There are shareholders, and then...

By Marcel Côté

Many people are worried about Canadian companies being bought up by foreign interests. The real problem, however, lies in the vulnerability of Canada’s publicly traded companies to hostile takeovers during inevitable rough patches.

The stock market is dominated by short-term investors who do not feel a shred of responsibility toward the companies in which they invest. At the first sign of weakness, they will abandon a struggling company, exposing it to hostile takeovers.

Even worse news for companies is that, at the mere hint of a hostile takeover bid, arbitrageurs take large positions in the targeted company, destroying its shareholder base. As a result, the company has no option but to let itself be bought, whether or not the timing is right. In fact, many companies decide to sell themselves to a friendly buyer for no other significant reason than management believing that it could not resist a hostile takeover.

But why can’t a healthy company stay independent? To avoid falling into the trap, more and more public companies are adopting defensive strategies and choosing to manage for the short term.

The dangers of short-termism
Managing a public company based on a short-term focus leads to serious underutilization of its potential, as corporations exist for the long haul. A short-term focus greatly impacts investment decisions.

Why make investments with a five-year to 10-year horizon if they will put the company at risk of a hostile takeover?

Short-termism also impacts innovation. Since experimentation increases business risk, it is frowned upon.

Paradoxically, corporations managed with a short-term perspective eventually languish in mediocrity, becoming even more vulnerable to hostile takeover bids.

Do shareholders have duties?
Is it normal for shareholders to run for cover at the first sign of a predator? While the law does not require any loyalty — shareholders can sell when they please — it does not prevent a company from demanding shareholder loyalty.

The Montreal-based Institute for Governance of Private and Public Organizations has suggested that corporations may choose to limit the right to vote on takeovers to shareholders who have owned their shares for at least a year, like countries that require a minimum residency period before granting citizenship and the right to vote. Such shareholder “citizenship” would reserve the right to decide a company’s fate to long-term shareholders.

Multiple voting shares, which corporate founders often own, have a similar impact. Although this practice is sometimes abused, especially in cases where a second generation has taken the reigns from the founder, the track record of corporations with multiple voting shares is fairly good. They perform better on the stock market than companies with only one class of shareholders. This is because a stable shareholder base is good for business.

We should re-examine our bias against multiple voting shares, which are frowned upon by numerous governance “experts.” Experience suggests that all shareholders benefit from the existence of these shares.

It is difficult for public companies to flourish if their shareholders are irresponsible and motivated only by self-interest. In such circumstances, corporations have a perfect right to protect themselves and to favour responsible shareholders with whom they share a long-term vision.

Marcel Côté is founding partner at SECOR Consulting in Montreal