The Fat Controller - Slimming Down the Excesses of Controlling Shareholders in UK Listed Companies

It has become fashionable to extoll the benefits of an incumbent controlling shareholder in companies. Indeed, many of the failures of the stewardship movement, that encourages shareholders in UK listed companies to take an interventionist approach to their investments, have been blamed on the prevalence of dispersed and fragmented ownership models. However, in the publicly listed company sphere, it is debatable whether the virtues of controlling shareholders outweigh the potential detriments, as evidenced by the corporate governance travails of Sports Direct International plc (Sports Direct).

The first part of this paper visits the classically defined benefits and detriments of controlling shareholders in listed companies. In essence, the presence of a controlling shareholder can exaggerate the potential for a dominant shareholder to extract private benefits of control from the company to the impediment of minority shareholders. On the other hand, the incentives on a controlling shareholder to actively monitor the company and the performance of its board are substantial. Such active monitoring can reduce the agency costs that managers of listed companies may otherwise be motivated to expend; in particular, such costs are theoretically evident in dispersed ownership companies lacking a controlling shareholder. While reviewing the literature on this theme, the article provides examples as to how such benefits and detriments may have manifested themselves in the actions and commercial life of Sports Direct. 

The remainder of this paper focuses on the experiences of Sports Direct and a number of other UK premium-listed companies with controlling shareholders. It is acknowledged that various constraints, including legal and regulatory constraints, market constraints, and psychological constraints, are effective, to an extent, in restraining the most egregious potential behaviour of controlling shareholders. The manner in which such constraints have curtailed the ability of the controlling shareholder of Sports Direct to extract private benefits is detailed, together with an exposition of where such constraints have been ineffective. Constraints are essential in shifting the balance to ensure that the benefits of the presence of a controlling shareholder outweigh the detriments.

Using Sports Direct as a launching point, the article reviews three specific areas ripe for regulatory reform in the context of controlling shareholders. A normative analysis of existing regulatory rules is supported by anecdotal evidence from a number of Main Market listed controlling shareholder companies. Firstly, existing rules giving independent minority shareholders an initial veto right over the appointment or re-election of independent directors to the board are undermined by the controlling shareholder being able to force through the appointment or re-election by participating in a subsequent second stage vote. It is advocated that, in the presence of a shareholder owning a majority of the voting rights in a listed company, the second element of the dual vote mechanism be eliminated. The current dual vote mechanic has proved to be ineffective in instilling corporate governance change in companies where independent shareholders have expressed dissatisfaction with independent directors, and dispensing with the second part of the dual vote may mitigate against the scepticism often projected on the efficacy of independent directors in controlling shareholder companies.

Secondly, although the Listing Rules provide that transactions between related parties and premium-listed companies should be subject to greater scrutiny if they exceed prescribed thresholds, numerous corporate governance controversies have arisen as a result of confusion as to the applicability of the relevant thresholds, or where the company has suffered injury from related party transactions notwithstanding that the relevant thresholds were not satisfied. Such controversies could have been avoided by eradicating the thresholds in the presence of a controlling shareholder. Although requiring independent shareholder approval for all related party transactions with controlling shareholders could constitute a fetter on the ability of such companies to conduct business efficiently, such companies should be required at least to obtain sponsor confirmation as to the fairness and reasonableness of all such transactions. Additionally, the definition of ‘associate’ of a controlling shareholder under the Listing Rules should, given the experiences of Sports Direct and certain other controlling shareholder companies, be extended to include a larger array of family members for the purpose of the related party rules.

Finally, the purported protection of minority shareholders ascribed by the requirement for controlling shareholders to enter into relationship agreements with their respective companies is substantively diluted by a potential lack of willingness of boards to enforce against breaches of such agreements, furthered by a lack of certainty as to the powers of the FCA in such regard. A simple amendment to the Listing Rules requiring boards to enforce the terms of relationship agreements could indirectly give the FCA greater enforcement powers, fostering greater co-operation by controlling shareholder company boards.      

In a post EU referendum environment, where the temptation is for the economy to prostrate itself towards the attraction of new business, the effectiveness of existing regulatory and legal requirements needs to be carefully considered. This paper contends that although the regulatory proclivity is trending towards further relaxation of provisions to attract listings of foreign businesses such as Saudi Aramco, in fact, the strength of argument with respect to controlling shareholders is geared in the direction of reinforcing constraints in a balanced and reasonable manner in order to protect minority investors without creating a chilling effect on further listings of controlling shareholder companies in the UK.

Bobby V Reddy is a Lecturer at the Faculty of Law of the University of Cambridge, and a Fellow of Churchill College, Cambridge.