Capital raises and shareholder primacy

It has never been clearer that the interests of current shareholders and the interests of a company are not the same thing.

ASIC and ASX announced new requirements last week for companies using the extra placement capacity allowance to publicly explain how they ran the bookbuild, including how investors were picked and whether best efforts were used to allocate pro-rata to existing holders. They will also have to give ASX and ASIC a spreadsheet showing granular details about the way the book was built.

Australian companies have been raising capital in swathes to tide over their cashflow needs.  The success of these raisings is, generally speaking, a great relief for the companies as well as their employees, customers, suppliers and creditors.  In that context, the co-ordinated ASX/ASIC announcements are interesting.  The explanation must be an underlying concern that companies may be conducting these raisings in ways that harm the interests of certain current shareholders.  The ASX/ASIC announcements are well-intentioned (they’re really just wanting to monitor new and extraordinary powers), but they are also a continuation of a long process where the balance of Australia’s corporate governance apparatus has tilted too far in favour one class of corporate stakeholder, with consequences for the others. 

It has never been clearer that the interests of current shareholders and the interests of a company are not the same thing.  Even before the pandemic we had the Royal Commission, and there was another reminder in last month’s Federal Court decision around Storm Financial

Placements always carry the potential to put the commercial interests of current shareholders and companies at odds – the best deal for the company may be a bad result for a particular shareholder.  And shareholders aren’t a uniform body either – for a shareholder who wasn’t going to participate anyway, their interests are best served by the company raising at the best price, regardless who from.  There’s a lot of judgment involved, and directors of Australian companies signing off on placements (as with all major corporate actions) are subject to incredibly strict duties.    

Ken Hayne explained the current-shareholder/company distinction well in his Final Report:

“Directors must exercise their powers and discharge their duties in good faith in the best interests of the corporation, and for a proper purpose. That is, it is the corporation that is the focus of their duties. And that demands consideration of more than the financial returns that will be available to shareholders in any particular period. Financial returns to shareholders (or ‘value’ to shareholders) will always be an important consideration but it is not the only matter to be considered. The best interests of the corporation cannot be determined by reference only to the current or most recent accounting period. They cannot be determined by reference only to the economic advantage of those shareholders on the register at some record date. Nor can they be judged by reference to whatever period some of those shareholders think appropriate for determining their results. ….Some shareholders may have interests that are opposed to the interests of other shareholders or the interests of customers. But that opposition will almost always be founded in differences between a short term and a longer-term view of prospects and events. Some shareholders may think it right to look only to the short term. The longer the period of reference, the more likely it is that the interests of shareholders, customers, employees and all associated with any corporation will be seen as converging on the corporation’s continued long term financial advantage.”

What Ken Hayne essentially says above is that boards err at law by pursuing short term shareholder interest.  But why do they do it? Commentators disdain shareholder-centric corporate behaviour without acknowledging that Australia has (probably unintentionally in some ways) weaponised shareholder primacy. 

The evolution of global capital markets broke the direct link between the financial success of company shareholders and the prosperity of the community that company operates in. That doesn’t make shareholders bad actors, it means a particular shareholder is just one interested party like many others, whose interests may or may not be aligned, all of which needs to be considered by a board acting properly in the best interests of a company. 

If legislators and regulators want to micro-manage or hold companies more strictly to account, the important question is why?  The “why” coming out of the Royal Commission was to align company actions more closely with community expectations.  But institutional shareholders are not a proxy for the community.  The potential for shareholder/community divergence was underlined in the interaction of our unique two strikes rule (which makes Australian boards extremely accountable to shareholders) and APRA’s originally mooted reforms to executive pay.  This was a regulator and an industry open to working together to create incentives for a more long-term mindset, but they were torpedoed by institutional shareholders and proxy advisors who, perfectly rationally, prefer financial targets.

There are claims that the pandemic might be the moment for stakeholder capitalism, where companies and communities come closer together.  They will certainly need to – Australia’s recovery from this crisis will depend on everyone co-operating in unprecedented ways.  It makes for an important time to consider if the way companies are regulated will support a broader perspective.  This relatively esoteric announcement (amidst an overall highly facilitative regime for capital raises and with ASX and ASIC being generally extremely helpful to currently distressed companies) is not in itself a major problem. But it shows the predisposition to a style of regulation that defers to institutional shareholders and tasks directors with compliance. ASIC’s announcement “encouraged” entities to apply this disclosure approach to all placements, not just the current super-sized ones. Seemingly harmless rules get added and never get wound back, they just add to the pile. Another reason for directors to be timid and more reason to accede to the short-term wants of shareholders.

I said in this article that society generally would be better served by a trade of less prescriptive rules for more old-school, big picture governance obligations.  A greater balance between capital and labour and companies and the community generally may derive from less, not more, of the shareholder protections that have developed over recent years.

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