, 16% had submtted shareholder proposals for the proxy statement, 15% had taken legal acton aganst management, and 13% publcly crtczed management n the meda. These forms of publc engagement lend support to the verson of the model where the blockholder moves observably before other shareholders. Snce July 2003, the SEC has requred mutual funds to dsclose how they vote proxes wth respect to portfolo stocks. Duan and Jao (2014 fnd that votng s an mportant source of governance; for conflctual proxy votes (defned by votes where the proxy advsory frm Insttutonal Shareholder Servces (ISS opposes management the probablty of mutual funds votng aganst management s 46.42% hgher than for other proposals, whle ther probablty of ext s 3.12% hgher. Passve mutual funds, by defnton, do 7
not trade very often, and therefore can only affect value through voce (as opposed to ext. Appel, Gormley, and Kem (2016a fnd that a one standard devaton ncrease n ownershp by passve funds leads to a 0.75 standard devaton declne n support for management proposals and about a 0.5 standard devaton ncrease n support for governance proposals. Nevertheless, there are several ways n whch mutual fund votng mght dverge from blockholder votng behavor n our base model. Frst, mutual funds mght have conflcts of nterest and vote more for management. 6 We descrbe such a stuaton n our paper as a based blockholder and examne t n an extenson. Second, funds may not do ther own research and be nfluenced by proxy advsory servces. 7 We do not examne ths n the paper. Thrd, and possbly most relevant for our paper, the 2003 SEC requrements are not just about dsclosure; they requre nvestment advsers to act n the best nterests of clents. Ths could be nterpreted as prohbtng mutual funds from abstenton and strategc votng. Our man results pont to the eff cency enhancng effect of allowng abstenton and strategc behavor, but such an nterpretaton would make ths mpossble to observe n the data. Brav et al. (2008 pont out that actvst hedge funds do not usually seek control n target frms. The medan maxmum ownershp stake for ther sample s about 9.1%. In ther sample, actvst hedge funds take many forms of publc acton that s not drect conversaton wth management or a takeover attempt. 8 Appel, Gormley, and Kem (2016b ponts out that the presence of passve mutual funds has facltated actvsm by supportng actvsts wth large blocks of shares, and show that ths has led to changes n actvst 6 See Davs and Km (2007, Ashraf, Jayaraman, and Ryan (2012, and Cvjanovc, Dasgupta, and Zacharads (2016. 7 See, for example, Malenko and Shen (2016 and Ilev and Lowry (2015. 8 Ths ncludes seekng board representaton wthout a proxy contest or confrontaton wth management (11.6%, makng formal shareholder proposals, or publcly crtczng the company (32.0%, threatenng to wage a proxy fght n order to gan board representaton or sue (7.6%, launchng a proxy contest to replace the board (13.2%, and sung the company (5.4%. 8
presence and tactcs and overall outcomes. Ths lnks drectly to our results on shareholders votng wth the blockholder to support ts nformaton. 2 Model The model setup s smlar to the strategc votng lterature (e.g. Feddersen and Pesendorfer, 1996 wth the novel departure that one voter (shareholder has more votes (shares than the others the blockholder. Most of the lterature reles on symmetry n order to pn down equlbra. However, n the corporate envronment, asymmetry n the number of votes partcpants have arses naturally. We wll allow for asymmetry n numbers of shares and asymmetry n strateges (for shareholders who have equal number of shares. There are two types of agents who own shares n the frm. There s a blockholder (B who has 2b shares and 2n + 1 other shareholders (each denoted by S, each of whom owns one share. Henceforth, we use the term shareholder only to refer to one of the 2n + 1 who each hold only a sngle share. The assumpton that the blockholder has an even and shareholders odd numbers of shares allows us to dsregard tes for many of the cases we study. For smplcty, we assume there s no tradng of shares. We also assume that the blockholder does not own a majorty of the shares: Assumpton A1: n b A proposal at the shareholder meetng 9 wll be mplemented f a majorty votes for t. If there s a te, as s standard n the lterature, we wll assume that t wll be mplemented wth probablty 0.5. There are two states of the 9 From Yermack (2010: In addton to drector electons, shareholders may vote on such topcs as the appontment of outsde audtors, ssuances of new shares, creaton of equty-based compensaton plans, amendments to the corporate charter or bylaws, major mergers and acqustons, and ballot questons submtted n the form of advsory shareholder proposals. Shareholders may also be asked to ratfy certan decsons of the board of drectors, such as related-party transactons wth members of management. When shareholder approval of an tem such as an acquston becomes tme crtcal, votes may be held at specal shareholder meetngs called n the mddle of a year. 9
world θ, management s correct (θ = M, and aganst management (θ = A, whch are both ex-ante equally lkely to occur. Let d denote whether management wns (d = M or loses (d = A. Shareholders and the blockholder have common values;.e. they both prefer the choce that maxmzes the value of the frm. We wll relax ths assumpton n Secton 5.3, where we allow the blockholder to be based and strctly favor one decson. The payoff per share u(d, θ from a vote depends on the decson and the state of the world. If the decson matched the state of the world, the payoff s 1 for each share: u(m, M = u(a, A = 1. If the decson dd not match the state of the world, the payoff s 0: u(m, A = u(a, M = 0. The blockholder and shareholders get ndvdual mprecse sgnals s {m, a} about what the correct state of the world s. Ths precson s gven by π (θ s, where {B, S}. π B (M m = π B (A a = q π S (M m = π S (A a = p The probablty that the blockholder nfers the correct state from the sgnal s q, and that probablty for the shareholder s p. We assume that q p > 0.5. Ths ndcates that sgnals are nformatve, as ther precson s above 0.5, and that the blockholder receves a more precse sgnal than the shareholder. The blockholder presumably receves more precse nformaton because she s a larger nvestor and possbly has ( more contact wth the frm, ( more nfrastructure n place to gather nformaton, and ( more ncentves to gather nformaton. In the analyss, we wll dscuss what happens when the blockholder s sgnal vares n the analyss and we wll look at nformaton acquston by the blockholder n the extensons. We allow the blockholder and shareholders to vote strategcally. Gven a partcular sgnal, they may vote for M, A, or abstan. Nevertheless, n order 10
to gan some tractablty and focus on the key trade-offs of the model, we restrct the votng behavor of the blockholder and shareholders as follows: Assumpton A2: The blockholder s restrcted to pure strateges, can vote only an even number of shares, and can not smultaneously vote for both sdes of the proposal. Assumng that the blockholder votes wth an even number of shares (lke the assumpton that the blockholder holds an even number of shares and other shareholders an odd number allows us to dsregard tes for many of the cases we study. Ths does not affect the results, but smplfes the analyss and presentaton. Preventng the blockholder from votng for both sdes of the proposal s more a queston of presentaton, as what wll matter n that case would be the net votes the blockholder produces for one sde, whch could be replcated by votng only a fracton of her votes and abstanng wth the rest (whch we allow. We also assume: Assumpton A3: Shareholders are restrcted to pure strateges. Ths assumpton has bte only n case shareholders are ndfferent between dfferent votng strateges, and can be understood as restrctng the way they respond to ndfference. In more general games, allowng mxed strateges may be requred to ensure exstence of equlbra we wll show that pure strategy equlbra exst n all the envronments that we consder. We rely on ths assumpton to reduce the number of cases that we consder and for tractablty. Intutvely, the nformatonally eff cent equlbra that we focus on should requre (potentally asymmetrc pure strateges rather than mxed strateges to avod costly mscoordnaton. Persco (2004 ponts out that such a restrcton, whch he also makes, stll allows for rch strategc behavor, whch we also demonstrate. Moreover, Esponda and Pouzo (2012 argue that n the votng envronment that we consder, pure strategy equlbra are stable, whereas mxed strategy equlbra are not. The precson of the sgnals and the structure of the game s common knowledge. 11
Lastly, the votng settng leads naturally to multple equlbra, even when the blockholder and shareholders are restrcted to pure strateges. It s natural to focus on the equlbra that lead to the best outcome. Note, that snce all shareholders have dentcal preferences and dffer only n ther nformaton, they all agree on what best means here the equlbra that lead to the hghest probablty of selectng the decson that matches the state. We wll refer to ths as the most nformatve equlbrum. In Secton 5.3, we allow the blockholder to be based, and therefore ths may no longer be the blockholder s preferred equlbrum. Nevertheless, ths selecton crtera wll reman the preferred one of the shareholders and we contnue to employ t. In the followng sectons we consder two varatons of the model; frst we suppose the blockholder makes no announcements before t votes, whch we denote as a passve blockholder. Next we allow the blockholder to observably announce ts poston before other shareholders, whch we denote an actve blockholder. 3 Passve blockholder In ths secton, we analyze the model outlned above where both the blockholder and shareholders care about maxmzng the value of the frm. Lookng at how much nformaton the blockholder holds relatve to shareholders s crtcal to understandng what the most nformatve equlbrum s n ths context. Consder two examples. In the frst example, the blockholder has mprecse nformaton, say equal to the precson of an ndvdual shareholder s nformaton. Nevertheless, n ths example, the blockholder owns 40% of the shares, whle each ndvdual shareholder holds less than 1%. If the blockholder voted wth all of ts shares n ths scenaro, the fnal vote wll then mostly reflect the blockholder s nformaton. If nstead, the blockholder dd 12
not vote all of ts shares, the fnal vote would reflect the nformaton of all shareholders. As the blockholder cares about maxmzng the nformatveness of the vote, snce that wll augment the lkelhood of ncreasng frm value, t s natural to post that the blockholder prefers not to vote all of ts shares. In the second example, the blockholder s perfectly nformed,.e. q = 1, but only owns 5% of the shares of a frm. Indvdual shareholders have mprecse nformaton. In ths case, f all ndvdual shareholders vote, the blockholder s vote wll have lttle mpact. But f the ndvdual shareholders could delegate the vote to the blockholder, they would prefer to do so, as that would maxmze the nformatveness of the vote. They can accomplsh ths by abstanng. These two examples lead us to two equlbrum outcomes that mght maxmze nformatveness. We prove n Proposton 1 that these are the unque most nformatve equlbrum outcomes. We frst defne an optmal vote share for the blockholder, b 1 ln q ln(1 q :=, so that 2b s the even number of 2 ln p ln(1 p shares that most closely corresponds to the optmal vote share (wthout exceedng t, 10 accountng for the fact that the theoretcal optmal weght n decson-makng may not correspond to a round number. In partcular ths defnton mples that b s the nteger that satsfes: ( 2b p 1 p q ( 2b p +1 1 q <. (1 1 p We also defne a condton that determnes whch of the two equlbrum outcomes s more nformatve. ( p 2n+1 =n+b+1 1 p n b > q =0 ( p 1 p 1 q (C1 10 The functon x s called the floor functon. It defnes the largest nteger less than or equal to x. 13
Fnally, we say that a shareholder or blockholder votes sncerely f they vote wth ther sgnal. Proposton 1 The most nformatve equlbrum takes the followng form: ( When b b, all shareholders vote sncerely and the blockholder votes sncerely 2b shares, ( When b < b and Condton C1 holds, all shareholders vote sncerely and the blockholder votes sncerely 2b shares, and ( When b < b and Condton C1 does not hold, the equlbrum s outcome equvalent to one n whch only the blockholder votes. An equlbrum always exsts where shareholders vote sncerely and the blockholder votes sncerely wth mn{2b, 2b } shares. An equlbrum also always exsts where the equlbrum s outcome equvalent to one n whch only the blockholder votes. We prove the proposton by frst observng that f we were to assume that votng was sncere rather than strategc, Ntzan and Paroush (1982 show that, n order to maxmze the nformatveness of a vote, a planner should weght the votes of voters wth heterogeneous nformaton accordng to how precse ther sgnals are. These weghts allow us to defne b. In our model, however, shareholders need not vote sncerely. Strategc votng mples they may vote aganst ther sgnals and/or abstan. We must therefore consder equlbrum behavor (rather than the planner s choce. In the case where the blockholder has more than 2b shares, ths s a smple exercse. McLennan (1998 ensures that n ths pure common nterest game, everyone votng sncerely wth the optmal weghts can be mplemented as an equlbrum (that s, that shareholders and the blockholder would not want to devate from votng sncerely accordng to these vote shares. Now consder the case where the blockholder has fewer than 2b shares. We begn by demonstratng that the equlbra we propose are, n fact, equlbra. We then show that they are the most nformatve equlbra, where Condton C1 determnes whch of the two s most nformatve. 14
Hence, when the blockholder has too many shares n comparson wth her nformaton, she wll not vote them all. If she were to vote them all, she would drown out useful nformaton from the other shareholders, mparng the effectveness of the overall vote. As the blockholder and the shareholders have a common nterest n maxmzng the value of the frm, the blockholder nternalzes ths effect and only votes a fracton of her shares. As mentoned n the ntroducton, for nvestment advsers (such as mutual funds, the requrement to act n the best nterest of nvestors s often nterpreted as prohbtng the blockholder from actng strategcally. Ths result demonstrates the eff cency loss from such a polcy. When the blockholder has too few shares n comparson wth her nformaton, there are two equlbra that may be the most nformatve. One s smlar to the above case - the blockholder votes all of her shares sncerely and the other shareholders also vote sncerely. In the other, only the blockholder votes. All other shareholders abstan to allow the blockholder s superor nformaton to determne the vote. Clearly strategc behavor s mportant to ths equlbrum - allowng the shareholders to get out of the blockholder s way by abstanng leads to ths result. For the case where the blockholder has too few shares, we now examne whch of the two equlbra s more lkely to be more nformatve. Ths, of course, depends on Condton (C1. The equlbrum outcome where shareholders abstan s more nformatve f shareholders nformaton s poor n comparson to the blockholder and the blockholder has few votes. Perhaps, somewhat less straghtforward s the observaton that ths equlbrum outcome s relatvely more nformatve f there are relatvely few shareholders. Equvalently, the equlbrum where shareholders vote sncerely s more nformatve when they are many shareholders. Ths s mmedate n the lmt: the more shareholders there are, the more lkely that ther sncere vote wll accurately match the state; ntutvely, when they are few then there s scope for nose and mstakes. We formalze these statements n the followng propo- 15
ston. Proposton 2 When b < b, the most nformatve equlbrum nvolves shareholders votng sncerely the ( hgher s p, ( the hgher s n, ( the hgher s b and (v the lower s q. We now study the case where the blockholder can announce ts poston to the other shareholders before they vote. 4 Actve blockholder Blockholders dffer from small shareholders n several ways beyond holdng more shares. Up untl ths pont, the only addtonal dfference we have assumed s that the blockholder has better nformaton than shareholders. Here, we suppose that the blockholder can also observably announce a votng strategy before other shareholders vote. Notce that the blockholder need not commt to the announced poston as ts objectves are algned wth other shareholders. Blockholders may easly be more vsble and scrutnzed. Any shareholder wth over 5% of the shares of a publcly traded frm must publcly dsclose ths to the SEC. Some blockholders are very publc about ther actvtes, such as actvst nvestors. Actvst nvestors make publc statements about ther ntentons and often dscuss ther ntentons wth other nvestors (see Coffee and Pala, 2016. The analyss of ths sequental game proceeds by backwards nducton and the equlbrum concept that we apply s Perfect Bayesan Equlbrum: the shareholders observe the blockholder s statement, drawng nferences on the blockholder s sgnal, and then choose ther votes; the blockholder, antcpatng equlbrum behavor of the shareholders n response to ther sgnals (and to ts own statement, wll choose ts votng strategy. Frst, we argue that n contrast wth the case of a passve blockholder, there need not be an equlbrum where all agents vote sncerely. We establsh 16
ths result frst. The ntuton for ths result also provdes some ntuton for our more central result on the most nformatve equlbra. Consder a blockholder wth few votes but very precse nformaton. Ths blockholder can t represent all of ts nformaton n ts vote. A shareholder wth an mperfect sgnal who has seen the blockholder s vote would then prefer to gnore ts nformaton and vote n lne wth the blockholder (to support the blockholder s nformaton, even f all other shareholders, who have smlarly mperfect sgnals, vote sncerely. Ths result s contaned n the followng Lemma. Lemma 1 Suppose 2b < 2b, there s no equlbrum where the blockholder and all shareholders vote sncerely. Note, however, that there s an equlbrum where all shareholders abstan. Ths s for the same reason that ths equlbrum exsts n the passve blockholder case: If no other shareholders are votng, then a sngle shareholder s vote can have no affect on the outcome, and there s no loss to abstanng. However, we argue below that n contrast to the case of the passve blockholder, ths cannot be the most nformatve equlbrum; nstead, some voters should mmc the blockholder s vote to make the weght of the blockholder s nformaton correspond to the optmal weght 2b wth the remander votng sncerely. We proceed by, frst, showng such an equlbrum s feasble, and then that t s the most nformatve. Proposton 3 Gven an actve blockholder, there exst equlbra where the blockholder votes sncerely wth mn[2b, 2b ] shares, and ( f 2b 2b, all shareholders voters vote sncerely, or ( f 2b < 2b, 2b 2b shareholders vote the same way the blockholder does, and the rest of the shareholders vote sncerely. We now argue, that the equlbrum characterzed n Proposton 3 s the one that s most lkely to lead to the acton chosen correspondng to the state;.e., t s the most nformatve one. 17
Proposton 4 There s a unque most nformatve equlbrum. descrbed n Proposton 3. It s as Therefore havng some shareholders gnore ther nformaton to support the blockholder s nformaton maxmzes the probablty that the vote matches the state. The most nformatve equlbrum nvolves 2b 2b shareholders gnorng ther nformaton; ths clearly leads to a coordnaton problem. Moreover, the shareholders only want to coordnate because the blockholder has moved frst. Ths suggests that leadershp and coordnaton among shareholders may enhance eff cency. 11 Actvst nvestors are often very publc about ther postons. For example, Bll Ackman of the Pershng Square Hedge Fund appeared almost daly on CNBC to take hs case drectly to nvestors (George and Lorsch, 2014. Drect communcaton wth other shareholders was permtted by the SEC s rule 14a-12 n 1999. Communcaton enters a gray area when nvestors have szeable stakes n the frm - an ndvdual OR group stake of 5% or more must be declared publcly to the SEC. The gray area s what consttutes a group -.e. do communcaton and parallel actons consttute coordnaton or not. The purpose of ths publc declaraton to the SEC under secton 13(d s to make other shareholders aware of changes n control of the frm (Lu, 2016. The downsde, therefore, of such unobservable coordnaton s that tradng profts are made by the nsders n a wolf pack whle other shareholders are unaware. However, the tradng profts may be needed to ncentvze such behavor. Our model demonstrates that there can be benefts from havng such a wolf pack,.e. havng ( a lead nformed actvst and ( subsequent coordnaton among some other nvestors to support the actvst s poston. As we do not ncorporate coordnated tradng nto the 11 Allowng for heterogenety among the shareholders n the precson of ther sgnal creates a natural coordnaton devce: the lower precson shareholders would be the ones who gnore ther nformaton and follow the blockholder. The lower precson shareholder only need know ther own precson and the dstrbuton of precsons for ths to work. 18
model, we cannot address the costs of such behavor. 12 It s natural to compare outcomes and the nformatonal eff cency of the equlbra n the passve blockholder case to that of the actve blockholder case. When 2b 2b, the outcome s the same. When 2b < 2b, welfare s hgher n the actve blockholder case. When condton C1 holds (all shareholders vote n the passve blockholder case, there are eff cency gans from the shareholders who gnore ther nformaton and vote to support the blockholder s superor nformaton. When condton C1 does not hold (only the blockholder votes n the passve blockholder case, t s clear that there are benefts to havng the blockholder s nformaton supported wth the approprate number of votes and to havng the other shareholders nformaton ncluded. Ths comparson mght then suggest that there s a beneft to vocal actvst blockholders. 5 Extendng the model We now extend the model to make the settng more realstc. In the frst extenson, we allow the blockholder to acqure nformaton and trade shares. Ths provdes a robustness check for our result that the blockholder may not vote all of ts shares, as t s natural to ask why the blockholder would not trade ts excess shares. We demonstrate that there can be a lemons dscount f the blockholder trades ts shares,.e., shareholders don t beleve the blockholder has acqured nformaton and therefore dscount the shares beng sold. In the second extenson, we examne further the SEC rules for nvestment advsers. In partcular, we show that forcng the blockholder to vote all of ts shares could potentally enhance eff cency as t mght provde t wth ncen- 12 Brav, Dasgupta, and Matthews (2016 provde a very dfferent motvaton for coordnaton by a wolf pack n a model that does not nclude votng. A suff cently large bloc of shareholders can make a value enhancng change n a frm. These actvsts have complementartes n ther costly decson to take a stake because they get reputaton benefts from a successful actvsm campagn. The complementartes lead to a coordnaton game. 19
tves to acqure nformaton. Ths offers a ratonale for such a regulaton on votng behavor. Lastly, we look at the stuaton where a blockholder may be based n the sense that t strctly prefers one outcome and that fact s common knowledge. In the passve blockholder case, ths creates opposton among shareholders to the blockholder. When the blockholder s actve and can commt to ts vote, ths can, counterntutvely, lead to the blockholder abstanng. 5.1 Informaton acquston and tradng In ths subsecton, we extend the model to provde an explanaton for why, f a blockholder does not vote all of ts shares, t does not sell the shares t doesn t vote. The votng game s the same as before (we focus on the actve blockholder case, but before the vote takes place we allow for the blockholder to acqure nformaton at a cost and to subsequently buy and sell shares. Informaton acquston can provde ncentves to have extra shares n the frst place - the blockholder only reaps the beneft f t has more shares whose value wll ncrease after the fxed cost of gettng the nformaton. The blockholder may not subsequently trade them away as new potental shareholders may be dubous about whether the blockholder acqured nformaton f she s tryng to dump shares on the market, and hence have a low wllngness to pay for them. In ths extenson, the blockholder begns wth the same precson of nformaton as a shareholder,.e., the precson p. The blockholder may then pay a fxed cost c to acqure nformaton, whch boosts the precson of ts nformaton to q > p. We assume that the decson to acqure nformaton s only observable to the blockholder herself. After the nformaton acquston stage, we allow for tradng. Gven the complexty of the model already, we opt for a smplfed tradng game where we assume the blockholder trades publcly and smultaneously makes taket-or-leave-t offers (to sell or buy. We assume she could sell to new share- 20
holders who can buy one share each and have precson of nformaton p. The blockholder could buy from exstng shareholders. The observablty of the blockholder s offers smplfes the nference problem of the shareholders and s lne wth SEC rules for shareholders who hold more than 5% of a frm. We assume for smplcty that the blockholder can only trade even numbers of shares. Once agan, we restrct all agents to pure strateges. We summarze the detals and tmng of the game: 1. The blockholder begns wth an amount of shares 2b > 2b. There are 2n + 1 exstng shareholders. The blockholder and each of the shareholders have nformaton wth precson p. 2. The blockholder can pay c n order to mprove the precson of ts nformaton to q. Ths nvestment decson s not observed. 3. The blockholder can smultaneously and publcly make take-t-or-leavet offers to sell to potental new shareholders or to buy from exstng shareholders. After tradng, the number of shares that the blockholder holds s gven by 2 b and the number of shareholders s 2ˆn + 1 = 2n + 1 + 2b 2 b. 4. The blockholder announces whether or not she has made the nvestment n nformaton and her votng ntenton. 5. Votes are cast. The followng proposton proves that an equlbrum exsts where the blockholder acqures nformaton and does not sell ts shares n excess of 2b. Proposton 5 There are parameters for whch an equlbrum exsts n the game defned above where ( the blockholder mproves her nformaton to precson q, ( the blockholder does not trade any shares (2 b = 2b shares, and ( she votes 2b (q shares. 21
The proof specfes the equlbrum strateges and belefs of the blockholder and the shareholders and the ncentve constrants of the blockholder. It demonstrates by numercal example that such an equlbrum exsts. The blockholder may have ncentves to trade her excess shares after acqurng nformaton snce, ( f her nformaton acquston were observable, she could get at least far value for the shares, and ( sellng to new potental shareholders could allow for the ncorporaton of more nformaton. However, as nformaton acquston s not observable, there s a lemons dscount for traded shares. Shareholders observe shares on the market from the blockholder and assume she dd not nvest n nformaton. Therefore the blockholder doesn t get full value for the shares, although t stll benefts from new nformaton beng ncorporated (pont ( above. There are, n fact, several other reasons that are not modelled here for why a blockholder mght have a dscount from tradng. One s that new potental shareholders mght not have useful nformaton to ncorporate nto the vote, reducng ther wllngness to pay (e.g. lqudty traders. A second s that we assumed t was observable that the shares sold were comng from the blockholder. If ths was not observable, and they were comng from a shareholder nstead, there may not be much gans to trade as shareholders wll be even more dubous about ther value. A thrd s that the blockholder s assumed to get the full surplus from any trade, whch s unlkely to be true. Lastly, there may be practcal mpedments to tradng. Ths could arse f the blockholder was an ndex fund who needed to trade to track the ndex or f the blockholder had to worry about havng too much of a prce mpact from sellng shares. 5.2 The benefcal role of regulaton As we pont out above, the SEC regulaton (SEC, 2003 that requres nvestment advsers to vote n the best nterest of ther clents can reduce the eff cency of the nformaton aggregaton process n votng. In ths subsec- 22
ton, we dscuss under what crcumstances such a rule could actually enhance eff cency. Our argument s that the SEC rule can make the blockholder more lkely to acqure nformaton, whch n some crcumstances can outwegh the neff cency the rule ntroduces nto the vote. We nterpret the SEC regulaton n our model as havng two requrements. Frst, the blockholder has to vote wth all her shares. Second, all shareholders and the blockholder must vote sncerely,.e., vote wth ther nformaton. Incorporatng ths regulaton nto the model mples that the value per share when the blockholder nvests n nformaton acquston s lower, as we have noted prevously n the paper. However, ths regulaton also mples that the value per share when the blockholder does not nvest n nformaton acquston s also lower. Ths second effect may be stronger as the blockholder mght be mpoundng very poor nformaton nto the vote. Ths can skew the blockholder s decson toward acqurng nformaton. Ths wll be socally benefcal when the blockholder would not have acqured nformaton wthout the regulaton, even though that would have maxmzed socal welfare. Our approach s to show that such a stuaton s possble wth an example. Lemma 2 There are parameters such that the SEC regulaton of nvestment advsers enhances eff cency. The SEC rule results n less eff cent nformaton aggregaton but the dfference between prvate and socal ncentves to acqure nformaton compensate for ths loss. Notce that the benefcal role of regulaton s lkely to be elmnated f tradng were ntroduced. When forced to vote all of ts shares, the blockholder has an added beneft here from sellng shares n excess of the optmal amount 2b - t wll make the vote more eff cent. Tradng her shares wll restore her ncentves to acqure nformaton that were present n the absence of regulaton, undong the benefcal effect of the regulaton. Thus ths reg- 23
ulaton may be benefcal only f tradng s restrcted, as mght be the case for ndex funds mnmzng trackng error. 5.3 Based Blockholder So far we have consdered votes where the blockholder and shareholders have had dentcal objectves. In ths secton, we suppose that the blockholder s based and prefers that the acton M s chosen regardless of the underlyng state. As dscussed earler, ths bas may arse because the blockholder s part of management or drectly ted to t through busness dealngs. We mantan that tmng, preferences and the qualty of sgnals are known by all. We begn by consderng the case of a passve based blockholder who makes no announcements. In ths case, we demonstrate that n the most nformatve equlbrum, shareholders wll try to oppose the blockholder by ether dsregardng ther sgnal and vote for A or votng for A when they receve an a sgnal and abstan when they receve an m sgnal. The latter strategy allows some nformaton to enter the vote. At the same tme, by cancellng out the blockholder, these shareholders can make way for sncere shareholders to have an nformatve vote. Thus, shareholders react qute dfferently here n an attempt to mnmze the effect of the bas on the vote. We then consder a based actve blockholder. We allow ths blockholder to commt to an observable vote choce up front (rather than just make an announcement. It mght seem that the based blockholder wll smply vote all ts shares for ts preferred poston, so that the dstncton between the passve and actve cases s unnterestng, but ths does not happen. Wth a passve blockholder, snce the blockholder s vote s not observed, t cannot have an effect on shareholder behavor. Instead, wth an actve blockholder, the blockholder s votng choce s observable and can change shareholders behavor (both to counteract the votes of ths based party and through the nformaton learned from the vote, and a dfferent outcome can arse. Indeed, we show that the most nformatve equlbrum has a blockholder 24
who abstans. Such an equlbrum s the most nformatve because t has all of the shareholders votng sncerely. It exsts because f the blockholder were to devate, shareholders mght nfer that t has nformaton that the true state s A, n whch case they would all vote for A, whch s the worst possble outcome for the blockholder. Both the passve and actve cases reflect a couple of central themes of ths paper. Frst, requrng voters to vote n lne wth ther prvate nformaton may lead to worse outcomes. Allowng shareholders to ether vote aganst the based blockholder and dsregard ther sgnal or abstan ncreases the nformatveness of the vote. Ths, of course, may requre coordnaton, whch also ponts to an eff cency enhancng role of coordnaton. Second, requrng voters to vote rather than abstan may lead to worse outcomes. In the actve case, the based blockholder abstans, whch allows an nformatve vote to occur. 5.3.1 Passve blockholder When the blockholder s passve and votes at the same tme as other shareholders, t s mmedate that n any equlbrum the based blockholder prefers to vote all of ts shares for ts preferred poston: In equlbrum, ts behavor (or a devaton from equlbrum behavor s not observed and can have no effect on the choces made by shareholders. Snce more votes n favor of ts preferred poston ncrease the lkelhood that ths poston s adopted, takng as gven the behavor of shareholders, t wll vote wth all ts 2b shares for M. Of course, multple equlbra can arse. Our focus here s on the equlbra that are optmal from the perspectve of shareholders - that s, equlbra that maxmze the probablty that the proposal adopted matches the underlyng state - the most nformatve equlbra. Frst, suppose that no shareholder can abstan. In ths stuaton, the most nformatve equlbrum nvolves 2b shareholders votng for A, thereby 25
effectvely nullfyng the based blockholder s nfluence, whle the remander vote sncerely. Proposton 6 In the case of a based passve blockholder, the most nformatve equlbrum wth no abstenton nvolves the blockholder votng for M wth all of ts 2b shares, 2b of the shareholders votng for A ndependently of ther sgnals, and the remanng 2n + 1 2b shareholders votng sncerely. Proposton 6 hghlghts that allowng shareholders to gnore ther sgnals can lead to more eff cent outcomes. The eff cency comes from those votes cancellng out the bas of the blockholder and allowng the sncere votng of the remanng shareholders to provde an nformatve vote. Notce that ths nvolves coordnaton among shareholders (to choose whch shareholders wll block the vote as n the case wth the unbased actve blockholder, but here t s to oppose the blockholder, rather than support her. Ths could stll ft nto the wolf pack scenaro, where the blockholder s management and the coordnatng shareholders are actvsts seekng to change management practces. Next, we pont out that equlbra that feature abstenton can be even more eff cent. We use a smple example that shows how abstanng rather than votng A when observng an m-sgnal can allow shareholders to reflect ther nformaton to some extent, whle stll mtgatng the nfluence of the based blockholder. The ntuton for ths s the followng. Take one based blockholder vote for M and add a vote where the shareholder abstans when observng an m-sgnal and votes A when observng the a-sgnal. If the state of the world s M, t s lkely that addng the two votes together wll produce one vote for M. Otherwse, t s lkely that the two votes wll cancel each other out. Therefore, ths produces some nformaton as compared to the case where a shareholder always votes for A and ths vote completely cancels out a vote of the blockholder. Example 1 Suppose that n = 1 and b = 1 so that the blockholder has two 26
shares and there are three shareholders. Then n the absence of abstenton, followng Proposton 6, the most nformatve equlbrum nvolves two of the shareholders votng A ndependently of ther sgnals and the thrd votng sncerely. Ths selects the correct acton wth probablty p. Suppose nstead that all three shareholders abstan when observng an m- sgnal and vote A when observng the a-sgnal. Ths selects the correct acton wth probablty 1 2 (p3 +3p 2 (1 p 1 2 + 1 2 (p3 +3p 2 (1 p+ 1 2 3p(1 p2. The frst term corresponds to the true state beng A. The vote wll reflect ths when all three shareholders have an accurate sgnal, or f two have an accurate sgnal (and the other abstans the vote wll be for A wth probablty 1. The second 2 term corresponds to the true state beng M. If all three shareholders have the correct sgnal they all abstan and the blockholder s votes wll ensure that M s chosen. Smlarly f there s only one vote aganst, and f there are two votes aganst, M wll be mplemented wth probablty 1. The overall expresson 2 can be wrtten as p(3 2p2 +3p and ths s strctly greater than p n the range 4 p > 1. Lastly, usng McLennan (1998, f ths s the most nformatve set 2 of strateges from a planner s perspectve, t must be an equlbrum. We also demonstrate ths equlbrum s the unque most nformatve equlbrum (avalable upon request. 5.3.2 Actve blockholder wth commtment We now turn to consder the case of an actve based blockholder who may commt to a vote observably before the other shareholders vote. 13 If the blockholder abstans (and the shareholders draw no nference about her nformaton then the most nformatve equlbrum nvolves all shareholders votng sncerely. Ths s a good outcome for a blockholder who s perfectly nformed that the state s M, as M s lkely to wn such a vote. Of course, a blockholder who knew that the state s A would not be happy 13 We allow for commtment here, as the bas of the blockholder has elmnated the common value envronment of the model, makng communcaton cheap talk. 27