1 March 2015

Moral hazards of finance

Corporate finance is often about understanding unavoidable conflicts of interest and then making sure that they are dealt with as best can be.

by John Royden

Head of Research

Investors appoint directors to manage companies on their behalf; directors often have interests which are not always aligned with shareholders: 

•           Directors want higher salaries which is not always good for shareholders. 

•           Directors don’t like being taken over because they can lose their jobs; investors love takeovers at a healthy premium. 

•           Directors like to keep cash in their companies as there is a positive correlation between company size and directors’ pay. 

I can’t help but feel that some of these conflicts would be easier to manage if shareholders could speak freely without worrying about the Takeover Code (“Code”). 

The Code is principally designed to protect investors; but it has an unpleasant side effect.

Rule 9 of the Code pretty much says that if you and your Concert Party own more than 30% of a company, then if any of your Concert Party buys one more share, then you have to make a cash bid for the company (a “Concert Party” is people with a common interest). 

The code has many layers of complexity and a simple example of Rule 9 might be when shareholder A thinks a company’s Finance Director should go, and mentions this to shareholder B, who mentions this to C, then they all form a Concert Party; even though A and C are unaware of each other.

If A, B and C own 30% or more and any of them buys one more share, they may have to make a cash bid. Investors don’t like making cash bids, so they have a tendency to keep quiet and not complain. 

Maybe the Code should be changed to allow more public debate?

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