How minority shareholders lose value
Minority shareholders face various challenges as investors in companies. Naturally, by being smaller shareholders, their vote will not be loud enough to influence the decisions of the company. This has, in some cases, resulted in their rights being compromised by bigger shareholders who can bulldoze ideas, to their detriment, because they have a deciding vote. Regardless, smaller shareholders remain part owners of the company and have been unfortunate to get the raw end of various deals carried out by companies they are invested in. The danger of such repetitive unfairness in any market is that it destroys investor confidence, and potential shareholders may find investing in such markets repulsive.
Given strict regulation and a good corporate governance culture across companies, no shareholder should fear possibilities of prejudice on their investment despite how small they may be. In some markets, there is greater emphasis on protecting the minority shareholders. Developing markets have been accused of laxity when it comes to enforcing regulationsthat ensure that integrity of markets is upheld. That lack of adequate oversight has resulted in certain corporate transactions being carried on the market which subjected minority shareholders to significant losses. Subsequently, there was no meaningful action taken to try and stop or correct the unfairness embedded in the transactions. Technically, if unfair transactions are rubber stamped by authorities, minority shareholders are left largely unprotected, as what only remain to decide whether or not a transaction can go through are votes at a shareholders meeting. With not much voting power, minority shareholders succumb to the decisions of the majority shareholder(s).
Regulation is also found wanting on suspected insider trading transactions. Major shareholders, because of their stake in a company can appoint board members that represent their interests in the company. This privileges them with non-public information of the company, whether negative or positive, that can influence investment decisions. To act on such information is prohibited by ethics as well as market regulations. In jurisdictions such as the United States of America, insider trading is a criminal offence that can attract a jail sentence of 12 years or more. Examples of Enron’s CEO Jeff Skilling come to mind as one of the highlight cases in the US that resulted in perpetrators being locked away for insider trading. It is only fair to do so as such acts destroy confidence in the market, and disadvantages smaller shareholders who are not privy to the same information. Yet, there have been cases of directors trading in closed periods and directors and major shareholders taking positions on shares, in suspected cases of trading on information that is not yet in the public domain. Lack of prosecution for such misdemeanours could mean that it was just mere speculation, or maybe that such malpractices are going on ignored.
Other than just market shenanigans, in house day to day operations in some companies can be quite telling. Popular conflict cases include the use of major shareholder’s external services in procurement of goods and services. It is important to highlight that agreements done above board, at market and fully disclosed and approved by other members are usually not expected to be problematic. Matters of concern however arise because of the nature of some of the contracts which do not seem market determined and are contentiously imposed without unanimous approval from all members. There have been accusations of overpricing of supplies by major shareholders, a premium that a company does not have to pay should it source independently in the market.
Money has also been lost through technical fees to the major shareholder, with not much benefit, if any, as a result of the supposed technical assistance. Essentially, a single shareholder would be indirectly benefitting from the company, even when the service they are providing is neither necessary nor the best execution for the business. This happens at the prejudice of other shareholders who lose out on potential dividends that could have been paid out to every shareholder equitably, should such agreements not exist.
Sometimes minority shareholders let themselves down by not actively exercising their right. Annual General Meetings (AGMs) are one platform where management should be brought to task over the operations of the business. If shareholders attend such meetings and simply go through the motions of the meeting without having taken time to actively scrutinize the annual report as well as the resolutions tabled, bad governance will perpetuate to their detriment. Even if a minority shareholding may not necessarily have the deciding vote, a vocal minority tends to draw unwanted attention to the company. Management and major shareholders may eventually work on the areas of concern raised to avoid a tainted imagine which may work against them in future when they are scouting for investors or seeking foreign debt. Effectively, minority shareholder concerns are addressed in the process. Likewise, any extraordinary matters should be analysed with even more scrutiny as failure to do so may result in the adverse effects such significant dilution and/or lose in value.
It seems difficult to be a minority shareholder in a market where protection of interests seems compromised. Without legislation or the absence of its enforcement, such markets will remain unattractive to bigger foreign funds. Minority shareholders would need to consider companies that uphold good corporate governance principles as a hedge against possible loss of value due to bad business practices.An analysis of the shareholders of the business is also important so that an investor can ascertain whether or not they are happy to get into bed with the members of that company. Questions asked should be: (i) How influential is the major shareholder in the running of the business? (ii) What existing related party agreements are in place? (iii)Has there been any controversy in the past over the involvement of major shareholders in the operations of the business? Such and many other questions should be a good checklist before any minority shareholder injects their capital in a company.
Cases of minority shareholders losing value are frequent. It takes the work of regulators to play a part in protecting minority shareholders, while investors themselves should go beyond just looking at the financial prospects of investments, but also verify the softer issues such as management culture and general corporate governance before investing. Once invested, each member, regardless of how small, should take an active role in ensuring that they exercise their rights.